Categories
Trader Resources

Forex Market Seasonal Patterns – Really!

Much of the time, when the idea of seasonal patterns is brought up in trading and the financial markets it is related to commodities. The commodity market, with its production cycles (crop harvest times, winter heating, summer driving, etc.), has some very obvious seasonals which impact the way prices move. This is all well documented.

The foreign exchange market, however, is not generally one where people thinking about the seasonal impact on prices. They exist, though. I’ve done research on the subject confirming that.

Several years ago I noticed an interesting pattern in EUR/JPY by which it rose regularly during a certain month of the year. I was able to use that knowledge profitably and it got me wondering if there were more such patterns. I wasn’t really expecting to find any.

Needless to say, I was surprised when calendar patterns showed up all over the place – in many different currency pairs, at all different times of year, and in both short and longer term timeframes. Knowing that information was something many traders would probably find extremely valuable, I put together a full 175 page research report – Opportunities in Forex Calendar Trading Patterns.

That was back at the start of 2006. I updated Opportunties at the start of 2007, but decided after that to retire the report. Toward the end of 2008, though, I started getting regular inquiries about it – traders wondering if it was still available. After asking around and finding out that there was definitely interest, I decided to revive the report.

Actually, I went a bit further than that. I completely overhauled and expanded Opportunities. It’s now 260 pages and even more useful than the previous editions. It covers all of the majors and major crosses, plus I created a set of individual indices for the major currencies (similar to the Dollar Index) to look at the general patterns of individual currencies outside of specific pair relationships. If you trade forex you’ll want to take a look for sure.

I’m not going to say I understand why all these patterns take place. It obviously has something to do with capital and/or trade flows during different times of year. I’ll leave the explanation of that sort of thing to someone more in the know on the subject than I am. I just want to know it’s going on so I can put that information to use in my trading.

Seasonals, of course, aren’t guarantees that the market will trade a certain way at a given time of year. What they can do, however, is help you put the odds in your favor. That’s really half the battle in successful trading.

If you want that extra edge for your trading, I definite encourage you to check out my forex seasonals research report.

P.S.: Much to my surprise, I was just contacted by a group in Singapore about getting copies of the report for libraries, companies, etc. That was quite interesting, especially since I haven’t really done much by way of getting the word out yet.

Categories
Trading Tips

Risking Something Other Than 1-2%

The idea that you should only risk 1-2% of your trading account is a bit of advice which is thrown around a lot in trading circles. It’s become trading dogma. I am not a big fan of hard and fast rules and this one falls into that category. While those percentages might work for the majority of traders – and certainly some very prominent figures in the markets have cited them – they are not necessarily appropriate at all times or for all systems.

The question was recently asked “When you can reasonably estimate the average % of trades as drawdown, the average % in profit ( per week/month) do seasoned traders increase their % risk from the recommended 1-2% of capital?”. The short answer is “Yes”.

It all comes down to testing. Backtest with different risk percentages and see what happens when you use larger risk ones. You may indeed find that 1-2% is the right area to be in, and you may not. Your position sizing should be a function of your system and your risk tolerance, not some rule you heard from another trader or read in a book.

Also note that there is the question of increasing the size of trades which are moving in your favor. That too is part of risk management and should be another element of the testing process if your trading strategy is one which is suitable for adding to open trades (trend trading, for example).

Categories
Deep Posts Reader Questions Answered

Money Management Question

I recieved the following from one of my list members yesterday: 

Hi John,

The most important question that I try to answer(with help from other traders, courses and books – your excellent book including) is:

How to keep as much of my earned profits as possible?

Today I know that the most important part of my strategy is money management(I use Fixed Ratio). I chose FRatio because I trade systems that are always on market. So there are no stop orders. So I have to use a money management strategy that uses system’s drawdown.

I had many situations when I had deep drawdown periods after nice profits. Unfortunately, in drawdown I had more contracts(because of earlier profits) so even if my losses in points per contract were similar to my earlier profits, my net loss was bigger because of the biggest amount of contracts at the beggining of drawdown periods.

Is there any smart way to improve results of my money management method?

Two years ago I tried to take out of the market a part of my profit from every profitable trade(usually half of it) and didn’t reinvest that part, but it doesn’t work good…

I think my question should be:

Is it possible to improve a profit factor of my money management strategy? 

Best regards,

K.D.

The whole concept of risk and money management is something that I’m finding to be perhaps the single most misunderstood element of trading – not just for new traders, but for experienced ones alike. There is a strong tendency to think of it only as protecting one’s self against outside losses, but that’s only part of the picture. I’ve actually decided to begin working on a very intensive educational program on the subject. I’ll keep you posted on my progress.

The short answer to K.D.’s question is “Yes”. In the end, money management comes down to position sizing. When you can optimize (or nearly so) your position-sizing you can improve your overall trading performance. The primary drawback to fixed ratio sizing is that while drawdowns tend to be shallower, they also take longer to come out of because of the smaller trades during the trough periods. What K.D. might want to look at is a stepped type of approach as I discuss in my book. It’s a sort of mix between fixed lots and fixed ratio.

Categories
Reader Questions Answered

Approaches to exiting trades

I had a question the other day from a member of my trading systems course in regards to getting out of trades efficiently. This is a very important topic, and one that a great many traders struggle with, but one which often gets overlooked in many trading discussions. In this post I’ll share with you the three approaches I take in getting out of a position.

The first strategy for closing a trade is to exit when the reasoning behind the trade is no longer valid. That means if you are a trend trader in a long position, you would want to exit when it becomes clear that the up trend is no longer in place. If you are a range trader, you would exit upon realization that the range has been broken. And if you are a fundamental trader, you would look for indications that whatever got you in to the trade – be it earnings, economic growth, or whatever – has changed. In other words, the trading method you use to enter trades should dictate the approach you taking to getting out of them.

The second exit approach is to have a predefined target when you enter the trade. For a value stock trader, for example, that might be the price that represents approximate “fair value” for the stock. In technical terms that could be an important support or resistance area, the edge of a range, a Fibonacci projection or some other type of measured move, and things of that nature. This is not something you are likely to use in pure trend trading as the whole idea is to ride the trend, but it can be used by a trader who dips in and out of a trend, trying to catch the swings and reversals.

The final approach I take to exits is to have a spot, especially when the market is moving aggressively, that represents an extreme situation. By that I mean the market has gone too far, too fast and is not likely to be able to sustain that level (or at least will stall out). Having this kind of exit strategy helps to avoid those frustrating situations where a position becomes quite profitable very quickly, but then gives much of it back (if not all) shortly there after.

It is worth doing some testing of exit strategies. You can do that mechanically as you would testing entries. You just need to be able to isolate the performance of a system as it pertains to the exits. By that I mean if you were to test a few different exit approaches you would have to ensure that they all were based on the same entry points. Otherwise, the results might not be comparable.

You will note that nowhere above did I mention setting a predefined stoploss. I don’t use them. The stops I employ are used to exit me from trades when the criteria I used for being in the position is no longer valid (first approach mentioned above). They have nothing to do with limiting my loss to a certain amount. I control my risk in that regard through position sizing.

A good book on the subject of trade exits is Trade Your Way to Financial Freedom, by Van Tharp. This is a book I recommend on a lot of levels as its discussion of trading psychology and risk management are both excellent as well. For the sake of this discussion, though, it is one of the few that really focuses on the subject of trade exits in a meaningful fashion.

Categories
Trading Tips

Close stops do not lower your risk

A lot of new traders fall in to an insidious little trap. Because they hear from those who they consider better, more experienced, etc. that your stop defines your risk, they draw the conclusion that closer stops mean lower risk. Sadly, this just isn’t the case.

Are you thinking something like this right now?:

A closer stop means I lose less money if the market goes against me than a stop put further away. Smaller losses mean less risk.

If so, you are only looking at one side of the equation.

The risk you take on a trade combines not just how large a loss you might take, but also the probability of taking one. As I think we can all agree, markets very rarely move in straight lines. Then tend to wander around a bit as different forces push prices back and forth, especially as you move toward the short-term time frames.

Because of that movement, as you put your stop closer and closer to current price you increase the chances of that stop being hit. A higher likelihood of your stop getting taken out means an increased probability of taking a loss. Sure, the loss might be smaller than it would be if you put the stop further away, but you’re going to take the loss more often. At some point you reach a threshold whereby the tighter stops, because of their increased likelihood of getting hit, offset the smaller losses taken when compared to the wider stops.

As an example, let’s assume we have a market which has a 20% chance of moving 10 points and a 50% chance of moving 5 points during our trading time frame. If we do ten trades that would mean the wider stop gets hit twice, costing losses of 20 points. The tighter stop would get hit 5 times for a total of 25 points in losses.

But that’s only part of the equation. There are two other elements at work here. First, having close stops that are within the market’s normal trading range not only means more losses taken, it also means more of those awful trades where the market goes against you enough to take out your stop, then reverses and goes profitable. Having the tight stops, therefore, means you miss some potentially big winners.

That’s pretty hard to deal with. For some traders, though, losing at a high frequency is even harder. It can become significantly destabilizing to one’s trading confidence. Not good.

My own personal philosophy on the placement of stops is to put them at a point where if the market reaches them, the move I expected to unfold probably isn’t going to happen.

I never place my stops based on how much I’m willing to lose on a trade. I set my position size based on where my stop is going to be and what that implies in terms of position risk.

Does all of this sometimes mean that you take smaller positions to keep your per trade risk level? Absolutely! It’s been my experience that most traders trade too big, though, which usually means bad news at some point. Cutting back on your position size, therefore, shouldn’t be seen as a bad thing.

Categories
Trading Tips

The value and usefulness of inflation data

Yesterday the US CPI inflation figures were released. There was, predictably, much talk about the figures on CNBC and in many other media sources. Inflation, of course, is something very important as an influence on the financial markets. It particularly influences interest rates, which then feed in to the relative value of currencies and in both the profitability of companies (interest expense) and the valuation of stocks (discount rates).

Here’s the thing, though. The CPI and other measures such as price deflators are measures of historical inflation. They tell us (with questionable accuracy) what prices have done. That, though, doesn’t really matter to the markets. Interest rates, stock prices, and currency exchange rates in the present are influenced by the expectations of inflation in the future. The same is true of central banks, like the Federal Reserve, in determining interest rate policy.

So as a trader, what do you do with the CPI release?

Well, if you are a news trader you can certainly play the market reaction to the figure. That aside, what you really want to be looking at is what, if anything, you can take from the data which points to future inflation. Does is give you a hint as to where prices might be rising more or less in certain areas? More specifically, you want to understand what traders are going to read in to the figures to determine the expectations for future inflation they develop. And of course no data release can be viewed in isolation. You need to be viewing it in conjunction with others to understand (to the exent possible) the full picture.

This probably sounds a bit convoluted. After all, if everyone is trying to read expectations from everyone else, you have a market based on the expectation of expectations. And there you have the reason why market sentiment and psychology are so important.