ForexSpirit

This is the second in a series of posts recounting some reader feedback that I have responded to in the past.

Let’s get straight to the follow-up questions I was asked:

I finished reading the book [BWILC], and it seemed to answer my suspicions about pure tech analysis. I’ve been trading aftermaths of the news lately with much success (with minimal tech. analysis), however, I want to gradually phase into intraweek trading over the next couple of years (intraday trading may become too demanding).

I feel that such a system as the 4×1 would be ideal for intraweek trading. Wouldn’t you agree?

It certainly sounds like the 4×1 method meshes with what you are looking for.

Anyway, I had some questions:

1) Although you’ve answered this before, when do you take losses? Is it after some pip value? Some negative news item? Break of a low? I know that you said before that this trading methodology is subjective, but closing a position too late could mean wiping out all the cumulative small gains. Could you provide some detail/examples on how to get out of losing positions?

I generally start to evaluate my losers when one of the following situations arises:

1. Current price is two quadrants below where the trade was entered. Since I use a 400 pip grid on EUR-USD, this means that if a trade is 200 pips in the red I seriously consider getting out before it gets too much further. If you trade GBP-USD then your grid would need to be more like 600 pips (since GBP-USD moves about 1.5 pips for every pip move in EUR-USD). [Note: I have recently refined this stop loss strategy. For more information see this post: Heads I win]
2. Price exits my grid in the wrong direction. This is a general sign that my grid is no longer correct and that my analysis is wrong.
3. My analysis of the market changes. If my one direction flips then obviously any open positions are no longer consistent with my new viewpoint and so should be closed.

To date pretty much all my losers have been of version one. Price gets to be in the red about 200 pips. The current fundamental outlook is generally turning dollar bullish after such a move and I most likely decide it’s better to close the trade at a loss and wait until the euro bulls begin to gain an upperhand before entering any new trades. When the euro bulls do regain the day, price is going to be in a lower quadrant of the grid, so larger positions can be put on, helping to eradicate the loss quite quickly.

Loses will be almost always way bigger than the small regular profits that you extract. This is why it is important to also go for some larger moves (in the 100-150 pip size). Your big winners are there to help offset your losses. Your regular daily bread and butter trades are then what results in a steady increase in your equity. If you don’t manage to get some of the big winners, then too many losers will eat into your small winnings far too much.

2) Is it advisable to trade breakouts?

Looking to trade breakouts is a perfectly fine thing to look to do. Since this method is taking a more long term approach to things, I would definitely just wait and see if the breakout has legs, to make sure that you don’t get caught in too many false breaks. It’s perfectly alright to buy into strength and sell again when you see that strength waning. I don’t particularly note if price is breaking out or not, apart from when major highs/lows are being tested. I.e. I only ever look at weekly or monthly breaks, and not intra-day ones.

3) Do you move the median grid wider every time it’s broken? Is there a max grid size?

The grid is moved when there is a sustained break of either end. Let’s say price moves through the top of the grid. If it stays above the grid high for a couple of days and the underlying fundamentals point to a continuing in that direction it probably makes sense to shift the grid up.

I already talked a bit about grid sizes above, but just to reiterate I use a 400 pip grid on EUR-USD. Volatility and pip values differ for each currency. An easy metric to decide on a grid is to just look at a chart for a pair for the previous three or four months. You should be able to identify strong support and resistence levels that hold across weeks and months. The distance between those support levels should allow you to approximate good grid sizes. If you move to six or more months of data you should then be able to see how your grid size would move up and down over time. Does the grid size hold up as price trends up and down, and at what points would grid shifts have been needed. Would the grid size still hold after a grid shift? Would price be contained within the new grid position for a few weeks before another grid breakout occurs?

Dirk mentions sometimes that banks and other big traders seem to use a slightly larger grid size on EUR-USD, in the range of 600 or 800 pips. They obviously look at a slightly longer time frame then Dirk goes for, so they use a bigger grid. So your time frame probably plays into it too.