Those traders who have been on the wrong side of a trade, have often observed that given a bit more time or more capital, a losing position would have become profitable.
Is this the lament of every loser, trying to pass blame, or is there some hidden truth being masked pointing to time as the critical factor contributing to a losing trade.
Those traders who have been on the wrong side of a trade, have often observed that given a bit more time or more capital, a losing position would have become profitable.
Is this the lament of every loser, trying to pass blame, or is there some hidden truth being masked pointing to time as the critical factor contributing to a losing trade.
First, consider the fact that there is a technical tendency for markets to revert to a mean after price action experiences bursts of volatility taking it to extremes. When trading small time intervals, the trade itself is really part of the “noise” of the market. Prices will naturally “vibrate” within a time-interval. More time in a position gives retracement a chance to work. Those trading off a 5 minute time chart interval have often ½ the average price range than trading off a 30 minute interval and the weekly ranges can approach over 200 pips. A second reason contributing to being right about direction but wrong on the timing is that there is often a disconnect between technical price patterns and fundamentals. Fundamentals and technicals are not always in sync because forex knowledge is asymmetrical. This means it is not shared equally among market players. Forex is not an equal playing field where the price efficiently reflects all reasonably known facts about an economy. While economic forces are the underlying impetus for forex price movements (changes in: interest rates;inflation; and growth), those very forces are often inaccurately measured. Just ask yourself: What is the inflation rate ? Can we trust the data? Bernanke and Trichet are asking the same questions and are having trouble getting answers that are reliable. If Central Bank economists can’t be sure about economic data-why should the desk-top home bound trader know more? No wonder forex markets get surprised when economic data releases come out. Uncertainty is built into the structure of the forex market.
The result is a conundrum or a conflict between accuracy in observations and accuracy in strategy. Trading intra-day and intra-hour provides less exposure to market uncertainty but increases risk of losses due to market noise. On the other hand, trader longer term reduces exposure to market noise but increases the probability of wider ranges. Being wrong on an intra day 5 minute trade results in a short term loss, while being wrong on a multi-day position can result in large drawdowns. If a trader has limited equity in the account and limited patience, multi-day positions can be a painful experience.
A resolution to this issue is not to not to make the situation an either or choice. Instead, forex traders should have two accounts. One for intra-hour or intra-day trades and the other for longer term trades. This is also better psychologically for the trader. It enables a focus on performance provided one has greater tolerance for the volatility of their P&L. When long term and short term accounts are mixed its often the case both strategies become undermined. The question then becomes, how do you do longer term forex trades.
For spot trading, longer term forex trades can be shaped off weekly charts. But launching a long term position strategy for forex should at first be done with the lowest leverage possible. Consider an account with $10,000 in equity. A long term trade of $50,000 placed on a currency pair risks $5 per pip. A 100 pip risk through a stop loss would result in 5% drawdown. Let’s assume that a trader sees 5 trades (different currency pairs) that offer a position trade with 100 pip risk. Being wrong on all three would result in a 25% drawdown. But the flip side is that if 2 of these trades work out at a 300 pip target, the total results would be profitable. The critical factor in position trades is to have and realize large profit targets. The mathematics of success in longer term trades is based on achieving very large reward to risk ratios that only monthly charts can provide. With a 3:1 Reward risk ratio a trader can be wrong 7 out of 10 times ( with a 100 pip loss) and still be profitable. The trader will have to be disciplined and allow the positions to work, but locking in a break even trade is highly recommended. The major advantage of longer term trades is that the trader doesnt not have to be riveted to the screen. Trades that offer these large Reward and Risk positions will not be many per month. Yet this strategy when implemented over period of a year, in-effect allows a trader to annuitize their income stream when targets are reached.
Challenge: Tell us which currency pairs offer 3:1 reward risk ratio today and send it in to [email protected]
