Identifying Over Extensions




A Teen Trader is an educational Site Only. The contents included in this website is not investment advice and are not meant to be taken as investment advice. Risk what you can afford to lose.

With the recent polls and survey’s I have been running on various social media, it’s clear there is a demand for more youtube and website content. With, I will begin posting AT LEAST 1 blog/youtube video per week (ideally more) around topics including Forex, Stocks, investments, and wealth building in general.

Introduction

In currency trading, one of the biggest mistakes I see traders make is the failure to identify overextended markets. Overextended markets are when a currency pair has been trending in one direction for such a long period of time with no significant pullback, making many traders feel that trend trading is the only options right now when in fact it is most likely the worst. Falling subject to overextended markets leads to various potential downfalls including increased probability of loss (due to a higher potential of a pullback) and a decreased potential to let trades run (decreased risk to reward).

Identifying Overextension 

Overextended markets are typically identified best on a medium to high time frame settings because overall trends are established on said timeframes. Short term fluctuations in price will not help to identify these moves because the timeframes themselves will now show the full picture. When identifying higher timeframe overextended moves, one must look for extremely rapid long term moves (like shown below on gold), these moves typically last more than one (1) full week because that’s about the length in time it takes for people to begin to identify clear trends.

With the gold example from above, we can identify a 13-day long downtrend, with the last half of the downtrend (time wise) resulting in 12/14 four hour candles closing very bearish and the only 2 bullish ones closely slightly bullish. These full-bodied downtrend candles help us to understand when these massive downtrends occur, but how do we identify it’s overextension? Again, overextensions occur when the future begins to appear obvious, retail traders and small commercial traders begin to sell heavily so what must happen now? Someone has to fill those positions. Banks fill those positions, resulting in them adding longs and this creates a reversal move after the overextended move. These rebounds are also a result of profit taking from short sellers (because cover a short position is buying them back) and moves (in the opposite direction) remain relevant due to short squeezes. Short squeezes are when people short get stopped out forcing prices further up. I will be making a separate post in the future regarding reversal moves after overextensions because it’s a very detailed process. As you can notice, this overextension move came to rest at a major support zone before reversing, which helps us to be able to identify these potential points in the price for taking profit or reversals to begin to look for moves back up.

Our next example is EUR/GBP which occurred just a few weeks ago. The downside move showed nothing but bearish momentum and by the end of the move the pair was nose-diving, these nosedives help to identify that an overextension is likely occurring. At the same time (as the nose dive), the market also found itself sitting on a historically major support region, again helping to identify regions in price to begin to look for taking profits (if short) or wait to see some market moves to justify getting long. Like gold, this currency pair’s movement saw moves retail traders and small commercial traders being nothing but short bais, this WILL continue to flush price down but not for too long as the market will… get overextended as to many people have begun to adopt the same bias. In this industry you won’t want to be with the majority of people, you want to be with the majority of orders (banks/hedge funds/etc)

Conclusion

All in all, overextensions in the forex markets are unfolding each and every week. The best way to put yourself in a position to understand them is to identify when markets are moving rapidly in one direction (trending) to the point where it has become rare to see even the slightest pullbacks. Then identify your major supports and resistances (because in overextended markets minor zones will likely be ignored) to begin to plot where markets will likely reverse from (or at least show struggles to reverse). Failure to identify overextended markets puts you and your capital of risk of loss and decreased risk to reward because you are not identifying that this “trend” is becoming too good to last.

Check out the Youtube video for this blog here!

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