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Adjusting Your Strategy to Market Conditions
12/11/2012 9:00 am EST
Forex trader Mike Kulej of FXMadness.com reviews a couple of recent trades to help you figure out what to do when adverse market conditions render your usual strategy less effective—or worse—useless.
For a long time, often mentioned on these pages, I have been trading a specific situation on Fridays. At the start of the London session, I would typically place a straddle order, just outside of the trading range established over the preceding few hours. That range must be relatively tight and easy to spot on 5- or 15-minute charts. Most of the time volatility picks up and currencies develop trends, at least in relation to the previous period. They do not have to be large, 20-40 pips is normally enough to capture quick gains. I use this on the USD pairs and the set-up looks like this.
We can see a nice, easy to recognize sideways drift, which leaves no doubt where to place orders. In the past few weeks, however, this approach did not bring desired results. Markets changed the way they behave during the set-up period, with more price movement happening before the London opening. Last Friday, for example, there was a rally in the USD-CHF, which ruined the foundation of this particular strategy. Incidentally, something like this will happen over time to all methods/systems when changing market conditions will render them underperforming or even useless.
For me this is not especially troubling development. This strategy is only a small part of my trading activity, so no action has little impact on the larger picture. Besides, in this case I simply took no trades, which did not create losses. The situation is, of course, different when changes in market behavior affect the primary method. What should we do then? One possibility is to change or adjust the approach, perhaps tweaking some rules. Unfortunately, that could be premature, as a shift to prior conditions would have a negative effect on the strategy once again. It all depends on the duration of adverse market conditions. From back testing and preferably from actual trading history, we should know how long these periods are likely to last. “Likely” because we never truly know for sure, but past results give us reasonable expectations (not certainty) for the future. Unless historical extremes are exceeded, one might as well keep using the strategy, although it would not hurt to lower the position size. As for me in this particular example, I will not change anything and simply try to wait out this adverse period.
The euro had strong losses late last week, which distorted charts of most of its pairs. I will wait for the prices to settle before taking more trade in those crosses, probably 1-2 days. Meanwhile, the CHF-JPY is starting to look inviting for a sell. It has been consolidating between 87.50 and 89.40, which could be a topping pattern. We do not know that yet as this could become a base before the bullish continuation. However, for now I am taking a bearish view, with the support at 87.50 the level to watch. As always at this time of the week, opening gaps are possible, even if they have been absent lately.
By Mike Kulej of FXMadness.com
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