Trading the European Session with London Breakout Strategy
Josh Martinez, MTI
The Forex market is the largest financial market with almost limitless amounts of liquidity. That means the opportunities for financial gain are almost limitless as well. When it comes to average daily trading volume, almost $5 trillion is traded daily in the Forex markets. In contrast, $22.4 billion is traded on the New York Stock Exchange, $18.9 billion is traded on the Tokyo Stock Exchange and $7.2 billion is traded on the London Stock Exchange. The volume trade in the major stock exchanges is a fraction of the volume of transactions traded on the Forex market. Because of that, it’s no surprise that top banks and investors like Warren Buffett and George Soros trade the Forex markets.
Another advantage to trading the Forex market is that it’s open 24 hours a day, 5 ½ days per week. If you work a day job, and can’t trade from 9-5, you still have trading opportunities available to you when you’re off work. The table below shows the 24 hour cycle of the major global financial markets.
In the Forex market, you deal in pips. A pip has the same relationship to a penny that a penny has to a US dollar. There are 100 pennies to a US dollar, and in the Forex market, 100 pips make up a penny. When you trade Forex, you are buying or selling fractions of pennies. The value of your pips is measured on a much larger scale when you trade the Forex market. In this chapter, we are going to be working with an investment of $2,000 US dollars per trade. This is known as a standard lot investment. When you invest $2,000, every pip on average is worth $10 US dollars. If you make 10 pips on a trade, you will make $100. Conversely if you lose 10 pips, you will lose 100 dollars. Your $2,000 dollar investment is not your risk. Your risk is measured in pips and your reward is measured in pips.
The strategy being discussed today is designed to generate between 200-500 pips per month, which translates in to $2,000 – $5,000 of real money in your trading account. So we are using a $2,000 investment to generate $2,000 – $5,000 in income every month.
This chart shows the GBP/JPY currency pair. As you can see, the Forex markets tend to have repeatable highs and lows on an uptrend, and it also has predictable lows and high on a downtrend. But here’s the most important thing to know, and it’s pretty obvious: Every trading day has a high and a low. And here is the essence of this chapter:
If you can become really good at identifying the daily low or high between 2am-5am, you have the potential to make a lot of money trading the GBP and its related currency pairs.
In this hourly chart, we see two yellow circles:
- On 7/1/14 the daily low was established at 2am EDT and the GBP/JPY went north for the rest of the day.
- On 7/2/14 the daily low was established at around 2am EDT, and the GBP/JPY headed north for the rest of the day
If you go back in time, you should be able to identify an obvious daily low or high on almost any day. In this example, neither of these days were small directional moves. The market rose over 75 pips. And 75 pips equals $750 in profits. Looking at the chart above, can you identify the low or high between 2am-5am for the previous three days? The bigger question is: How do we take advantage of this information to make money trading the GBP currency pairs?
The next thing you need to know is that the distance between the daily low and high is the Average Daily Trading range (ADT). The ADT for the GBP in the summer months is about 100 pips. Since, the ADT is 100 pips, the goal is to make 50 pips per day per trade. 50 pips yields a $500 daily profit on a standard lot investment.
Let’s begin within the opening of the trading day. The European markets open at 2:00am EDT, but London opens at 3:00am EDT. When the London markets open, what typically happens with the Bank of England? A wealth of transactions that have built up from the previous day need to be cleared. The majority of large currency exchanges are processed through the Bank of England every day. It’s the largest currency hub in the world. 3:00am EDT is also the final hour of trading in the Tokyo Exchange. The combination of activity in these two markets will usually result in a strong bullish or bearish directional move in the GBP and its associated currency pairs.
The key to this strategy revolves around an hourly chart and the 3am bar. There are two ways to use this strategy: The “Blind Straddle” and the “Educated Straddle”
Step 1 – Place a 10 pip Entry BUY Order above the one-hour 3:00am EDT candlestick wick high. With the Blind Straddle, you want to wait for the 3am hourly candlestick to close at 4am. The first step is to place an ENTRY BUY order +10 pips above the wick high of the 3:00am EDT closed candlestick. In this example, the entry buy is 174.04. This is not a market order. You are not physically in the market yet. An entry order is a pending order. You are making it a requirement that the market crosses over your specific price point before entering you in the market. If the market does not touch your specified price point, then your trade is never activated.
Step 2 – Place an Entry SELL Order -5 pips below the one hour 3:00am EDT closed candlestick wick low. The reason why you have an entry sell order -5 pips below and not -10 pips below the 3:00am EDT closed candlestick wick low is because of the bid and ask price. The chart above is a bid chart. That means you are only seeing the sell price. The ask price is also known as the buy price, and it is usually 2-5 pips above the sell/bid price. The above chart does not show the ask/buy price. So there is no need to compensate for the spread at an additional +5 pips when selling.
Step 3 – Once you are in the market, cancel the opposite order. The candlestick has crossed over your entry sell price. Your entry order is now an active market order. You are physically in the market selling. Once this happens, you want to immediately cancel your outstanding ENTRY BUY order, because you don’t want that order floating. It has served its purpose. Get rid of it.
Step 4 – Set your STOP +5 pips above the previous candlestick high.Your risk will be the distance in pips between your market sell order and your stop. In this example, your risk is 24 pips or $240 dollars.
Step 5 – Set your reward at 50 pips from your market SELL order.You’re done. You are risking 24 pips, or $240 to make 50 pips or $500. A very nice risk/reward ratio. In fact you would only have to win 4 out of 10 times to make money with this risk/reward ratio. Now we wait.
Step 6 – Collect your profit. This strategy uses an hourly chart. Notice that in just 5 hours, we cross our reward line. In just five yours, we close out the trade and pocket $500. And this strategy works over and over again with the GBP and its related currency pairs.
Note: If you click on the YouTube presentation at the end of this chapter, Joshua Martinez will take you through multiple examples of using the “Blind Straddle”, and it is well worth watching just to show you how repeatable this strategy is within a given month.
Make Sure You Have a Profit Plan
It’s also very important to have a Profit Plan with this strategy. A profit plan keeps you from flying blind in your trading. It is advisable to set up your profit plan on 10 trades. That’s about 2 weeks of trading time. Here’s what happens if you win four out of ten trades with an average profit of 50 pips and an average loss of 25 pips.
What if you win six out of ten trades? Then the Profit Plan looks like this:
In the first profit plan, we make $500 every two weeks ($1,000 per month), winning just four out of 10 trades. In the second profit plan, we make $2,000 every two weeks ($4,000 per month).
The London breakout strategy, if followed properly, works very well within your profit plan. The five major currency pairs this strategy produces the best results are:
When evaluating these currency pairs, we are using an hourly chart, but it’s also important to take a long-term view of the market, since the long term history of a chart controls the short-term charts. Let’s look at the GBP/NZD on a monthly chart. What do you see? Is the market moving up, down or sideways?
When you plot support and resistance lines, what you see is this currency pair is range-bound within 1,848 pips for the past four years. That’s an $18,480 directional move that happens every six months on average. If you could take a $2,000 standard lot investment and generate over $20,000 in profits per year, would you consider that a good return on investment? Looking at the monthly charts can also provide some valuable insights into your current trading month.
In this exploded monthly view of the GBP/NZD, you can see a clear uptrend during the previous four months. The current month has broken the trend line, but there are still 21 days left in the month, and history suggests that there is still plenty of buying to do. If the trend reverses, there is still an 800 pip range between the last candlestick and the support line, offering an opportunity to pick up $8,000 possibly within the next five months.
Let’s drill down and superimpose a daily chart below a monthly chart. Remember the longer time frames always control the shorter time frames. What do you see? Will the market go up or down?
In this case, we see two levels of consolidation in the daily charts. A consolidation is when you see equal highs and lows over a period of time. Since Consolidation phases tend to bounce off support and resistance lines, it makes sense that the market will probably move up. But how can you confirm this? This is where analyzing wave patterns with Fibonacci tools helps.
Fibonacci tools are wonderful when you learn how to use them. They identify highs and lows and they will help you learn if the markets are in a retracement or an extension. We identify our first low (A) at the support line and our proper high (B) at the resistance line. That gives us our up A/B boundary. This chart illustrates a Fibonacci adage:
“As long as the market doesn’t take out the “A”, it has no choice but to go your way.”
What this means is that once the market reaches the “B”, any retracement will be short term, and the market will be moving to the upside. For a more detailed view of Fibonacci analysis, click on the YouTube of this presentation and fast-forward to the 49:00 minute mark.
The key to the “educated straddle” is to gather more information about the probable direction of the market on a daily basis.
- Take a longer-term view of the GBP currency pair. The more information you have about the longer-term direction of the market, the more certain you will be about the direction of the market. Make sure to look at the monthly, weekly and daily and hourly charts to help make your decisions about the direction of the market.
- Learn how to use Fibonacci tools. The can help you identify market tops and bottoms, and whether the markets are set to retrace or extend their direction.
If you can master this information, and you know that the daily high or low will likely be established between 2am – 5am EDT, how much more confident will you be making trading decisions?
The London Open Breakout strategy has been successfully traded for many years. The rules are based on a very simple premise:
If you are able to successfully identify whether the market will form a low or high in the morning, and you know where to set your strike price, stops and reward targets, it is possible to make $500 per trade and $4,000 per month on a $2,000 standard lot investment.