Chapter 14
In This Chapter
Opening up trading positions
Averaging into trade setups
Trading on breakouts
Dealing online and placing orders
“You gotta be in it to win it” is a favorite saying that currency traders like to throw around. The “in it” part refers to being “in” the market, having the right directional view expressed with an open position (long/short) in a currency pair.
But there’s always a trade-off between having the right position and getting into that position at the most advantageous price. For example, being short AUD/USD may be the correct position to have, but if you enter at the wrong price, you may have to endure some pain before the trade moves your way.
In this chapter, we walk you through some of the different ways of entering trades and establishing the position to fit your overall strategy.
You can make trades in the forex market one of two ways: You can trade at the market, or the current price, using the click-and-deal feature of your broker’s platform; or you can employ orders, such as limit orders and if/then contingent orders. (We discuss order types in Chapter 4.) But there’s a lot more to it than that. Certain trade setups suggest a combination of both methods for entering a position, while others rely strictly on orders to capture rapid or unexpected price movements. Then there’s the fine art of timing the market to get in at the best price at the moment.
Many traders like the idea of opening a position by trading at the market as opposed to leaving an order that may or may not be executed. They prefer the certainty of knowing that they’re in the market. Actively buying and selling is also what makes trading as fun and exhilarating as it is hard work.
For short-term trade entry at the market, you want a good handle on the recent price action, which means knowing where prices have been over the past several hours. Just because you’ve settled on a strategy to buy USD/CAD doesn’t mean you have to close your chart window, open your trading platform, and pay the offer.
Take a step back and look at shorter-term charts, such as 5 or 15 minutes, to get an idea of where prices have been trading recently. Chances are you’ll observe a relatively narrow range of price action, typically between 20 and 30 pips. Unless the situation is urgent, a little patience can go a long way toward improving your entry level. Why buy at 1.0550 when you have a viable chance to buy at 1.0535?
Medium- and longer-term trade strategies typically benefit from averaging into a position. Averaging into a position refers to the practice of buying/selling at successively lower/higher prices to improve the average rate of the desired long/short position. The idea here is to allow larger market swings to unfold and use them to establish a larger position at better prices than current levels in anticipation that the market will eventually reverse course in line with your strategy.
One possible strategy would be to buy USD/JPY on the current weakness, spacing your buys so that you can buy as low as possible, but above 81.00 where you don’t expect it to trade. (The stop-loss exit in this example would be somewhere below 81.00.) Imagine that you buy one lot of USD/JPY at the market, now at 82.00, just so you have some piece of the position in case the market rebounds abruptly. You decide that 81.20 is another good level to buy at because it’s a margin of error above the key 81.00 level. If your order to buy at 81.20 is filled, you’ll be long two lots at an average price of 81.60 ([82.00 + 81.20] ÷ 2 = 81.60).
Take a look at what just happened there. To begin with, you were long one lot from 82.00. To add to the position at 81.20 means the market was trading lower, which also means you were looking at an unrealized loss of −80 pips on your initial position from 82.00. After you buy the second lot, your unrealized loss has not changed substantially (assuming that the market is still at 81.20 and excluding the spread, you’re still out −80 pips, now −40 pips on 2 lots), but your position size has just doubled, which means your risk has also just doubled.
If the market rebounds from 81.20, your unrealized loss will be reduced. But if the market continues to decline, your losses are going to be twice what they were had you not added on to your position. If your strategy plays out and the market reverses higher, you now have a larger position from a better entry price than if you had entered the two lot position earlier at higher levels.
We’ve seen the practice referred to as pyramiding in other trading books, and the advice is usually to avoid doing it (as in “Don’t pyramid into a losing position”). Sometimes “adding on” to winning positions is acceptable, such as after a technical level breaks in the direction of your trade. The result of adding on to winning positions, however, is a worse average rate for the overall position — a higher average long price or a lower average short price. If the market reverses after you add on, any gains in the overall trade can be quickly erased.
So what’s the deal? Should you average into positions or not? As with most questions on trading tactics, the answer is a straightforward “It depends.” Before deciding whether to average into positions, consider the following:
But that still doesn’t stop people from averaging into losing trades, even professional traders. Here are some indications that averaging is probably not a good idea:
Depending on the trade setup, you may be entirely justified in averaging into a position. In fact, with some trade opportunities, you’ll be hoping to have the chance to average into the position at better rates, because if the trade setup is correct, you’ll want to have on as large a position as possible.
What all these setups have in common is a price difference between current market levels and the ideal entry point based on the setup. For example, major daily trend-line resistance dating back six months may lie above in EUR/USD at 1.2960/70. Current market levels are well below at 1.2890, and there has been a spike rejection from an intraday test to 1.2930/35. Adding up these observations, we may justifiably conclude that the current market price is just below an area of major resistance, suggesting a short position as the overall way to proceed.
But we have no accurate way of predicting how much higher the market might trade, or even if it will, before the anticipated reversal lower takes place. The market could start moving directly lower from current levels. It could retest the spike highs seen earlier in the day, or it could make it all the way to test the key trend-line resistance before stalling. So where might we look to get short?
The answer is in that zone of resistance we just identified between current market levels and the daily trend-line resistance. This is where it makes sense to average into a trade to exploit the trade setup.
As an example of our own approach, we may not know how much higher the market will go, so we may be prepared to short a portion of the overall position at current market levels, in case the top has already been seen and prices move directly lower. We may also be prepared to sell remaining portion(s) of the position at successively higher levels, if the market allows it. We’ll save our last portion of the position for the trend-line resistance level in case it’s reached.
When considering where to leave your limit-entry orders to average into a trade, be aware of what your final average rate will be if all your orders are filled. The difference between that average rate and your stop-loss level multiplied by the total position size will give you the total amount you’re risking on the trade. (In Chapter 16, we look at the profit/loss implications of closing out a multiple lot position that was averaged into.)
If hourly momentum studies have already topped out and crossed over to the downside, for example, the upside potential is likely more limited. This may argue for being more aggressive in establishing a short position, such as making the initial sale at current market levels and placing any additional limit orders to sell above at closer levels. But if hourly momentum studies are still moving higher, we can reasonably wait and look to sell at relatively higher levels using limit sell orders.
If the setup works out, you’ll have taken advantage of any favorable price moves the market has made, resulting in a better average rate on your position. If the setup fails, averaging into the position at successively better rates will cost less in the end than entering the whole position at the current market level.
A breakout or break refers to a price movement that moves beyond, or breaks out of, recent established trading ranges or price patterns captured with trend lines. Breakouts can occur in all time frames, from weeks and days on down to hours and minutes. The longer the time frame, the more significant the breakout in terms of the overall expected price movement that follows.
In the very short term, prices on a 15-minute chart may establish a trading range of 20 to 30 pips over several hours, for example. A breakout on such a short time scale might result in a 30- to 50-pip movement in a matter of minutes/hours. Daily trading ranges of 300 to 400 pips may see a breakout result in an initial 50- to 150-pip movement in subsequent hours, with more to come in following sessions.
There’s no real fixed ratio or scale for range breakouts; we’ve just given those examples above to give you an idea of the relative scales involved. To be sure, a breakout of a 15-minute range can lead to the break of an hourly range, which can lead to a breakout of a daily range.
For a range to break, then, by definition something must have changed in the market’s thinking. And there’s only one thing that will change the market’s thinking: new information. New information can be anything from news and data to rumors or comments, down to the prices themselves. Many traders rely on price information as their primary source of decision-making information. If prices in USD/CHF have been capped by 1.0500 for the past four weeks, a price move above that level is new information and requires adjustments in the market.
The beauty of breakouts from an individual trader’s perspective is that you don’t necessarily need to know the reason for the breakout — just that prices have broken out. Of course, being aware of what’s going on and what news is driving the market always helps give you a leg up in anticipating and preparing for potential breakouts.
In terms of entering a position, breakouts frequently represent important signals to get in or out of positions. In that sense, they take a lot of the guesswork out of deciding where to enter or exit a position.
The first step in trading on a breakout is to identify where breakouts are likely to occur. Pinpointing likely breakout levels is most easily done by drawing trend lines that capture recent high/low price ranges. In many cases, these ranges will form a sideways or horizontal range of prices, where sellers have repeatedly emerged at the same level on the upside and buyers have regularly stepped in at the lower level. Horizontal ranges are mostly neutral in predicting which direction the break will occur.
Other ranges are going to form price patterns with sloping trend lines on the top and bottom, such as flags, pennants, wedges, and triangles. These patterns have more predictive capacity for the direction of the eventual breakout and even the distance of the breakout. (We review the most common patterns and what they imply in greater detail in Chapter 11.)
After you’ve identified a likely breakout point, you can use a resting stop-loss entry order placed just beyond the breakout level to get into a position if a break occurs. To get long for a break to the upside, you would leave a stop-loss entry order to buy at a price just above the upper level of the range or pattern. To get short for a break lower, you would leave a stop-loss entry order to sell at a price just below the lower level of the range or pattern. Figure 14-1 is a chart showing EUR/USD and where stop-loss entry orders could be placed to trade breakouts.
The appeal of using stop-loss entry orders is that you’re able to trade the breakout without any further action on your part. Breakouts can occur in the blink of an eye. Just when you thought the upper range level was going to hold and prices started to drift off, for example, they’ll come roaring back and blow right through the breakout level.
Price moves like that can leave the most experienced traders caught like deer in the headlights. By the time they react, the break has already seen prices jump well beyond their desired entry level. Worse, by trying to trade at the market in a fast-moving breakout, you may miss your price and have to reenter the trade, by which time prices may have moved even farther in the direction of the break.
The other way to trade a breakout is after the break has occurred. You may not have noticed the significance of a particular technical level, or you may not have left orders in overnight to exploit a break. You turn on your computer the next morning to discover that prices have jumped higher overnight and feel like you’ve missed the boat. But you may still get a chance to trade the breakout if prices return to re-test the breakout level.
A retest refers to prices reversing direction after a break and returning to the breakout level to see if it will hold. In the case of a break to the upside, for example, after the initial wave of buying has run its course, prices may stall and trigger very short-term profit-taking selling. The tendency is for prices to return to the breakout level, which should now act as support and attract buying interest.
But to the extent that it’s a common-enough phenomenon, you still need to be aware of and anticipate that prices may return to the breakout level. From a technical perspective, if prices do retest the breakout level, and the level holds, it’s a strong sign that the breakout is valid, because market interest is entering there in the direction of the break.
Breakouts are relatively common events in currency trading, especially in the very short-term. But not every breakout is sustained. When prices break through key support or resistance levels, but then stop and reverse course and ultimately move back through the break level, it’s called a false break.
Although there’s no surefire way to tell whether a breakout is a false break or a valid one that you should trade, a few points to keep in mind are:
When using an online trading platform, entering a position is as easy as making a few simple mouse clicks. At the same time, the simplicity and speed of online trading platforms make those simple mouse clicks a done deal that puts your trading capital at risk.
We take you through the basic steps of making a trade online in Chapter 4, but here we aim to clue you in to some of the human and technical aspects common to online trading.
Most every online trading brokerage now provides for click-and-deal trade execution. Click and deal refers to trading on the current market price by clicking either the Buy button or the Sell button in the trading platform. Before you can click and deal, you have to:
This may sound silly, but make sure you’ve selected the currency pair that you actually want to make a trade in. When the market gets hectic, and you’re switching between your charts and the trading platform, you could easily mistake EUR/USD for EUR/CHF if you’re not careful. This can also happen when different currency pairs are trading around similar price levels. If EUR/USD is trading at 30/33 and USD/JPY is trading at 31/34, it’s easy to home in on the price and overlook the big figures, which would tell you you’re in the wrong pair.
Make sure you’ve specified the correct amount you want to trade. Different platforms have different ways of inputting the trade amount. Some use radio buttons, others use scroll-down menus, and others allow you to type the amount manually. When the trading is fast and furious, make sure your selection has been properly registered on the platform. Some trading platforms allow you to customize your default trade sizes in advance, so you’re able to simply click and deal on the currency pair of your choice.
Remember: This is your money; be certain now or be sorry later. In case you think input errors can’t happen to you, think about the equity trader at a New York investment bank who meant to sell 10 million shares of a stock but ended up entering 10 billion. By the time the trade was stopped, the system had sold several hundred million shares. Ouch!
Be sure you know which side of the price you want to deal on. If you want to buy, you’ll need to click the higher price — the trading platform’s offer. If you want to sell, you’ll have to click the lower price — the platform’s bid. Most platforms have labeled the sides of the prices from the user’s perspective, so the bid side will be labeled Sell, and the offer side will be labeled Buy.
After you’ve clicked Buy or Sell, the trading platform will confirm whether your trade went through successfully, usually within a second or less. If your trade request went through, you’ll receive a confirmation from the platform. Double-check your position, and make sure it’s what you want it to be.
If the trading price changed before your request was received, you’ll receive a response indicating “trade failed,” “rates changed,” “price not available,” or something along those lines. You then need to repeat the steps to make another trade attempt.
Attempts to trade at the market can sometimes fail in very fast-moving markets when price are adjusting quickly, like after a data release or break of a key technical level or price point. Part of this stems from the latency effect of trading over the Internet, which refers to time lags between the platform price reaching your computer and your trade request reaching the platform’s server.
If you’re continually getting failed trade responses, it may be due to the speed of your Internet connection, which is preventing your trade requests from getting to the brokerage trading platform in a timely way or delaying the incoming prices you’re seeing so that they’re always behind the real market. For more on how to optimize your trading on your smartphone or tablet, turn to Chapter 4.
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