ForexSpirit

As part of my request for some reader feedback I received a whole host of interesting questions from Nead S.

Naed’s questions generally concern themselves with the 4×1 methodology that I use. If you are unfamiliar with this methodology, or would simply like a refresher course, then you can get a basic overview in my Keys to trading success post. I have also previously posted on the money management and charting setups that I use, as well as how I ended up using this method as my main trading strategy.

With all that background information out of the way, let’s get to Naed’s questions.

Naed: As a frequent reader who has recently signed up for Dirk’s mentoring course, I’m missing how you interpret the fundamentals at certain positions within the four quadrants (Q1-Q4). Does that make sense? If Dirk’s way is strictly fundamental (but not news trading) how do you determine whether or not to pull the trigger at certain ‘Q’ positions? What is your deciding factor, especially given all that jazz about randomness?

If you’ve ever used technical indicators as part of a trading system then you’re probably more than familiar of having your trade entries and exits triggered by some movement or change in your indicators. The indicators are your guiding light; they lead the way as to what you are supposed to do. In a simple multiple moving average trading system you would enter and exit on the crossing of the moving averages. When the shorter time frame moving average crosses the longer one you have a signal that you can then follow. You can look at your charts and see exactly when a trading signal has been given.

Getting naked
When you throw out all your technical indicators, all you’re left with on your charts is naked price. You are left with your wits and whatever fundamental knowledge and analysis that you can scrounge together.

You no longer have something clueing you into when you need to enter or exit a trade; you are just left with your intuition and hopefully some framework in which to apply it. The way I currently trade that framework is the 4×1 methodology, and I enter and exit trades sometimes for a specific reason or for no reason what-so-ever.

A specific reason could be anything from a recently released economic report to unfolding price action on the chart.

When I enter a trade for no reason what-so-ever it means that I have no overriding short term signal telling me what I should be doing. There has been no specific piece of news or market movement in the last minute, five minutes or hour that is telling me that I should act now. Instead I place a trade based on the conviction of my ‘one direction’, the long-term directional bias that I have on which way the market is going to go.

Everyone loves birthdays!
When it comes to exactly at what price I should be entering my trade I will as often enter at the current market price as I will at a specific price, which will normally be at a birthday level price. A birthday level price is an arbitrary price level and is very easy to calculate. Take the final two numbers from the year of your birth. For example, if you were born in 1980 you would use the final two digits which are 80. You then subtract fifty from this number. In our example, 80 minus 50 equals 30. You now have your two birthday levels: 30 and 80. You can then enter when price hits one of your birthday levels, e.g. 1.3030, 1.3080, 1.3130, 1.3180, etc.

When using these birthday levels you are looking for the randomness in the markets to allow price to hit your entry limit order. You let the inherent randomness of the markets at very short time frames take price to your entry point.

As you begin to follow the overall storyline that is made up by all the fundamental factors underpinning your chosen currency pair you will begin to feel the ebb and flow in the events and data releases that take place. With patience and practice you’ll come to learn how to push your trades, looking to take advantage of strong prevailing winds that coincide with your long term outlook of where the market is going. When things are murkier you’ll hold back a bit and become more apt to just test the waters rather than looking for pips from large profitable positions.

Where price is within your median grid gives you some clues as to how forceful you should be, which is reflected in the gearing that you will use on your positions. If your long-term bias is on the long side, then you will look to make bigger plays when price is in the bottom part of your grid (in Q1 and Q2), and you’ll ease and test those waters more often as you venture into the upper part of the grid (Q3 and Q4).

You end up pulling the trigger in each and every of the four quadrants as you see fit. Some weeks can be slow, or price can be bound in a tight range. In situations like these, it would probably be wisest to limit your profit goals and just look to extract 30 or 50 pips from a trade.

Other times, your favoured market could be all the rage and volatility could be high. Now is when you should look to extract some larger moves, anywhere from 100 to 200 pips.

This slowing and quickening of your preferred currency pair will reveal itself as you come more and more familiar with the economic storyline.

The eye of the beholder
Think of when you first started learning to trade. If someone had shown you a chart with five different technical indicators on it and had then asked you to interpret that chart for them you wouldn’t have known what to say. A few months later, after you’ve learnt all about technical analysis and pattern recognition, if you’d been shown the same chart again, I’m sure you could have talked about what you see at length. You’re able to see and recognise patterns and information as you have a new mental paradigm of what you’re looking at.

Being able to interpret the economic storyline is somewhat similar. At first, all the data releases and other economic events don’t see to have much relevance. It seems to take months before there is any significant repercussions to a seemingly good or bad data release (a 30 pip spike is not a significant repercussion).

The more you tune into the day-to-day events at the macro economic and fundamental level, the more you begin to peel back the layers on what is really going on. Your mind (especially your subconscious mind) is better able to parse and filter the information that continually appears day by day.

No matter how many layers you peel back, you still have to be mindful that there is no core to what you are focusing on. It is not an onion that you can peel away to arrive at some kernel of trading truth. You must continually cope with the constant uncertainty in the market and the information that is available to you.

Naed: About the one direction/one lot approach: what would you have done when the Euro crashed at its height at the start of 2005? The U.S. started raising interest rates so the dollar got stronger; hence, the Euro crashed and the Dollar gained ground. Yet we have this overwhelming twin deficit and from a distance ([from where we view] the big picture) the fundamental trend is still up.

Any answer I give here is purely speculative, and probably biased in that I hope that I would have known the euro was reaching the end of its bull run, and the dollar bulls were about to step in forcefully.

Unfortunately, at the time (end of 2004, early 2005) I was a pure technical trader, and barely paid any attention at all to the fundamentals. I do have vague recollections of euro bulls calling for a move to 1.40 by the end of 2005, but they were being countered by those who felt the euro’s bull run was due a correction.

If I were to postulate that my viewpoint at the time would have been similar to that of my trading mentor, Dirk, then I can say that more than likely I would have been on the wrong side of the market here. The strong effect that the raising of interest rates had on the return of people buying US dollars again was seemingly underestimated.

As you say, the supposedly larger economic hurdles of the twin deficits were seen to weigh heavily on the American economy. It came to pass that people really didn’t really care about these deficits (and still don’t!). Interest rates became the main focus once again, and all other actors in the EUR/USD story were pushed aside.

At the time it might have been viewed that the strengthening dollar in 2005 was just a correction in the multiyear euro up trend that began in 2001.

Another way to look at it is to examine the returns realized by Dirk’s managed fund at the time. I don’t have the full results for 2005, but what I do have is (from the DayForex website):
2004 Q4: 17.16%
2005 Q1: 2.4%
2005 Q2: -11.45%
2005 Q3 (up to 31/08): -0.7%

It seems fair to say that Dirk was caught on the wrong side of the market at this time, as would I have been most likely. The long term view that the dollar would weaken played out correctly in 2006 and if my results are anything to go by I’m sure Dirk did very well that year.

Naed: What would you have done recently, for example, trading the Yen? Just out of nowhere it dropped like a hot potato. Yet the daily yen charts gave an early warning sign showing divergence on the MACD. Yet Dirk’s way is to ignore many of the indicators.

Dirk does indeed ignore indicators such as the MACD, and any divergence signals that would have been given from them.

The dollar/yen storyline was building up to something happening, such as what did unfold. All factors were pointing to a severely oversold yen against the other major currencies. There was a G7 meeting the weekend before the yen began to appreciate substantially. Economists, banks and politicians were expecting a statement from the G7 to say that the weak yen would no longer be tolerated, or at least hint at it. If such a statement had been released then it would have been perfectly reasonable to assume that the markets would react and begin to buy yen again.

In the end there wasn’t even a mention of the yen. The buildup to the G7 meeting was seemingly so overwhelming, and the state of the yen so apparently undervalued, that the markets didn’t need some politicans to point it out to them. They decided to do things on their own, and thus began the strengthening of the yen.

There was no cut and dry moment or signal that it was going to happen, but there certainly was enough buildup and discussion that something was most likely going to happen and soon.

That discussion is still even now playing out in the market place, with the never ending speculation on when the carry trades (which have primarily piggy backed on the yen and Swiss franc) are going to unwind. For they will unwind and most likely incredibly quickly. You only have to look back to 1998, with the Russian default scenario, to see how quickly the yen can move hundreds of pips.

Naed: It’s hard for me to place a buy trade on the Euro now especially after reading all the Elliot wave and other TA stuff saying it’s headed for a “C” wave down, yet recent fundamentals still point to EUR/USD going up. I’d like to learn more about the way you filter your decisions. Is Dirk’s mentoring program in itself enough? Or do I have to combine it with other approaches?

Mixing and matching your trading techniques can certainly lead to confusion. One system or indicator says that price is going this way. Another system says the opposite. Which one to choose?

The answer is up to each individual trader. You have to find the system and methodology that best suits you. Unfortunately I can’t pick out what works for anyone else apart from me. This is where the hard work comes in making it as a trader.

I gave a brief overview of the way I filter trades in the first half of this post. Unfortunately, I can’t really think of any other cut and dry rules I have that come into play. Your best bet on seeing what works or doesn’t is firstly to try it yourself and secondly to follow and discuss your decisions with your mentor. You might also be able to extract other additional useful information from the other journal entries that I post. I sometimes discuss the reasoning, or lack of, for a given trade and how I managed the position.

Dirk’s mentoring program is certainly a huge help in being able to put into practice what I have been discussing. Like any good mentor, Dirk has a way of shining a light to lead you, but at the same time you are the one that has to do all the hard work. He is there to answer questions, but at the same time, you’ll probably find that the answers result in you having to examine yourself. You end up figuring out something about your outlook, mental approach or psychology that you need to change or improve.

There is nothing stopping you from melding Dirk’s training with other approaches. You are the best judge of that. Take everything that makes sense and seems to work for you. Then try and meld and merge them together into a trading system that is your own. Your trading methodology and way of looking at the market will end up being as unique as you are, just the way it should be.

Naed: By the way, I think you really talk to the reader the way you write. I live through your trading journal vicariously and feel your highs and lows. I’m sorry if I come off as a beginner. I’ve been trading (surviving) for about 3 years now.

Thanks. I think a beginner’s mind is a great thing to have. It always reminds me of the phrase ‘Zen mind. Beginner’s mind’.

A beginner’s mind is one of the most useful teachings that you can get from Zen. You are always open to new things as a beginner. You don’t cut yourself off from information or knowledge that conflicts with an already held belief. You open yourself up to infinite possibilities. It is a well spring from which great things can arise.

Keep the questions coming!