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Resident trader
A frustrating foray into forex
Will Kraa, December 5, 2007
As I am writing this article I have some time to trade Forex. The share market does not appear to be doing much today so it is a good opportunity for watching some intraday Forex trades develop.
Most trading methods for Forex that I have come across are fairly complicated but I like simplicity. Long term trades need to find and stay with a trend for as long as possible. This can be done by using the ATR system described in my volatility articles or by the use of other fairly simple indicators. The main thing to avoid in trend following trades is periods when the market moves sideways with not much direction such as at the present time. During such times very short term trades are more likely to be profitable.
The currency pair I prefer to trade is the AUDUSD and as we all know this pair has had a very good run up to touch 94 cents recently. There were some who predicted parity with the USD but as worries about the US economy again surfaced there was another retreat. This would seem to be contrary to what might seem reasonable since it is the US economy that is in trouble while the Australian economy is likely to do better. In Australia interest rates are going up while in the US they are more likely to be falling. It would therefore be expected that people would want to buy the AUD rather than the USD.
But there are other things in play here. Since Australia has high interest rates compared to other countries there are many people who like to hold Australian dollars so as to benefit from the higher rate in Australia. You may have heard of the ‘carry trade’ and this is it. When there is another outbreak of worry about the world credit problems and such like, those who hold these trades want to get out of them and the only way to do that is to sell the AUD. There may also be worries about the sustainability of the commodities boom and this also causes people to sell the AUD.
So currently the AUD is to a large extent reflecting the appetite for risk, up one day and down the next. Short term trading can take advantage of these moves. In short term trading (usually intraday trading) indicators may not be much use since they invariable lag behind the price action. The simplest method I have found so far is the one I described in a previous article [link] of counting back three candles to get your entry and exit. I also take notice of support and resistance.
It is not always easy to ensure a high proportion of profitable trades under these circumstances and so it is very important to use very strict risk management strategies. The first thing to determine is the level of risk that is appropriate. To some extent it depends on the size of the account but more importantly it depends on your ability to tolerate drawdowns, both in the financial sense and also in what you are comfortable with. It is no good setting stops and then finding that you can’t implement them because the loss it may entail is more than you can tolerate. This will inevitably lead to bad trading. Another thing to take into account is the state of the market. While the market is volatile it may be hard to have a high ratio of profitable trades and so it may be good to reduce the size of individual trades and thereby limit the risk.
The higher the risk taken the greater the probable reward but there is a limit beyond which the drawdowns are likely to be catastrophic. This is why trading competitions are usually won by those who take far more risk than they should. Many competitors lose badly but one who is lucky will win by taking too much risk. If your Forex account is only a small portion of your overall capital it may be that you will be able to take larger risks but especially while learning about Forex it is important to limit the risk per trade.
Those who have studied risk tell us that 5% risk per trade is where the reward is likely to be greatest without drawdowns being too great. For larger accounts 0.5% to 1% is usually recommended. Many people use 2% and I am comfortable with 3% seeing the accounts I use for trading CFDs are not a large proportion of my capital. For my larger accounts trading physical shares I use a smaller percentage.
For the purpose of the trades I am going to talk about now I will be using 2 – 3% risk per trade. The account I will use has currently about $6,000 in it. It started with $5,000 not long ago and by careful trading I have had it up to $7,500. But you might remember a couple of weeks ago I told you about that week when I made some silly mistakes. I must confess I did not tell you everything. It really was a week I should have left my computer switched off. One other stupid thing that I did was trying to do too many things at the same time. I put on one Forex trade and did not notice that the trade amount accidentally finished up being four times as big as I had intended. Fortunately the trade went my way and then I started to notice that the profit was getting larger at a much faster rate then I had expected.
It was then that I noticed the mistake but of course a little bit of greed set in. I was rather enjoying seeing the profit grow at such a wonderfully rapid rate. Of course what I should have done immediately is to close the trade seeing the risk was too high for the account. Isn’t that what you, the reader, would have done? Yes, of course you would. Well, I did not as I allowed that bit of greed to take over and I imagine you know very well what happened next. The trade reversed, the profit disappeared as rapidly as it had come but by then I was operating under the control of greed. Yes, I know you would have killed the trade immediately at a small loss but greed does not allow such rational thinking. So I thought it might come back up and of course it did not. When reason (or was it fear?) asserted itself again, the loss, by the time I did exit, was substantial. It did not do my account much good at all and undid most of the good trading I had used to build up the account.
Now let’s go back to looking at the trades I did today. Below is the chart showing the first two trades and as you can see at the start of the chart, early Monday, prices had gone up, declined and then appeared to be rising again. Counting back three candles, the price had exceeded the last three back so was a Buy with a stop one pip below the lowest low of the last three at 0.8830 (under the long tail of the candle). This was a risk of 15 pips and a trade contract of $100,000 is $10 per pip so the risk is then $150 for a $100,000 trade which is 2.5% of the $6,000 account.
This was a suitable risk and I opened the trade by buying a contract for $100,000 at 0.8845. As you can see, for a short time it went well then reversed and my stop was hit at 0.8830 for a loss of $150. I had thought that since the US share market had done well on Friday there might have been a rise in the AUD but that was not what happened.
Still looking at the same chart you can see the second trade. By then it appeared the trend was down so a short trade was in order. Counting back from where I entered the trade by a Sell order at 0.8820 you can see a small doji candle marking the last high. Accordingly I set my stop one pip above that at 0.8832. As you can see from the chart, I was quite correct about the direction of the market. It first rose slightly, then fell to make a very profitable trade.
Unfortunately, I was no longer in the trade as I was stopped out at 0.8832 as indicated on the chart. However, as you can see the price did not go up to 0.8832, so why was I stopped out of the trade? It was in fact an oversight on my part. Another silly mistake which cost me money. The spread on a buy trade is 2 pips which are added to the current price when you buy, but not when you sell. The stop is done at the quoted price, not the actual price it trades at, so even though the price did not go up to 0.8832, the quoted buy price did and so my stop was executed and I missed out on a very profitable trade by exiting at a loss of $120.
I knew all this but just forgot to add 2 pips to the price where I wanted my stop placed to account for the 2 pip spread. I could have got back into the trade but by then had to attend to some other things so did not.
The next trade is shown on the chart below, still the same day but a later time. By that time there had been considerable support as seen at the end of the chart above and at the beginning of the chart below. There is a small number of candles missing between the two charts but they all sit above the support at 0.8788.
I decided to enter a trade by buying just above the support and as you can see on the chart opened another contract for $100,000 at 0.8792. I placed a stop 14 pips below the buy price at 0.8778 which is well below the support level for a risk for the trade of $140. I expected to have time to keep on monitoring the trade but it was not to be. I had to do some printing for magazine inserts to be sent out that evening and half way through that job the rather new printer decided it did not have any more toner left. Even a good quality printer is shipped with one of those stupid starter cartridges that give up very quickly.
So I had to go and get one which took care of a fair slice of the afternoon. When I got home the price had gone up considerably to a high of nearly 0.8830 at 6.30 am London time (on the chart). From there a count-back stop would have got me out at about 0.8818 but it was way past that when I got home again. By that time (7.30 am on the chart) the lowest low after the high had been at 0.8805 so I reset my stop at 0.8804 which was hit not long after. This trade was profitable getting me 12 pips for a profit of $120.
I had to go out in the evening to a working bee to post the magazines and got back to find a rising trend (shown by the trend line on the chart below). I figured another long trade was possible and as you can see on the chart below got in at 0.8825 with a stop one pip below the previous low at 0.8818. This trade with a lower risk of just 7 pips could have been larger ($200,000 would have been fine) but I decided to stay with the $100,000 trade size.
As this trade progressed I moved the stop up to one pip below the next low on the chart at 0.8827, just above the break-even point and then noticed that by placing a horizontal line over the highs on the chart that a rising triangle was forming. These are usually a sign that an uptrend will continue and that a good upward move is probable if the price breaks above the resistance line. As you can see it did not work out and I was stopped out at 0.8827. The price fell through the trend line and continued down for a while, made another high later but then continued to fall to the much lower levels seen today.
Seeing it was now well after midnight there was no time for another trade. The score for the day was a loss of 13 pips or $130. This is in USD and in AUD it is just under $150.
A simple mistake of forgetting to figure in the 2 pip spread when setting a stop robbed me of a good profit. The short trade opened with a Sell order at 0.8820 was stopped out at 0.8832 by a mistaken order. If the stop had been where it should have been (2 pips higher) the trade would not have been stopped and using a count-back stop after the the next low would have stopped the trade at 0.8798 for a profit of 22 pips instead of a loss of 12 pips. This would have turned the loss into a profit of 21 pips and if the printer had been supplied with a proper cartridge that trade would have been exited at 0.8818 instead of at 0.8804 for another extra 14 pips.
Without these simple small problems a loss of would 13 pips would have been a profit of 35 pips or US$350 and in AUD nearly $400.
As you can see when learning it pays to use relatively small trades. Plenty of practice in all the aspects of doing these trades is essential before opening larger trades where good profits (and corresponding losses) are possible.
More articles from this edition of CompareShares:
Investing: How to make money from new energy plays
Stocks: Stocks for the Long Haul – QBE and Leighton Holdings
Resident Trader: A frustrating foray into forex
Trading: The ultimate guide to trading shares for beginners - part 4
Markets: Cash injection won't help liquidity crisis
Economics: Inflation pressures just “tommy rot”
Outlook: The impact of commodities prices on mining companies
Rates: RBA leaves rates on hold
IPOs: Surge of IPOs deliver scant returns
Markets: ECB, US officials downbeat on recovery
Whatever your views, you can discuss this article - or any of Will's articles - on our message board Your 2 Cents.
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