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MENAFN - DailyFX - 13/11/2012

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If there is one market condition that excites traders and analysts alike, it would probably be the breakout.

Breakouts occur in fast markets, when news or fundamentals have triggered a strong rush of buyers or sellers into the marketplace, as prices purge previously respected support or resistance barriers.

LEARN_FOREX_SSI_BREAKOUTS_body_Picture_4.png, LEARN FOREX: SSI Breakouts

Created with Marketscope/Trading Station II

In the article The Ballistics of Breakouts, we examined how traders can look to speculate in these markets and with the rush of news flowing out of The United States, Europe, and China – this could be a market condition you might want to get more familiar with.

To take a breakout strategy a step further, traders can look to filter there trading opportunities with various indicators. Some traders look to trade breaks only in the direction of the trend – so they might look to a moving average to denote which direction the trend is moving so that the breakout entry order can be properly applied.

An indicator that has wide applicability for these circumstances is SSI, or The Speculative Sentiment Index.

What is SSI, and Why Does it Work So Well With Breakouts?

The FXCM Speculative Sentiment Index is a measure of the positions held by their retail traders. This data is given as part of the DailyFX PLUS package available to all FXCM Account Holders.

SSI, which is the shorthand abbreviation for The Speculative Sentiment Index, will measure the number of traders’ long in a currency pair v/s the number of traders’ short.

The picture below will show the ‘positioning’ aspect of SSI, which is the ratio for the numbers of traders that are long versus the number of traders that are short.

LEARN_FOREX_SSI_BREAKOUTS_body_Picture_3.png, LEARN FOREX: SSI Breakouts

SSI Positioning as shown in DailyFX PLUS

In the picture above, a number is given for each of the listed currency pairs – expressed as a ratio.

So, when we see -1.85 for GBPUSD that indicates for every 1 trader holding a long position, there are 1.85 short position holders. Since the number is negative, we know that retail traders on FXCM platforms are holding a net short position.

Or, for example, the 3.10 reading for USDCAD indicates that for every 1 trader short, there are 3.1 long positions in USDCAD.

SSI is a contrarian indicator, meaning if a net short position is seen, trader want to look to potential long positions in that pairing. So, for GBPUSD in the example above, traders may want to look at opportunities to go long.

Or, in the case of USDCAD traders may want to look to initiate short positions to treat SSI as the contrarian indicator that it is.

The reason that SSI is a contrarian indicator is the portion of the market being analyzed, retail traders, and their propensity to try to call tops or bottoms in trending situations. Often-times, however, traders would be better served to trade in the direction of the trend, and SSI can be a fantastic indicator to assist with finding those trends in which retail traders are attempting to call a top or a bottom.

Sure enough, if we look at the GBPUSD Daily chart, we’ll see that the pair has been in a staunch up-trend and retail traders (from above) are holding a net short position in the pair:

LEARN_FOREX_SSI_BREAKOUTS_body_Picture_2.png, LEARN FOREX: SSI Breakouts

Up-Trend in GBPUSD

And in the case of USDCAD, which was seeing over 3 traders long for every one short (meaning traders would want to investigate short positions), the pair has been in a strong down-trend:

LEARN_FOREX_SSI_BREAKOUTS_body_Picture_1.png, LEARN FOREX: SSI Breakouts

Down-Trend in USDCAD

How to Trade Breakouts with SSI

Since SSI is a contrarian indicator that will often expose situations in which retail traders are attempting to pick tops or bottoms in trending situations, traders can implement standard breakout procedures to enter pairings in the contrarian direction of SSI.

So, in our GBPUSD example above, traders would want to look to use entry orders to BUY in the pair. Or, in the case of USDCAD, traders would want to use entry orders to SELL breaks of support.

There are numerous mannerisms of trading breakouts, but most revolve around a similar premise: Identifying resistance levels that traders want to buy if broken, or support levels that traders want to sell if broken. This can be done with Price Action, Pivot Points, Fibonacci, or any other mechanism of identifying support or resistance levels.

Using SSI to filter these opportunities can greatly assist traders in finding opportunities that may be most accommodating to trading in breakout market conditions.

--- Written by James B. Stanley

To contact James Stanley, please email Instructor@DailyFX.Com. You can follow James on Twitter @JStanleyFX.

To be added to James’ distribution list, please send an email with the subject line “Notification,” to JStanley@DailyFX.com.

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