Forex trading often reminds us of the Greek myth of Sisyphus, who was condemned to push a rock up a mountain and at the top, the rock falls down, requiring Sisyphus to start over. Too often the focus becomes the immediate price action, with the added desire for a quick grab of pips. Yet traders who consistently capture 20 pips per day are rare. The problem with short-term trading is not only the difficulty of separating meaning from the noise of intraday patterns, but also the risk that one trade can wipe out days or weeks of profits. Being able to score a series of small wins becomes a futile task if such a series is followed by a large loss.
The greater challenge is shifting to a focus on trading as a quality-controlled production process where the goal is to manufacture on a monthly basis a predictable level of profits. This comes down to the mathematics of percentage of winning trades and the margin of profits over losing trades. There are many combinations of win/loss ratios and average gain/average loss that result in profitable outcomes. The percentage of wins is not itself sufficient. A good benchmark to begin with is the following: If 50% of your trades are winners, an average gain of twice the average loss would guarantee a profitable total result. This kind of outcome is easier to achieve when shifting away from the heat of the moment to monthly charts. The longer- term focus allows you to participate in larger moves. Shifting the focus to large gains can work to change a struggling intra-day scalper into a calm swing trader. Let’s look at a few currency pairs that provide big move potential.
First we look at the AUD/USD. It experienced a 3,000 pip move from October 2008 to November 2009 after an even sharper downward move in 2008. In 2010, we have a potential retracement of this move, offering a realistic chance of a 1,000 pip gain. Such a scenario involves anticipating a weakness in the Aussie based on a slower than expected global recovery and problems in China leading to a contraction in exports. Selling the Aussie at the market at the current price of 0.8830 with a profit target of .7705 (50% fibonacci line) gives us a profit potential of more than 1,000 pips (see “Looking for the big one”). Keeping in mind a reward/risk ratio of 2:1, a stop loss at 0.9337 would be put into place (we may look for an entry at 8,906 so our stop can be placed beyond the recent high). The duration of this kind of trade can be several months.
The EUR/JPY provides another good example of a 1,000 pip opportunity. It was at 111.91 at the start of 2009 and rose to 139.10. It has been in a sideways fibonacci range for most of 2009 and in early February was probing 125.13, a breakdown of the 23.6% fibonacci support. A successful breakdown here technically can be the start of more than a 1,000 pip move down. You could sell at 125 with a profit target at 115 and a stop loss of 130.
The EUR/USD moved from 1.2420 In January 2009 to 1.5120 in January 2010. It has retraced to 1.3864 and is positioned for either a retracement back to test previous highs or a descent to the lows of last year. In either case, it is more than a 1,000 pip move.
There will be temptations to disregard discipline and take profits earlier once the anticipated direction results in a several hundred pips. It is plainly difficult to leave alone profitable positions. The solution set for the trader is to really have multiple lots. Put on two lots, one with the long-term strategy and the other allowing for open management of the positions. This will allow the trader to satisfy the temptation for quick profits, but at the same time leave on the longer-term move. You may need to use mini or micro contracts as a standard $100,000 position would require a $50,000 account to limit risk to 10%, too much risk for one trade, especially one you anticipate holding for several months.
To follow such a strategy looking at several currency pairs and trading multiple lots would require an account in the high six figure range. Even using minis, this approach requires more capital than is in your average forex account. However, if your account is not that big, it is still a good exercise to follow because it shows potential big moves. You would like all positions to have large move potential. When entering trades based on shorter timeframes and with tighter parameters, you want to enter in the direction that holds that potential large move. By using multiple contracts, you can take profits along the way and provide some room for a big move.
Abe Cofnas is the author of the forthcoming book “Sentiment Indicators” (Bloomberg Press). He can be reached at email@example.com