Do you ever ask yourself will the market go how far? Will it turn around and go against me? If so, what will you do when it does?
In this episode of Truth About FX, Walter delves into the area of market levels, chart patterns, and the different exit methods that might suit you depending on your beliefs. He also touches on the many sort of things that can happen against your trade and how important it is to accept that those things can also happen to you.
According to Walter, the market has a memory and that it is imperative to anticipate these events and recalculate your risks.
Download (Duration: 10:37 / 12.1 MB)
In This Episode:
00:34 – the philosophy
01:53 – a magnet
03:24 – the meat of trading
04:53 – a gift
06:58 – misleading
08:02 – a balance
09:07 – going downhill fast
10:12 – a major hit
You have to assume that the market will continue onward. [Click To Tweet].
You need to have control over your profit target. [Click To Tweet].
Just because you got stop loss, doesn’t mean you’re at max risk. [Click To Tweet].
Announcer: Sometimes, forex trading is a wild and wooly place to be. That’s why Hugh is here, to post your questions to Walter, the naked forex guy. Hugh’s got questions and Walter’s got the answers. Here at the Truth About FX Podcast.
Hugh: Hi, Walter! How do you know how far the market will go? How do you know where to place your profit target?
Walter: This is really an interesting question and I’ve been discussing this with other traders because it gets into the philosophy that you hold as a trader. The way that I approach it — which is not necessarily the right way for everyone — is that I have a belief that the market has a memory and that there are places on the charts where price repeatedly reverses.
It goes to a high that it has been to before and it pulls away from that and starts turning lower. Likewise, it’ll go to a low that it remembers from sometime historically and then it’ll start trading higher. I believe that it bounces off those levels and sometimes it’ll go to a level and stop there and wait and pause and gear up for a burst through the level. That is how I trade.
Really, what I am doing as a trader is I am waiting and waiting and doing a lot of waiting ‘till the market gets to one of this levels, print a pattern, and make it forex liable pattern that I know I’ve tested and I am comfortable with. That pattern tells me whether the market is going to reverse at that level or whether it is going to be breakthrough that level.
That is really how I trade. Now, the question about targets comes in and my belief is that once the market either reverses off one of this support and resistance levels or breaks through one of this supports and resistance levels it is now attracted, it is almost like there is a magnet at the next level.
Price, naturally, will find itself attracted to that next level so my targets are pretty clear. They’ve got to be the next level or the level after that if I am really going to get really aggressive, or I am going to assume that the market will break through and keep going after the first level.
Sometimes you have to go for this second level and not for the first level just because of the reward to risk ratios. You have to assume that the market will continue onward. I will often move my stop loss to breakeven if I am concerned about it coming back or something like that.
To me, breakeven trades are not a bad big of a deal. I guess this long winded answer to your question, Hugh, is that I believe that it goes to this specific spots on the chart. Some traders are not going to jive with you and it may not make sense to you.
If that is you, then perhaps what you needed to do is adapt a different approach. It maybe that you watch the market and you decide yourself when the market is going to turn around.
May be you use a reversal signal so you get into a trade, you try to milk it for everything it’s worth, and you wait for a reversal signal. Or, maybe you use the trailing exit where the market… Basically, your system has a stop loss that follows the market as it keeps going in your favor and, eventually, it will turn around enough to kick you out of the trade.
Trend followers are well known for that sort of stuff, well known for using those type of exit for really bagging really big winners. It gets into the meat of the trading because I think that when you get advanced as a trader, you start to see that your entry strategies or your reasons for getting into a trade are not as necessarily as critical as how you get out of a trade whether or not you decide to use support and resistance or trailing exit, or maybe you just use a simple ways based on how far the market goes.
Let’s say, you are trading the EUR and you notice that the EUR tends to move on most days about a 110 pips. Well then, what you can do and the way that you do that. Of course, if you want to use the indicators, you can use the average true range, put that up on your chart.
Maybe use a ten day period so the last day ten days which will be two trading weeks on the EUR approximately, then you’ve got about how long, how far you expect in pips the market to go each day.
You could do something like that where you go to a 110 pips on the EUR, and I expect this to go — my trade to go — about three days worth of EUR movement so I am going to take a target of a 330 pips.
You can do something like that, as well. There are many different approaches but it really comes down to. You need to have control over your profit target which is kind of the way I trade. I think I have this philosophy that the market is going to go to a support and resistance level so that is why I have my targets there.
Or, if you are okay with the style of the trading that the trend followers often use which is you let the market dictate that. If the market is really going to take off and give you a gift, then you are happy to go with that. You know what I mean?
It depends, I don’t know. How do you do it? Do you do a little bit of both or do you use trailing exit? So, how do you do it?
Hugh: I use a little bit of both. Just depends on the method but I prefer the way that you do it. Just targeting specific levels or the next levels. Just out of curiosity, do you just look for a one to one risk/reward a minimum or do you not care?
Walter: This is one thing that a lot of my students have trouble with. The reason why they have trouble with this is, oftentimes, they’ll look at my trade and say “Walter, you are on this daily — let’s say, you are trading the GBP/AUD. GBP/AUD is pretty volatile, right? “So, you’ve got 350 pip stop on the GBP/AUD Walter and your target is only 300 pips away. That is not one to one”.
That is true. That is valid, I don’t disagree with that. That is absolutely true. Let’s say that I have two targets: one is 300 pips away and another one is, let’s say, 500 pips away. It is better than one to one but not quite two to one.
Some traders will come to me and say “look, Walter you are risking 350 pips and you are only going for 300 and this does not just jive with me”. So, what I typically say is, “I understand, that makes sense. However, if you go back and look at my trades historically, what you will find is, I rarely ever have a losing trade where it hits my full stop level”.
In other words, if this GBP/AUD trade totally goes pear-shaped, I am more likely to get out at, let’s say, a loss of 270 pips or 250 pips rather than the whole, the full 350.
Even though if I hit target one, my reward/risk ratio is 0.85 or something like that, it is not quite one to one. If you look at the way that I get out of the losing trade, I actually — usually, I rarely let it go all the way to hit my stop loss.
When that happens, usually it’s because I am sleeping. It is a little bit misleading. I still calculate the hour which, of course, is the ratio for trade between what was risk and what was gain.
When you see my hours, you will see things on target one like .8, .75, .92. I think I just had one this week where it hit my first target and it was .92 so it was not quite .1 or 1.0, I should say.
That’s a fair argument but the other thing that you can do, if you trade like I do, is you can just ignore target one. If your target one is only at .75R or you are making 75 cents for every dollar at risk then that’s fine.
Just go for target two and go for 1.6R. You know what I mean? Something like that. The problem when you start doing that is your win rate comes way down. It’s a trade-off and trading between having really tight stops or really aggressive targets. Either way, what that does is that it increases your reward/risk ratio.
If you really have an aggressive targets that are very far from your entry price, the chances of you hitting that are reduced and so, your win rate is also going to be subsequently reduced. It’s a balance between how often do you want to be right versus how much money do you want to make when you are right. Do you know what I mean?
I think for some traders it makes sense to actually have targets on some of your positions on a trade, like maybe half on targets. The other half for your positions uses a trailing exit or just a super aggressive target so that you will occasionally, maybe three times out of ten, get that really aggressive target or that really long runner that you can capture with the trailing exit.
I understand that and it is a common criticism about the way that I trade, I completely understand it. I just think that there are ways around it. If you don’t want to do it that way, go for a more aggressive target, go for target two.
I always have two targets on my trades but the other way to do it is, like you say, you can split it up and you can use trailing exit on half and then use a target on the other. What do you do with your trades?
Hugh: I did two targets. I generally look for one to one on the first. If not, I usually pass but it works pretty well for me. I don’t usually exit early on this. I know that it’s really going downhill fast so, that is what I do.
Walter: That makes sense because what that means to you then is that your R that you calculated on any given trade is pretty true to what was at risk. Right? Whereas, when I calculate my R, it’s not really that. I mean, if you look back this year, for example on my trades, I think you’ll find less than three that hit the full stop.
I think there’s only two. It might have been three to hit the full stop, my other loser would have been less than the full 100% risk. Calculating that hour is a bit misleading but I still do it because you’ll never know what’s going to happen in any given trade. In fact, to be completely honest, you and I both know that if we are on a trade, the market could go beyond our amount at risk.
We can get gaped, our broker could slip us horrendously like what happened with the Francogeddon thing and stuff like that. All that stuff is totally in play. Just because you’ve got a stop loss, does not mean that you’re at max risk. That is another thing to keep in mind.
You should expect every five years or so, you’re going to have a major hit. If you are trading, if you are in a market a lot, probably every five years you’re going to get something massive happen to you that is not going to be what you expected and so, you should really brace for that and anticipate that. It is a great question. I appreciate it.
Hugh: Thanks for insight. That was awesome.
Walter: See you next time.
Hugh: See you.