Marc Walton on September 22, 2013
So there you are……you’ve done your homework……and taken the trade.
You found a great spot for entry, all signals were go, and you entered
the market. Within a few minutes of getting in the market though, you
find yourself in drawdown. You have a 50 pip stop and before you know
it, you are half-way there. You think “Well, if I thought my initial
entry was a good price to get in, I should really love where the market
is now and take another order.” “That will make it so much easier to get
to profit once the market moves in my favor, IN FACT, I won’t even have
to get to my original entry before I hit b/e.” Yeah…. the ol’
“dollar-cost averaging” philosophy. Although this works great much of
the time when you are investing based on fundamentals over the
longer-term, it can be a seriously risky maneuver when trading based on
technicals in the short-term.When I started trading forex, I had the unfortunate experience of having VERY good results right at the beginning. Why was this unfortunate?? Aren’t gains good??? In fact, I tripled my account in under 2 weeks of trading. What this experience set me up for though, was the confidence in my abilities that I did not actually posses and the willingness to take risks based on that assumption. After all, I had always done very well in equities buying on dips that scared away everyone else. In fact, I had been handsomely rewarded for aggressively buying stocks when the market crashed in the Fall of ’08 when I bought so many different sectors when everyone was looking for the door. I stopped buying in March of ’09 and rode my gains for some time and cashed out.
When I entered the forex trading arena, I had not been sensitive the changes I would need to make in the conversion from investing to trading. So there I was, with my first live forex account tripled in two weeks and I was ready to make more. I found myself with a losing position on the Usd/Cad and I decided to add another position since it was clearly at a better price than my initial entry. Not using any stops, I kept adding positions as my orders kept losing assuming that the pair would have to turn around. I watched my open, floating drawdown quickly increase as the pair continued to move against me. It never turned around.
Finally after a gut-wrenching 6 hours of watching my account dive deeper into the red (floating profit), my broker closed my losing trades before the account was fully “blown-out”. Yup, I vaporized 80% of the account in one night of reckless trading. That was almost the end of my forex experience and it took me 3 months before the word “trading” didn’t come with a bitterness and anger in my heart. It took A LOT of learning and experience with different strategies and systems to figure out exactly the depth of my bad trading on that fateful night so early in my forex career.
One of the things I learned from it, was although the “dollar-cost averaging” principle works pretty well in investing, you actually need to think completely opposite when it comes to successful day trading. What I am driving at here is rather than adding more positions to losing trades, you should be adding more positions to winning ones! There are two primary factors at work here:
1. The Trend is Your Friend
Oh yes, this old adage strikes again, and I’m not just talking about the “bigger picture” trend. The fact is that usually when you get your first entry right, and go into profit, you actually tend to do better than when the order goes against you. Much of the time, when you get the direction of movement right, it will continue for some time before making a reversal. Rather than fighting the direction of the market in the near or mid-term, you are going with the flow of the market.2. Risk, Risk, Risk
The MOST important factor here is how much total exposure to risk your account will take assuming the worst-case scenario. By adding a new order when you are already in profit, you have the option to move your original stop to b/e or better, therefore eliminating your original risk and potentially only risking your newest order or even less than that in the case of a chain of orders of more than 2. On the other hand, when you add a new order to one that’s already losing, you are simply adding more risk without eliminating any. Sure, if price turns around it is easier to reach overall b/e than if you hadn’t taken the second or third, etc… order, BUT if price doesn’t turn around you get hit for full risk on every single order. That can equal a big total loss.Let’s look at a quick example to illustrate my point. Let’s assume trader #1 adds one order each 20 pip move against their original position while trader #2 adds one order for every 20 pips in FAVOR of their original position. Both traders are using a 50 pip stop for each order and a 50-pip take profit. Each order will risk 2% of the account. Max of 3 orders.
Trader 1:
- Worst Case Scenario: Trade goes against position, 2nd trade is taken, then trade continues towards stop loss, so 3rd position is taken. Our total risk is 2% X 3 positions for a total of a 6% loss.
- Best Case Scenario: Trades go against trader, but just enough to get 3 positions into the market and then market goes into full t/p for each of the 3 orders. Total risk is 6% but gain is 6%.
- Alternate Scenario: Trade just goes into profit without drawdown. 2% risked for a gain of 2%.
Trader 2:
- Worst Case Scenario: Trade goes against initial order all the way to stop. 2% risked, 2% Lost
- Best Case Scenario: Trade goes in favor of order, second trade is taken and first stop is moved to b/e, and then trade continues in favor to 3rd order which now places first stop at second order b/e. Total risk=0% Total gain=6%. Keep in mind, that the worst possible risk at any time during this process is 2%, but never more because new orders are opened, older orders are adjusted.
- Alternate Scenario: Trade just goes into profit, all the way to the third order, and then reverses and stops everything out. Total Risk=2%, Total Loss=little more than 1% (1st order is +20 stop at third order opening, 2nd is b/e stop, and 3rd has the risk of full s/l)
Now let’s get more extreme and imagine a 300-pip move for both traders with no limits on how many orders they can open.
You can see trader 1 is ALWAYS adding more risk by adding new orders while trader 2 is ALWAYS reducing risk by adding new orders. Trader 1 is fighting against the prevailing movement of the market while trader 2 is always going with the movement of the market. And think about this, by the time trader 2 is on their 4th order, they are guaranteed some sort of a win, while trader 1 is risking 8% of their account and has a ways to go before overall b/e.
No matter what, trader 2 never risks more than 2% in ANY market conditions, while trader 1 has risk only limited by the number of order they are willing to place. Of course, whipsaw markets can affect the outcome of either trader, but the risk is guaranteed never to be more than 2% for trader 2 and trader 1……better hope for ideal conditions. Ask yourself this “Would you rather only ever be on the hook for 2% to gain potentially much more, or would you rather risk a % to make that same percentage back in the best case scenario only?”
So I now know to add to winners, and just let my losers go. Although this may fly in the face of good investing, day trading requires not only a new set of tools, but a new psychological approach as well. Pyramiding when you are winning can greatly enhance your gains while never adding risk, while doing this when you are underwater adds extra risk without compensating you adequately for it.
Forex Weekly Analysis for Week Beginning September 22nd, 2013
FOMC (Funny Our Market Crashed) came and went and it brought with it some moves!! It has been a more important time of the month for the last few months, even bigger than NFP. The market keeps holding its breath waiting for Ben and friends to crash the party. They keep reassuring the market they won’t stop making “liquor runs” and force the alcoholics (banks) to stop drinking the free booze (Quantitative Easing). Oh boy. This saw many pairs break above areas held for some time. But it didn’t cause massive breakouts across the board. By week’s end, the results look mixed. Use caution this week, because although I am seeing a lot of signs of big trends getting under way, there is still reason to think we might see some reversals first. Overall though, it seems Fall is really starting to get under way and great trades are out there to be had.Euro/$: We broke 1.3400 on the weekly!!! Hooooraaayy!! Yes, finally!! And that’s going to be the area of focus going forward this week. Although I don’t normally like to just take trades because of 1 reason, 1.34 has been such a strong area, I believe it is worth a look. Of course, if we slip further, 1.3300-1.3318 looks REALLY nice for longs. Amazing as they usually are, fibs are giving us lots to talk about. Check video for much more detail.
Gbp/$: Looks so bullish, yet couldn’t break above important area of 1.6050 to end the week. That is the 78.6 fib of the last major down-move and also a prior area of horizontal support and resistance. Ideally, I would like to long on a breakout above this area. Of course, we may slip a bit first. As I discuss in the video, don’t mess with trades in between 1.6050 and 1.6000. Long above that “zone” or short below but don’t get caught in the middle. Check the video for a long discussion about that. Pullbacks to 1.5850 will have me also interested for a long.
Aud: . Seems to be the clearest pair to read. We have cleared .9300-.9325 although I would gladly take longs from that area if we pull back there again. We finished the week right at .9400 which was my last bearish line in the sand. Moves above this area are a super clear signal to me that the Aud/Usd is back on the march upward. If the market reacts to this area, I will take trades from it but will NOT simply take a long from there at market open Sunday. Check the video for all the details.
Euro/Gbp: A little tricky at the moment but we did have a bullish engulfing candle formation on the weekly. That should indicate a reversal after the prior 3-week move down. Problem is we have a bit of “traffic” in the form of EMAs and trendlines above and below where price is now. I would ideally like to see a breakout above .8600 for a long, but that is a ways off from now. Counter-trend traders might be thinking of shorting at around .8500 for a few different reasons, although it’s a stretch that I would call it a “counter-trend” trade since the last three weeks prior to last week were bearish. Either way, be careful trading this pair. I discuss all the options in the video.
$/Yen: This pair is being a stinker at the moment. I’m only interested in a trade on this pair (long) if we get a solid daily break above 100.00. Check video for details.
Euro/Yen: After the failure of breakout at 132.50 a couple of weeks ago, this pair blasted above this area and stopped cold at the trendline we have had in place for some time as well as the horizontal s/r of 135.00 That becomes the new area to look for a long trade if we break above it. Pullbacks again to 132.50 for a long would also work for me. Check the video for more info.
Aud Yen: Like the Eur/Jpy, this pair made a failed breakout attempt of the important area of 93.00 a couple weeks ago. This last week’s breakout seems more legitimate, BUT we still couldn’t finish the week above 93.60. I am definitely interested in an M2 trade above and from this area. Pullbacks to 93.00 will also have me interested in a long. Check video out for more details.
Cad: Gadzooks this pair is tricky. Sure we had a weekly close that seems to look like a pretty big pinbar reversal candle. BUT, it wasn’t “ideal” (long wick, but wrong colored body). I am steering well clear of this pair unless we break back above 1.0400 again. I cover a couple extra angles in the video for the adventurous. .
New members please note: If I am looking to take a trade long, at for example 1.5000 , I place my order 10 pips above & 10 pips below for a short. This is because price often does not quite reach a major line and you need to allow for spreads.
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Hope you enjoy the analysis!! See you Wednesday for an update!! Best wishes and happy trading to all!!!