Trades of the Month March #1

Sometimes you get you make a trade that so clearly demonstrates the power of technical analysis as a trading tool. This long trade of the USD/NOK (Norwegion Krone) was one such trade. The technical price action of the currency pair effectively predicted the eventual interest rate change days before it's announcement. In the weeks prior, the USD/NOK pair had broken out of a tight range, and with someone large gyrations had found every higher support (the most recent major weekly support level is the red dashed line on the chart).

The Sequence of Events:

• 2/26 - 3/1. The pair fails to break through major support and in doing so forms an inverse head an shoulders pattern (a strong sign of bullish reversal.
• 3/5-3/8. The pair sells of strongly but fails to reach the long term support level. It immediately rebounds
• 3/12 -3/13. The pair finds higher support and breaks sharply up. This is where I entered expecting a short term breakout and start of the next leg of the upward trend.
• 3/13 - Then Norwegian central bank announces an interest rate cut of 0.25%, which over time will decrease demand for the Krone, causing the USD$ to strengthen against it in relative terms. The result is an almost immediate rocketing up in price. I used a 2hr bar chart for the sake of context, but the majority of that huge bar's movement took place in about 5 minutes. I exited my positions in stages on the way up and just after the peak.

The increasingly high short term support levels leading up to the central bank decision, clearly show that the smart money (large banks and their trading desks) anticipated the interest rate change. As a result, a portion of this expectation was already built into the price. When this is the case, a currency pair will often move dramatically just after news is announced, but will then retrace much of the move over the following days as the anticipation of the announcement had already been priced in. Note on the chart that over the following days, 100% percent of the sharp upward move was retraced, almost to the pip. Trading immediately following news announcements hasn't been part of my strategy at all, in the future I may experiment with fading news announcements and try to capture some profits on the retracement.

The road is bumpy, but the grass is green

When I finally committed real money to a Forex broker, I did so with the full knowledge that I would lose my first deposit. As such, I deposited a relatively small sum. Do I want to lose money? Of course not, but I needed to learn the flow of the FX market and test the limits of my current techniques of analysis in this setting. To do this I needed to trade a sum of money small enough to be long term unimportant, but large enough that I would care about losing. This is why paper trading is a poor substitute for real trading, you just don't get the emotional effect of watching your hard won equity disappear. Even though I dove in headfirst willing to lose the entire balance of my account as the price of education, I honestly half expected to win right off the bat. Did I receive a rude awakening! The speed at which price can move and the severity of the short term whipsawing in the market took me completely off guard. Not only this, but I didn't fully appreciate going in the added complication of increased leverage. Trading stocks, I never had better than 2:1 margin, so I could happily commit my full margin to my positions without any real danger of sustaining a massive loss (at least not in the short term). FX is completely different. At the start, I was using my full margin to attempt to maximize my gains, only to find that I was getting stopped out of positions rather quickly by a quick down swing and then forced to watch price march off in my previously anticipated direction. The first month I lost 63% of my deposit. The remainder was gone in the next 4 months. The number of false breakouts and show reversals in the FX market completely blindsided me coming from an equities background. Not only this, but I totally underestimated the effect of leverage. At 30:1 leverage (standard for he EUR/USD Pair), at $.01 change in exchange rates can wipe out 1/3 of your account, and a $.03 price move could take all your equity. Given that the pair moves around $.01 per day on average, I needed a new approach.

I looked back on my trading records and discovered that in general, my directional analysis was pretty good, had I been trading smaller lots I would probably have shown a profit, even at the start. The primary cause of my early failure was risk management. At this point, summer was starting (peak season for poker) and I largely abstained from trading over the next 6 or 8 months while I focused on my poker career. In the interim, I committed myself to devising a system of risk management to maximize gains while minimizing drawdowns and the possibility of an equity crippling loss. One of the books I read over the course of my trading education (I cannot for the life of me remember which one) cited a study that analyzed the level of loss in an account which, if sustained, made it more likely for a trader to lose the remainder than to recover to his previous level. This inflection point was found to be right around 35% for high leverage markets. (Options, FX, Futures). My goal going forward is to never sustain level of loss (calculated only from end of month or start of month), and to have increasingly low draw-downs as my equity grows.

This blog is intended to be a journal of my successes and setbacks, as well as a forum in which to share the hard won knowledge gained in my quest to become a professional trader. The real journey starts now.