ForexSpirit

This week is turning out to be a great time of self-analysis and learning. For too many months now my main currency pair has been stuck in a rut. It has certainly been an experience being trapped within a 400 pip range on EUR-USD; trading in a congestion range is an important skill to have as markets never trend 100% of the time.

Up until yesterday I was of the opinion that we going to see a continuation of the range trading. Especially given the reduced volume and leverage that we’ll have today and tomorrow due the closure of the American markets for Thanksgiving.

Of course the one constant in the markets is that change is inevitable. Nothing lasts forever.

It looks like a change is currently in progress. While the US markets might be closed today, and for all intents closed tomorrow (officially the equity markets are open for half the day but just about everyone takes the day off) I had forgotten that the majority of currency trading is done out of London. This means that plenty of trading is still going to be done and is not going to be undone when things get back to ‘normal’ next week.

The two trades I placed so far this week were with my prior view that the range was going to hold. I entered a Q4 trade at my birthday level of 1.2822 on Monday morning. Since my expectation was that the 1.29 level would hold once again, I went for a safe profit target and exitted for 30 pips at 1.2852.

Wednesday morning saw a break of the mystical 1.29 level. It looks like a pretty sustained break at this stage, but it is still way too early to really consider a change to the grid levels just yet. The first half of next week should provide some clearer guidelines on making a decision one way or another with regard to that issue.

Back to yesterday morning. On the initial breakout move, with my view that price would revert back into the range, I entered a short position at 1.2936. I was expecting a pretty rapid reversion back into the grid. When that didn’t happen by this morning it was time to re-evaluate. Some interesting insights in Dirk’s e-mail today contributed to my change of mind. FXCM’s sentiment index shows a large short bias on EUR-USD. Since FXCM deals with retail clients, and retail clients are the small fish in the huge forex ocean then you will more often than not see the small fish get eaten by the big fish. Don’t swim with the small fish or you too will be eaten. The big fish are also looking to position themselves for the end of 2006 and into early 2007. With everything still pointing towards continued dollar weakness it was just a question of when they would make their move.

With America distracted by the Thanksgiving holidays it looks like now might be that time. The end of the 1.25-1.29 range could be at hand.

This morning I closed out my short for a 33 pip loss. With my change in perspective on the market it is better to clear out my trade blotter. This allows me to return my full attention to looking for good entries back in my one direction.

Another part of this week’s learning is to do with a tactic that Dirk likes to call the ‘toe in the water’. This is a term that means keeping a position in the direction of your one direction (this would mean long EUR-USD in my case), potentially for a rather long time, to take advantage of any sustained break out of the grid. You never know when the breakout is going to occur which is why you have to expect to hold that trade open for quite a while.

This can be a tricky tactic to use in practice. The last time I used the ‘toe in the water’ tactic was when price was in Q4 earlier this summer. Unfortunately price never broke out of the range and I ended up having to close out the trades for some losses when price entered the lower part of the grid.

I always try to always prevent a trade that has entered into some profit from becoming a loser. This can mean looking to exit a ‘toe in the water’ before it moves into the red. You then have to wait for price to retrace so you can enter another ‘toe in the water’ at a reasonable level.

With a Q4 trade you generally want to exit it rather quickly as the top line of your grid should be a level that is expected to provide significant resistance. Within the median grid there is generally the expectation that price will return to the median line rather than breakout when price approaches one of the grid extremes. Of course a break out will occur sooner or later, so you have to be on the lookout for telltale signs of when that breakout has a greater probability of happening.

Since I did not spot any telltale signs this time I did not have a ‘toe in the water’. I feel that I might be avoiding using this tactic given that I got burnt using it last time. I was not being open and receptive to any signs that the market was making available to me. I was turning a blind eye.

‘Toe in the water’ is a valid tactic to overcome a limitation of using a median grid and a tactic that I should not discard or give up using due to one time when it did not work out as expected. No strategy or tactic in the trading world is guaranteed to work every single time.

A second difficulty in using a ‘toe in the water’ trade occurs if you have to hold the trade for a long time and the interest rate differential is against you.

The US interest rate is currently higher than the euro zone interest rate. This means that if you go long EUR-USD then you will pay for holding those euros when your broker’s daily interest rollover occurs. Those payments can certainly add up if you have to hold that position for days or weeks on end.

I have also noticed a recent tendency for me to go for regular short term profits from all my trades. I am not looking to hold positions for the occasional 100 or 150 pip move like I use to. This change might be a result of the extended congestion that the market has gone through over the last half year.

Price also had a tendency to linger more in the top half of the grid. My trading plan states that I should look to primarily take 30 or 50 pips profit from my Q3 and Q4 entries. When price did enter the lower half of the grid I did not avail myself of the opportunities to enter larger move trades back in my one direction.

My recollective is that I was more concerned with re-establishing some confidence and profitability after having just suffering some loses that had to be closed out.

It is vitally important that I look to re-establish entering trades and looking to hold on to some for large moves every so often, as these sorts of trades are the main defense against the large loses that are part and parcel of my trading methodology.