Forex Success – Top Ten Tips (Part 2)

So you have opened a position at what you believe is the right moment, now what?  How do you manage that trade in the best way possible?

The moment of greatest possible exposure to risk in Forex occurs in the first few minutes after opening a trade.   Account erosion (the leading cause of blown accounts) occurs due to being stopped out repeatedly.  How do you select your entry point and protect your investment at this critical moment?

Unlike other market instruments (e.g. the stock market), the margin for error in Forex is extremely tight.  Gaining mastery of the Forex instrument requires a high level of precision.  If traders lack knowledge or skill in a particular area, this market will be anything but gracious about it.

In preparing this section, it has been necessary to assume that most readers are across the TA basics. The focus is on tips to help with Trade Management and to extend a trader’s existing knowledge of TA tools that work consistently well in Forex (with some allowance made for bringing new traders up to speed).

There is no universally right or wrong way to approach TA or for that matter, trading style (swing, intra-day or scalp).  Every trader has their own style and preference.

That said, scalpers bear the highest possible level of risk since the moment of entry (and frequent entry) is the time of greatest exposure to potential trade failure.  Nevertheless, some traders become very proficient scalpers, trading within the body of moves already in progress and prefer this method of trading over swing or intra-day trading.

What can traders do to maximise their chances of success?

1. Select Your Precise Moment of Entry Carefully.

Getting on board the Forex freight train while it’s still moving is not a simple task.  Precision in execution at this critical juncture is extremely important.

Wait until you have solid evidence that price momentum has expired or peaked -

* Look for evidence of sellers or buyers coming in to the market at that level.
* Look for bullish engulfing or bearish engulfing candles in the 1M charts, 5M charts and 15M charts and hammers/inverted hammers in the 5M or 15M charts.  The higher the time frame (e.g. 15M upwards), the more reliable the candles (or bars) become.
* Wait for price to test.

Don’t rush into a trade just because it reaches your entry point.  Wait for price to test.  Wait for evidence that confirms your choice.  Price may overshoot before recovering.  Keep your finger off the trigger until you see visible evidence that it is about to change direction.  Price may arrive at your entry point but that does not necessarily mean other traders believe similarly and are going to buy or sell at that point – you need to see hard evidence that selling/buying is occurring in sufficient volume and with sufficient consistency to generate a reverse move (or further extend an existing directional move).

What you are looking for at entry is speedy immediate results as soon as the trade is opened, that is, at the time of greatest risk, the trade quickly moves into profit. Unless buyer/seller support has been established (it has legs that hold), getting your trade into profit quickly won’t happen.  The objective is to capture the right “shoulder” of a price move at the exact moment it begins to gather steam and accelerate.

Successful traders recognise that price will grind on support or resistance levels more than once before changing direction; they wait for evidence of buyer or seller support coming in and for that support to be tested before getting on board; they seek to time their moment of entry with precision in order to capture an immediate positive result for the trade.

2. Cover Your Investment Immediately.

As soon as your trade moves into profit and you have 10-20 pips clearance (or more, depending on the pair you are trading, practice this until you have a pip clearance formula you are comfortable with), move your stop up or down to immediately lock in protection of your investment.  Never leave a trade that has moved into profit, flapping around in the breeze.  Despite appearances, the testing of levels may not yet be complete – momentum that looks expired or peaked can be re-energised to test again one or more times.  Cover your position immediately at the break-even entry point, since this is the time of maximum possible exposure to risk.

The benefit of this approach – the worst thing that can happen is -

o the trade will be stopped out at break even or in very small profit. If this occurs, step back and reassess, market is telling you your entry point is (possibly) not correct, don’t argue. Market is always right.  Wait for the re-test to complete before entering again.

The best thing that can happen with this approach –

o the trade will continue to run in the direction you anticipate.

Either way, you win.

Employing this technique in the way a trade is managed at the critical high risk juncture will help to reduce your error rate, prevent erosion of your account and preserve your capital funds, proviso you have met the criteria in #1 and chosen the moment of entry carefully to begin with.

Successful traders guard their trading capital closely and insure their investment against loss at the first available opportunity.

3. Quarantine Your Trade Against Retracements.

Take profit off the table when a threat looms.  No trader ever goes broke taking profit.

If you need to re-enter at a later stage, you can.  Be clinical and ruthless about taking profit.  The objective is to extract as much money out this market as you possibly can. When market gives you money, take it, bank it, and wait for the next opportunity. Move your TP stops up or down as the trade progresses (with an appropriate degree of allowance for zig zag price movement along the way and your preferred style of trading).

Develop a set of trading rules that give you clear guidelines for when you need to act to lock in profit.   Don’t cling to hope when contrary evidence is building.  Learn to recognise the most reliable signs for when your trade “goose is cooked” early (e.g. for intra-day traders, hammers/inverted hammers in 5M or 15M charts, higher time frames for swing traders, indicating reversal).  When a profitable trade reaches your target or price begins to test a support/resistance level along the way, or you hold concern about the trades’ potential to keep running, close it out immediately to lock in your profit.  There are no guarantees that price will continue to run in the direction you expect. If, once the level is tested and it does continue to run, you can always make the choice to get back on board safely.   Closing out does two things.  It locks in profit and it provides opportunity to trade the counter trend move (or you may prefer to wait for trend resumption).

Some trend traders / swing traders use an approach that takes half of the profit off the table while leaving the balance in play and moving TP stops up or down to just above/below the threshold of the 50% retracement mark.  This is a judgement call for you as the trader to make.  (More on swing trades at Tip # 8.)

Successful traders recognise and respect the risk of threat to a profitable position in progress, and exit; they lock in profits from the moment of entry until the trade target completes or the threat of retracement reaches their threshold to exit.

4. Understand and Monitor Price Action Drivers Closely.

One of main issues often overlooked in Forex education is detailing the inter-relationships of various currencies to each other, and the inter-relationship of the currency market to other markets.  What actually causes price to move?

The primary drivers of price movement are as follows –

1. Risk aversion climate.  This can be tracked by watching price on the USD/CHF and USD/JPY charts (which, for the benefit of new traders, is why these two charts are always two of the default templates in any trading platform.)  When risk aversion kicks in, traders buy the USD/CHF and sell the USD/JPY (usually).  This has a flow-on effect to all other currencies.  Traffic on these two charts, but especially the Dollar/Swiss (USD/CHF) tends to control all other price action.
2. Economic news releases.  Expected bad (or good) news can be factored in to the market during the hours prior to release.  This explains why news, once released, does not always move in the direction you might expect.  It may have already been factored in. News release data may occasionally also, simply be ignored.  Print off the weekly calendar and keep it next to your trading station.  Know when news items are in the queue, research the historical data on that issue (e.g. via the links in FF calendar page and other news sources).  Look for anything in the news that might move the market in either direction in the period of time before the news is released (e.g. speculation on good /bad data can drive price up or down to resistance/support thresholds before the event).
3. Gold and oil prices, and the commodity currencies they relate most strongly to (gold – AUD/USD and oil – USD/CAD.)
4. Action on the stock market – the Dow Jones, NASDAQ, and the S & P in particular.  Currency markets are especially sensitive to movement in the futures market for these indices (as a measure of economic confidence/risk aversion dynamics).
5. Profit taking.   This occurs particularly around whole numbers and Fibonacci levels or pivot point levels.  When market becomes concerned about the capacity to break through psychological or support/resistance barriers, profits can be taken out and locked in while the issue tests.
6. Domino stops effect and stop hunts.  Since many traders utilise similar stop levels, a move that “clips” these can trigger an extended domino effect.  This may or may not reflect a bona-fide move.  This may also occur in reverse when new highs are being tested.  Buy orders are in the market immediately above the threshold of resistance.  If price clears upward of resistance, this can “clip” the buy orders into action.
7. Random spikes, also known as whip saw.  Protecting your trade against this alone is one reason why traders need to lock in profits at every step along the way and use stops religiously.
8. Greed.  Market can move simply because the opportunity exists to make money.  It doesn’t always need a “fundamentals” reason.
9. Sudden unexpected news.  This may include public health threats (like swine flu), terrorism acts, geological or climate events, or sudden escalation of a war threat.
10. Carry trade price action, particularly ahead of the weekends when institutional traders are looking to park funds in the place that will have the best short term interest rate.
11. Price action on the EUR/GBP cross holding control over price action on the EUR/USD or GBP/USD and the Yen Crosses (GBP/JPY, EUR/JPY).
12. The time of day.  When Europe controls the trading floor before the US session starts, momentum tends to support the Euro and GBP heading north (proviso risk aversion is not on the agenda that day, monitor the economic news data, US futures, FTSE and DAX for further clues on this).  When the US session starts (around 7.00am ET), it’s “Game On” time.  If the US Dollar is going to find or extend its support, it is most likely to happen at the beginning of the US session (though not always, Europe can also buy up the Dollar and short everything else, subject to risk climate).  Each global trading zone is prone to supporting their own currencies, particularly at market open times for that region. (Make your own observations/draw your own conclusions on this). The EUR/GBP cross can hold much influence on price while Europe controls the trading floor.  New traders needing a desktop international time-clock can obtain a good free one from here  http://qlock.com/download/  (scroll down for the free download version).

More than one monitor screen displaying live to market data feeds/charts for other instruments is useful (not essential but helpful if possible).  Those without platform feed on these can check the (slightly delayed) US futures data (trading 24/5) here http://finance.yahoo.com/indices?e=futures (bookmark this item if needed).

Successful traders monitor the key drivers to price action closely.  They keep their finger hard on the pulse of any potential change to the trade circumstances.

5. Support and Resistance

The importance of support and resistance and the role it plays in the Forex market cannot be emphasized enough.

Traders’ approaches to monitoring this can vary; these are some of the most common ways of plotting and tracking this -

* Trend Lines
* Fibonacci retracement levels (weekly, daily, hourly).
* Pivot Points.
* Elliott Waves.
* Forks.

For traders who prefer Fibonacci (include me here), you may wish to add the setting of 76.4 to your default program.  This level is often omitted in default Fibonacci retracement indicators but it is a key level that many advanced traders know and use.

Successful traders know the value of support and resistance; their preparation includes plotting these levels on their charts; they often use these levels as triggers for trade entry/exit.

6. Technical Analysis That Works in Forex

Successful traders have put in the time and effort to identify a TA system that works consistently well for them in the fast paced dynamic market that Forex is.  TA that works in other markets may not apply in Forex.   In addition, successful traders know that there are circumstances under which their standard TA approach may not hold true.  Getting acquainted with the “exceptions” is part of the apprenticeship.

Every trader has their own preferred set of TA, however a common theme is to “Keep It Simple”.   Charts that are too “busy” or overloaded with “noise” can complicate rather than streamline the trader’s job.

An important skill to develop is identifying the potential direction outcomes (both long and short) in any given chart and assigning a proper weight to each scenario.  Quality analysts always give you both sides of the equation, and for good reason.  Look for and examine any contrary evidence in the TA (because news tends to follow the TA, not the other way around – the signs (usually) appear first in the TA.)  When clarity is absent, stay out.

Some additional TA knowledge you may find useful for trading Forex is outlined in the next sections.  (Please keep in mind that this information is not intended to be a definitive expose’ on the subjects, just a quick tips guide in condensed form.)

Successful traders utilise a TA system that works consistently well for them in the Forex market; they know the individual circumstances (via experience) when their TA can be relied upon and when it can’t.

7. Chart Time Frames & Candles.

Although the shorter time frames are used for selecting a precise entry point, short time frames can be unreliable for candlestick purposes.    Reliability is most evident in the 15M time frame upwards.  Hammers and inverted hammer candles are important, having a high degree of reliability that increases with higher time frames (1H – 1D).  Other candles with a good degree of reliability are: piercing line, gravestone doji, dragonfly doji, bullish engulfing, and bearish engulfing.  Keep in mind that there are no 100% bullet-proof strategies – what you are looking for are the candle formations with the highest degree of reliability (80% or more).

Some lesser known but highly reliable candle formations are outlined below.

Candle Wicks. Pay attention to the wicks of candles as well as the body of the candle.  A collection of 3 or more wicks on a 15M chart (or higher, the higher the time frame, the more reliable candles become) can mean solid price rejection (reversal imminent).  These are called tri-tips (3 wicks), quad-tips (4 wicks) or quin-tips (5). If you can draw a horizontal line across the top (or bottom) edge of the body of the candles, horizontally intersecting a collection of 3 (preferably more, sometimes up to 6) wicks, you have a very reliable signal of price reversal.  Price tends to move in the opposite direction of the wick(s).  Long wicks are especially interesting since they indicate price is being driven with force in the opposite direction (this is what generates hammers/inverted hammers).

Tweezers. One bearish, one bullish, side by side, both with good (equivalent length) wick extension to the downside (bear candle first, bull candle second, for bullish reversal) or wick extension to the upside (bull candle first, bear candle second, for bearish reversal).  Tweezers are especially useful on daily charts as an indicator of major trend reversal.  They also have application on 15M time frames and higher.  A good example of classic bullish Tweezer candles (and what they can do to price) can be seen on the USD/CHF chart on July 15/16 in 2008 below.  They are called Tweezers because (other than looking like a pair of tweezers) they “pinch” price and propel it with force in the direction of the last candle in the tweezer.

Always review the daily and hourly time frames before entering a trade.  It is important to step back to look at the bigger picture before launching into the microscopic detail and hitting the trade trigger (because higher time frames usually hold precedence over lower time frames.)

Successful traders keep the big picture in view; they have ascertained the most reliable time frames to suit their trading style; they know candles (or bars) with the highest degree of reliability.

8. Swing Trades and Knowledge of Chart Patterns.

Since market has a habit of repeating itself, chart patterns are a useful trading tool. Recognising a chart pattern with an attendant trade set-up forming, and recognising it early, helps.

Chart patterns are particularly important for swing traders.  Having the confidence to leave a trade on the table when retracement of the initial move begins (and being able to sleep at night!) requires experience and close familiarity with the pattern a trader is seeing.  Swing trades that run successfully for several days or longer are the most profitable form of trading Forex.  Many traders cite the “let your profits run, cut your losses” mantra (which holds truth), however, doing this with confidence is an acquired skill and contingent upon your knowledge of chart patterns.  There are times when letting your profits run is the perfect strategy, and other times when letting your profits run can be a recipe for disaster.  Knowing the difference, the times when it is appropriate to do this, and at what point to close out a swing trade, forms part of the trader’s skill and sound judgement.

Some of the most common chart patterns traders should be familiar with –

Head and Shoulders, Inverse (or Reverse) Head and Shoulders, Flags, Wedges, Triangles, Breakouts, Double Bottoms, Double Tops, M shapes and W shapes, Continuation patterns.

For new traders, further information on these can be found at

http://www.investopedia.com/search/searchresults.aspx?q=chart+patterns&submit=Search

or

http://www.babypips.com/school/pattern_schmatterns.html

(or any other good quality site that provides education on chart patterns).

Successful traders recognise chart patterns as they are forming; they understand the implications of the pattern for a trade in progress or as a potential entry set-up; they know when the pattern has reached it’s limitations to warrant an exit (or partial profit taking while allowing the balance to run).

9. Moving Averages

Both exponential (EMA) and simple (SMA) moving averages are widely used in the Forex market as a guide to trend direction and in some instances, for the generating of trade signals.  Typically, moving averages have most impact on daily charts, however some traders also use MA’s across multiple time frames.

Commonly used EMA’s to plot and pay attention to are the 21, 55 and 200. (As shown in tweezer chart at #7, 200 = hot pink, 55 = violet, 21 = light pink).  The 200 EMA is particularly important since it has the characteristic of behaving either like a gorilla (bearish) or a trampoline (bullish) in terms of its impact on price.  Looking at the USD/CHF tweezer chart at tip # 7 – note what happened to price after the 21 crossed the 55, and especially note what happened when price touched the 200 in two places (the trampoline kicked in).  Review of where price is in relation to your MA’s (either SMA or EMA) should be part of your daily preparation routine.

When moving averages converge, their effect is compounded.  Price can become “stuck” between two moving averages.  Once it clears the hurdle however, it may take off with speed.  When moving averages cross over, price is likely to continue moving in the direction of the line crossing over.  Daily MA’s can also act to support price or act to suppress price when there is no other apparent support/resistance level in play.  This is one reason why referring back to the daily time frame during the trade session is important (if a key MA is near the price action).

Successful traders often plot and pay attention to the moving averages of most proven value to their trading system.

10. Oscillators & Momentum Indicators

An oscillator that works well in Forex is the full stochastic with parameters set on 20, 2, 2. (Shown in the chart below). This gives a very clear signal since it glues itself to the ceiling or floor when momentum has expired or peaked.  It has application across all time frames.  The lower 1M, 5M and 15M time frames are especially useful for selecting the precise moment of entry.  Using the 15M time frame as the base, look for the signal to be sitting in the same place on the floor or ceiling across all shorter time frames (as well as the 15M) and for evidence of the signal beginning to turn up or down in the opposite direction to where it has just been.  Look also for confirmation in the candles.

This gold chart below shows the value of the 15M time frame for this oscillator.

The caveat with oscillators (of all varieties) is that they can be close to useless when market is moving strongly.  Overbought or oversold conditions can remain the status quo for a very long time.  This is why you need to see supporting evidence in the candles to warrant acting on the signal. It’s also why referring to higher time frames constantly, matters.  When market is running strongly, the base reference point for this oscillator needs to shift from the 15M to the 1H time frame.  Look for the oscillator hitting the floor or ceiling in unison on all time frames – 1H, 30M, 15M, 5M and 1M.  Look also for confirmation in the candles.

Oscillators (and other TA tools) have value but only up to a point. Interpreting the value of these, when they apply, when they don’t apply, is a skill learned through trial and error experience.  This is one factor that contributes to a trader’s sound judgement.

Successful traders understand the limitations of their TA indicators; they may use oscillator and momentum indicator tools as a second opinion to their own judgement and other market signals in combination.

Summary
Choose your moment of entry carefully, wait for price to test.   Time your entry with precision.  The objective is to get your trade into profit as speedily as possible in order to contain the high level of exposure to risk at this critical juncture.

Cover your investment at break-even as soon as practically possible. As price moves in the direction you anticipate, move your stops up or down to protect your earnings.  Decide on an adequate level of risk to hold once a trade is in profit and lock in profits whenever a threat reaches an unacceptable level. Learn to recognise the most reliable signs of retracement. Don’t cling to hope or stretch your TP stops.  Be clinical and ruthless about taking money out of the market and putting it in your own pocket.

Closely monitor all key drivers of price for the currencies you trade.  Research thoroughly, do your own DD (Due Diligence), look for potential sources of threat to trend direction.  Critically appraise any and all information you read, including analyst opinion.

Find a TA system that works consistently well for you in the Forex market and refine it until you reach a level of precision in its use.  Prepare your charts ahead of the market week and update daily, include the key support and resistance areas and plan your trades around these (unless scalping).

Successful traders possess sound judgement, borne out of two things –

* Knowledge of TA tools that work in Forex, the rules and exceptions that come with market experience.

* The skill of the trader, in particular -

- the capacity to recognize safe and potentially profitable entry points;

- precision of execution at the moment of entry;

- keeping the error rate low;

- quarantining trades against retracement / knowing when to exit;

- accumulation of consistently successful “winning” trades;

- competence in trade management.

Next in the series, Forex Success – Top Ten Tips, Part 3, Personal Qualities of the Trader.

TA Acknowledgements:

Steve Karnish, Cedar Creek Trading, Colorado.  (Candles, Wicks, Tips, Tweezers, Oscillators, MA’s)

Tony Church, Trading with Foresight, California.  (Candles, Trend Lines, Higher Time Frames).

Fellow Fx traders. (Fibonacci retracements, S & R, Oscillator setting for Fx, Chart Patterns, EMA’s for Fx, Pivots, Forks, Elliott Waves). Market.