I must confess I really look forward to Sunday mornings; no stress getting the munchkin ready for school, nice big breakfast with mommy and daughter, and best of all, Krystal’s prediction and analysis video. I mostly like them because her predictions are usually better than mine. Last week Krystal mentioned at the end to “be your own indicator”, which I thought was wonderful advice. Remember, in trading, money management is everything. I remember when I was just getting started in Forex trading I couldn’t wait to jump in a trade when I got a signal.
Today I know better. I like to treat trade signals as “suggestions”. Don’t get me wrong, is not that all trade signals are bad or suspect, you just need to remember that this business is based on probabilities. A certain percentage of your trades WILL go against you, so in keeping with the idea of safe money management, there are number of things a trader can do diminish risk and additionally enhance trading performance.
For example, at the top of my “unloved trade list” is that most despised of all trades, the one where you enter a market order (jump right in the trade) and price action immediately moves against you. Is this unavoidable? Well, to a certain extent, its effects can be diminished, and here’s an easy way to do just that. Take a look at the one hour EUR/GBP chart below:
The downward pointing red arrow is a sell signal that was triggered by the cross of the red (10 EMA) crossing the orange (50 EMA) line. This is part of the strategy I was describing in Pipsqueaks #19. The gray arrow shows the price level when the signal was generated. Look what happened – right away the trade moved against the signal and price touched the 50 EMA, a 35 to 40 Pip move. If I entered a market order with a 40 Pip stop loss when the signal was generated, I would have been stopped out. Disappointing considering that in the next hour price continued its downward trajectory easily grabbing 40+ pips. What I actually did here was to place a pending sell order slightly below the current price and watched the price go up. As it did, I dragged my pending order up to match the price action, stopping just below the red line (10 EMA). Within the hour price started heading back down. My pending trade had a 20 pip stop loss, which stopped out around +50 pips. Handily my best trade of the week!
Entering this trade was fairly comfortable as I not only had favorable indication from the moving averages, but also from the oscillator that I added to the chart as well. This particular oscillator uses color to enhance interpretation, but really almost any oscillator would do here. The essential arithmetic is that prior to the EMA cross signal being generated, the oscillator flipped to the downside (crossed below the zero line).
This is an example of “filtering”, that is, contrasting the indication of indicator “A” with indicator “B”. If you like indicator-based strategies, that’s fine (I do use them although my favorites are still the “indicator-less” strategies like The Ice Cream Sandwich/Sominex). Filtering is important because, as good money managers, we never want to enter a trade based on only one indicator. Now it’s interesting here is that we as traders have many indicators to choose from, and can mix and match different combinations that suit our preferences. I myself like to keep indicators to a minimum, and to make the most of them.
Look again at the example one hour chart above. After the signal was generated, in addition to the EMA cross, spot price was below the 50 EMA and below the shaded area of the ribbon (although it did briefly wander there – don’t enter a market order when price is in the shaded part of the ribbon, but a pending order below it is okay). Also the 10 and 25 EMA’s are sloping downwards, the 50 EMA is slightly sloping downwards in the screenshot (and was at the time in a major downtrend), and the ribbon shaded area color is red – all bearish indicators.
Using a second indicator is one mechanism of filtering. In part two we will look at some other ideas of using filters to help us make trading decisions. Until then bye for now and happy trading!
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