A good friend of mine called me over the weekend and explained that he wanted to start trading, and was looking for some basic advice. In our relatively brief conversation, I covered several major topics, so I thought I would share them here. I could have talked to him for days about the thousands of ideas and issues we cover here on a regular basis, but I instinctively selected the below items, I assume, because I view them as the most relevant. I’ve either appropriately or inappropriately entitled this article “My Top 5” because these are the items which flowed most naturally when asked for advice. In the order in which I spoke, here they are:
1. Learn to be a Position Trader
The first thing I told him was to learn to be a position trader (leaving positions open for several days to weeks/months). I told him that by doing this, he learns two absolutely essential things: to control his risk, and focus on the information that really matters in the currency market. If you learn those things, I said, trading on an intraday basis becomes much, much easier. If you have a good handle of the macroeconomic environment, and what’s truly driving investor sentiment, intraday scalps will cause you very little worry. Nothing gives you more confidence than your ability to score 500 pips on a single trade.
Counter to this, I told him that one of the biggest makes people make when they first start out trading is that they focus on miniscule moves of several ticks at a time which usually develop into massive losses. They become ‘hard-wired’ to this particular way of trading, and it usually ends up devastating them in the end. I said “They don’t understand what’s really moving the market or the value in basic fundamental analysis. It trains them to use ridiculous leverage when what they should really be doing is first learning to trade profitably then raising more capital to trade with profitably, instead of trying to turn 10k into 10mm. People, you will find, are very willing to give you their money if you’re making 20% a year after fees. Trust me. It comes. Billionaires don’t become billionaires because they ‘organically’ took 10k and turned it into a billion. Other people’s money always comes along the way.”
2. The Plan
The second thing I told him was to make a list of rules and stick to them. This is basic, and you hear it all the time, but I have a slightly different interpretation of the relevance of this, I believe. If things don’t line up, simply don’t trade. Your planned trades are the ones that always bring in the bigger money. Patience, and waiting for the right ones, are key, as we’ve discussed many times. And when that magical moment arrives where all conditions line up and the perfect entry is staring you in the face, by all means take it. Eventually, they come. Eventually being the key word, here. Staring at a chart and saying “I should have taken that one” or “I can’t believe I missed that” will get you nowhere. You didn’t get in for a reason. There are just as many times I could have stared at a chart and seen winners I should have taken versus trades that would have turned into losers. Not to mention any of the money management disasters which could have occurred along the path.
Most traders, especially in the retail environment, don’t have a written plan. I’ve found the most valuable thing that has come out of my writing a trading plan is not just the plan itself but the realization of all of the things that go into making a trade. Trading is a complex process. There are just as many short term implications which need to be taken into account as there are longer term. Risk management, selection of the right pivot levels, investor sentiment, capital flows, profit management, etc., are just the beginning of a long list of topics that go into hitting “buy” or “sell”. Writing a plan usually opens up the eyes of any trader and makes him or her realize all of the implications of what it is they’re really doing. Sitting down at the computer and executing an order doesn’t make you a trader. My one year old nephew could do that. It’s everything else that really matters.
3. Keep an Open Mind
“Anything can happen, at any point in time”, I told my friend. Particularly in volatile environments, things can turn dramatically in the blink of an eye, so it’s important to visualize all possible outcomes of what could happen next. Becoming too rigid, or stuck to an idea which is clearly fading away tends to paralyze a trader and force a lack of reality on their actual trading.
Charts are merely a visual output of all of the thousands of factors combined in a given instrument. Visualizing different variations of price action is important for any trade, as it removes any of the “shock value” when things don’t play out in the exact manner you visualized. It keeps you flexible, nimble, and able to react to a variety of different conditions.
Most traders “see” price doing once certain thing when they take a trade, and block out all of the other possibilities. I’m a very visual person in general, which could be a reason I find it easy to identify key areas sometimes. But most importantly, I force myself to visualize all possible scenarios of what future price could look like. And I’m not just referring to price moving higher or lower. It can move sideways, a little higher, then lower, than higher again, consolidate for a little bit, then spike up, and then spike down, etc. The list is endless, but at the end of the day I’m simply keeping an open mind of major possibilities which could result due to any number of different factors.
4. The Most Obvious Thing to Do
This week I signed up to CNBC’s Million Dollar Portfolio Challenge; I figured it wouldn’t hurt to try it out. The worst that could happen is that I don’t actually make a half a million dollars and get 10 free hours on a private jet. So I immediately bought 4 ETFs and allocated 100% of my available cash to them: SH (Short S&P 500), DOG (Short Dow 30), PSQ (Short QQQ) and DRR (double short EUR). This isn’t a lesson is horrendous disregard for portfolio diversification (needless to say I was was swinging for the fence here on fake money) or to pat me on the back for calling the right shots here (though I’ll admit my portfolio is on steroids right now) as much as it is a blatant realization of what’s going on out there, and how important it is to always remain on the right side of the most obvious conditions.
In my daily overview of the market and planning process, I keep in mind one thing that seems to keep me alive: “What’s the easiest thing to do here, what makes the most sense, and don’t forget, Steve, if you go against it you’re at a much greater risk of taking a loss”. Simple. Keeping with this trend has been the easiest shot throughout, and as the bad news pours on day over day, its no wonder the stock market is tanking and bringing everything along with it. Always keep the big picture in mind, and never forget it.
Also, on an intraday basis, some trades are so obvious, so clear, it seems you would be foolish not to take them. But you don’t, whether it be a fear of drawdown due to overleveraged or any other number of different factors. Be smart, control yourself and take the obvious ones when they’re there. The agony of not taking a trade you plainly should have can be a lot more painful than taking an actual loss.
5. Losing and Winning Streaks
The final thing I told him was that, if you, by any chance, get on a losing streak, stop trading altogether, take some time off so you can go back in and think clearly. Losers tend to lead to more losers, and I like to think of it as a virus. It just keeps on growing unless you give yourself some rest and medicine to knock it out. A winning streak can do the same to you. There have been many times in my career where I have simply stopped trading for a few days or weeks just to get my head cleared out of any emotional nonsense which is blocking my way to success. It happens to all traders at one point or another, and many, I know, usually end up calling it quits for at least a few days.
A big mistake many traders make is that they keep on plugging away, causing them to force trades, or take those that they wouldn’t normally take if they were in the right frame of mind. The best trades I have ever taken have come when I am calm, cool, and have a clear head. The worst trades I have taken have always followed previous losers that just didn’t work out as planned. This pattern is more predictable than anything I know of. I’m very cautious to get caught up in it.
Today we had one of the largest ranges ever on the S&P index, and its affect on EUR/USD was an initial selloff, followed by a huge spike in price. For this trade, we took a short at the high of this trend, when price hit confluence of the major diagonal trendline and horizontal resistance.
Most of the questions I get surround knowing when its safe to fade, and when its not. For the other areas marked up on the chart, I hope to explain why they weren’t good areas to take shorts.
Marked up in orange in the chart below are possible price turning points when EUR was in its heavy uptrend. The most significant of these is marked in blue. Price started off where the “x” is on the chart.
1.2650 was a heavily watched number, for good reason. It was the lowest low on the last cluster of price before price finally broke through it. Here’s why we didn’t fade here, and instead could have bought into it instead:
This pattern is very, very common. Price will approach a low made in a previous wave, and bounce off it (short). Alternatively, buy stops always reside above these areas as well. If price doesn’t fade it, there’s a good chance its going to keep moving if it’s broken on the first approach. It happens all the time.
Important, something I stress all the time and where many traders go wrong: there is a good amount of time here for the area to get noticed and for stops to get accumulated. This won’t work as steadily on smaller timeframes because of the lack of time passing in between these areas. But this one has been sitting there for a couple of days, so there’s more than enough opportunity for traders to take attention. When I discuss this system with other traders they make this common mistake of trying to force trades when there has not been enough time passed. How much time is necessary for each trade varies, and can be discretionary…..I use the ‘reasonable person’ standard when it comes to this, and just use good judgment and common sense. We’re looking for ‘no brainer’ levels; if you have to think hard about it, chances are something is wrong.
Now we scroll down to a 1 min timeframe of the same chart. You can clearly see that in all instances of the key areas, price blasted through them quickly and without haste; especially our 1.2650 level. When that 1.2650 area became violated, it’s a very good sign that price has a ways to go before it starts to seriously fade. That indication alone tells us to take a back seat on any shorts for a moment and if you’re not long already, sit to the side. When you see this pattern, and price taking out a low like that, take it easy on shorts is the bottom line and wait for something really good. As I say chances are you’ve got a ton of buy stops above it, and, based on common sense and seeing momentum leading up to it alone, tells you to back off.
So up to the entry point. Price finally reached 1.2840, which was taken out by about 10 pips or so, because price was ‘reaching’ for the diagonal trendline in order to entice buyers. This happens all of the time, as well. You’ll see horizontal resistance (or support) surpassed slightly so that a diagonal trendline can get hit. There’s your queue to go short. Price had a massive run, and is ready to kneel down at a key area.
What about profit targets? A good initial target for this is 1.2665 area, which is visible from a 15 min chart. It’s the low created on the first retracement after price broke through 1.2650. Secondary target could be 1.2630 area, or the high in this last cluster. A shorter term trader could have used 1.2725, the first major high made on the way up.
For a stop loss, I tucked it above 1.2885, which is the ‘bottom of the bucket’ and former resistance, on the last leg up. A break of that area and I would be concerned. I could also consider 1.2925, though unlikely as my risk:reward becomes skewed, and at that point, I’m already down over 70 pips. Not worth it. Better to start off new.
I'm still piecing together other materials but in the meantime this video was sent to me earlier today from MarketClub if anyone is interested. Adam, the presenter, refers to "Demand Destruction" at the end of the video, which is taking shape sooner than later here....I'm pretty much in agreement with what he's saying here and been following it all along. Thought you would want to have a look. You can click here to watch it.
I'm a religious reader of IFR (Reuters) data, and theyre looking to sell against the dollar at some pretty high levels from where price is currently, but I've been trying to get in sooner than later on any pullbacks, pretty aggresively. GBP/USD is getting weighed up the heaviest lately, due to further rate cuts expected and just very negative commentary and data coming from the BOE, not to mention the correlation and deterioration in equities worldwide. What a wonderful world.
EUR/GBP has been going nuts lately and its no wonder why. GBP/USD has an ultimate target of 1.4040.....ouch.
EUR/USD has been seeing some consolidation over the past few days but overall, lots of opportunities to sell coming from up above and I'm a little antsy to watch it go higher....I keep on taking stabs at shorts; targeting 1.2050 for now, but its going to be a slower mover I suspect.
In terms of anything near term, price really hasn't taken a 'breather' on many of these pairs so I'm still keeping upside risk in check as I jump on any heavy shorts for core holds. Just keeping a close eye on the equity market, which is due for a minor retracement in the very near term.
Based on the poll, I'm working on materials (written and video) in terms of 'when to fade, when not to fade', and more color on actual trading dynamics in order to clear up any ambiguity. I get a lot of questions in regards to this and I hope to have many of them answered in the next piece.
One of the biggest myths about trading, and what is usually stamped into the heads of traders from the very early stages of their careers, is that successful entry techniques will lead you to consistent profits. This is wrong! This and this alone is only one component, and there are unarguably many other factors which attribute to consistent success.
In most books and articles I have read about trading, the main focus of discussion is typically centered around entering trades. There are literally thousands of ways of doing it, as more and more indicators and trading strategies are developed over time. As we start trading, however, we learn that entering the trade can become rather easy once we have it practiced enough, and that managing a trade and knowing when to take profits becomes perhaps our biggest obstacle.
Trade management is perhaps one of the most overlooked yet vitally important aspects of trading. Any experienced portfolio manager will tell you that knowing when to call it quits and defining a systematic means of trade management is as important of the trade selection itself.
Poor trade management, just as with poor entry selection, can lead an otherwise profitable trader into an area of undesirable consequences if not executed properly. Here, we will outline the basic aspects of trade management: risk/reward, position sizing, taking profits and using stop losses.
Before we delve into any detailed discussions of the above, it is important to note that all three must be executed in terms of the market we are trading. In other words, they should be dynamic, or not a fixed pip amount. Many newer traders will define both a stop loss and profit target based on a fixed pip amount. This is generally an inefficient strategy because it completely ignores any dynamics of the market, and hinders their risk/reward ratio. The market does not “think” like we do, in terms of fixed numbers or profit goals, and instead reacts to key price areas, as we have outlined in previous articles. We are on it’s turf; its not on ours, so we have to shape our trading plan around its rules. Defining our trades around static numbers can be good if setting an ultimate limit on risk, but regardless, is not a recommended approach, especially in terms of taking profits.
One of the largest benefits of setting dynamic stop losses and take profits is the generous increase they can provide in terms of your risk/reward ratio. There have been many trades I have taken where I am only willing to risk appx. -25 pips and offered a payout of several hundred. My selection of a stop loss, in these cases, is based on a clear violation of a level I am expecting to be a sharp turning point for price. Any violation I would consider to be unexpected and not part of the overall trade plan. An example of this would be if I were to short EUR at 1.3000 resistance, and price broke through it, and then used 1.3000 as support. It’s a clear sign that price is likely to continue and I might look to exit if the price high is not valid resistance, as well. The combination of these two factors indicates strongly that price is going to continue heading upwards.
A newer trader is likely to overlook or disregard many discussions on risk/reward because they are either busy fantasizing about millions in profits or too inexperienced to understand the importance of maintaining a proper risk/reward ratio. It is completely possible to have a system that wins 99% of the time, with the other 1% wiping out an entire account if not properly managed. It is also possible to have a system that loses 99% of the time, with the other 1% maintaining a net profit.
For myself, everything begins with risk/reward. One of the first questions I ask before considering any trade is “Is the trade in the boundaries of my risk/reward ratio?” If it’s not, I immediately pass and stop wasting any more of my time. If it doesn’t fit my risk/reward criteria, I’m not interested.
Risk/reward ratio refers to the amount a trader is willing to risk versus his or her expected reward.
If your risk/reward is 1:3, you only need to win 3 out of 10 trades to turn a profit (eg risk losing 50 pips to gain 150 per trade).
For example, lets assume 10 trades with a 60 pip take profit, with a -20 pip stop loss and trading 5 contracts where 7 were losers and 3 were winners (risk/reward 1:3)
60 * 3 = 180 pips * 5 contracts = $9,000
-20 * 7 = -140 pips * 5 contracts = $-7,000
Net them out and you have a profit of $2,000
This higher your risk/reward ratio, the better. Without proper usage of risk/reward, consistency over time is extremely difficult if not downright impossible. If the math doesn’t work out, the profits simply won’t be there.
So what’s a good risk/reward ratio to use? It depends on your system and historic performance. If your win rate is better than 50% at a static risk/reward ratio, then slightly better than 1:1 is all you need to turn a profit. If your win rate is only slightly better than 30% at a static risk/reward ratio, then 1:3 is required to turn a profit.
I see little point in seeking any less than 1:3 risk/reward on all of my trades, though this is not necessarily always the case. Even though my win rate is better than 50%, by maintaining a strict risk/reward profile I am able to enhance my performance, and weed out any potentially weak-performing trades. For myself, it is a matter of discipline. 1:3 is my ‘benchmark’, but there are times when its necessary to adjust this for better bottom-line performance.
Ultimately, your risk/reward ratio should never drop below a certain level based on the historical performance of your trades. When starting off and without a good history of trades by which to measure, it is a good practice to prepare for the worst and assume at least 1:3. Once you begin to build a history of trading activity you will be better able to apply a more dynamic ratio to your routine.
Tied to risk/reward, the size of your positions dictates how much you are willing to risk per trade versus how much you will gain. As a general rule of thumb, I risk no more than 1% or 2% of my portfolio on each trade. That allows me the potential to gain as much as 6% per trade if adhering to a 1:3 risk/reward ratio.
In terms of position sizing, money comes first, not pips. This is important.
Just as stop losses and take profits are dynamic and relative to the market you are trading, so should be your position size. For example, GBP/JPY is a very volatile pair to trade. I might consider expanding my stop loss to 50 pips on a GBP/JPY trade based on its history of oftentimes erratic and volatile nature.
And just as I expand my risk in pips, so I adjust my position size. Many traders make a common mistake of not adjusting their position sizes in accordance with more risk assumed in terms of pips, and the consequences of this are typically fast and painful if bad entry is taken. I’ve known several traders to wipe out accounts quickly (and I mean very, very quickly) trading GBP/JPY, assuming the same position size as they would with a less volatile pair. But fundamentally, they were wrong from the beginning.
The psychological consequences of seeing 50 pips tear against you at full position size in a matter of minutes is not something you want to deal with. By understanding the dynamics of the market you are trading, and adjusting your risk accordingly, you can withstand any ups and downs as with any ‘normal’ trade. Greed is typically the factor in trading full-size on a pair like this, not brains. But brains tend to prevail over time.
What is also important to note is that the $ amount per pip on certain pairs varies. For instance, I trade in a USD denominated account. For me, 1 EUR/USD contract is equal to $10/pip, whereas 1 USD/CAD contract is currently worth approximately $8.37/pip. I would adjust my position size according to maintain the same money management rules on the USD/CAD position as I would on the EUR/USD position.
When we enter any trade, we have two basic goals:
1. Obtain the maximum amount of profit
2. Protect ourselves from losses
It starts from the beginning . Look for the most profitable opportunities in the market, as opposed to a series of weak trades just for the sake of trading. This and this alone should be a prerequisite for any trade. It avoids taking trades that offer weak payouts and keeps your risk/reward at a desirable level.
Stop losses and profit targets work hand in hand due to risk/reward. Both should be dynamic, and work off of one another in terms of value. For instance, if I identify a trade with a profit target of 150 pips, I know that I will be willing to risk no more than 50 pips in order to fit within the bounds of 1:3 risk/reward. In many cases, however, 50 pips isn’t needed for me to tell whether or not the trade I am taking is going as planned, and I will close it before then if I see signs of it clearly moving against me. My article on stop losses explains this in further detail.
Alternatively, if I identify a trade with a profit target of 50 pips, I know that I am willing to risk only -17 pips in order to fit within the bounds of 1:3 risk/reward, or -25 pips to fit within the bounds of 1:2 risk/ reward.
Some might argue that the distance of the profit target assumes more risk, as it is harder to get 150 pips out of a trade versus 50. But by developing a consistent approach in regards to general profit target marks (appx 150 or so, or whatever the case might be), the math works out over time if this mark is consistently achieved. The trader’s history alone can determine this.
Both profit targets and stop losses should be dynamic based on surrounding support and resistance levels, or other market factors. In the following articles, I’ll explain in deeper detail, methods for doing so.
In my experience, and as I have discussed in other articles, I tend to focus more on what can go wrong rather than what can go right when it comes to taking a trade. Because of this, I always start with risk as my primary assessment tool. If I am unwilling to risk a certain specified amount on a trade, I won’t take it. It’s black and white.
My selection of a stop loss amount is usually a combination of factors, and dynamic based on key support and resistance areas. First, I look at the potential profit on a trade to determine if there is any way a feasible risk/reward ratio can even be achieved. I typically look for a 1:3 risk/reward ratio on all of my trades, but will drop lower (but no less than 1:2) or move higher based on different variables.
Once I determine my profit target, I calculate my default stop loss based on my risk/reward ratio. For instance, if my profit target on a trade is 150 pips, my default stop loss, based on math alone, would be -50 for 1:3.
I then look to the area below my entry level for a long position, or the area above my entry level for a short position, and mark up any key support or resistance areas less than -50 pips from my entry level. I determine whether or not, if broken, price is likely to go in the direction of my trade or against. If I believe the levels are strong enough, I am likely to tighten my stop loss just above these levels for a short position or below these levels for a long position (but not too close so they can be taken out by small spikes).
Its important to note that with most, if not all, of my entry points, I intend on very little drawdown. The entry techniques for this strategy calls for price to turn ‘on the dime’, and violation of areas of entry immediately imply that a trade is not working out as planned. The areas marked up in between my entry level and default stop loss based on risk/reward are more or less ‘meters’ for me to ask “if price exceeds my entry level, where is it likely to turn next, and if it exceeds that level, am I calling it quits?”
“Soft Stops”
Many times, clues on smaller timeframes can tell you that a trade will not work out as planned, and whether or not price is likely to continue moving against you. These opportunities allow you to close a position prior to your default stop loss getting hit, thereby incurring a smaller loss. Additionally, they allow you to reverse a position and trade in the direction of the prevailing trend.
In the example below, a long EUR/USD position was taken at 1.3080, with a profit target of +151 pips and a default stop loss at -50 pips based on 1:3 risk/reward. Price moved in favor of the trade for +59 pips before coming back and taking out 1.3080, the original entry point. Price then began using 1.3080 as resistance, waving a red flag that it is likely to continue moving lower, and against your intended trade. In a situation such as this, after seeing price use 1.3080 as resistance, there is little reason to leave the trade running against you and waiting for your default stop loss to get hit for -50 pips, when you could be out of the trade for only -10 to -20, and profiting from a newly created short position.
Many traders don’t pay close enough attention to these clues and it only hurts them in terms of overall performance. Focus, and more importantly, reaction to these clues is essential.
It’s not uncommon for a trader to get “married” to a position, and maintain their directional bias, when clues on smaller timeframes blatantly tell them that price is doing otherwise. Quick response by trading what you see and disregard of your prior bias is the only way out of it.
In order to set a reasonable profit target, we need to know the following about our trade:
1. Is it a countertrend trade and against market sentiment?
2. Is it in the direction of the trend and in line with market sentiment?
3. Is it a reversal point where we expect the entire trend to reverse?
Naturally, the trades that tend to pay out the most are in the direction of the overall trend and reversal trades. Countertrend trades should be used for scalping alone and of course pay less. It is important to identify which type of trade you are in to gauge its ability to continue and set reasonable profit targets.
With any of the 3 types of trades, obstacles are our major concern. The trade will continue as long as obstacles continue to get broken. There are two major types of obstacles, both in line with our reasons for entering trades:
1. Opposing horizontal support/resistance
2. Diagonal trendlines
3. Major key fibonacci levels
These obstacles also serve as my profit targets on any given trade. When determining a viable profit target I consider the following:
1. Is my target a reasonable point where price is likely to travel?
2. Is my target in line with my risk/reward ratio?
3. Is my target in line with my strategy in terms of how I normally trade/within my comfort level?
As previously discussed, profit targets should be dynamic, meaning they are not a fixed pip amount. Defining both a stop loss and profit target based on a fixed pip amount is inefficient because it ignores any dynamics of the market, and can hinder our risk/reward ratio. Again the market does not “think” like we do, in terms of fixed numbers, and instead reacts to key price areas, as we have outlined in previous articles.
By examining the type of trade I am taking (countertrend, trend following, or reversal), I already have a general idea of the profit target I would like to see hit. If it’s a countertrend scalp, I might be looking for only +50 pips, whereas if it’s a trend continuation trade I look for significantly more, possibly in the range of +150 pips to +250 pips, dependent on the strength of opposing market obstacles. Other traders might reach for more pips in these situations by looking at bigger timeframes, but these numbers are in line with my personal style and comfort level of trading.
I mark up the most significant price barriers counter to my trade and find a reasonable level at which price has the ability to reach. In the example below, a short trade was taken at 1.3280. This is a reversal trade, and a bigger payout is expected. Due to the price action on the last move leading up to the short, few obstacles lay in the path of the trade. The first obstacle comes in the form of a diagonal trendline, which price reacted to by bouncing approximately 100 pips. A shorter term trader could have taken profits at this alone for a healthy payout, or even faded the trendline for a countertrend trade. When the trendline was eventually broken, price charged through the next obstacle at 1.2975, which was former resistance on the last move leading up. You can even see on the hourly chart posted here that this level was actually used as resistance again on the move down, while price was ‘breathing’ from its move through the level. Eventually, the final target was hit at 1.2815, or the major low made as price was moving upwards. These lows, if build up enough, tend to be very strong areas, and I fade them quite frequently. It was perhaps the strongest level of support for my trade, hence, the ultimate target.
Scaling out of positions
It is important to state from the beginning that it is always better to let positions run for full profit. Only if intraday conditions change severely, and leave a high level of doubt that your profit target will not get hit, should you consider taking partial profits.
There was a time when I would regularly take partial profits when certain market obstacles were hit, though I soon began to realize that this practice was inefficient over the long run. The problem with this technique is that my risk/reward became skewed, and I was severely limiting myself in terms of upside potential. Most of my profit targets would eventually get hit, and nullify any of my reasoning for “protecting” my position by taking partial profits.
My solution to this problem came through simple math, and is derived from the basics of risk/reward. First, I will typically only take partial profits by 1/3 of the full position amount or 1/2 of the full position amount. The level at which I take these must be equal to the amount of initial risk originally put on the trade, or 1:1 risk/reward. For example:
Long EUR/USD at 1.3000
Stop Loss = 1.2880 (-40 pips)
Profit Target 1.3120 (120 pips)
Risk/reward on trade = 1:3
If I felt there was sufficient risk and that upside was uncertain, and I wanted to scale out of the position in halves (1/2 now 1/2 at final target), my first level of doing this would be at +80 pips. The reason for this is simple. I am allowing myself no less than 1:1 risk/reward, with the potential for further gain if the trade works out and hits the full profit target. This basic model assumes that I have a success rate of over 50% on all of my trades in order to turn a profit. By closing the rest of the position at +120 pips, my final risk/reward ratio comes out to 1:2.5. Here’s the basic math, assuming 5 contracts are traded:
Closing half to secure 1:1 risk/reward, final result 1:2.5 risk/reward assuming final profit target hit:
Stop Loss (Risk) = -40 pips * 5 contracts = $-2,000
Take Profit = 80 pips * 2.5 contracts = $2,000
Take Profit = 120 pips * 2.5 contracts = $3,000
Total gain = $5,000
Alternatively, closing the full position at +80 pips would secure 1:2 risk/reward
Closing full position at 80 pips, final result 1:2 risk/reward:
Stop Loss (Risk) = -40 pips * 5 contracts = $-2,000
Take Profit = 80 pips * 5 contracts = $4,000
There are many other variations of doing this, and the math is quite simple, but this is just one basic example of how to scale out of a trade while maintaining a proper risk/reward ratio. Ultimately, the most important factor to realize is that your risk/reward is not skewed or unaligned with your trading history and ability to pull in the number of pips you are targeting per trade.
There are 2 big levels here:
1.2655 (bottom of 1hr bucket)
1.2640 (intersection of diagonal trendline)
I went long at 1.2656 just in case 1.2640 didnt get hit. Because they were so close together, only 15 pips, it was worth risking the 15 pip drawdown just in case price wanted to go lower and try to grab bids at 1.2640.
If you look at the 1 min chart, you can see price making a jump when it finally hit the level. These kinds of little clues are the type of things I look for. I went long when I saw that, and only missed out on about 3 pips from the very low.
If the diagonal trendline was about 50 pips away, and price broke downside, I would have closed the first position for a tiny loss and waited for the bigger one to get hit. But in a case like this, it makes sense to hold onto the first one.
In regards to why this level was okay for me to fade, price has been crawling down at a slow pace all night, and 5, 15, hourlies are all cooked in terms of downside, and we havent seen any real sizeable retracements in the past few hours. Not to mention its just a big key area in general. If there is anywhere price is going to react, it was going to be around here.
The euro and pound have been dropping steadily over the past 20 hours on speculation of dramatic cuts in interest rates. Both are expected to announce cuts at around noon GMT today (7:00am EST - BOE 7:45am EST - ECB), with varying degrees of severity. The expectation on both is for a drop of 50bps, with the BoE announcing the possibility of a much deeper cut.
Based on the news that gets announced, we have a couple of possibilities. If the cut calls for more than just 50 bps, we are likely to see the pairs drop even further. From what’s being published across the world tonight, it’s a very good possibility at this point. If the cut comes in as expected, historically, we have seen little reaction, to a possible up-move driven by the equity markets increasing on a rate cut and currencies following along.
At 14:30GMT we have the ECB press conference, and this is where we usually see some bigger price moves of the number comes in as expected. Trechet has been notorious for ‘saying the wrong thing’ in regards to supporting the euro in the recent past, and comments in relation to growth and consumer spending are what usually does it.
World equity markets are falling lower, with the SPX taking one of the steepest falls it has seen in over a week. The change in interest rate from the UK and eurozone could lift the equity markets today, or lean into consolidation. I’m still leaning higher on the dollar, again keeping with the trend, but if we get an expected rate cut then upside potential on EUR, GBP is there. As I write, all of these pairs are quite oversold without a serious correction. GBP remains the most vulnerable to downside risk at this point.
Bottom line:
Selling pullbacks on GBP/USD, and EUR/USD prior to today’s announcement, buying USD/CHF. Upside pressure likely early on. There will probably be a correction of today’s downfall, but selling pressure likely to take precedence, but not until later. Announcement will dictate moves for the rest of the day. Looking for downside breakouts of 1.2795 on EUR and 1.5750 on GBP – not looking to fade immediately based on fundamental backdrop, though if pairs start to bounce might be worth a shot, being quick to reverse the position on any clear breaks. Major trendlines are still intact on both EUR and GBP (4hr). Look for violations of these around major horizontal resistance areas for longs. I don’t buy breakouts based on diagonal trendlines alone……most times this will fail. I need a good resistance area busted as well in order to tempt me.
Levels:
EUR has levels above at 1.2950, 1.3115, 1.3295 levels below at 1.2665, 1.2600, 1.2530, 1.2445, 1.2335
GBP has levels above at 1.5970, 1.6055, 1.6110, 1.6195, 1.6400, 1.6500 levels below at 1.5750, 1.5725, 1.5600, 1.5400, 1.5275
CHF has levels below at 1.1565, 1.1550, 1.1475 levels above at 1.1710, 1.1745, 1.1800, 1.1888, 1.1980
JPY has levels below at 97.40, 96.33, 96.07, 94.93 levels above at 99.44, 99.60, 100.55
Reading:
http://www.theglobeandmail.com/servlet/story/RTGAM.20081104.wibeurope05/BNStory/Business
http://www.bloomberg.com/apps/news?pid=20601083&sid=a3QRepsaVl4o&refer=currency
http://www.bloomberg.com/apps/news?pid=20601087&sid=aExXKDH9qqA4&refer=home
http://www.bloomberg.com/apps/news?pid=20601083&sid=aykUGI_BDLbo&refer=currency
Tonight’s news of Barack Obama being elected as the 44th President of the United States spiked the US Dollar, sending most pairs back considerably from daily highs and lows. The freshman Senator’s win had USD buyers across the board, bringing back former trends.
What we have now is a mixed environment. On one side we have dollar strength being driven by dollar strength alone and lingering poor data from abroad, and on the other hand we have the potential for equity markets to accelerate on news, sending risk-related pairs upwards. This pull, if strong enough, could bring USD lower today if pairs pegged to carry trades become more bid.
Tonight in Japan, the Nikkei is trading up once again, and the S&P index closed up considerably today, giving rise to any risk related pairs and bringing up base pairs with them. S&P futures are pointing higher as I write, and currently resting at 1008.50 resistance. A break of this targets 1034.00.
What is to be noted, however, is that the S&P is trading in a tight channel, and the lower level has become very fragile at this point. Any downside moves could accelerate quickly.
Crude has been seeing mixed sentiment in the past 3 days, as had Gold, but fading tonight and weakness noted. It hit resistance today rather hard today and falling off quite nicely. Gold has been in a sideways channel as well, and like Gold, falling lower tonight.
In times like these of mixed sentiment, I look for breakouts of key areas for bias, giving consideration to existing macro trends. Our current trends are still intact: EUR/USD short, GBP/USD short, USD/CHF long and USD/JPY short. I’m maintaining this bias on all, with careful attention being paid to the equity environment.
Currently short EUR/USD and GBP/USD. Key trendlines on hourlies are present on both, but ultimately looking for lower on these pairs. USD/CHF just the opposite; look for a breakout of 1.1800 to accelerate price. USD/JPY could get a lift higher, and if it does, I’ll be tracking the equity environment for any potential reversal points, but ultimately looking to sell it as well.
The Dollar Index
For the dollar, the macro trend is still up, though the disturbance of this yesterday sank the dollar index back to 85.00 support. The next support level lower rests at approximately 83.30, with a target on longs at 90.70. At this point, 85.00 has weakened, and any attempts to take it out should not be done with great difficulty. Regardless, it is still intact, and keeping with the trend, I’m long until I see confirmation (break below 83.30) otherwise.
Pair Focus: EUR/USD
Looking for a 'buildup and breakout' of current 1.2788 lows with initial target 1.2650, the next major support level down. Very little support on the way down here in between these marks. Look for intraday price action on 15 minute timeframes to confirm areas for sells. If pair jumps higher, looking for break of major diagonal trendline around key resistance areas to spear buying opportunities. 1.2920 another potential breakout upside point, being careful because short term resistance lies right ahead at 1.2960 area. Not many other major obstacles in current path; might have to wait out sideways movement for further volatility.
Levels:
EUR has levels above at 1.3048, 1.3150, 1.3290, levels below at 1.2673, 1.2650, 1.2525, 1.2442, 1.2333
GBP has levels above at 1.5916, 1.5982, 1.6107, 1.6172, 1.6228, 1.6400 levels below at 1.5760, 1.5725, 1.5605, 1.5550
CHF has levels above at 1.1750, 1.1800, 1.1888 (61.8% monthly), 1.1980 area, levels below at 1.1650, 1.1588, 1.1568, 1.1523, 1.1476, 1.1464 (long term level, 50% of monthly)
JPY has levels above at 101.36, 102.40, 103.00, levels below at 98.35, 97.88, 97.40, 96.50
Risk related pairs have been dropping steadily as well, though driven mainly by their base currencies today, and not JPY. Even on such bad PMI data being released, the SPX was able to close just about flat for the day and the pair has remained rather well afloat despite the news. Tonight, the Nikkei is strong and propping up world index futures for the time being, though I’m not expecting it to last. This could set a trend for higher equities today, but we are treading on fragile ground. Downside is still very vulnerable, and I would be much more inclined to sell any rally as it fatigues. Regardless, it’s a strong move we are seeing out of Asia tonight, and I’m watching other equity markets closely for any more follow through.
The dollar index bounced right off of 85.00 resistance turned support today and is heading back to where it started. Next major target is approximately 90.70.
In keeping with the trend, still looking to buy USD, with the exception of playing countertrend bounces. Again this equity rally could have us selling the dollar temporarily but hopefully only into more attractive levels for buys. I suspect we will get a good sized correction tonight (USD selling) into tomorrow if equities stay strong, but still feeling safer buying later on today and into tomorrow. UJ is the only pair I am skeptical to buy at this point, as its related to risk, unless it is willing to break highs at app. 99.70. I think if funds were truly dropping risk rapidly, as we’ve seen in the immediate past, UJ would have dropped far more than just the 100+ pips it did today. Keeping a close eye on it; using it as a meter.
Levels (I’m sketching together a guide on using these and will have it ready in the near future)
EUR (looking for sells, breakouts on lows) has levels above at: 1.2666, 1.2787, 1.2900, 1.3000 levels below at 1.2440, 1.2330, 1.2130 (50% of monthly)
CHF (looking for buys) has levels above at 1.8000, 1.1893 area (618% of 1.3283-.9644), 1.2000, levels below at 1.1686, 1.1590, 1.1480
JPY (looking for sells, breakout on lows and highs) has levels above at 99.70, 100.85, 101.30, 102.40, 103.00 levels below at 97.85, 96.40, 96.05, 94.90, 94.20
