Chapter 15

Managing the Trade

In This Chapter

Staying on top of prices and news

Listening to what other markets are saying

Updating the trade plan over time

Protecting profits and extending gains

So, you’ve pulled the trigger and opened up the position, and now you’re in the market. Time to sit back and let the market do its thing, right? Not so fast, amigo. The forex market isn’t a roulette wheel where you place your bets, watch the wheel spin, and simply take the results. It’s a dynamic, fluid environment where new information and price developments create new opportunities and alter previous expectations. Actively managing a trade when you’re in it is just as important as the decision-making that went into establishing the position in the first place.

We hope you’ll take to heart our recommendations about always trading with a plan — identifying in advance where to enter and where to exit every trade, on both a stop-loss and take-profit basis. (We go into more detail about developing trading plans in Chapters 10, 12, and 13.) Bottom line: You improve your overall chances of trading success (and minimize the risks involved) by thoroughly planning each trade before getting caught up in the emotions and noise of the market.

Depending on the style of trading you’re pursuing (short term versus medium to long term) and overall market conditions (range-bound versus trending), you’ll have either more or less to do when managing an open position. If you’re following a medium- to longer-term strategy, with generally wider stop-loss and take-profit parameters, you may prefer to go with the “set it and forget it” trade plan you’ve developed. But a lot can happen between the time you open a trade and prices hitting one of your order levels, so staying on top of the market is still a good idea, even for longer-term trades.

Shorter-term trading styles looking to capture intraday and even smaller price movements will necessarily have more frequent adjustments to overall trade strategies. We say necessarily because short-term price movements can be extremely rapid as well as short lived. If your trade strategy is designed to capture only smaller price shifts — say, on the order of 30 to 50 pips — you’ll need to be more proactive in guarding against short-term reversals of 15 to 25 pips, which constitute nearly half of your expected upside.

On top of that, short-term price movements are the market noise that makes up larger price movements. There will be a lot more 30- to 50-point moves than 100- to 200-pip moves. If you’re going after the more frequent fluctuations, you’ll have to be more nimble when it comes to adjusting to incoming news and price developments.

Monitoring the Market while Your Trade Is Active

No matter which trading style you follow, it’ll pay to keep up with market news and price developments while your trade is active. Unexpected news that impacts your position may come into the market at any time. News is news; by definition, you couldn’t have accounted for it in your trading plan, so fresh news may require making changes to your trading plan.

The starting point for any trading plan is determining how much you’re prepared to risk, which is ultimately the result of the size of the position and the pip distance to the stop-loss point. When we talk about making changes to the trading plan, we’re referring only to reducing the overall risk of the trade, by taking profit (full or partial) or moving the stop loss in the direction of the trade. The idea is to be fluid and dynamic in one direction only: taking profit and reducing risk. Keep your ultimate stop-out point where you decided it should go before you entered the trade, when your emotions weren’t in play.

Following the market with rate alerts

One way to follow the market from a distance is to set rate alerts from either your charting system or your trading platform. A rate alert is an electronic message that alerts you when a price you’ve specified is touched by the market in a currency pair you specify. Rate alerts are a great way to keep tabs on the market’s progress.

Rate alerts on charting systems usually have the capability of alerting you to price developments only while you’re logged on to your computer or using your smartphone or tablet and the charting service. With charting systems, you’re able to work on other tasks on your computer and keep the charting system minimized or in the background, which means you can use these at your job. If your requested price level is hit by the market, the chart system will typically start beeping or flashing and send a pop-up message.

Some forex brokers, including FOREX.com, can send rate alerts via email and text message direct to your smartphone. Many brokers now also have a large presence on Twitter and Facebook, so it’s worth following your broker on social networks as well.

Rate alerts are a convenient way to follow the market remotely, but they don’t take the place of live orders and should never be substituted for stop-loss orders. By the time you respond to a rate alert and log on to the trading platform or call your broker’s trading desk, prices may have moved well beyond your desired stop-out level, leaving you with a larger loss than you anticipated. Rate alerts are a nice little extra service, but only orders represent obligations on the part of your broker to take an action in the market for your account.

Staying alert for news and data developments

Every trade strategy needs to take into account upcoming news and data events before the position is opened. Ideally, you should be aware of all data reports and events scheduled to occur during the anticipated time horizon of your trade strategy. You should also have a good understanding of what the market is expecting in terms of event outcomes and anticipate how the market is likely to react.

For instance, if the Fed chair is scheduled to deliver remarks on the economy or the monetary policy outlook, find out what her recent comments have been. Is she currently leaning hawkish or dovish? If it’s an economic data release, make sure you understand what the report covers and what it means for the market’s current expectations. At the minimum, be sure you know what the consensus expectations are for the report and what the data series has been indicating recently.

It’s often said that the market’s reaction to news and data is more important than the news or data itself. But you can’t properly interpret the market’s reaction if you don’t have a grasp on what the news means in the first place. (See Chapter 7 for a detailed look at economic reports and Chapters 5 and 6 for major fundamental drivers and how the market interprets them.)

The other reason to stay alert for news while your trade is active is that many trade strategies are based on fundamental data and trends. If your trade rationale is reliant on certain data or event expectations, you need to be especially alert for upcoming reports on those themes.

Part of your calculus to go short EUR/USD, for instance, may be based on the view that Eurozone inflation pressures are receding, suggesting lower Eurozone interest rates ahead. If the next day’s Eurozone consumer price index (CPI) report confirms your view, the fundamental basis for maintaining the strategy is reinforced. You may then consider whether to increase your take-profit objective depending on the market’s reaction. By the same token, if the CPI report comes out unexpectedly high, the fundamental basis for your trade is seriously undermined and serves as a clue to exit the trade earlier than you originally planned. There’s no sense hanging on until the bitter end if your trade rationale has already been knocked down. You may even consider reversing your position in light of the new data.

Speculating based on expected event or data outcomes is perfectly okay. It becomes a problem only if you maintain the trade even after the data/event outcome has come out against your expectations and strategy. Always relate incoming news and data back to the original reason for your trade, and be prepared to adapt your trade strategy accordingly.

Keeping an eye on other financial markets

Forex markets function alongside other major financial markets, such as stocks, bonds, and commodities. Although these financial markets have seen higher long-term correlations with forex in recent years, short-term correlations are far less reliable.

But there are still important fundamental and psychological relationships between other markets and currencies, especially the U.S. dollar. In that sense, we look to developments in other financial markets to see whether they confirm or contradict price moves in the dollar pairs. So, even though there may not be a statistically reliable basis on which to trade currencies based on movements in other financial markets, you’ll be a step ahead if you keep an eye on the following other markets.

U.S. Treasury yields

U.S. government bond yields are a good indicator of the overall direction of U.S. interest rates and expectations. We focus on the benchmark ten-year Treasury-note yield as the main interest rate to monitor. We also keep an eye on shorter-term rates, like three-month T-bills and two-year notes. Rising yields tend to be dollar positive, and falling yields tend to be negative for the dollar. If yields are rising, but the dollar isn’t, it suggests that other factors are at work keeping the dollar down and that dollar bulls should be cautious. If yields are falling and the dollar is falling, too, you’re getting confirmation from the bond market of a negative U.S. dollar environment — lower interest rates.

Make sure you understand the reason for the bond yield’s movements, because it can suggest different interpretations. If it’s based on interest rate expectations — due to data or Fed comments, for instance — it’s more likely to reflect overall dollar direction. If it’s due to market uncertainty and a flight to quality — due to European debt concerns, for example — the impact on the U.S. dollar may be more positive. The larger the change in yields, the more important is the message that’s coming from the bond market. Yield changes of more than 5 basis points (1/100 of a percent) should get your attention.

Gold and silver prices

Precious metals like gold and silver are typically viewed as hedges against inflation and safe-haven investments in times of financial market uncertainty. In recent years, gold and silver have seen heightened demand as alternatives to the major currencies, most especially the U.S. dollar, but also the euro, as the European debt crisis has threatened the single currency. As such, gold and silver prices tend to move in the opposite direction of the U.S. dollar overall (inverse correlation), but the short-term correlations are trickier. Gold and silver are relatively illiquid markets and mostly take their cues from the larger forex market, but the metals are no stranger to their own market-specific gyrations, typically based on breaks of technical levels.

Look for confirmation of the U.S. dollar direction in gold and silver prices. If the dollar is rallying and the metals are falling, for instance, it’s a good sign that the dollar’s gains are for real. If the dollar is rallying but gold is holding steady or even rising, the dollar’s strength looks more suspect.

Oil

Oil is similar to the precious metals and other commodities in that it has a long-term inverse correlation to the U.S. dollar (dollar down/oil up and vice versa). But the same caveat also holds true — shorter-term correlations are less reliable, and oil is especially vulnerable to oil-specific supply/demand shocks. We would also note an asymmetric bias to the relationship between oil and the U.S. dollar. What that means is that oil is likely to experience greater strength on a falling dollar than weakness on a rising dollar, if all else is equal.

We also like to look to oil price developments for what they suggest about interest-rate expectations and relative economic growth. Higher oil prices tend to increase inflation pressures, which may lead to higher interest rates. At the same time, higher oil prices tend to reduce economic growth by undermining personal consumption. Between the two, oil’s impact on the growth outlook is more important due to the speed with which consumers react to changes in oil prices. Interest rate changes take longer. The recent surge in emerging market nations’ growth has also heightened global demand for oil, so oil increasingly functions as a barometer for overall global growth.

Stocks

Long-term, such as over the last decade, there is very little correlation between stock markets and currencies. However, since the Great Financial Crisis of 2008–2009, there has been a stronger relationship between stocks and forex, especially the U.S. dollar. The relationship is best described as risk on/risk off (see Chapter 5 for more on risk sentiment), where stocks are considered risk-seeking assets and the dollar is viewed as the safe-haven asset, as investors buy USD to buy U.S. Treasury debt, the ultimate safe harbor. In recent years, the risk-on/risk-off scenario has typically played out as follows: When the overall market environment is positive, investors embrace risk and buy stocks, reducing the demand for dollars, usually leading to dollar weakness. When the news turns bad, however, investors have dumped stocks and fled to the safety of U.S. Treasuries and the greenback. As long as recent financial travails plague the global economy, this relationship seems set. But when economic and financial conditions begin to improve to something resembling normalcy, we would expect the stocks/forex relationship to return to lower historical correlations.

Updating Your Trade Plan as Time Marches On

If you’re like most traders, after you enter a position you’re keenly aware of every single pip change in prices, at least as long as you’re watching the market. Every little price change, and the attendant change in your unrealized profit and loss (P&L), evokes emotions ranging from joy to despair and everything in between. And that’s to be expected. After all, at the end of the day, it’s the P&L that matters, and pips are how that’s measured.

But one element that tends to receive remarkably little attention from traders, at least on a conscious level, is the passage of time. Prices may seem to stand still for extended periods — when a currency pair may be stuck in a range (that is, it keeps trading back and forth over the same ground) — but time is constantly moving forward.

Staying aware of time and its passing is an important skill for traders to develop. You know where the market price is now, so the question is really: Where will the market price be in the future? As soon as you think of the future, it becomes a question of time: When will it be there? If you consider these questions as you formulate each trade strategy, you’ll go a long way toward incorporating time into your overall trade planning. More important, you’ll gain an intuitive appreciation of the importance of time in trading, and you’ll find yourself asking when as often as why or where.

On the most concrete level, as time progresses, it brings with it routine daily events, such as option expirations and the daily fixings, to name just two. These are specific time periods where traders can reasonably expect a flurry of activity, though it doesn’t always materialize. (We run through the series of regular trading-day time events in Chapter 2.)

Time’s passing also brings you nearer to scheduled news or data events. The pricing in of market expectations for major events occurs in the hours and days ahead of the event or data release. As the release time draws closer, anticipative speculation generally declines, and price movements can become more erratic as traders take to the sidelines ahead of the release. Prices may chop around more, but ultimately not go anywhere. All these market reactions are as much the result of time as they are of the event itself.

On a more objective level, as time progresses, it can add significance to, or detract significance from, price movements that have already occurred, frequently providing trading signals as a result. For instance, the failure of prices to make an hourly close below a break of trend-line support suggests that it may be a false break and that prices are likely to rebound higher. But if the break occurred at 10:12 ET, for instance, you won’t know until the next hourly close in 48 minutes. Potentially more significant trading signals are generated from longer time periods, such as a daily close above long-term trend-line resistance or a prior daily high.

Trend lines move over time

If you’re basing your trading strategies on trend-line analysis, you need to be aware that price levels derived from trend lines will change depending on the slope of the trend line. The slope of a trend line refers to the angle of a trend line relative to a horizontal line. The steeper the slope of the trend line, the more the relevant price level will change over time; the shallower the slope, the more gradually the price levels will change with time.

Figure 15-1 gives you a good idea of how short-term price levels based on a 15-minute trend line will shift over the course of just a few hours. Note how steeply the trend line is sloping upward. For prices to continue to move higher in line with this trend line, they must stay above the trend line as it rises over time, suggesting price gains of 10 to 15 pips per hour are needed.

Using your charting system, you can pinpoint relatively accurately where prices must be in the future for the trend line to remain active as a support/resistance level. To do this, slide the cursor along the trend line, and note the time that appears on the horizontal axis at the bottom of the chart.

The same applies with longer-term charts, but the price shifts are typically less pronounced, meaning an hourly trend line may see levels adjust by 10 to 15 pips every 6 to 12 hours, and daily charts may see levels shift by 10 to 30 pips over a few days. But there are no concrete rules on this; it all depends on the slope of the trend line.

No matter what time frame you’re trading, be sure to factor in the shifting levels of trend lines, if they’re part of your trade strategy. You may need to adjust your order levels accordingly. In particular, consider the following:

• Short-term and overnight positions: Consider where trend-line support or resistance will be over the next 6 to 12 hours, when your position is still active but you may not be able to actively follow the market. You may want to use a trailing stop as a proxy for changes in trend-line-based support/resistance levels.
• Limit-entry orders: If your limit buying/selling order is based on a sloping trend line, periodically adjust your order so that it’s still in play according to changes in the trend line. You may miss a trade entry if the trend line is eventually touched, but, in the meantime, its level has shifted away from where you first placed the order.
• Breakouts: A significant trend line that looks to be a mile away one week may suddenly be within striking distance in the following week or two weeks, substantially altering the market’s outlook. Alternatively, the market may be focused on a price high/low as a breakout trigger, when a sloping trend line touching that high/low may actually be the catalyst for a breakout.

Impending events may require trade plan adjustments

As you develop your trading plan, we strongly recommend that you look ahead to see what data and events are scheduled during the expected life of the trade. If you follow that simple advice, you strongly reduce the chances of having your trade strategy upset by largely predictable events. More important, you’ll be able to anticipate likely catalysts for price shifts, which will give you greater insight into subsequent price movements. Forewarned is forearmed.

If you’ve entered into a trade strategy based on an upcoming event — an expected weak U.S. data report, for instance — and the market has cooperated and priced in a lower U.S. dollar before the report is released, you may be looking at a profitable position before the data is even released. As the release time draws near, you may consider taking some profit off the table and holding on to the remaining partial position.

Consider the possible outcomes. If the data comes in negative for the U.S. dollar, and the market reacts by selling the U.S. dollar, you’re still in the partial position to gain from further dollar weakness. But what if the data comes in stronger than expected? Or what if the data comes in weak as expected, but the market takes profit on short-dollar positions made in advance, in a “sell-the-rumor/buy-the-fact” reaction? You’ve protected your profit and taken some money out of the market before the event ever transpired. Now, that’s called playing the market!

In the preceding scenario, we intentionally depict a short trade to remind you that being short is as common as being long in currency trading. You may be more familiar with “Buy the rumor, sell the fact.” We just want to make sure you know that it works both ways.

Before major data and events, the market also frequently goes into a sideways holding pattern. The event speculators have all put on their positions, and the rest of the market is waiting for the data to decide how to react. These holding patterns can develop hours or days in advance, depending on what event is coming. Especially if you’re trading from a short-term perspective, be prepared for these doldrums and consider whether riding through them is worthwhile.

Updating Order Levels as Prices Progress

Just because you’ve got a well-developed and considered trade plan doesn’t mean it has to be carved in stone. Well, at least the ultimate stop-loss exit should be carved in stone. But when you’re in a position, and the market is moving in your favor, it’s important to be flexible in adjusting take-profit targets and amending stop-loss orders to protect your profits.

The key to being flexible in this regard is also being prudent — don’t adjust your take-profit targets without also adjusting your stop-loss order in the same direction. If you’re long, and you raise your take profit, raise your stop loss too. If you’re short, and you lower your take profit, lower your stop-loss order as well.

Increasing take-profit targets

You’ve put together a well-developed trade strategy ahead of your trade, as we’ve recommended, so now that you’re in the trade, why would you change your take-profit objective? That’s a very good question, and you’d better make sure you have a very good answer, because we’ve also touted the virtues of not tampering with a trade plan after the position is opened.

So what constitutes a very good reason to extend your take-profit objective? Keep an eye out for the following events to consider extending your take-profit targets:

• Major new information: More likely than not, the new information will have to come out of left field. If it was a scheduled event, like a data report or speech, the market speculation surrounding it would have sopped up all the interest and muted its impact. Major means it has to come from the very top echelons of decision-making, like the Fed chairman, the European Central Bank (ECB) president, or other central bank chiefs; the U.S. Treasury secretary; or, increasingly, China. Surprise interest rate changes or policy shifts are always candidates. The more at odds the information is with current market expectations, the better the chances that it will generate an extensive price move.
• Thinner-than-usual liquidity: Reduced liquidity conditions can provoke more extensive price movements than would otherwise occur, because fewer market participants are involved to absorb the price shocks. Reduced liquidity is most evident during national holidays, seasonal periods (late summer, Christmas/New Year’s), end of month, end of quarter, and certain Fridays.
• Breaks of major technical levels: Trend lines dating back several months or years, Fibonacci retracement levels of major recent directional moves, and recent extreme highs and lows are likely to trigger larger-than-normal price movements.
• The currency pair: The more illiquid and volatile the currency pair you’re trading, the greater the chances for an extreme move. GBP and JPY are the most common culprits among the majors, and the commodity currencies (AUD, CAD, NZD, and ZAR) are also candidates.

As you can see, the list is pretty short, and there may be only a dozen or so events in the course of a year that warrant altering your trade plan. Be careful about getting caught up in the day-to-day noise and routinely extending your profit targets — it undermines trading discipline and the basis for your trade strategy.

Tightening stop-loss orders to protect profits

We’re generally reluctant to extend our take-profit objectives unless there are significant grounds to do so (see the preceding section) or we’re using a trailing stop loss. But when it comes to protecting profits, we’re much more comfortable about adjusting stop losses to lock in gains. When you’ve got a profit in the market, taking steps to protect it is always a smart move.

When formulating your overall trade plan, always consider what price levels need to be surpassed to justify moving your stop loss. If it happens in the market, you’ll be ready and know exactly what to do.

We like to focus on hourly and daily trend-line levels, highs/lows, and breaks of Fibonacci retracement levels. When these technical support/resistance points are exceeded, it’s an indication that the market has seen fit to move prices into a new level in the overall direction of the trade. When that happens, consider moving your stop-loss order to levels just inside the broken technical level. If the market has second thoughts about sustaining the break, your adjusted stop will then take you out of the trade.

For example, say you’re long GBP/USD at 1.5250, your original stop loss is at 1.5180 below, and your take-profit objective is above at 1.5380. Also above is resistance from yesterday’s high at 1.5335. If that level is surpassed, consider raising your stop loss to break even (where you entered, at 1.5250) at the minimum. To more aggressively protect profits, you may raise the stop further to 1.5315 or 1.5325, locking in 65 to 75 pips minimum, on the basis that 1.5335 should now act as support.

The risk with adjusting stops too aggressively is that the market may come back to test the break level (1.5335, in this example), triggering your adjusted stop loss if it’s too close, and then go on to make fresh gains. But the trade-off in that situation is between something and more of something, or potentially nothing and more of nothing. We prefer to have something to show for our efforts.

Another way to lock in profits in a more dynamic fashion is by using a trailing stop-loss order (see Chapter 4). After a technical level in the direction of your trade is overcome, similar to the preceding example, you may consider instituting a trailing stop to replace your fixed stop-loss order. Set the trailing distance to account for the distance between the current market and the other side of the technical break level, possibly allowing for a margin of error in case the break level is retested.