“Stop Hunting” and Other FX Trading Questions

07/22/2010 12:01 am EST

Focus: FOREX

Sam Evans

Instructor, Online Trading Academy

Firstly, I would like to take the time to thank each and every one of you who read my articles. It is your continued support and interest that keeps me coming back for more. As I have mentioned before, I receive a large number of e-mails from my ongoing students and readers alike, and answering each one does take its time, with a few slipping through the net on occasion, I must admit! However, every once in a while, I like to address some of the best questions publicly through an article, so without further delay, let's review a selection of recent questions:

Dear Sam,

After demo trading for almost two years I recently began live trading spot forex on a Swiss ECN, yet found myself perplexed by a simple issue I should have addressed long ago; which chart do I use when selling "EUR/USD" and which chart do I use when buying the "EUR/USD?" The bid or the ask chart? When I am buying, bid charts seem to better demonstrate where to enter and place my stops on a market buy order. Conversely, when I am selling, ask charts seem to better demonstrate where to enter and place my stops on a market sell order. I've managed to confuse myself. Can you help?

Thank you for your time. Kind regards, David G

Many thanks for your enquiry, David, and trust me, it is a common one so don't feel alarmed. Due to the nature of the spread in forex spot trading, we always have to be aware of the prices we actually pay to buy and sell in our trades. To keep things simple, just remember that no matter the actual market price, we always get filled on buys at the ask price, and on sells at the bid price. My charts are defaulted to show the bid price, and this is what I leave them on at all times. This way, if I execute a long trade, I will be paying a slightly higher price than my chart shows as this will be the ask. And when I go short, I will be filled at the bid price, which is showing on my chart at the time of the fill.

With this in mind, I can then factor in the spread when placing stops and targets, knowing that I will be filled at a slightly different price than is shown on my bid chart. This will be something for me to keep in mind when I am placing orders to buy only, and in the case of sell orders, I will just add the ask spread onto the price shown on my chart to ensure execution.

Hello Sam,

Since reading your articles and taking your professional forex trader class, I have taken an interest in the dollar index and I have been finding it a useful tool in my analysis across the US major pairs and with some cross-pair analysis as well. After the dramatic rise we saw on the dollar in the last five to six months, I noticed a while back that it was looking like it was creating the classic head and shoulders reversal pattern. I was struggling with this as it is not the cleanest looking one I have ever seen but I am still keeping a watch on it for guidance. Have you noticed the same thing and what are your thoughts on it?

Best wishes, Carla H

Hi Carla, and thanks for your e-mail. Yes I did notice the same pattern formation on the dollar index a little while ago and it has been something my students in the ongoing extended learning track (XLT) program and I have been paying close attention to. Let's take a look:

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Figure 1

As I have marked off on this chart, we can see that the typical left shoulder, right shoulder, and head have all formed on this daily chart of the DXY. As you pointed out in your e-mail, this is by far not the cleanest example of a pattern we have seen, but also in my experience I have found that chart patterns in everyday life are rarely as clear as they are in the textbooks, so this does not surprise me. More vital is the price structure itself, which shows a clear momentum change in the dollar itself, with a failure to sustain higher highs and with lower lows being formed. Considering the speed with which the index rallied, I am not surprised by such a violent correction in the price action.

For a completion as such in this pattern, we could see the index fall lower to support at the 80.00 area, but should also note that there is a possible bounce approaching in the 82.00 area, too. If the dollar fails to show strength shortly, I would be looking closely to see its reaction to this 82.00 mark as it will potentially have buyers in this area to deal with first before it can push lower still.

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Hi Sam,

After recently starting to trade the forex markets, I have become concerned with broker intervention on my trades. My studies and research have hinted that dealers can often take us out of trades in an effort to profit. Should this be a concern for me moving forward?

Thanks, Harry S

Hello, Harry. This is a great question and is often asked of me. To be honest, it is something I rarely worry about. Sure, the brokers can see our stop orders in their system, but we also need to remember that we can only be taken out of a trade when price is near to our stop in the first place. When you are on the right side of the market, there is little that the dealer can do to control the overall price action and you will be fine. Understand this: Most novice traders are the apparent victims of broker "stop hunting," but they are more often also taking low-probability trades as well. A dealer will always profit on the spread no matter what, and we also have to remember that the money they make on the novice losing trades will pay for the winners belonging to the professionals, so things will always even out. If it was something that really was a hazard to my trading, then I would have given it up a long time ago, but nevertheless, a great point to illustrate.

Dear Sam,

Thanks for your ongoing contributions to "Lessons from the Pros." I have taken your advice and drafted a trade plan, but I have noted that you also encourage traders to journal their activity. Why is this necessary and how can it affect my long- term results?

All the best, Karen T

I am glad to hear your have formulated your trade plan, Karen, as it is a key component of the trader's arsenal and helps to maintain discipline at all times. You are right in saying that I recommend keeping a journal of your trades, as it can be a great tool to have and be of benefit during the reviewing process. You see, you might have a great plan or strategy for the most part, but there may be one tiny aspect that is letting you down from time to time. It is like having a broken engine and thinking that you need to take the whole thing apart to find the problem when all it really needed was an oil change. Trading is not so different. The market is in a constant state of evolution, and while I strive to maintain consistency at all times in my trading, I also like to adapt to the market conditions. In the XLT program, we use a planner that also acts as a journal for taking trades:

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Figure 2

As you can see, we jot down the proposed trade and detail our odds enhancers (which I have removed out of respect for my students), so we know exactly why the trade was taken and record every unique aspect of it. This way, we can look back on our reasons for taking the trade in the first place, checking what is working for us and what is not. It is a powerful tool in many ways. Consistency is the key to achieving measurable results in the long run.

By Sam Evans, instructor, Online Trading Academy
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