Slow and Steady Wins the Race
Like a locomotive that is slowly traveling from one part of a country to another, slow and steady investing is about taking things easy-enjoying the ride, and not stressing about the time it takes to get where you’re going. Chapter 6 talked about how investing in the forex market is slightly different from investing in the stock market. The high amount of leverage available to forex traders magnifies profits and losses, which is why the holding period of currency investments tends to be shorter than that of equity investments. In this chapter, we will talk about different ways to join moves that last for weeks.
One of the most memorable moments in my career was when John Bollinger, the mastermind and namesake behind Bollinger Bands, stood behind a crowd and watched me show traders in Singapore the Double Bollinger Bands. He said to one of my colleagues that it was a “clever way to use the bands.” Of the hundreds of technical indicators out there, the Double Bollinger Bands are hands down my favorite. Through the years, the bands have become a critical component of my trading. The reason I really love the Double Bollinger Bands (BB bands for short) is they provide a wealth of actionable information. They tell me whether a currency pair is in trend or range, the direction of the trend, and when the trend has exhausted. More importantly, Bollinger Bands also identify entry points and proper places to put a stop.
Bollinger Band Basics
Before describing how the Double Bollinger Bands work, it is important to first explain them. Bollinger Bands consists of three lines-a 20-period moving average, which is the center line and then the upper and lower lines, which are basically a specific standard deviation away from the moving average. Just imagine a two-lane highway with a center divider that is the moving average and barriers on either side, which are the standard deviations.
The default Bollinger Band parameters on most charting packages are 20 periods and two standard deviations. Although understanding the math behind how the bands are created may be complicated for some, the way they are used is more important and simple to grasp.
The purpose of the bands is to determine how high or low a currency pair has moved in relation to the average price over the past 20 periods. Two standard deviations are considered quite rare because, in Statistics 101, it is said that 95 percent of all activity should fall within two standard deviations of the average and only 5 percent should fall outside of that amount. Applying this to currencies means that when the currency pair reaches the second standard deviation band, the movie has hit an extreme point because the idea is that 95 percent of the time the currency pair trades between the bands. However, the problem with this notion is that a quick look at currency charts overlaid with Bollinger Bands will show that reaching the extremes happens more often than we would think. We all know that currencies can travel in one direction for a long time, and there will be instances when it touches the Bollinger Band five days in a row, turning a once-in-a-lifetime event into a common occurrence. This is why we developed the Double Bollinger Band Method, which we believe is a far better application of Bollinger’s work.
The Double Bollinger Band Method consists of using two sets of Bollinger Bands. In addition to the second standard deviation Bollinger Band just mentioned, we also use a first deviation Bollinger Band. The centerlines (or medians) are excluded because otherwise, the charts become very messy and crowded. Exhibit 8.1 shows how the Bollinger Bands would look on a daily chart of USD/JPY. The two outside lines are the second standard deviation Bollinger Bands and the two inside lines are the first standard deviation Bollinger Bands. Once the Double Bollinger Bands are set up, they can be used for identifying whether the currency is in a range or trend, if and when a trend has exhausted, where to find value within the trend, and how to get into a new trend.
Exhibit 8.1 Using Double Bollinger Bands with USD/JPY
The most important thing that the Double Bollinger Bands do is answer the $500 million question of whether the currency pair is in trend or range. When a trend is very strong, most of the currency pair’s price action will be confined within the one and two standard deviation Bollinger Bands. The Double Bollinger Bands also determine the direction of the trend. The two bands at the lower part of the chart capture the downtrend while the two bands at the upper part of the chart capture the uptrend.
Getting into a New Trend Finally, the Double Bollinger Bands can also be used to get into a new trend. We have talked about how a currency pair is in an uptrend when it trades between the two upper Bollinger Bands and in a downtrend when it trades between the two lower Bollinger Bands. Yet at some point, it had to get into the bands first, and the point where it enters the uptrend or downtrend zones creates an opportunity to join a new trend that could be emerging. When the currency pair ends the NY session (4 p.m. Eastern Time) within the first and second bands, there is a reasonable chance that it will remain within the bands for days to come.
Take a look again at Exhibit 8.2. Starting from the left to the right of the chart, the first arrow points to a day when the GBP/USD has gone from the range-trading zone into the downtrend zone, and the next day, there was a continuation. The continuation was not very significant because it only lasted for only 24 hours before the GBP/USD recovered. However, three days later, the same pattern occurs, where the GBP/ USD once again closes within the downtrend zone, but in this case, it becomes a strong move that lasts for almost a month. The first example is the scenario that occurs more often, but the second scenario is not all that uncommon either. As a result, it is critical to employ the T1-T2 way of quitting the trade because we never know whether it will become a minor or large move. We can hope that all of our Double Bollinger Band trades will lead to a new trend that will endure for weeks, but we must also be realistic and accept that the move may only last a few hours. As a result, seize your winnings early and let the market decide whether or not to reward you with extra profit. The chart’s third arrow from the left reveals another close into the Double Bollinger Bands, this time into the uptrend zone.
Unfortunately, this is a failed trade and I always like to show losing trades along with winning ones to remind everyone that no trading strategy will work 100 percent of the time. Finally, the fourth arrow from the left of the chart shows the GBP/USD once again closing into the uptrend zone; this time, it indeed marks the beginning of a prolonged uptrend that lasts for almost a month.
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Bag Your Winners Quickly
Although staying with the trend will give you an edge in trading forex, the real secret to developing consistency is to bag your winners quickly. Most traders spend hours and hours looking for the perfect entry point and barely give their exits a passing thought, but it is the exits that can separate the winners from the losers. When I was trading at a major investment bank, I sat between two experienced forex traders named Tom and Masa. One day, they went long and short the EUR/USD at the exact time. By the end of the day, both were profitable. Why? Because Tom was only looking to make 20 pips on a large position and remained in his trade for less than an hour while Masa nursed his trade for most of the day, rode out the initial losses, and waited for the currency to turn around and hit his profit target of 50 pips. The entry, in this case, did not matter at all because Tom and Masa took opposing positions at the exact same time. Instead, what made them both winners was their exit.
In Trading or Investing 101, all of us are taught to maintain a strict 2 to 1 risk/reward ratio or better. In other words, for every $100 risked, we need to look to make $200. The reason is that we need to be right only 50 percent of the time to be net positive and even less if the risk/reward ratio is higher. For example, if you had a trading strategy that risked 50 points for a return of 150 points on every trade, you would only need to be successful 30 percent of the time to be a net positive. In other words, if 7 out of 10 trades were losers and 3 were winners, the net return would still be 100 points. Sounds attractive, right?
The standard trading advice is to have your winners be much larger than your losers, but anyone who has traded currencies has most likely experienced the frustration of watching the trade turn profitable, but for one reason or another, the profits start to disappear like ice cubes in your hand and eventually turn into a losing trade. The problem is that markets are generally not that generous, and for some traders, 2 to 1 risk/reward ratios may be ideal but not realistic.
Imagine a short-term trader who is only looking to risk 35 pips on a given trade. To keep with a strict 2:1 ratio, he would need to make 70 pips on the trade. However, on any given day, a currency pair only moves an average of 100 pips, which means that in the isolated amount of time that he is available to monitor the trade, he is looking to make 70 percent of an average day’s move. Another possible scenario is that our trader plans to make 20 pips per trade. Under a 2:1 ratio, he needs to set his stop at 10 pips. However, a 10-pip stop can be clipped in the blink of an eye, particularly since the spread reduces the stop by 2 to 3 pips, depending upon which currency is traded.
An overly ideal risk to reward ratio encourages traders to try and take more from the market than is being offered and may encourage scalpers to use excessively tight stops. So how do you overcome this? By using the T1-T2 method.
To minimize the risk of letting profits melt in their hands like ice cubes on a hot sunny day, many professional traders like to bag their winners quickly using a T1-T2 method to exit their trades. Ti simply refers to Target 1 and T2 refers to Target 2. Not only have I met many traders who say that the TiT2 method has transformed their returns but I use this methodology in my own trading. The idea is to have a conservative, relatively easy-to-achieve first target and a more ambitious second target. So if I am looking to risk 40 pips on my trade, my first target should be approximately 40 pips. In order for me to be net positive, my strategy needs to hit 60 to 70 percent more winners than losers. However, with a smaller first target of 40 pips, the chances of the limit being reached can be greater than a target of 70 pips. When the target is hit, I would close out half of the position and move my stop to breakeven on the remainder of the position. The idea is to limit your losses to your initial entry point. If the trade continues to move in my favor, then I will trail the stop to lock in more profits. If the trade moves backward to stop me out at my initial entry price, which is known as breakeven, the overall trade would still be a positive one because I banked profits on the first half of the position.
Sifting thru the Headlines
Taking an alternate primarily based totally on an information launch may be volatile due to the fact the markets are extraordinarily unstable after the discharge and agents should widen their spreads. However, if we’re speedy and livid with handling the alternate and stay with the fundamental pairs (pairs ruled via way of means of the greenback), buying and selling information releases can nevertheless be fruitful.
When buying and selling the information, there are 3 questions that we want to invite ourselves earlier than each alternate: Is the information vital? Is the marvel huge sufficient? And is the marvel in keeping with the marketplace’s sentiment?
- Is the information vital? The first mission to hand is to determine what subjects and what don’t. Just as it rains these days has no importance except we had been in a drought for the beyond 3 months. In Chapter Five, we indexed the pinnacle 3 portions of probably marketplace-transferring monetary records for any country, which can be the employment reviews, retail income, and production and provider area interest records, additionally called the ISM or PMI reviews. In addition to those, the Gross Domestic Product (GDP) releases and the inflation reviews (purchaser and manufacturer prices) also are tradable. What isn’t always tradable are reviews just like the Beige Book due to the fact there may be no concrete range for comparison, records are launched weekly, and any Japanese or Swiss monetary reviews are nearly usually overshadowed via way of means of the overall sentiment withinside the marketplace. If you’re having a difficult time identifying if the records are tradable or now no longer, maximum foreign exchange websites will list the effect that every piece of records may also have on the foreign money. High-effect activities are those that we need to alternate.
- Is the marvel huge sufficient? The 2d query is the trickiest of the 3 due to the fact it’s miles of a challenge to interpret, however, the exact factor is that the marketplace will typically do the translation for you. As a rule of thumb, if the range is more or much less than the forecast via way of means of greater than five percent, it’s miles taken into consideration a large marvel, however, every now and then a 2 percentage marvel is sufficient to elicit a large response withinside the foreign money. So what do need to you do? Just be patient with how the marketplace responds to the discharge. If the foreign money pair slightly budges, then maximum likely, the marvel isn’t always that significant. If the foreign money pair without delay shoots better or falls like a rock, there is a great hazard that the marketplace changed into surprise. The key’s to attend 5 mins earlier than moving into the alternate to make certain that the foreign money responds in the manner that it is meant to. In different words, a fantastic marvel needs to pressure the foreign money pair better and a poor marvel needs to pressure it lower.
- Is the marvel in keeping with the marketplace’s sentiment? The 1/3 query is vital due to the fact every now and then the monetary records are something that we’d generally assume to elicit a large response, however, for something motives, the rally fizzles fast or investors genuinely do not care. This generally happens whilst something else is overshadowing the records and using the overall sentiment withinside the foreign exchange marketplace. It can be something from the hazard urge for food to U.S. records or issues approximately issues in Europe. If the monetary records marvel or “basics” is in keeping with the triumphing sentiment withinside the marketplace, it’s miles a more potent alternate. In different words, if the marketplace desires to shop for greenbacks and retail income is strong, it generally offers foreign exchange investors a good higher purpose to ship the dollar better. However, if the marketplace is involved approximately the outlook of the U.S. financial system due to the fact the Federal Reserve is cautioning that there might be a greater problem to come, then exact records won’t do a whole lot for the greenback due to the fact it might be checked out with skepticism.
Quantifying a touchy-feely factor together with the triumphing sentiment withinside the marketplace may be difficult, however, transferring averages can assist due to the fact they degree the modern-day fashion withinside the marketplace via way of means of averaging a positive range of beyond prices. If the records are ideal and the foreign money pair is buying and selling above the 50-length transferring common on a five-minute chart (or the records reasons the foreign money to interrupt above the transferring common), then there may be a higher hazard that sentiment and basics will assist the alternate. However, if the records are ideal and the foreign money pair is buying and selling nicely beneath the 50-length transferring common, then it indicates that the triumphing sentiment does now no longer assist the monetary marvel. In this case, we can now no longer take the alternate due to the fact we need to have as many key variables aligned with our preference as possible.
To summarize, we best need to alternate monetary records this is vital, with surprises that are huge sufficient to cause a response withinside the foreign money, and best if the monetary records are in keeping with the overall sentiment withinside the marketplace. With those tips in hand, allow me to display to you ways speedy and livid information buying and selling works.
Sticking with High-Probability Trades What professional traders look for are the “high-probability” trades or the ones with the most variables aligned in their favor. Here are some secrets to determining whether a trade is a high probability or not.
Let’s say that the EUR/USD is in an uptrend and also you see a possibility to shop for the forex pair on a retracement or dip. If you had been buying and selling merely on what you noticed in an unmarried chart or setup, you will maximum possibly simply dive proper in and buy. Unfortunately, this is similar to riding down the street with blinders on! At a minimum, it’s far vital to test the overall fashion withinside the marketplace due to the fact being blind to your surroundings can cause pointless risks.
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Fundamental and technical signs in addition to marketplace sentiment are 3 elements that could have an effect on each alternate. If you may look ahead to the one’s elements to line up to your favor, you’ve got got a miles more threat of decreasing your hazard and touchdown an ability earnings. Ask yourself those inquiries to assist determine whether or not an alternate is really well worth the hazard or now no longer:
- How deep is the retracement or dip? Imagine you accidentally reduce your finger with a knife whilst reducing vegetables. The deeper the reduction, the longer it’ll take on your finger to heal. If it’s far only a shallow slice, then a band-resource will do the trick however in case you accidentally chopped off a part of your finger, then it’s far a long way extra complex and a sanatorium go to could be necessary. In buying and selling, a totally sturdy retracement or dip is lots extra tough to get over than a shallow decline. Therefore, shopping for after a deep correction in a normal uptrend is normally a decreased opportunity alternative to shopping for after most effective a small retracement. Just as a deep reduction will increase the hazard of dropping a finger, a deep correction will increase the hazard of the forex pair breaking its uptrend.
- Is there an awesome essential purpose in the back of the decline withinside the forex pair? If the decline withinside the forex pair turned into brought on via way of means of totally disappointing financial records including an abysmal document on patron spending, then it’s far a decrease opportunity alternate that you can need to rethink due to the fact short-time period basics aren’t for your side. However, if there may be no essential purpose to give an explanation for the dip, then the coast is apparent and there may be a more threat that the uptrend will resume.
- Could tomorrow’s information launch harm the alternate? When buying and selling the EUR/USD, it’s also vital to test to peer if there may be a bit of Eurozone or U.S. financial records scheduled for launch over the subsequent 24 hours that might have an effect on your alternate. For example, if German retail income is on the calendar and the marketplace believes the records might be sturdy, it creates the backdrop for a better opportunity alternate. This could additionally be actual if there may be U.S. financial records on the calendar that the marketplace expects to be weak. However, if there may be a purpose to consider that the German records will marvel to the drawback or U.S. records will marvel to the upside, then it can be higher to skip at the alternate.
- What is the overall sentiment withinside the marketplace? Does it guide the alternate? Considering the overall sentiment withinside the marketplace, called its “hazard urge for food,” is likewise very vital. For example, if the Dow plunged three hundred factors, there is a great threat that the Asian markets will alternate decrease withinside the subsequent consultation due to the fact if American buyers are nervous, there is a great threat that Asian buyers may be as well.
Therefore, it can now no longer be this sort of appropriate concept to shop for the EUR/USD on a dip after a pointy sell-off in shares due to the fact the dip ought to become in additional losses if Asian buyers be a part of at the selling. However, if hazard urge for food is regular and equities ended up, flat, or most effective barely decrease, then the coast is apparent. If the hazard urge for food is simply effective with buyers positive sufficient to rally shares, then there may be a more threat that the rally withinside the EUR/USD will resume.
- Which key stages ought to have an effect on the alternate? Key stages on a chart, or technical signs, also are vital. If the dip withinside the EUR/USD stopped simply above a good-sized guide stage like 1.3000, assuming the guide stage maintains to hold, going lengthy EUR/USD could be a better opportunity alternate. However, if it broke under the guide stage, then there may be scope for extra losses if the guide will become resistance. In this case, it can be higher to skip at the alternate. These 5 questions are recommendations that may be carried out to each buying and selling and making an investment however they’re now no longer guidelines that might be set in stone. Oftentimes the solutions to those questions will war and this is while our judgment has to be used to decide which elements are extra and much less vital.
If You’re a Short-Term Trader …
For short-time period buyers, there are extra factors that may be taken into consideration to create even better opportunity trades.
One yr after I turned in at a buyers’ convention in Florida, I met a tall middle-elderly dealer named Dave, who stated he turned into having a tough time turning earnings in his foreign exchange buying and selling. I requested him to inform me a bit approximately his buying and selling approach. He replied via way of means of announcing he loves to search for breakouts. I pressed for extra info and he defined his buying and selling day.
Dave is married with kids and works as a full-time accountant in the course of the day-an average American lifestyle. He comes domestic from work, has dinner together along with his spouse and kids, watches TV for approximately an hour, is going into his domestic office, activates the computer, and starts offevolved buying and selling. He begins offevolved via way of means of drawing trendlines on 5-minute charts to seize the variety during the last few hours after which appears for breakouts. What is inaccurate with this picture?
The trouble is that once Dave receives round to buying and selling, it’s far about eight p.m. East Coast time, that’s the start of the Asian buying and selling consultation. Unfortunately, that is the time when extra “fake-outs” than breakouts arise due to the fact the start of the Asian consultation is generally one of the quietest instances withinside the forex marketplace. Most of the essential currencies are generally alternate in very tight tiers between the cease of the New York buying and selling consultation (round four p.m. Eastern Time) and the start of the European buying and selling consultation (round 2 a.m. Eastern Time). In this approach, Dave is searching out breakouts at the worst time possible. Therefore, in relation to short-time period buying and selling, different factors want to be taken into consideration:
- Is it the proper time of day for my buying and selling approach? It is vital to realize that positive instances of the day are extra appropriate for positive buying and selling strategies. Very regularly currencies might also additionally vary in a variety earlier than a vital U.S. financial launch, however, the worst issue to do could be to try and select out short-term tops and bottoms at that point due to the excessive hazard of a breakout. If a breakout or trend-following approach units up while the European and U.S. markets are each open, then it creates a better opportunity to alternate due to the fact there are sufficient members withinside the marketplace for gasoline continuation. If a breakout or fashion-following possibility offers itself every other time, we want to be a chunk extra skeptical approximately the pleasant of the alternate.
- Is this the first-class forex pair to alternate? Picking the proper forex pair to alternate can imply the distinction between a hit and unsuccessful trades. In speedy and livid information buying and selling (Chapter 9), we most effectively traded the majors, however, that might not constantly be the first-class option. For example, there are numerous instances wherein U.S. and Canadian financial records are launched at identical times. If the Canadian records could be very weak, one could anticipate that the first-class forex pair to shop for after the information is launched is USD/ nic records are more potent than expected, however, if it’s far weak, then the U.S. greenback and the Canadian greenback ought to each decline, main to no essential continuation in USD/CAD. In that case, it can be higher to don’t forget to express the Canadian information alternate via every other forex pair including AUD/CAD or CAD/JPY, a good way to be much less suffering from the U.S. financial records. The identical is actual when you have an awesome piece of European records however the marketplace is bullish closer to the greenback for one purpose or every other. Then possibly shopping for euros in opposition to the pound is the better opportunity alternative.
These are judgment calls that short-time period buyers need to make on the time of the alternate, and they’re vital due to the fact they could imply the distinction between a hit and an unsuccessful alternate. It’s really well worth the greater minute you will take earlier than diving right into an alternate.
