Chapter 10
Technical Trading Strategy: Fading the Double Zeros

One of the most widely overlooked areas of trading is market structure. Developing a keen understanding of market structure and its dynamics can help day traders to gain an unbelievable advantage. Developing a feel and understanding for market dynamics is key to profitably taking advantage of short-term fluctuations. In foreign exchange trading this is especially critical as the primary influence of intraday price action is order flow. Given the fact that most individual traders are not privy to sell-side bank order flow, day traders looking to profit from short-term fluctuations need to learn how to identify and anticipate price zones where large order flows should be triggered. This technique is very efficient for intraday traders as it allows them to get on the same side as the market maker.

When trading intraday, it is impossible to look for bounces off every support or resistance level and expect to be profitable. The key to successful intraday trading requires more selectivity and only entering at those levels where a reaction is more likely. Trading off psychologically important levels such as the double zeros or round numbers is one good way of identifying such opportunities. Double zeros represent numbers where the last two digits are zeros. Examples of double zeros would be 118.00 in USDJPY or 1.1100 in the EURUSD. After noticing how many times a currency pair would bounce off double zero support or resistance levels intraday despite the underlying trend, we have observed that these bounces are usually much larger and more relevant that rallies off other price levels. This type of reaction is perfect for intraday FX traders because it gives them the opportunity to make 30 to 50 pips while risking only 15–20 pips.

This trading technique is not difficult, but it requires individual traders to develop a solid feel for dealing room and market participant psychology. The idea behind this double zero methodology is simple. Large banks with access to conditional order flow have a distinct advantage over other market participants. The bank's order book gives them direct insight into potential reactions at different price levels. Dealers will often use this strategic information to put on short-term positions in their own accounts.

Market participants as a whole tend to put conditional orders near or around the same levels. While stop-loss orders are usually placed just beyond the round numbers, traders will cluster their take profit orders at the round number. The reason why this occurs is because traders are humans, and humans tend to think in round numbers. As a result, take profit orders have a very high tendency of being placed at the double zero level. Since the FX market is a 24-hour continuous market, speculators also use stop and limit orders more frequently than in other markets. Large banks with access to conditional order flow, like stops and limits, actively seek to exploit this clustering of positions to basically gun stops. The fading the double zero strategy attempts to put traders on the same side as market makers by positioning traders for a quick contra-trend move at the double zero level.

This trade is most profitable when there are other technical indicators that will confirm the significance of the double zero level. Here are some guidelines for fading the double zeros or “round numbers.”

Strategy Rules

Long:

  1. Identify a currency pair that is trading below its intraday 20-period simple moving average on a 15-minute chart.
  2. Enter a long position 10 to 15 pips above the figure.
  3. Place an initial protective stop 20 pips below the figure.
    1. When the position is profitable by the amount risked, close half of the position and move your stop on the remaining portion of the trade to breakeven.
    2. Trail your stop as the price moves in your favor.

Short:

  1. Identify a currency pair that is trading above its intraday 20-period simple moving average on a 15-minute chart.
  2. Short the currency pair 10 to 15 pips below the figure.
  3. Place an initial protective stop 20 pips above the round number.
  4. When the position is profitable by the amount that you risked, close half of the position and move your stop on the remaining portion of the trade to breakeven. Trail your stop as the price moves in your favor.

Market Conditions

This strategy works best when the move happens in quieter market conditions without the influence of major reports. It is more successful for currency pairs with tighter trading ranges, crosses, and commodity currencies. This strategy also works in the majors but under quieter market conditions since the stop loss is relatively tight.

Further Optimization

Round numbers are important because they are significant levels but if the price coincides with a key technical level, a reversal becomes more likely. This means the strategy has an even higher probability of success when other important support or resistance levels converge at the figure. This can be caused by moving averages, key Fibonacci levels or Bollinger Bands, or other technical indicators.

Examples

Now let's take a look at some of the examples of this strategy in action. The first example that we will go over is a 15-minute chart of USDJPY shown in Figure 10.1. According to the rules of the strategy, we can see that on April 24, USDJPY was trading above its 20-period moving. Prices continued to move higher with the currency pair drifting toward 120.00, our double zero level. In accordance with the rules, we place an entry order a few pips below the round number at 1110.85. Our order is triggered, and we put our stop 20 above the figure at 120.20. USDJPY climbs to a high of 120.08 before turning lower. We close half of the position when it moves by the amount risked or 35 pips at 1110.50. Notice that USDJPY falls and then rallies again before hitting our initial profit target. When the first profit target is reached, the stop on the remaining half of the position is moved to breakeven or our initial entry price of 1110.85.

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Figure 10.1 USDJPY 15-Minute Chart

Source: eSignal

We then proceed to trail stop. The trailing stop can be done using a variety of methods including a monetary or percentage basis. We choose to trail the stop by two-bar low for a really short-term trade and end up getting out of the other half of the position at 1110.50 as well, earning us 35 pips on the first and second half of the positions.

The next chart that we want to look at is GBPUSD. What's interesting about Figure 10.2 is that there are a number of examples. In the first example, labeled “1,” we can see that GBP/USD was trading above its 20-period moving average on a 15-minute chart and headed for 1.55. According to our rules, we place an order to sell at 1.5485 (the high on this move was 1.5492) with a stop at 1.5520 for 35-pip risk. GBPUSD moves in our favor, and our first profit target is hit at (1.5485 – .0035) at 1.5450. We then move our stop to breakeven, or our initial entry price of 1.5485, and proceed to trail it by the 20-day SMA + 10 pips. If we manage our trade using this type of trailing stop, the second half of the position would have been exited at 1.5350 for 35 pips on the first half of the position and 135 pips on the second. Part of the reason why this trade was so successful is because the 1.5500 is also a significant technical level. Example “2” is a long trail that reversed but not by enough to hit the profit target. Example “3” is a successful long trade that hit the first profit target.

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Figure 10.2 GBPUSD 15-Minute Chart

Source: eSignal

Making sure that the double zero level is a significant level is a key element of filtering for good trades. The last example shown in Figure 10.3 is USDCAD on a 15-minute chart. The great thing about this trade is that it is triple zero level rather than just a double zero level. Triple zero levels hold even more significance than a double zero level because of their less frequent occurrence. In Figure 10.3, we see that USDCAD is also trading well below its 20-period moving average and heading toward 1.2000. We look to go long 15 pips above the double zero level at 1.2015. We place our stop 20 pips below the round number at 1.1980. The currency pair hits a low of 1.2011 before moving higher. We then sell half of our positions when the currency pair rallies by the amount that we risked at 1.2050. The stop on the remaining half of the position is then moved to breakeven at 1.2015. We proceed to trail the stop once again by the two-bar low and end up exiting the second half of the position at 1.2055. As a result, we earned 35 pips on the first position and 40 pips on the second position.

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Figure 10.3 USDCAD 15-Minute Chart

Source: eSignal