How to Handle Multiple Technical Outlooks When Trading

04/02/2015 9:00 am EST

Focus: FOREX


Tyler Yell, of DailyFX.com, outlines the difference between strong vs. corrective trends and why many traders often put too much emphasis on the current trade due to wanting to avoid pain or seek pleasure/gain without regard to the overall impact on their portfolios.


Talking Points:

  • Strong vs. Corrective Trends
  • Deciding Which Trade to Take
  • Allowing Trade Size to Calm You Down

“He also taught me one other thing that is absolutely critical: You have to be willing to make mistakes regularly; there is nothing wrong with it. Michael taught me about making your best judgment, being wrong, making your next best judgment, being wrong, making your third best judgment, and then doubling your money.”
-Bruce Kovner, Interview in Market Wizards by Jack Schwager

Have you wondered what makes a market tradable? In short, you have to have two parties who agree on price but disagree on value. The seller thinks that the price is high relative to where price will be in the near or distant future, whereas buyers think they’re getting a steal by being able to buy at the current price. In a tradable market, following the trend is preferred, but deciding where to enter is up to you.

Strong vs. Corrective Trends

Rarely is there consensus across the board where a majority of credible participants in the market like banks, traders, and economists agree. This rarity recently developed in EUR/USD, where banks continued to lower their forecast for EUR/USD by yearend. Many who started their outlook towards parity began re-issuing outlooks towards the 0.8500-0.9000 region as the price continued to fall beyond expectations.

EURUSD Has Been on the Highway to Parity Since Summer 2014

chart
Presented by FXCM’s Marketscope Charts
Click to Enlarge

Some traders will look at a chart like the one above and say that it only makes sense to sell as the trend is down. However, there are others that will say, the time to buy is right as price is sure to bounce somewhat. Often, a mix of both views is best whereas you wait for a bounce to clear resistance and for a higher low to develop and buy off of that higher low with an appropriate protective stop point.

NEXT PAGE: When the Emotional Fear Creeps In

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Of course, some charts aren’t as clear cut as EUR/USD. This is especially the case on shorter-term charts like USD/JPY over the last few months. Price appears to be converging between resistances around 122 and a rising support line coming up from 115. This dilemma causes traders to discern whether they should enter in an ongoing trend or wait for a correction to enter.

USD/JPY Getting Set for Next Big Move?

chart
Presented by FXCM’s Marketscope Charts
Click to Enlarge

Deciding Which Trade to Take

Many traders know to trade with the trend but there is also an emotional fear that creeps in before entering the trade. The fear often comes in the form of a question. What if I’m the last one in this trend and it reverses on me? While it is possible, buying the top can be akin to the unlucky lottery as a long-term trend change, especially in FX, is rare as many fundamental events often go into FX trends.

Nevertheless, this fear can prompt some traders to look for a correcting trend. The USDJPY above is an example of a correcting trend where as a trader would look to trade in the direction of the trend when a breakout develops and validates the larger trend’s continuation. This is a popular approach of many traders as the correction against the larger trend can allow new traders into the market who will take the move the next leg higher whereas joining mid trend does have the risk of entering near an interim top, although entering at a major top is again, a rare occurrence.

Allowing Trade Size to Calm You Down

If you’re uncertain about which way to go, either entering in the direction of the larger trend as it stands or waiting for a correction to enter, you’re not alone. What’s more, if you’d like to be in the trade, you can simply trade in the direction of the trend with half the trade size you would normally put on and add the second half on a continuation move in the direction of trend after a correction or along the way with any dips that prove to be a higher low in an uptrend, or lower high in a downtrend.

Either way, limiting your trade size or keeping your trade size the same and increasing your balance is a great approach on multiple levels. First, it allows you to take part in the larger waves of the market without getting shook by the small ripples that develop day to day, whereas an overleveraged trader is more than likely to be adversely affected by a smaller move that doesn’t impact the overall trend they may be wanting to trade. Second, a lower trade size allows you to stay in the trade longer allowing you to get more out of the large trends in FX. Staying with a move longer as opposed to jumping in and out can be a huge benefit compared to the overleveraged trader who catches a few hundred pips but leaves a thousand on the table.

Summary

Whether the trend is in progress or correcting, you can trade with it as long as you don’t overleverage. When you drop your leverage, the mistakes hurt less and you tend to care less about individual trades, which is a good thing for most traders as the brain often puts too much emphasis on the current trade due to wanting to avoid pain or seek pleasure /gain without regard to the overall impact on your portfolio.

By Tyler Yell, Trading Instructor, DailyFX.com

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