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2011-12-15 12:56:45
Invented by and named after renowned educator Dr Alan H. Andrews, the technical
indicator known as Andrew's pitchfork can be used by traders to establish
profitable opportunities and swing possibilities in the currency markets. On a
longer-term basis, it can be used to identify and gauge overall cycles that
affect the underlying spot activity. Here we explain what this indicator is and
how you can apply it to your trades using two different approaches: trading
within the lines and trading outside the lines.
Defining the Pitchfork
Available on numerous programs and charting packages, Andrew's pitchfork
(sometimes referred to as "median line studies") is widely recognized by both
novice and experienced traders. Comparable to the run-of-the-mill support and
resistance lines, the application offers two formidable support/resistance
lines with a middle line that can serve as both support/resistance or as a
pseudo-regression line. Andrews believed that market price action would
gravitate towards the median line 80% of the time, with wild fluctuations or
changes in sentiment accounting for the remaining 20%. As a result, the overall
longer-term trend will (in theory) remain intact, regardless of the smaller
fluctuations. If sentiment changes and supply and demand forces shift, prices
will stray, creating a new trend. It is these situations that can create
significant profit opportunities in the currency markets. A trader can increase
the accuracy of these trades by using Andrew's pitchfork in combination with
other technical indicators, which we'll discuss below.
Applying the Pitchfork
In order to apply Andrew's pitchfork, the trader must first identify a high or
low that has previously occurred on the chart. The first point, or pivot, will
be drawn at this peak or trough and labeled as point A (as shown in Figure 1).
Once the pivot has been chosen, the trader must identify both a peak and a
trough to the right of the first pivot. This will most likely be a correction
in the opposite direction of the previous move higher or lower. Turning to
Figure 1, the minor correction off of the trough (point A) will serve nicely as
we establish both points B and C.
Once these points have been isolated, the application can be placed. The handle
of the formation begins with the pivot point (point A) and serves as the median
line. The two prongs, formed by the following peak and trough pair (points B
and C), serve as the support and resistance of the trend.
Figure 1 - Application of Andrew's pitchfork to a chart showing the price
action of the EUR/USD. The pivot point (A) has been drawn at a previously
occurring trough, and points B and C have been established to the right of the
pivot. The line drawn from point A is the median line, while the two "prongs"
serve as support and resistance.
When the pitchfork is applied, the trader can either trade within the channel
or isolate breakouts to the upside or downside of the channel. Looking at
Figure 2, you can see that the price action works well serving as support and
resistance where traders can enter off of bottoms (point E) and sell from tops
(point D) as the price will gravitate towards the median. As always, the
accuracy of the trade improves when confirmation is sought. A basic price
oscillator will be just enough to add to the overall trade.
Figure 2 - Application of the pitchfork on an uptrending GBP/USD. Notice the
multiple opportunities offered to the trader inside and outside the boundaries.
Additionally, the trader can initiate positions on breaks of the support and
resistance. Two great examples are presented at points F and G. Here, the
market sentiment shifted, creating price action that strayed from the median
line and broke through the channel trendlines. As the price action attempts to
fall back into the median area, the trader can capture the windfall that tends
to happen. However, as with any trade, sound money management and confirmation
must play important roles.
Trading Within the Lines
Let's take a look at how a trader might profit from trading within the lines.
Figure 3 is a good example, as it shows us that the price action in the EUR/CAD
currency pair has bounced off of the median line and has risen to the top
resistance of the pitchfork (point A1). Zooming in a little closer in Figure 4,
we see a textbook evening star formation. Here, the once-rising buying momentum
has started to disappear, forming the doji, or cross-like, formation right
below the upper prong. When we apply a stochastic oscillator, we see a cross
below the signal line, which confirms downside momentum.
Taking these indications into consideration, the trader would do well to place
the entry at point X (Figure 4), slightly below the close of the third candle.
Using sound money management and including an appropriate stop loss, the entry
would be executed on the downward momentum as the price action once again
gravitates towards the median line. Even better, here, the trader would be
entered into a profitable position of close to 1000 pips over the life of the
trade.
Figure 3 - Another great setup in the EUR/CAD cross currency: we see a prime
example of an "inside the line" profit opportunity as price action approaches
the 1.5000 figure.
Figure 4 - A closer look at the opportunity reveals textbook technical
formations that aid the entry. Here, the trader can confirm the trade with the
downward crossover in the stochastic and the evening star formation.
Trading Outside the Lines
Although trading outside the lines occurs considerably less frequently than
within, they can lead to extended runs. However, they can be slightly trickier
to attempt. The assumption here is that the price action will gravitate back
towards the median, like wayward price action within the lines. But it is
possible that the market has decided to shift its direction; therefore, the
break outside may very well be a new trend forming. To avoid a catastrophic
loss, simple parameters are added and placed in order to capture the
retracements into the channel and, at the same time, filter out adverse
movements that ultimately result in traders closing their positions too early.
Looking at Figure 5, we see that the price action at point A offers such an
opportunity. The chart shows that the EUR/USD price action has broken through
support in the first week of April. Once the break has been identified, we
isolate and zoom in to obtain a better perspective.
Figure 5 - Notice how the price action gravitates once again towards the
median. This is a great opportunity, but money management and strategy remain
important in capturing the run-up.
In Figure 6, the trader is offered multiple opportunities to trade a break back
into the overall trend as the underlying spot consolidates in ranging
conditions. However, the real opportunity lies in the break that occurs later
on in October. More specifically, the trader can see that the price action
ranges or consolidates prior to the break, establishing the $1.1958 support
level (blue line). Using a moving average convergence divergence (MACD) price
oscillator, the individual sees that a bullish convergence signal is forming,
as there is a large peak and a subsequently smaller secondary peak in the
histogram. The entry is key here. The trader will see a potential breakout
opportunity as the price rises to test the upper resistance at $1.2446.
Figure 6 - The convergence in the MACD, combined with the decline in the
underlying spot price, suggests a near-term upward break.
How would you place the entry in this example? First, you need to make sure
that the upper resistance is tested before you even consider a trade. If the
resistance is not tested, it may mean that a downward trend is in the works,
and by knowing this, you will have saved yourself from the trouble of entering
into a non-profitable trade. You can see in Figure 6 that the price action
breaks back into the prongs in early October, hitting a high of $1.2446. If the
price action can break above this resistance, it will confirm a further rise in
the price action, as fresh buying momentum will have entered the market. As a
result, you should place your entry 30 pips above the target (red line), with
your subsequent stop applied upon entry. Once your order is executed, the stop
should be applied 5 pips below the previous session low. Given buying momentum,
the assumption is that the low will not be tested because the price action will
continue to rise and not spike downward.
Breaking It Down Step-by-Step
Although the two methods discussed here (trading within the lines and trading
outside the lines) may seem somewhat complex, they are quite easily applied
when you break them down step-by-step. Traders will find that the pitchfork
method yields far better results when applied to major currency pairs such as
the EUR/USD and GBP/USD because of their nature to trend rather than range.
Cross currencies, although they do exhibit trending patterns, tend to be
choppier and yield less satisfying results. (For further reading, see Make The
Currency Cross Your Boss and Identifying Trending & Range-Bound Currencies.)
Figure 7 - Identifying two great opportunities in the NZD/USD currency pair.
Now, let's break the process down. The NZD/USD currency pair, seen in Figures
7, 8 and 9, presents a perfect example of both "within the lines" and "outside
the lines" opportunities that traders can capitalize on. First we'll take the
in-line approach, choosing example A in Figure 7:
Identify price action that has broken through the median line and that is
approaching the upper resistance prong.
Testing the upper resistance prong, recognize a textbook evening star or
another bearish candlestick pattern. Looking at Figure 8, we see a textbook
evening star formation at point X. This will serve as the first signal.
Confirm the decline through a price oscillator. In Figure 8, a downward cross
occurs in the stochastic oscillator, confirming the following downtrend in the
currency. Also notice how the cross occurs before the formation is complete,
giving traders a heads up.
Place the entry slightly below the close of the third and final candle of the
formation. As little as 5 pips below the low will usually suffice in these
situations.
Apply a stop to the position that is approximately 50 pips above the entry. If
the price action rises after the evening star, traders will want to exit as
soon as possible to minimize losses but still maintain a healthy risk measure.
In this example, the entry would ideally be placed at 0.6595, with a stop at
0.6645 and a target of 0.6454 - an almost 3:1 risk/reward ratio.
Figure 8 - An evening star formation at point X suggests an impending sell-off
that is confirmed by the downward crossover in the stochastic oscillator.
For breaks outside the trendlines, we take a look at the next example, point B
in Figure 7. Here, the price action has broken above the upper trendline but
looks set to retrace back to the median or middle line. Using the same NZD/USD
currency pair, let's take another approach:
Identify the price action moving toward the median or middle line. What traders
want to confirm is that the price is indeed falling and will break back through
the upper trendline. In Figure 9, the currency spot falls through the
trendline, confirming selling pressure.
Identify the significant support/resistance line. Here, traders will want a
confirmed break of a significant support level in order to isolate sufficient
momentum and increase the probability of the trade.
Place the entry order 30 pips below the support level. In our example (see
Figure 9), since the support level is at the 0.7200 figure, the entry would be
placed at 0.7180. The following stop would be applied slightly above the 0.7300
figure - the previous session's high - and give us an almost 2:1 risk/reward
ratio when we take profits at the 0.7000 price.
Receive confirmation through a price oscillator. The downward cross that occurs
when the stochastic oscillator is used gives traders ample confirmation of the
break of support in the price.
Figure 9 - Taking a closer look, a great opportunity exists as the price action
moves towards the median line.
Conclusion
Although it is primarily applied in the futures and equities forums and seldom
used in the currency markets, Andrew's pitchfork can provide the currency
trader with profitable opportunities in the longer or intermediate term,
capitalizing on preferably longer market swings. When the pitchfork is applied
accurately and is used in combination with strict money management and textbook
technical analysis, the trader is able to isolate great setups while weeding
out the sometimes choppier price action in the forex markets that may increase
his or her losses. If all of the criteria above are applied, the trade will be
able to ride its way to profitability compared to its shorter-term peers.
by Richard Lee