Tag Archive: forex

Quora Question: “How long does it take for a newbie to learn Forex trading from scratch if he can dedicate 15-16 hours a day?”

littl121 post on February 19th, 2019
Posted in Trading Tags: , ,

I recently answered the above question on Quora.

” I won’t know how long it will take you. It took me 2 years for forex. Maybe I am slower. There are many elements to learn in trading in order to be consistently profitable – understanding market structure and determining the edges are just two of many. Money management, trading psychology, trading plans are also part of a plethora of learning required. Your personality, your emotional, financial support, and how you devise your learning also affect your ability to become a profitable trader.

Allow me to share my personal experience – hopefully it will provide an alternative angle.

Trading 15 to 16 hours a day, even in training mode, really screws up one’s life, so I don’t recommend it. (I did 7 days a week, averaging 15 hours to 20 hours days – over the weekends, I was catching up on reading, preparing charts, reviewing notes and strategies, reflecting – I was learning to trade 24 hour timezones, and 2 other markets beside forex. All these took me slightly more than 3 years from the day I started. )

It was a really wild ride, and draining – mentally, emotionally and physically. But every time I climbed back up, I grew stronger in every way. (But physical recovery took longer – that’s why I don’t recommend it.) I had the support of my family which helped me weather the ups and downs. I was also a different beast, and I had planned to learn trading years before. So I prepared financially, discussed with my wife, achieved much of my job goals, and when the time came, left my job and started to learn trading. (I had tried to learn trading whilst working – but work responsibilities were my priority so my trading did not progress significantly). Even so, my original plan – stupidly – was to achieve trading success in 1 year – ha ha ….

All that started in 2012. I now trade a few times a week, or once every 2 weeks – whenever the markets present opportunities. Trading in any timeframe can be profitable if you know what you are doing – short and longer timeframes offer different challenges and risk reward scenarios. Yes I benefited from trading, and will always be able to do so. But it has never been my long term plan to trade forever, so I spent the last 2 years learning to code, design and am automating my trading processes so I can move on to other challenges.

Learning to trade is a heavy commitment – be sure you know what you want.”


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The Most Consistently Profitable Trader Is Also The Best Loser

I saw this on a T Shirt recently –  ”Second place is the biggest loser”. Most of us are indoctrinated against losing. We sing praises of those who overcome impossible odds, we hail the champions, and we immortalize heroes. In schools, at work, we battle to win, we do not learn to lose.   Resilience is that resonant voice that picks up our spirits, and girds us in the face of adversity.   But to do well in an activity, where losing is a common occurrence that afflicts performance, we must learn to lose well. In the sport of Judo we first learn how to take a fall safely, in cycling we almost always fall off a bicycle before we successfully ride freely, and in boxing, we learn how to take punches correctly to survive long enough to fight back.

 

How often does a trader lose?

Analysts at Dailyfx.com, drawing from 43 million trades between Q2 2014 to Q1 2015, showed a large incidence of losing trades amongst Forex traders (between 40% to 50% of all trades). (Illustration below from www.dailyfx.com)

More Winnng Trades Than Losing Trades

No doubt, losing is common in trading. Thankfully there were more win trades than loss trades – in fact, anywhere from 50% to 61% (EUR/USD) were winners across the 15 most commonly traded pairs.

 

It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” George Soros

Yet despite this optimistic observation, trading results showed traders lost more money than they gained ultimately.    The average number of pips lost for each losing trade well exceeded the number of pips gained for winners.   (Illustration below from www.dailyfx.com)

Average Losing Pips Exceed Average Winning Pips

 

Why were the loss pips so much higher than the winning pips? Prospect Theory on risk behavior from Daniel Kahneman (Nobel Laurette) offers an intriguing explanation.

According to the theory,  we hate to lose more than we like to win.  This means if we have a choice between a certain probability of losing a sum of money (for example, 10% chance of losing $800), against a definite loss of a certain amount (say $50), we tend to try to reduce our potential loss or  even strive to turn a profit – we will not take the definitive loss even if the potential loss may ultimately cost us more.  A short term trader hanging onto a losing trade which ultimately becomes an unplanned long term investment, and various martingale strategies typify such an attitude. When we hit a winner, we do not let the trade run its profitable course.  Rather than wait for a higher prospective profit (and risk potential loss or profit erosion), we willingly settle for a concrete smaller profit, and perhaps shortchange ourselves on the full potential of the trade. Taking profits too early and the commonly accepted adage “you never go broke taking a profit” mirror this mindset.

So we hate to lose, we lose miserably, and we win miserly. That about sums it up.

Unless you have a superior edge like reliable insider knowledge or a magic crystal ball, losses in trading is inevitable. A consistently profitable trader must learn to roll with the punches on a regular basis like a boxer.   Only when we embrace this mindset, do we see the light for more rewarding trades.

 

Is 1 : 1 reward risk ratio enough?

When pursuing a proven strategy, we should not lose more than what is expected if the market turns against us - the best loser respects stops and entry limits.  To win masterfully, we need to let profits run. We can augment this by taking trades with reward risk ratio of at least 1:1 or better.  Dailyfx’s analysis of sample data concluded that 53% of the accounts operating on 1:1 ratio were profitable for a 12 month period, whilst only 17% operating on less than 1:1 reward risk ratio were profitable for the same period. This means a trader with at least 1:1 reward risk ratio is nearly 3 times more likely to be profitable than one who does not.   (Illustration below from www.dailyfx.com)

Equal reward risk ratio raises potential of profitable trade

 

Simple empirically driven principles …. with a caveat

So we can summarize, a consistently profitable trader accepts regular losses, uses correct strategies with at least 1:1 reward risk ratio, respects stops and entry limits, and lets profits run.  Doing these,  he minimizes his losses and creates opportunities for more winning pips.

The caveat – not every trading opportunity permits use of these suggestions. As a trader, you have to filter through conditions, and identify strategies and market circumstances that allow  exploitation of these recommendations and know when they are inappropriate.  If for example, your trading strategy is based on 5 min charts with momentum bursts, letting profits run in a volatile environment may result in fatal whipsaw stop-outs instead. If your strategy is powered by a stressor edge (example - war claims leading to demand for safe haven currencies), which over time have diminished in severity, it then becomes unwise to wait for a predetermined reward risk target  to be reached.  If you deploy high reward risk ratio strategies in short term volatile environments, you may  have to contravene common consensus with a suitable position sizing plan that thrives on high frequency, repetitive opportunities and perhaps even amalgamate with an adjusted martingale formula.

So we cannot blindly impute any principle into a strategy without clearly understanding its potential limitation.  Such dogmatism is suicidal.  However, traders can choose to abandon strategies that do not sufficiently  accommodate the principles described in the findings.  That is perfectly alright.

It is important to understand, our job is not to trade every opportunity or strategy. A trader’s mission is to trade only the highest probability opportunity or strategy and to win and lose consistently well in order to stay profitable.


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Less Risks, More Profits? Love Stress!

littl121 post on October 13th, 2015
Posted in Trading Tags: , , , , , , , , ,
    Nervy Third Quarter

The last quarter (June – Sep 2015) was a tragic tale with many acts. Some US$11 trillion was wiped out as stock markets were brutalized across Asia, Europe and US. Commodities accentuated their downward spirals, and funds continued their flight from emerging promised lands, (nearly US$1 trillion drained away over 13 months till July, much of it from China). For many days, depressive equities regulated the pulse of different markets, and there was even a brief period when desperate hands enthroned Euro as a pseudo safe haven currency. In Asia, we watched how the credit sound Singapore dollar was trampled when naysayers connected dots between China and Malaysia as Singapore’s top two trade partners. Later we witnessed the mighty US dollar being resuscitated in its invincibility. We saw how hopes recovered when China injected stimulus funds into the stock markets, and growing relief that a low Fed rate regime would likely pervade in the immediate future. Even when most equities started languishing in ranges, plummeting oil price drew an unwavering trend line as supply continued to flood the market despite expected decrease in seasonal refinery demand. Then of course, Glencore and Volkswagen provided the final act for the curtain call to end the quarter. Indeed through the many rampages, experts and soothsayers from economists, politicians, analysts, to business leaders and traders were finally singing the same chorus – we were in total crap.

    Stress Creates Advantageous Opportunities

So what did the astute, mercurial trader do? He embraced stress. In one of the most noteworthy third quarters, the world was launched in a clear trajectory on many fronts, and the stress driven events which evolved created many risk efficient, profitable trading opportunities.

An example was when China devalued the yuan on Aug 11, and stunned markets all around. The ensuing mania spurred a massive exodus from Asian currencies to the relative safety of European dominions. As events unfolded over the next few days, the Euro’s fairy tale “stability” (in recognition of ECB’s consistency) propelled the Euro upwards. During that week, nimble traders longed the Euro and Sterling but shorted China related currencies such as the Singapore Dollar, and the equity markets, particularly the unfortunate Hang Seng Index. Following that short episode, markets were still vexed by uncertainties, and the probability of a US rate hike diminished markedly. Given that environment, the Euro naturally climbed as risk averse investors continue to unwind the Euro carry and reduced short Euro hedges. Again it seemed so natural to long the Euro during that anxious period of low rate expectations and un-acquitted challenges.

What we saw was stress from significant events drove different markets in apparent pathways. Market players who were previously pursuing different agendas became united in one purpose as they bolted for the same exits with largely the same intent. These created clear sustained momentum in obvious directions. For a trader, this was a godsend – direction bias and strength permitted smaller stops and faster profit goals. Less risks, more profits. Hence anxiety over existing portfolios need not eclipse the lucrative opportunities stressed markets present, instead the trader should take prompt actions to exploit them.

More recently, the September quarterly close was itself a prominent event. September was the month liquidity was to return en massed after the summer siesta. In a way, it was convenient that Glencore and Volkswagen drove the US and European markets southwards. The downward trepidation in the last weeks was a necessary prelude to the spike up heralding September’s window dressing close. For this year at least, the markets rewarded such an attentive trader.

Next Quarter – Dining On A Buffet Of Opportunities

So what happens next? After the dust has settled, investors and traders will question what has really changed. Will volatility decrease? Has economic progress turned backwards? Do we have an inverted yield curve? Have the confusions that punctuated last quarter drawn any meaningful road map for the next? Are central banks any clearer than they were? Rather than be stressed over contentious answers – perhaps it is more rewarding to focus on what is going to be served in the most tantalizing quarter of the year.

The final quarter is usually the last opportunity for businesses to energize their earnings for the financial year. It is buffered with high liquidity, and potentially profitable opportunities such as October book closure for a large number of mutual funds, the earnings reporting season, change in seasonal demand for commodities such as oil, quadruple witching expiration, year-end window dressing and pressing deadlines for key decisions like the elusive Fed rate hike.

Not on the calendar are unexpected events that will again throw momentum in biased aims. Startling economic health revelations, and unanticipated statements by leading figures can provoke searing market responses. Speculation is rife that Japan and ECB may introduce more easing measures this quarter, whilst strategic maneuvers in the Middle East may whip up oil prices. In fact any high tension political drama can sound risk off alarms world-wide.

Of course, we also sleep under an ever descending ceiling of daggers – with receding liquidity in the bond market as financial institutions reduced fixed income inventories, and with much irony, living in the most debt burdened world since time immemorial. Combined public and private debt is now 265 percent of GDP in developed countries (a jump of 36 percent since 2007), and 167 percent of GDP for emerging economies (China alone owes 235 percent of GDP). Offshore US denominated debt has reached $9.6 trillion, and approximately 80 percent of the dollar debt in China are of short term nature. Can you imagine what will happen if the Fed really raises the rate this quarter?

The last quarter promises action galore and stress driven opportunities. A clear mind and a well-organized roadmap of information will help the nimble trader find trades with the best risk reward advantage. Will you be stressed or be ready for desserts? (OK a bit corny but I can’t think of anything better for now.)


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Edge, Not Direction Is The Basis For Strategy

littl121 post on September 29th, 2015
Posted in Trading Tags: , , , , , , , , , ,

Oft times I am asked where a particular currency is headed. My usual answer – I am a short term trader and have little grasp on forecasting currency direction. Some are smarter and ask whether they should buy or sell a particular currency. My reply – both are acceptable, insofar as they have identified a buy edge or sell edge before jumping in.

Which brings me to the point – a trader does not trade direction, he trades the edge.

This is not to discount direction, but with crystal clear thinking, direction is just the result of an edge in action. (What about momentum? Momentum is a bit more complicated, and can be used as an edge or be a mere spectator by-produce. But more of that next time.) So a trader can buy the US Dollar or sell the US Dollar, it does not matter if he has identified a worthy edge when he buys or shorts the currency.

Normally when I develop a strategy, I identify the possible edges, and then construct the most proficient set ups I can to take advantage of those edges. Conversely, if a set up appears, I want to know if the edges are in high probability play. Some traders advise when a set up appears, one must take the trade regardless how he feels – since emotions can convolute judgement. By all means, if that works for you, go ahead. That edge may lie in success based back testing, position sizing, continuous trend run and so forth. Truly, there are many ways to successfully skin a cat. Knowing how unpredictable the market can be, I be a fool to claim otherwise, and am merely sharing what I know works for me. But whatever method a trader employs, he must always be able to see the edge in what he does.

This passage may appear fuzzy and incongruent to some. It is not by deliberate effort or accidental thinking that I wrote in such manner. Either the reader understands or does not. If he does not, then he requires more screen time and reflection – truly that is the secret of seeing where the edge lies.


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Giving Up, Letting Go

A person’s journey is marked by the milestones he leaves in his wake. Imagine how short that journey will be if he keeps carrying the marker stones around.

Recently my son was preparing for his first story telling competition. The young lad slaved without break and was all pumped with vivid imagination. He finished his first draft with a flourish and gleefully showed me his masterpiece. Admittedly I was impressed, but there were key parts of his creative work that a first time audience would not be able to connect together. Hence crops of his work had to be rewritten, even deleted so the audience can embrace the simple joys of a good tale. His eyes began to ream red as he pondered the murder of his art. So I asked him – where was the value of a piece of work if the audience could not share in its delight. Which was more important to him – to show off his polish, or to share the joys of a wonderful story – and possibly even win the competition. Which was more satisfying?

And so it is with a trader’s progress, how much of his past successes and failures he is willing to let go in order to evolve. The trading guidelines, principles, learnt set-ups and trading patterns – all the hard work and sacrifices made to acquire those skills – to drop them and move on.

This is a mandated metamorphosis necessary to thrive in a market which continues to change regardless if we do. It is an emblem of maturity worn by those who continue to better themselves. The maturity to let go and the courage to push the envelope. But pride, laziness and a stubborn chain to past endorsements often restrain us. It is at such point, the journey stops.


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How Much To Bet?

littl121 post on October 17th, 2013
Posted in Trading Tags: , , , , , ,

Any financial market opened to risk taking is a casino.

A friend asked me how much to risk on each Forex trade.  I reprised what Ed Seykota has advised : Risk no more than you can afford.  Risk enough so the win can be meaningful.  If you cannot achieve both – don’t trade. That about sums it up:  How much one can afford to lose?  How much one hopes to make?  How good is one’s edge ie.  can it help you achieve both mandates?  (Ed Seykota is incidentally a great trend trader who generally does not risk more than 5% in each trade.)

The Bottom Line

Chande, in my previous post, has demonstrated the prospect of ruin by risking beyond 2% of equity for various probability trade set ups and pay off ratios.  For example if your payoff ratio is 2:1, you need to win at least 35 to 40% of the time to possibly avoid risk of ruin comfortably.  (Note “possibly”.)  Chande underlined the probability of ruin for stop losses amounting to 1%, 2%, or 3% of equity etc,  calibrated against the trader’s edge (payoff ratio and probability of winning).

An Optimal Bet Size

Ed Seykota with Druz proceeded to show that each trading edge had an optimal betting percentage – beyond which the returns start to dwindle.  The optimal “bet size”  or “optimal heat” for a 50:50 toss of a coin with a 2:1 reward ratio is 25% of equity.  The theoretical return is approximately 12.5% after a 50%  gain and a 37% drawdown.

Evidently, how much to risk and how much to bet are different concepts.  A trader may risk 10% of his equity by entering a position that uses 50% of his equity.  How much to risk is a money management decision.  How much to bet is a strategy decision depending on how good the trader’s edge is.

How Much Do You Want To Bet In A Casino?

The forex market is like a casino.  Casinos as a rule only offer games that favor their owners.  This is known as the House edge.  Gamblers in casinos usually engage in negative expectancy games.  That means if they play long enough, they will eventually lose everything in accordance to probability theory.

Several years back, I was engaged to develop a financial feasibility study for a casino acquisition in Macau.  In my diligence, I had the opportunity to confer with an old Don of the establishment.   One gem he shared was that a casino did not need to cheat.  All its games had built in advantages and safety valves.  The two key principles were simple – have a “small” house edge (eg. the double zeroes in roulette) so that gamblers think they still have a good chance, and keep the gambler actively betting for an extended duration (think free rooms, free drinks, no clock). Over time, regardless how much the player had won, he would likely give the winnings back.  This is the negative expectancy game.  Many would get “cleaned” out.  If the player had walked into the casino with $100, the casino would not mind letting him rake in profits.  As long as the gambler continued with the casino’s games, he would most likely give everything back, and more importantly – the “play money” he originally brought with him.  The gambler’s initial profits if any, were merely the casino’s “working capital” – (now even more conveniently “stored” on digitized prepaid cards – think QE).  It is only by taking over the player’s original equity, that the casino gets richer.     The casino is further assisted by the gambler’s psychology.   How often does one walk into a casino with a  mental stop loss and hopes of large cash winnings?  The gambler had already been primed to at least lose a pre-determined amount and is further seduced by greed.  He would be lucky if he only lost what he originally  intended.  But the casino’s edge is only a small percentage, would it not take forever to clean out the gambler’s original equity?  Well, how fast that happens depends on how much the gambler bets …….. (think trade size and excessive leverage for the retail trader).

Forex – A Casino By Any Name   (By the way, Singapore’s third casino is also third largest in the world)

The spread between bids and offers, the private collaboration between market makers,  and the confidential intelligence that bank dealers have  (eg. major customers’ buy and sell orders), are tremendous “house” advantage – not privy to the ordinary retail trader.  Additionally, many traders wrestle against unscrupulous brokers with dealing desks (some hidden), and unethical practices of widening spreads inordinately to pick off stops, “slowing down quotes” according to the win-loss profile of the trader, and ill timed slippages.   Brokers also know where the traders put their stops.   Many offer excessive leverage, marketing promises that are difficult to keep, and deceitful half truths disguised as trading advice.   Like a casino punter, nothing a retail player does can modify the behavior of the Forex market.   The odds against the ordinary retail trader are simply incredulous.  As with all negative expectancy games, the trader will have a higher probability of losing his complete equity the longer he stays in the game.

Is This The End Game For The Retail Trader?

What does the retail trader have – his edge, his money management system, the ability to control when to play and how much to speculate each time (bet size).

How a trader bets should depend heavily (not wholly) on how good his edge is.  Assuming the trader already has his basics in place – money management, sound trading psychology – then his edge and game plan will tell him how much to bet in volatile situations and in highly favored scenarios.

Is there a formula for bet size?

There are many formulas for bet size (eg. Kelly criterion, Fixed Fractional, Unit Betting ), and many are relevant when used with complementing strategies.  Bet size depends on the trader’s edge and his ability to take the “heat” (ie. stomach for the risk undertaken).   There is no one universal formulation.

But there is definitely a correct bet size according to one’s edge.  At the very least the trader’s money management system shall be able to suggest a maximum bet size for his account’s acceptable level of risk.  (That said, will you trust a strategy with no money management system in place?)

However many traders do not know how much they should bet on each trade or how effective their current bet sizes are.  Obviously, many traders do not know their edge and strategy well.  They are looking for quick answers.  They will complain of not being able to determine stop loss points, exit points, and some will even give the excuse, ” gotta to let your profits run”.

Let us be clear, there are successful traders who do let profits run, and there are others happy with predetermined exits.  There are traders with lenient stops, tight stops and even no stops (there are tactics for this).    Indeed successful contradictions abound.

Different game plans, different edges – yes, but each trader that is consistently profitable knows his edge very well.  The trader will know whether to reduce or run up his bet size when the odds are favorable, or how to vary his bet size to reduce risks and yet achieve targets.   His strategy and edge will tell him when and how to enter or exit a trade.  His strategy will clearly tell him what to risk if stops are too near, too far or cannot be identified.  His strategy will tell him what conditions are favorable, and how to exit based on signals.    If a trader does not know his edge well, and has no discipline to organize his trading game, he will not be able to size his positions.  Unfortunately, over time he will likely lose whatever amount he has won, regardless his bet size.  (Reflect on how casinos work.)

PS.  If the trader’s edge or its execution is unreliable, and falls below the market’s house advantage, then it will ultimately be a negative expectancy game for him.

3 good articles to read on money management are:  http://www.littledada.com/tag/money-management/ ,    http://www.investopedia.com/articles/forex/06/fxmoneymgmt.asp , http://www.futuresmag.com/2011/12/31/simple-money-management-wins-over-time


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Unrequitted Passion

littl121 post on September 29th, 2013
Posted in Trading Tags: , , , ,

Recently I completed work on a short term trading system based on holding a trade for a longer duration (approximately 4 hrs to 30 hrs holding time).  Before this I held my trades anywhere between 5 mins to 6 hours, and was used to trading exclusively in the first halves of the Asian and European sessions.  You can imagine how much havoc the longer holding period wreaked on my sanguine lifestyle.

I had to start accounting for volume peculiarities and changing behaviors on opened positions across 3 or 4 sessions (ie. Asia, Europe, US, Asia again).  I had to develop a system for scouting entry and exit opportunities across 24 hours  instead of only up to 6 hours previously.

Hence even when I was resting, eating, playing or sleeping, there was a burden to appraise the market for trade opportunities, position erosion, or profitability enhancement at critical timings  and at key price zones.  Done at stretches, this became debilitating and intruded into my family life.

As an opportunistic trader in equities, I am very comfortable holding positions in terms of days, weeks and months ( any equity held for more than a year generally means I am losing money on it….I am also terrible at holding intraday equity positions).  But Forex “short term swing trading” is mentally exhaustive.   I am not talking about the stress of losing money – that is an unhappy occurrence, but easily manageable.  Rather it is the stress of keeping pace with the market, keeping apprised of changing market behaviors in different sessions, watching profits evaporate and return,  making trade management decisions to add on or reduce position size, evaluating market movements for impact on later sessions etc .   Even when I was not trading, I was thinking about the markets.  How does such a trader truly rest?  Particularly one infatuated with understanding how the market dances.  I had to manage myself – otherwise it would be back to square one, when I first started trading – no day or night.

To cut the story short - the culprit is infatuation with the market – an obsessive passion for the market – regardless if the cause was addiction or as a replacement for something missing in one’s life.  When a person’s other priorities are not as favored as trading the market – he is in trouble.  It is as simple as that.  When we do not have other compelling commitments to look forward to, we are not fully detached from the market, we have no time to heal.  That means we cannot walk away with a quiet heart  at the end of each trading day — there is no end to the trading day.  We cannot leave the trading desk knowing we have something more pleasurable and important to attend to, and the trading result that day will not matter tomorrow.  There is a risk we return to the trading desk rationally composed, but emotionally disquiet.  Our emotions are likely to become more distorted, and we fall prey faster to the bad habits we have tried so hard to overcome previously – impulsiveness, the need to make up lost opportunities or losses, the need to jump on the wagon and increase our profits – because the music has not stopped  we keep dancing. Once I realized I was seduced by my compulsive need to develop this new trading system, I put in safeguards, and completed the system with rules and principles I can live with – life back to normal.

Then it occurred to me  why Livermore  might have “failed”.  Though he held membership in gentlemen’s clubs, enjoyed the opulent life, took vacations, had enviable companionships, he could never extract himself out of the market.  His life was the market.  He was one of the market’s greatest traders – and its infamous victim.  But what else was he?  Why did he pen “ … I was a failure…”?  Here was a man, whose mind never stopped turning, (he believed one had to be intelligent to trade the markets),  and ultimately he became emotionally attached to the trades that did him in. He took risks, but he was not a compulsive gambler.  He was bipolar but his decision making framework was smart and simple, and he had made similar decisions to run up or close down trades successfully many times.    But the latent emotional baggage would finally be too heavy one day, particularly after successive losses, and smothered his will to follow rationality.   Seduced by whatever the market offered him, he could not shake free -  too much of himself became entwined with the market.  Perhaps Livermore’s failure was his singular dedication to the market.  To him the market had become personal, but in truth the market never loves anyone back.

 


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Intraday Forex Trading – Help, where to place stops?

mango post on December 16th, 2012
Posted in Stop Placements Tags: , , ,

WHERE TO PLACE PRE-EMPTIVE STOPS

Should we place stops –  10 pips from entry?  At 3 times the ATR (average true range)? At the extremes of noise levels around support/resistance lines?  When price crosses a SMA support?   Must it be 10 pips – can’t it be 3 pips instead?  At the last pivot point or 50% Fibo retracement?  At the last swing high or low which shows clearly that the set up has failed? What about whipsaw?  Should we put the stops 20 pips from or maybe 50 pips from such a point?  Maybe we should not place a stop, and wait for price to rebound.  Simply pick the most conservative stop that meets money management guidelines? ….  Seriously??

There is no universal standard for putting stops, and every set up or strategy must have good logic (abeit sometimes subjective), for stop placement. Apply a universal stop, and what works with one strategy  will prove disastrous for another.

STOPS ARE CLEARLY DEFINED BY LOGIC AND TRADE MANAGEMENT

Successful pre-emptive stop placement is dependent on 2 skills – our ability to associate the rationale behind the set up we are using with its proposed stop(s), and how we make a trade entry.

As an example –  If our setup is a momentum motivated quick scalp with intended 5 to 10 pips profit target within 15 to 30 minutes, then preparing for a possible price retracement which shows a change of direction or shows overall momentum retarding,  will indicate where the stop should be. Most likely we shall need a fixed value mental stop (eg. fixed stop of 3 to 5 pips from trade entry).  Will a retracement of 3 to 5 pips be sufficient to show definitive change of direction?  Does it matter?  If the set up is to capitalise on impulse momentum generated by the market maker to take out obvious nearby stops within a 10 pip range, than a 3 to 5 pips stop is clearly compelled by money management guidelines.  Momentum retarding becomes the main trigger – we don’t wait for definite direction change.  If we widen the stop to 10 pips away, it may give  price a chance to rebound in the desired direction. Great if it works, but what if it does not?  We are gambling once we place a stop that is incongruent with money management guidelines, and  the reason why we took the trade (ie. momentum ramp up that should be sustained by stop catching).  If we maintain an open position after momentum slows down, and HOPE momentum will pick up again, we are gambling on faith.  Continuous misalignment between stop loss placement and this driven scalp strategy will likely ruin our equity account.

On the other hand, if our strategy is to catch stops in a retracement move over the next 3 hours for  20 to 40 pips average profits, then our stop will likely be a certain number of pips below or above that major support/resistence level coinciding with price action (eg. a reversal hammer with a long tail bouncing off the support/resistance level).  The trader may also consider the ATR value as well as money management guidelines (eg. 10 pips below the support if the ATR is 8 pips).  Should the stop be 10, 20 pips away from the support / resistance level?  That depends on the logic behind the setups we use and when we enter.  If we take a trade after a hammer reversal with a long tail, complemented with a following higher low or lower high, we can set a small pip value (eg. 3 pips) from the support or resistance level.  If price further bursts through a minor congestion in our favor, we can move the stop loss to the higher low or lower high.  If price fails, ie. it retraces violently towards  support/resistance, that means our setups (eg reversal hammer + possible 1-2-3) have failed, so why risk more pips at the support/resistance level in hope?  Some would question whether we be entering at a premium price -  does it matter?  Assess the reward risk ratios of both options, weigh the value of risk mitigation, and make a decision.  (By the way, I speak of setups in simple terms here to facilitate reading – but whether we even take an entry based on a “set up” depends on many factors – in the current example, this may include higher timeframe trend analysis, news release, whether price action has settled into a congestion/range or is likely to, estimated market liquidity.)  Setup strategies can be covered in future articles. What we are pointing out is  setting an optimal stop involves common sense regarding strategy and set up rationale, rather than just a “loss tolerance” money managemenet exercise.

NO STOP LOSS

No stop loss?  I know at least 1 person who does not put stop losses and trades successfully.   Some studies have shown that stop losses in certain market conditions actually impair longer term profitability performance.  Perhaps he is wise in such areas. I personally do not put stop loss on mid term equity investments, but I have non-monetary conditions for hedging or closing such positions (eg.  the company is not competing well in the industry regardless of stock price).  As for Forex, this trader  friend had been willing to take longer term trades, had been successful, so I do not argue against his results.  But I trust I generally sleep better than him.

That’s one part of stop placement – it depends on the strategic logic of a trading set up under prevailing market conditons.  How we enter a trade determines stop placement too - watch for that instalment in an upcoming article – Stops and Whipsaws.


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