Why 1% must be enough on a Counter Trend Trade

Bad Assed Trader:  Back on December 3 2011 I shared with you a trade I was stalking on NZD CHF.  At the time it looked like price was pretty much in a range and nearing the top of the range so I was looking for it to bounce off the resistance line (ceiling) at the top of the range when I would sell (once the four hourly chart showed a lower high and price dropped to form a lower low).

I promised to let you know how it all panned out so this is the story of my trade on the NZD CHF.

I have to start at the end of the story because my coach Emmanuel saved me from myself on this one like the knight in shining armour that he is.  I know I called him a midwife only recently when he helped me deliver my strategy but Emmanuel is made of magic gold dust and can turn from midwife to knight in the mere blink of an eye such are his powers.

So I lost no money.  But nor did I make any...and as Emmanuel pointed out - strictly speaking I shouldn't have taken the trade in the first place.

So here's the chart showing what happened (yellow arrow is when I sold and my stop loss was at 0.7260 - well above the high of the spikey red bar):

NZD CHF Counter Trend Trade from 08 12 11 on the Four Hourly Chart

This is the four hourly chart which is the one I use for entry into my trades.  The yellow arrow marks the entry point - although as you can see the second peak is not actually lower than the first which is why the trade didn't actually meet my rules.

Clearly at the time I was anticipating the second peak to be lower and because it was a spikey outsize bar (larger than the previous bar which had also engulfed the bar before - good reversal signs) I must have justified it to myself as equating to a lower high.

Also, and perhaps more importantly, price had actually broken up through the resistance level on the daily chart (not shown here but see Dec 3 blog) and closed above it so my ranging strategy was now a counter trend strategy if I'm completely honest.  And with counter trend trades my rule is to only expect 1% profit and to set my target there.

So I entered at the break of the neckline as shown by the yellow arrow and set my target at a rather ambitious 222 pips (0.6938) rather than at 1% profit which would have been 100 pips or 0.7060.

As you can see, price plummeted the next day but not quite to a 1% profit target level.  It then bounced back up off the 20MA on the daily chart (not shown here) and showed indecision for a few days before testing the 50MA on the daily chart, partying wildly there for a while and then springing back into action.

As you can see, I have marked on where 1% profit could have been taken if I'd had my wits about me and had actually noticed that I was in a counter trend trade (which I didn't until after the trade was closed).

I had a session trading with Emmanuel on Monday (December 19) who, in his lovely gentle way, pointed out that the slightly higher high on the four hourly chart meant I had broken my rules and so I should move my stop loss to break even so as not to lose money on a trade that I shouldn't be in.  He's a wise man and as you can see on the chart after that price went in only one direction really - up.

This trade provided me with a couple of really useful lessons:

1.  When I'm stalking a trade where I expect price to stop somewhere in particular (eg at a support/resistance level on the daily chart) and it doesn't but is sufficiently close for me to justify taking the trade then I must review the label I am giving to the trade.  When I trade a range I set 3 or 4% targets most of the time but a counter trend trade only justifies a 1% target.  I didn't show good mental agility with this trade.

2.  I need to stick to my rules and not see what I want to see rather than what is actually there (a higher high on the 240)

3.  If I find myself in a trade which broke my rules I should follow Emmanuel's advice and move the stop loss to break even.

So even a crap trade provides useful lessons!

What an Excellent Trader Does

Bad Assed Trader:  I'm blogging from my trading desk in France today.  This sounds more glamorous than it is.  My desk is in fact a table identical to one I saw in a local french bakery the other day, with a marble top and wrought iron legs.  Mine has a laptop on it rather than flour, dough or patisserie but it's the same table and probably belongs in a bakery.  But for now it's a trading desk.

I like the fact that technical forex trading is a craft requiring few tools.  On my desk I have only a small notebook in which I set out the trades I plan to take and a small pile of forms which I call my Daily Analysis (it's a simple form I complete every evening and review every morning on which I record what is happening to each of the 30 odd currency pairs I'm willing to trade, whether they are going up or down and more importantly what needs to happen for my trading set up to occur).

I also have a couple of pens and two highlighters to pick out the currency pairs I'm presently stalking and my current guide book: "The Daily Trading Coach" by Brett N Steenbarger.

Sadly there's no patisserie on the table but this past week I have indulged in numerous eating marathons and frankly couldn't face a choux or eclair however inviting.  These marathons, when done by the french, seem to result in trim figures - the evidence of triumph of continual troughing over fast food.  But when done by us, the Brits, usually end in tears when we get home and face the scales and another set of clothes too tight for comfort.

But enough of my feeble attempts at the french lifestyle.  Today I am reminding myself, before I enter another trading week on Monday, that to be an excellent trader I must do as an excellent trader does.  This seems obvious I know but I'm still at the stage where I have to remind myself.

Having developed my strategy (shared in detail last week here on this blog), I am now getting into the rhythm of analysis, planning the trades and executing them according to plan.

Trading has become less effort and whenever I am tempted to cut short a trade because it is well into profit and I know it's due to retrace a bit (which can be the uncomfortable part as you watch your profits melting away) I am able to remind myself: what does an excellent trader do at this point?  An excellent trader lets the profits run - they expect the retrace and as they've only entered a trade about which they are confident then it does not feel uncomfortable because they anticipated it happening. And so I sit on my hands.

Similarly, when I have been stalking a trade for days and start to see price action indicating that the necessary change of direction is in the air I remind myself that an excellent trader waits for evidence and confirmation before placing a trade.  No more jumping in.  This is not what excellent traders do.  Gradually, by continuously reminding myself of what an excellent trader does I am losing the urge to make these amateur errors.

And just when I think I'm getting the hang of spotting, executing and managing trades I reach a point in The Daily Trading Coach where Brett talks about the challenges of making trading your income and unearths a whole new set of tasks and thought processes that I must master.

Apparently I must diversify to ensure my trading technique does not become redundant due to market changes, or as he puts it: "Diversification in your trading enables you to stay afloat when any one of your strategies stops working for a while and becomes obsolete."  But I'm not sure how this relates to my trading strategy which is all about spotting a turn from up to down or down to up and trading it.

When I read on I discover that I must track my returns in different conditions.  So for example when I'm trading the return back to trend following retracement, or when I'm trading counter trend (the retracement itself) or when I'm trading in a ranging market where price ping pongs between two levels - I should know which of these situations gives me the best results.

I should also know which currency pairs bring me the best results.  And if I sometimes use my trading strategy principles on a smaller time frame then I should know which time frame gives me the optimum return.  I should know whether I get better results from trading the bounce against horizontal levels or moving averages.

Basically I need to scrutinise every aspect of my trading to see and know which parts are most effective.

It seems my trading analysis will need to be taken to a new level.  Up until now I have only assessed my past trades for what I did right or wrong in spotting, placing and managing the trade as this has been my main concern.  I can feel another set of goals coming on and the ghost of Faceless Bureaucrat haunts me still.

But if Brett says this is what excellent traders do then this is what I must do.  I feel as though I am almost back at school, trying to earn the gold star from the teacher judging my work.  And yet I am judging my work so I am the one awarding the gold star as well as the one being excited about getting one. Which is a spot odd.

I guess it's all about clarity as to what excellent means and then taking focused action to deliver that.

Time to award myself a gold star for recognising the next step I reckon...

Even Traders Need Motivation Tools

Clarity brings results

Bad Assed Trader:  Having only recently taken delivery of my very own strategy I've been rather obsessive about it this past week.  It has haunted my dreams and occupied my waking thoughts.

Another session with Emmanuel last week helped me to clarify in precise detail what it is I am actually trading. Emmanuel's patience knows no bounds (just as well...) and if I was looking at my strategy with blurred vision he has now provided prescription glasses to enable me to see with absolute clarity.

That clarity has brought results.  November was my best month ever with a 6% return.  If I am able to demonstrate consistency with my strategy during December then in the New Year I will start to build up my trading account with chunks of my redundancy payoff and hopefully by the summer my trading income will equal what the NHS paid me.  This is the plan and has always been my goal...well, since last Autumn.

In my last blog I promised to reveal my trading strategy.  So for anyone who is interested here are my Rules, in their entirety.

Cautionary note before I start: For readers who are not traders - please don't try this at home without proper training first.  I've been doing this now for coming up to a year and a half and even with the Rules there is judgement and discretion involved.  A strategy that works for me will not necessarily work for others - to be successful as traders we have to build our own strategy, one that works for us and in which we have confidence.  So here we go....

My Trading Rules

I trade Cyclicity combined with Support and Resistance and Price Action

Entry

1.    Identify the trend on monthly, weekly and daily charts – daily is the chart I’m trading. Up, down or ranging, all are ok but identifiable pattern exists

2.    Identify Support and Resistance levels – horizontal or 50 Moving Average – which must work for the trade (ie bouncing, only use breaking if combined with bouncing).  Trade must be bouncing off strong Support or Resistance (S/R) & the stop loss goes behind whatever it is

3.    Identify target – reward to risk must be at least 1:1.  Ensure no strong horizontal/respected moving average levels of S/R are in way of target.

4.    Wait for cyclicity to be in my favour – ie we're at the early part of new phase 1 or 2 in whatever time frame I’m trading.  Countertrend is ok if conditions are exceptional and it’s clear price has a long run before it’s likely to return to phase 1 – in this case be extra conservative with target & double check lines of S & R that may cut the trade short

5.    Spot the inklings of change: Use the hourly chart for signs of the cyclicity phase changing eg lower highs or higher lows (M or W shape)

6.    Wait for price action to confirm the shift of sentiment eg doji bar, high/low test bars, train tracks, W, M on 240 (four hour) timeframe

7.    With trend trades: Ensure MACD/stochastic indicators are not diverging from price action.  This is the only reason to stay away if other factors are present.  Indicator divergence after entering a trade is irrelevant – stick with it.

8.    Counter trend trades: Ensure indicators (MACD/Stochastic) are diverging from price action and exhaustion of phase 1 is clearly confirmed by the indicators as well as cyclicity and price action (on the 240 time frame)

9.    Enter the trade on the break of the neckline of M or W on the 240 chart after seeing the lower high or higher low.

10. Set stop loss with reference to the daily chart: place above the daily high/low of the bounce cause.  If there is a moving average/horizontal S/R or big number within about 10 pips from the bounce spot place stop loss behind it for added protection (price sometimes spikes up to retest these things).  The exception to that would be if I’m targeting over 200 pips and my reward to risk is over 2:1 (then can put the stop loss >10 pips over where it previously bounced)

Mixed Signals means indecision and a warning to stay out

Management of the Trade

Set target and place a limit order for it based on next zone of S/R based on price action using discretion with conservative bias

If trading counter trend target is unlikely to be more than 1% but is based on next level of soft S/R or a respected moving average.  If significantly more than 1% looks likely then take half off at 1% and move stop loss to break even and trail daily.  Once close to target trail more aggressively on 240 or 60 using discretion (maximise protection of stop loss as priority) eg behind price swings and moving averages 

If trading with the trend trail stop loss on daily basis using daily bars as a guide but protecting stop loss using S/R on 240 or even 60 min charts (as above) as get closer to target

If price is fuffling this is not a reason to delete a trade, consolidation is normal before a move.  Think of snake down/snake up.

Trade deletion or interference loses money so set realistic target and leave.

Only take trades where you have a high level of confidence and can therefore sit through the random erratic movements on the way to profit without fear/anxiety.

Set stop loss realistically - adding a few pips for safety (as price has often just pipped me out before going my way).  Add more pips for larger timeframe (eg 5-10 for daily chart) and how choppy the pair is. I always protect my stop loss by Support or Resistance preferably with a big number as well. Expect Chop At The Top – cable often has a choppy bottom too!

If market gaps on opening and enters trade at different level then only take trade off if risk exceeds 2%, otherwise leave as it is with stop loss in same place.  Market gapping means correct anticipation of direction of travel and possible strong move.

The best trading is finding great trades that meet all the criteria, being confident in taking them, being realistic in setting profit and stop loss and being calm and competent at execution. 

If in doubt, stay out.  As Rob says: better to be a pilot on the ground wishing you were in the air than a pilot in the air wishing you were on the ground.

                                                  ************

So there it is, for the record.  My very own strategy in it's full glory.  


And just by way of demonstration, here's a possible trade I'm stalking. 

NZD CHF on December 2nd 2011

It's the New Zealand dollar against the Swiss franc. Price has been ranging for months and months, basically between the two horizontal grey lines (I've put two lines to represent the top of the range as there's a bit of a zone rather than a precise point: what was support back in January/February with price bouncing up off it has now turned to resistance with price being pushed back down from it).

Price is nearly at the top of the range so I'm waiting to see signs of reversal before I take it short (sell).  We already have a high test bar on Friday which is a good reversal sign but as per my rules I'm looking for more price action confirmation of buying exhaustion on the 240 and 60 minute time frames.

I'll let you know how it goes....