In part 1 we looked at how human psychology pushes prices away from fair value.
When there are extreme moves away from fair value you can make a contrary trade to the majority and pile up big profits with low risk.
So what tools do you need? Lets take a look.
As a general rule these tools will work in any market not just forex markets.
What sets ups do you look for?
Generally you want a set up that is the news where there is no end in sight to a spike move.
This generally indicates that greed and fear have taken hold and the market being looked at is emotionally driven and away from fair value.
This happens all the time:
The recent spike in crude oil, the 87 stock market crash and many others including in the forex market.
First place to start
Is the chart look for huge price spikes in short time spaces accompanied by experts and the news telling you there is no end in sight.
Now delve a bit deeper to see the true picture.
Useful technical tools are:
RSI, Sochastics and Bollinger bands
Then add in these sentiment tools to the mix.
% Bullish
This indictor is a poll of people, experts, brokers etc that have a view or interest in the market.
When this poll indicates above 70% are bullish the market is in overbought territory and when below 30% is in oversold territory.
In the currency markets we like to look for even more extreme readings of below 20% and above 80%
Commitment of Traders Net - Traders Position Report
This is a tool used for years by futures traders and shows the breakdown of open interest among three main participants.
We will explain what it means in a minute buy here is its definition of the groups.
Hedgers The smart money commercial traders
Large speculators These are normally large funds with reportable positions
Small speculators everyone else.
The commercials are long term traders and are close to the fundamentals and move very slowly they are hedging not speculating and not influenced by greed or far and are the smart money.
Speculators on the other hand, both funds and small speculators, are driven by greed and fear
If you see a set up where commercials start to move the opposite way to speculators at a market top or bottom and hold an opposite extreme, then prices have moved to far from fair value.
With the commercials taking and building the opposite position to speculators in a rampant bull or bear market you know prices are probably due to re bound.
You must only use extremes with this tool and this normally means 8 months to 2 years.
Breaking it down
Study chart first, look for experts telling you there is no end in sight to the move, then look at % bullish and then net trader report.
Finally, use the technical indicators to confirm the move.
These moves do not happen often.
Maybe a few times a year.
But when they do
You can zero in on a contrary trade that not only offers huge profit potential but offer low risk.
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