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TRADING TECHNIQUES Sat 15 Dec

Entries: To fight for every pip, or not?

Deciding how to manage your entries Trading successfully can be quite a challenge. Interpreting sentiment, understanding the fundamental outlook for a currency, pairing it suitably with another currency, and then managing your risk are all hard enough. However, once you have done all that a key question still remains: when and where should you enter the trade? How do you manage the entry, so you don't have to a) endure lots of drawdown and b) suffer too much financial pain if you are wrong? This article will consider when you shouldn't be for fighting for every pip in your entry, and when you should be. Times when you shouldn't fight for every pip Trading the squawk There are definitely times in your trading when you should not be overly concerned with your entry price. There are times in trading when you want to be in as soon as possible. When might these occasions be? This is particularly true in trading headline news. For example, there has recently been a good deal of tradable news headlines on two key political and financial events; namely NAFTA and Brexit. Now, when the news first came out in the squawk a couple of weeks ago that Mexico and the US had ironed out their disagreements over the NAFTA deal there was an immediate reaction as the Mexican Peso gained value. This would be an instant when you would not want to worry about your entry value, just get in as soon as possible, USD/MXN short. Similarly, when the EU's negotiator Michel Barnier stated that he was prepared to offer Britain a deal with the EU, like no other country, the GBP rallied quickly. This was not the time to wait for a 'perfect entry', as the news was so significant that the GBP would rally for a good 50+ points. Not bad for a headline. Trading surprise announcements You have an interest rate announcement coming up for a central bank. The chances of a rate hike are seen as 2%, but then the central bank makes a massive surprise move and hikes their interest rates. This is the sort of time when you just enter in as soon as possible. In the chart below you can see when the Bank of Canada surprised markets with an interest rate hike CAD appreciated for the next few weeks on the back of that one decision. That is not the time to be concerned about a 'perfect entry', simply make sure you are in the trade. At first, this can seem hard, but overtime you develop a good understanding of which trades you just want to get in straight away. Times when you should fight for every pip Technical entries Say, you are trading a currency pair in the Asian session. Perhaps you don't want to be awake/at the screen during the session and you know that ranges tend to narrow during that session. Well, you might choose a currency pair that is unlikely to be affected by any Asian session news and try a technical bounce off a key level. In this instance you would want to make sure you set your entry very carefully, as overnight moves tend to be smaller and technical ranges come into play when there is no market news to move price in a strong direction. When you want to be in, but not at any price A recent example of when it would be appropriate to do this can be seen in the USD/CAD chart when there was a significant deviation for Canada's CPI reading. It was expected to be 2.5% y/y and instead it was released as 3.0% y/y.Say you came to the chart and you saw that price had already traveled a long way from the news announcement. By drawing a fibonacci level on the chart you could have entered in at the 38.2% level and round number of 1.31000. In this situation you may not want to chase price, but instead 'fight for your entry'. The only weakness with this approach is price may not retrace to your fib level and you may miss out on a potentially profitable trade. When you correctly analyse a currencies direction, but it's extended Sometimes you will quickly analyse a currencies direction, but you will see that price is already heavily extended in one particular direction. In this instance, you don't want to simply jump into the market as there is always a natural ebb and flow in price. Not every interaction with the market is due to speculators. There are many currency transactions that take place every day for a variety of business and government reasons. Staff have to be paid, currencies need to be converted, and balance sheets need to be adjusted. So, prices will often pull back in a trend. If you get into the habit of buying at any price, you make your risk of drawdown considerable. Also, you will have to use a large stop to allow for a normal technical pullback, say to a moving average. This is when you want to take an entry that allows for a reasonable, but not too large a stop.For more on how to trade, check out our new forex education section and let us know what you think. ForexLive

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TECHNICAL ANALYSIS Fri 14 Dec

Morgan Stanley does not like the USD. What about the technicals?

Some overhead resistance to get through. Adam posted Morgan Stanley's view that the dollar would head lower.  They cite some plausible reasons for their assessment, but as most people realize, what we think most times does not play out the way we think.   That is especially true when we face things like China/US, Brexit, US/Europe, central banks, Pres. Trump, geopolitics, etc.  There are a lot of things that go into the formula.   As a result, I like to also look at the price action and tools applied to that price action for clues that the story is playing out and the "market" (who move the price), is on board.    For example, "If the dollar is going down, is there overhead resistance that might stall the rise?"  If that ceiling stalls the rise, the price can go down.  Another question might be "Is there a lower support level that if broken, would shift the bias more to the downside?"   To go lower, the buyers need to change their mindset from buying to selling. Breaking key technical levels, does that.  Looking at the daily chart above of the DXY (the weighted dollar index), shows that the index is approaching a resistance area at the 97.873 area.   The 61.8% retracement of the move down from the 2017 swing high comes in at that level.The swing high from June 2017 stalled at that levelA topside trend line (see red numbered circles) come in near that level tooThere is overhead resistance from multiple tools that could attract technical sellers.  When multiple tools converge at an area, that are becomes a barometer for bulls and bear.   Trade above it is bullish.  Stay below and sellers are trying to take back control against the key resistance area. It may not lead to a big move lower, but it IS a start.   Right now, we are near a key level for the bulls and the bears. That is off the daily chart.  Drilling down to the hourly chart below, the high price today moved higher to test the swing high from November 12th.  The high price today reached 97.71. The high from November 12th came in at 97.693.  Below the highs, there were some other swing highs from November 28th and December 11th. Those highs come in at 97.538. The price moved above those more recent swing highs today, but we are currently just below those levels. Sellers are taking more control.  So to answer the question,  "Is there overhead resistance that might stall the rise?"   The answer is YES on both the daily and the hourly charts.  That is clear.  If the price can stay below the 97.87 area that would keep the sellers in play for a reversal of the DXY (the USD). The 2nd question is  "Is there a lower support level that if broken, would shift the bias more to the downside?"  Looking at the hourly chart first, the pair has been confined in an up and down trading range. More recently in December, the 96.379 was a double bottom (lows from Dec 4 and Dec 10).  The highs at 97.69 and then 97.54 (see red and green numbered circles) are the higher extremes.    In between those levels are the 100 and 200 hour MAs.  The price lows on Tuesday and Wednesday and Thursday this week found buyers near those MA line (the price dipped below but not my much). The 100 hour MA is now at 97.139. The 200 hour MA is at 96.998. Both are moving higher.  If the price goes and stays below those MA, the bias would shift more to the downside.   Below that the 96.379 double bottom would be targeted.  Again, get below and stay below is more bearish.  On the daily chart, the 50% midpoint of the range since the high in January 2017 comes in at 96.036. The 100 day MA is at 95.842. Moving below those levels would tip the bias for the dollar even more toward the bearish side. Remember, after a rally, the sellers need to wrestle control away from the buyers. They need to change the mindset from buy the dips to sell the rallies.  Getting below targets on the downside, helps to do that.  So, downside targets - that if broken  - would increase the bearishness of the USD include: 97.139 - rising 100 hour MA96.998 - rising 200 hour MA96.038 - 50% of the range since 201795.842 - 100 day MA SUMMARY. It is one thing to say you think this will happen because of this that or the other, but "the market" needs to agree and the crystal ball also needs to be right for it to play out like you (or Morgan Stanley) believes. As a result, it is also important to plan out the road map for that idea. The price action and technical tools, help to give you the feedback you need to bring home the profits and complete the story. ForexLive

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UNUSUAL MARKETS Tue 11 Dec

Fake news isn't just a problem for the public, it's a problem for algos

Algos are reading headlines, but what if they're wrong? Algos are all over the newswires and twitter. The straightforward way is a race to trade on news and economic data. As a result of an arms race that's lasted the past 15 years; it's gotten hyper-competitive and now the moves are unbelievably fast. The next frontier was sentiment and that's been mined heavily for the past five years. The next frontier may be gaming the system. If there are algos trading on twitter sentiment, then what's to stop someone from making a trade and then bombarding social media with commentary about it. Or gaming news services. It's something  Marko Kolanovic is worried about. He's one of the earliest algo/quant professionals on Wall Street and the global head of derivatives and quantitative strategy at JPMorgan. "f someone is creating fake tweets to hurt your strategy, are you allowed to defend yourself by throwing off that algorithm? Where's the limit of market manipulation vs. defense?," he said in a Bloomberg profile. At the same time, he's worried about fake news that simply designed to throw of people, but can also throw off machines. He said recent market moves may have been amplified by fake news. There are "specialized websites" that present a blend of real and fake news and distorted write-ups of financial research, he said, without citing the specific sites."If we add to this an increased number of algorithms that trade based on posts and headlines, the impact on price action and investor psychology can be significant," Kolanovic told CNBC. The Bloomberg profile is particularly interesting: There's this fragility in the marketplace that came with the new structure of liquidity, with electronic market-making, computers, and growth in passive. Passive assets and quant assets will grow, and computers and AI will have a bigger role in ­market-making. At some point that's going to end up badly-most likely when the next recession hits. ForexLive

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TECHNICAL ANALYSIS Mon 10 Dec

FX Trading Education: GBPUSD trend stays alive for the day. Here's why...

Corrections are modest is the clue. The GBPUSD has trended lower today after the pair peaked against it's 200 hour MA a 1.27586.  Since then the price has moved to the downside.   The move has moved 255 pips from the high to the low. The corrections have been modest.  That is what a trend move does.  It moves: FastDirectional with limited corrections, and Tend to go farther than traders expectYou can see that and measure an intraday trend move by looking at the 5-minute chart. Below is that 5-minute chart for the GBPUSD today.  At the top of the chart, the pair was moving sideways, but when the price stalled at the 200 hour MA, it was the start of the first leg down (see red circle 1).  That leg moved down to a new low of the day (from the 1st hourly bar), but stalled.   The correction off that low  corrected up to the 38.2% of that leg down (just above it). That is a modest correction and implies that sellers are in control.   The price of the 1st leg higher then moved below the lows with momentum.  Sellers were pushing and the buyers were scrambling. The next leg down (red circle 2) saw a bigger move lower.  Like the 1st leg, the pair bottomed and started a correction.  If you put a fibonacci of the trend leg lower, you can measure the "will of the buyers".   If the buyers can't get above the 38.2-50% retracement area (I call it the correction zone), are they taking control?  No!  The seller remain in control.  Seller can lean against the yellow area. If the price goes above, the waters for the trend are muddy. Stay below, however, and the seller remain in control.  Start of trend leg 3 down. The third leg lower was a quicker and steeper trend move lower. The longs and dip buyers are really felling the pain. The price nearly runs to 1.2500, stalling just above that level at 1.2505 where another correction is started. The third correction has the same targets.  The fibonacci of the leg lower has the 1.2560-78 as the "correction zone". Stall in that area and the trend is alive. Move above, and the trend waters are muddy. Putting it another way, the buyers and sellers are more balanced. In this case, the correction moved right up to the 50% retracement and stalled again. Are the buyers taking control?  Not really.  They did put up a bigger battle vs. the sellers but are they winning?  No.   What next? Well, the sellers are still in control and the trend is still in play.  What would muddy the water is a move above the 50%. It might not end the downside momentum forever, but it does muddy the water. The sellers feel some of the pressure of a bigger correction.    Until then however, the trend potential continues.     The sellers remain in control.    Trends are: FastDirectional with limited corrections, andTend to go farther than you expectIf you can recognize a potential trend move early by noting the price action, measuring the corrections, seeing that trend legs stay below the "correction zones", you have a chance to ride that trend by understanding who really is in charge, and who is feeling the pain. The run in the GBPUSD today clearly shows sellers in charge and hurting any buyers in the process.  Until the waters get muddy, assume the pummeling has the potential to continue.   ForexLive

ECONOMICS Sat 8 Dec

What is Goodhart's law

When everyone is looking at something, it changes In quantum physics, the observer effect is the theory that simply  observing a situation or phenomenon necessarily changes that phenomenon. Economics has something similar, called Goodhart's law. It's named after British economist Charles Goodhart who observed that when a measure becomes a target, it ceases to be a good measure. The issue is that once everyone is watching a measure or a target and knows what it means, then the observers anticipate the effects and adjust for the outcome, thus changing the effect. The idea is prescient because of the market's intense focus on the yield curve inversion. When longer-dated yields fall below shorter-dated yields, it's a classic recessionary signal. Intuitively it makes sense because it signals a situation where people would rather have long-term safety than earn more yield in the near-term. Its effectiveness as a predictor of recessions is undoubtedly excellent but whether the curve is inverted is always a matter of interpretation. Surely 10-year yields falling below 3-month bill yields is an inversion but is 5-year yields falling below 2-year yields as strong of a signal? More importantly, does Goodhart's law apply? If all market participants believe it's a sure sign of a recession, then they will surely behave differently than they would otherwise. Similarly, central bankers are also watching the yield curve more closely than ever and as the curve approaches inversion, they may react. Taken to a further extreme, you may have central banker who actively target the entire yield curve in the belief that so long as the curve is steep, a recession can't occur. The idea of Goodhart's law is that any statistical relationship will break down when used for policy purposes. This is frequently seen in regulation and even in the workplace. Whenever targets are set, people find ways to game and abuse them, and so do broad markets and the economy. ForexLive

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EDUCATION FROM BROKERS | TRADING PSYCHOLOGY Wed 28 Nov

The role of luck in trading

Where does luck come in to trading markets? In the previous article, we talked about trading and probability . Continuing to develop this topic, let's talk about trading and luck. What is the relation between these two concepts? Can a trader count on luck to get profit? Is it possible to suffer from bad luck in trading? How random are the results of your trading? Technical analysts propagate the idea that there are sense and consistency to the market and there's much to be said in favor of that. After all, there are trends and patterns on charts that get replicated from time to time. However, there's still a lot of noise, i.e. moves of the price that can be explained by analysts only a posteriori but not as or before they happen. This noise can mess up with a trader's position. On the other hand, if things go just as a trader thought they would without any surprises from the market, a trader may consider himself/herself lucky. There seems to be a big element of randomness here. Are there any traceable borders of the randomness we observe in financial markets? Maybe the swings of the price, even the minor ones, are not random, it's just that people are not able to see the governing principle? How strongly a trader's success depends on skills and how much does it rely on luck? The authors who researched this idea a lot - Nassim Taleb, Michael Mauboussin, and Robert H. Frank - came to the unexpected conclusion that talent and efforts are not enough to succeed in the modern world, you should actually find yourself in the right place at the right time. It means that if we look at some traders who absolutely nailed it, it might seem that their success is the natural result of all the actions they have made. The reality, however, is much more complex. Most great achievements are to some extent marked by randomness. As the sociologist Duncan J. Watts cleverly indicates in the name of his book "Everything Is Obvious: Once You Know the Answer", people have hindsight bias and underestimate the role of luck, randomness, chance, or whatever you call it. The conclusion is that a trader's performance is a summary of skills and luck, the proportion of each unknown. Make it work So, it's not all up to us and the role of chance in our life can be big enough, even though we don't always realize that. Where does this idea can lead? It is abundantly clear is that one cannot rely on the mere luck while trading. Otherwise, there would be no real need for the word "trading" as "gambling" would suffice. A person can shape the world around him and doubting this idea will get you nowhere. At the same time, remember that you are not the master of the market and you can't wield it as you wish. The price won't go up just because you opened a buy trade and in no way can one trader beat the avalanche of the market. The sin of overconfidence will be sternly punished by the market. So, what's the best option here? You have probably heard about a pattern called the Pareto Principle (we wouldn't go as far as to call it an objective law). It says that 80% of the results are achieved with only 20% of the total efforts. That, of course, doesn't mean that you should twiddle your thumbs and reduce the number of efforts you make to achieve your goals. What it means is that by definition not all of your trades will be successful and only a fifth of them will likely account for the main chunk of your gains. Evidently your risk/reward ratio should be better than 1:1. Another idea to ponder is related to the time you spend on trading. If only 20% of it is really efficient, it's worth examining what you do during the remaining 80% and try to optimize it. There's always a way to improve productivity. For example, maybe you can spare a while for the analysis of your own trades? To sum up, we can say that as with many things, it's hard to give an unambiguous answer about what really leads a trader to success. Various factors are so closely intertwined that it's hard to separate them. It's a fact that good mathematicians and well-read economists won't necessarily make successful Forex traders. An understanding of price action mechanics comes to a trader over time. Experience will help you develop market intuition and an ability to control your emotions. And you'll definitely need some luck, but the necessity of luck should in no way limit your work on self-improvement. Remember that the disciplined risk management, the healthy mental state, reasonable expectations and actions, and the willingness to learn and practice are the things which will help you use your luck with 100% efficiency. P.S. Good luck in your trading!  This article was submitted by FBS. ForexLive

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TRADING TECHNIQUES | TRADING PSYCHOLOGY Fri 23 Nov

Trading and probability

The psychology when it comes to making choices "Probability is not a mere computation of odds on the dice or more complicated variants; it is the acceptance of the lack of certainty in our knowledge and the development of methods for dealing with our ignorance." ― Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets Forex is all about choosing a trade idea with the highest probability of success. However, human intuition and common wisdom can be rather deceitful and lead to poor judgments. In this article, we will revisit the main laws of probability that can be applied to trading and learn from them. The flaws of intuition The problem is that many times when we go with our intuition without giving it a deep thought, we make a poor estimate of probability. Let's resort to the prospect theory developed by Daniel Kahneman and Amos Tversky. This theory explores the ways we make decisions which are associated with risks. Imagine that you face a choice: 1. A 75% chance to win $100 with a 25% chance of getting nothing. 2. A sure profit of $70. There's one more test. This time necessary to choose between: 1. A 75% chance of losing $100 with a 25% chance of losing nothing. 2. A sure loss of $70.  Logic would say that a risk-averse person would choose option 2 in both cases (limited profit plus limited risk). However, in reality, the majority chooses 2 in the first choice and 1 in the second choice. The prospect theory shows that people overestimate the probability of getting no gain but overestimate the chance of losing nothing. They seek to reduce their risks and in doing so they may get a smaller profit and a bigger loss.  In other words, losses psychologically affect people more than gains. If the probability of success is low, people tend to risk more, while if the probability of success is high, they, on the contrary, are reluctant to take risks. It's clear, that to maximize utility, one should do everything the other way round. The same bad tendencies are observed with losses. The higher the probability of loss, the more people tend to risk. When emotions are ruling your trading decisions, you are not really trading, you are gambling. You are tempted to limit your profit and let your losses run. The solution that can help improve the situation self-control, a decent trading system (we'll return to this later) and the respect of risk management. Amanda Cox, the editor of the New York Times' The Upshot, provides a nice visual of the human fallacy in judging probabilities: The problem arises when we move from probability to predictions and actions based on these predictions. If we estimate the chance of profit by 80%, we may be carried away and disregard a protective stop. Even though it's hard to think probabilistically, traders should make this effort. The gambler's fallacy Let's make sure that the concept of probability started to sink in. Imagine that you toss a coin. The outcome is random, so the probability of either heads or tails equals to 50%. For example, you are betting on heads. Will the probability of your success decline after 5 heads in a row? The answer if no, it will still be equal to 50%. The reason is that we don't count the probability of several events at once, but start anew with an independent event, so the possibility of success is 50% each time. This is called the gambler's fallacy (the mistaken belief that, if something happens more frequently than normal during a given period, it will happen less frequently in the future) and was witnesses in Monte Carlo often enough.  Traders should also remember it when chilling after a set of gains or brooding over a series of losses. Befriending mathematical expectation Of course, a trading decision is more complicated than a coin flip. And yet, it all comes to probability. The goal of a trader is to build a trading system with a positive expectation and combine it with sound risk management. Regrettably, the maths doesn't allow us to predict the future performance of a trading system. All we can do is to study historical data gathered during the period when you backtested your strategy. The formula of positive mathematical expectation will be something like: [1 + (W/L)]xP - 1, where W is the amount of average winning trade, L is the amount of average losing trade and P is the probability of winning. Remember that mathematical expectation is not predictive in nature, but a system with a positive expectation is your basis for successful trading. The other crucial element is proper risk management. Incidentally, risk exposure is the one thing we can actually control in trading with tools like position sizing, risk-reward ratio, and stop loss orders. Risk management allows maximizing the gains provided by the trading system with a positive expectation while limiting risks. It's wise to use your power when it can be used and make it yield you the benefits. It's a way for a trader to stop looking for a "holy grail" (a 100% success system) and start actually making profits ― thinking probabilistically as he/she is doing so.   This article was submitted by FBS.ForexLive

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TECHNICAL ANALYSIS Wed 21 Nov

EURUSD choppy but higher. If the dollar is going lower, what do the charts have to tell us?

If the dollar has peaked, what do traders want to see? Adam asks a key question at the end of his recent post.  "How much will the dollar fall if the Fed hits the pause button on rate hikes?" For me the price action and technicals help tell the story. Today the price action shows a rebound from yesterday's sell off, but the price action on the hourly chart shows choppy up and down trading.   What I see technically though is that the fall yesterday took the price below the 100 hour MA (blue line - bearish) and marginally below the 38.2% of the move up from the November 12 low. That level comes in at 1.13736.   What did NOT happen yesterday or today is a move below the 200 hour MA (green line) or 50% retracement.  That makes the move low more of a modest correction.   The rebound off that modest correction has taken the price back above the 100 hour MA currently at 1.1390. Watch that level for bullish/bearish clues intraday. Stay above and the dollar selling (higher EURUSD) can be expected.  Move below and the choppy run higher tilts more to the bearish side once again (with a move below the 1.13736 level more bearish).   So stay above the 100 hour MA allows the dollar to sell off more - technically. Taking a broader look at the daily chart below, what does it say about bullish/bearish and where can a more bearish dollar target? Well, the month's low fell below a floor at 1.1398-12 area (see green circles). That level can be tested before moving higher, and still lead to a more bearish dollar picture. Hence the importance of what the hourly chart says (il.e watch the 100 and 200 hour MAs there).   On the topside, if the EURUSD does continue its move higher (lower USD) by staying above the 100 and 200 hour MAs, the 1.1506-296 area (see red circles) has been a swing area and would be the next key upside target area. Move above that area will then target the 100 day MA at 1.1553 (blue line in the chart below - it is moving lower), followed by a downward sloping trend line at 1.1600 currently.  Above 1.1600 and the dollar has more room to roam back higher.  Of course the story line can change in an instant. If Brexit slows EU growth, if slowing US slows global/EU growth more. If Trump continues to go on a tariff rampage (trade deficits are not getting that much better afterall). If the Fed continues to tighten.  All those can keep the dollar bullish.  However, the price action will tell the story. So listen to the story by watching the price.   ForexLive

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EDUCATION FROM BROKERS | TRADING TECHNIQUES Fri 9 Nov

Trading and probability

Embrace the odds in your trading "Probability is not a mere computation of odds on the dice or more complicated variants; it is the acceptance of the lack of certainty in our knowledge and the development of methods for dealing with our ignorance." ― Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets Trading is all about choosing a trade idea with the highest probability of success. However, human intuition and common wisdom can be rather deceitful and lead to poor judgments. In this article, we will revisit the main laws of probability that can be applied to trading and learn from them. The flaws of intuition The problem is that many times when we go with our intuition without giving it a deep thought, we make a poor estimate of probability. Let's resort to the prospect theory developed by Daniel Kahneman and Amos Tversky. This theory explores the ways we make decisions which are associated with risks. Imagine that you face a choice: 1. A 75% chance to win $100 with a 25% chance of getting nothing. 2. A sure profit of $70. There's one more test. This time necessary to choose between: 1. A 75% chance of losing $100 with a 25% chance of losing nothing. 2. A sure loss of $70.  Logic would say that a risk-averse person would choose option 2 in both cases (limited profit plus limited risk). However, in reality, the majority chooses 2 in the first choice and 1 in the second choice. The prospect theory shows that people overestimate the probability of getting no gain but overestimate the chance of losing nothing. They seek to reduce their risks and in doing so they may get a smaller profit and a bigger loss.  In other words, losses psychologically affect people more than gains. If the probability of success is low, people tend to risk more, while if the probability of success is high, they, on the contrary, are reluctant to take risks. It's clear, that to maximize utility, one should do everything the other way round. The same bad tendencies are observed with losses. The higher the probability of loss, the more people tend to risk. When emotions are ruling your trading decisions, you are not really trading, you are gambling. You are tempted to limit your profit and let your losses run. The solution that can help improve the situation self-control, a decent trading system (we'll return to this later) and the respect of risk management. Amanda Cox, the editor of the New York Times' The Upshot, provides a nice visual of the human fallacy in judging probabilities: The problem arises when we move from probability to predictions and actions based on these predictions. If we estimate the chance of profit by 80%, we may be carried away and disregard a protective stop. Even though it's hard to think probabilistically, traders should make this effort. The gambler's fallacy Let's make sure that the concept of probability started to sink in. Imagine that you toss a coin. The outcome is random, so the probability of either heads or tails equals to 50%. For example, you are betting on heads. Will the probability of your success decline after 5 heads in a row? The answer if no, it will still be equal to 50%. The reason is that we don't count the probability of several events at once, but start anew with an independent event, so the possibility of success is 50% each time.  This is called the gambler's fallacy (the mistaken belief that, if something happens more frequently than normal during a given period, it will happen less frequently in the future) and was witnesses in Monte Carlo often enough.  Traders should also remember it when chilling after a set of gains or brooding over a series of losses. Befriending mathematical expectation Of course, a trading decision is more complicated than a coin flip. And yet, it all comes to probability. The goal of a trader is to build a trading system with a positive expectation and combine it with sound risk management. Regrettably, the maths doesn't allow us to predict the future performance of a trading system. All we can do is to study historical data gathered during the period when you backtested your strategy. The formula of positive mathematical expectation will be something like: [1 + (W/L)]xP - 1, where W is the amount of average winning trade, L is the amount of average losing trade and P is the probability of winning. Remember that mathematical expectation is not predictive in nature, but a system with a positive expectation is your basis for successful trading. The other crucial element is proper risk management. Incidentally, risk exposure is the one thing we can actually control in trading with tools like position sizing, risk-reward ratio, and stop loss orders. Risk management allows maximizing the gains provided by the trading system with a positive expectation while limiting risks. It's wise to use your power when it can be used and make it yield you the benefits. It's a way for a trader to stop looking for a "holy grail" (a 100% success system) and start actually making profits ― thinking probabilistically as he/she is doing so.   This article was submitted by FBS.

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BASICS Sat 3 Nov

How to find a great entry price and reduce your stop size

Placing stops: Mastering trade management and risk control Trade management is a key skill to grasp and a good entry price will enable you to reduce your stop size. Entering a stop is simply where you place an order in the market where you will 'exit' the market if your trade goes against you. You should always, always place a stop level as soon as you enter a trade.  The benefit of using stops is that it gets you out of the market instantly. The market can have shocks and surprises and run for hundreds of points in certain situations. You never want to be in a trade without a stop if you want to ensure you keep trading. So, be resolved to put your stop order in straight away, and preferably as you enter the market. How to decide on the size of your stopYou size of stop will depend on a large number of variables. Are you swing trading? Are you only expecting to be in the trade for 1 day? Are you basing your trade off the weekly chart? However, as a very rough guide, when you are day trading, you would usually want to consider a stop of around 25-50% of the daily average range. The average range of the chart you are trading can give you a good rough guide as to the size of stop you should be using.How your entry price impacts your size of stop lossOnce you have properly conducted your analysis for your trade (this article assumes that you have a good fundamental or sentiment bias for your trade) then you need to look for a key place to enter. Let's look at an example. Around the 23 October I was looking to buy Gold. The equity markets had been tumbling, the Italian budget crisis was in motion, the US China trade war was bubbling away and Gold had been bought strongly as investors looked to use it as a safe haven again. I considered that the time was right to buy Gold. I identified the 100EMA as the place that I wanted to enter. You can see my entry marked on the chart below by the small blue arrow just above the 100EMA on October 24. Sure enough, price moved down to the 100 EMA. I waited to see how price would react to the level and the rejection confirmed my analysis. I knew I wanted to enter long. As price returned to the 100EMA again, I entered a long with a very tight stop. I knew that my entry level was correct and any further falls down through the 100 EMA would mean that my analysis was incorrect. The equity markets were continuing to fall and at the time it was the S&P 500 falling, so I entered with confidence and made a profit that was more than double what I risked. My stop could be tight because I entered at the right technical place. Specifically that was  a place where the 100 EMA and a horizontal support level met. By looking for key places to enter, you can ensure that your stop is as small as possible. Obviously, the smaller the stop you can use the better.Place your stop in a place that you think price should not get to if you are correct in your analysis. Look for them and then, once you have found them, use them as your entry prices. Moving your stops to breakeven Now, once price moves in the direction of your trade you know that you can start reducing your risk. In the trade example above, once price had moved above the 50EMA just above the entry price and cleared the overhead highs at 1233.00, you could have considered moving the stop to breakeven. Risk would have been managed and limited. In certain situations it is also possible to trail your stop as you move into profit How a good exit helps you keep profitable Now, it won't matter how cleverly you place your stops if you don't take your profit. Make sure that you do actually take your profit. Use an area just before key technical places as targets. In the trade above there was an obvious place to take profit and that was at the overhead highs of 23 October. When I came to my desk on October 25 and saw price at those highs I took profit. I am very glad I did as I would have otherwise been taken out at breakeven. So managing your trades is a developed skill. This article has shown you that by choosing your entry place wisely, you can limit and reduce your risk in order to maximise your reward. ForexLive

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