Tag Archives: scalping

Lusitania

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Today turned out to be a great trading day. A good part of the reason why it was so great was directly related to having a disastrous start.

The minute I opened up my trading platform I spotted that price was bouncing off a strong support level at 1.4410. I was in like flynn, even though I hadn’t done any pre-session analysis. In addition my trading platform was on the wrong profile and my trade size was incorrect.

I have various profiles set up in Oanda. I have one for my scalping, another for my screen grabs I use on this blog and others from times past. When Oanda starts up it defaults to the screen grab profile as one of the first things I do as part of my pre-session analysis is to take a screen grab of the market (which ends up as the first chart in these scalping journal posts). The trade settings on the screen grab profile default to my prior scalping approach, and have a default lot size that is 10:1 and much tighter TP and SL levels. So when I fired on that trade I was taken out in short order by my SL being hit at -6 pips.

This turned out to be fortuitous as once I had done my analysis I decided that sticking with the morning’s downward trend made more sense. The breakout below 1.4410 seemed to be real.

My panic buying was a mistake. It was a rush of blood to the head, thinking that I was missing out when I hadn’t even gotten a proper lay of the land yet. But it wasn’t a disaster, in that my previous setting limited the damage done by the mistake. Even if I hadn’t been taken out automatically, once I’d done my analysis, I knew the right thing would have been to get out of that trade ASAP.

Right out of the gate I was in the red. What made it a great trading day was that I was to make back that loss and pile on some profit for good measure.

Too often in the past I would have been like a ship that experienced a hull breach. I would have been unable to steer the boat to safer waters to bail out the water and repair the damage. Instead there would have been more mysterious explosions and I would have been sunk.

EUR/USD analysis - 14 April 2011

Bias: short
Conviction: medium

I’ve already discussed the mess-up red trade sequence so I’ll move onto the green one. I would have gone for a heavier third entry if price had made it back up to the 1.4410 resistance level. Otherwise I felt it wise to stick to another 5:1 entry as it broke below 1.4400 in case it moved higher once more. The gain from the green sequence completely gained back what I had lost from the red sequence.

Right after closing out the green sequence I was tempted to go long, purely because this was the third touch of 1.4390. As it moved back up I would have gone short if we’d seen a touch of 1.4405 again. Instead it just reached 1.4400 and then moved back down, making a new low for the session.

When priced pulled back up into the range at 1.4390 it was a classic false breakout setup and I got long. A quick ride up to near the top of the range at 1.4398 and I was out.

My only minor regret was not taking the short once 1.4405 was eventually hit at 6:56 EDT. It was getting so close to the end of the hour and I didn’t want to have to babysit a bad trade if I was wrong. Too bad; it would have been a great short, as it zipped straight back down 20 pips to the low at 1.4385.

EUR/USD - 14 April 2011

October 2008 Review

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October was the first month since May 2006 that I did not place any live trades.

Looking back at my performance this year it is pretty obvious that I don’t really have any consistency going for me. There have been up months and down months; the downs have generally been bigger and it’s not exactly a trend that I want to see continue.

This chain of events is not exactly surprising considering my blow up at the end of last year. Since then I’ve been trying to find a new path, evidently without too much success given the cold hard numbers on my bottom line.

Instead of digging myself deeper into a hole of my own devising, I’ve decided to revert to demo trading. I still get to keep my toe in the markets and trade, but I don’t risk damaging my equity.

While the scalping method I have been using since last month is nothing revolutionary or even unique I am starting to feel that it suits me well. It incorporates a lot of the components of the BWILC method that I found to be beneficial while also (hopefully) eliminating the weaknesses, which were often directly attributed to my character flaws.

All four parts of the 4×1 methodology exist as part of the scalping method. Let’s go through them in turn:

One currency

Each and every currency is its own animal. Learning the ins and outs of even just one currency takes lots of time and energy. It therefore makes sense when learning to trade to focus on just one currency. There are plenty of traders out there who are quite happy and profitable just trading a single currency pair. There are others who feel more comfortable trading multiple pairs.

I think the key here is that it makes sense to focus on just one until you know it intimately. Only then should you look to expand your repertoire. Even then it continues to make sense to limit the number of markets you monitor to a manageable level.

I traded EUR/USD exclusively for around 18 months (from early 2006 into 2007) before adding currency pairs such as USD/JPY, GBP/USD and AUD/USD. This was a key factor in my subsequent downfall as I failed to properly manage my overall leverage with multiple positions open across more than one currency pair.

I then started to cut back on the number of markets I traded eventually returning to just EUR/USD.

It would certainly be possible to scalp in just one market. At the same time there is nothing really stopping me from trading multiple markets as long as I learnt my lessons from the past and severely restrict having simultaneous positions open in different markets. This point was driven home on October 28 when I had three scalps go sour at once.

GBP/JPY and EUR/JPY are often regarded as prime markets for scalping in as they make decent moves, can be volatile and are still extremely liquid.

To try and marry the best of both worlds I’ve decided to focus on EUR/USD, GBP/USD and EUR/JPY. EUR/USD is my old stalwart. I picked EUR/JPY over GBP/JPY as I have more familiarity with the euro. EUR/JPY is also slightly less volatile than GBP/JPY.

One direction

The second pillar in the 4×1 methodology is determining the long term trend in the market being traded. All trades are taken with the long term trend in mind; this normally means trading exclusively in the direction of the trend. For some it might also involve selective trades against the main trend, catching corrections.

When I traded the pure BWILC method I kept things simple and only traded in the long term trend direction, which at the time was long EUR/USD.

I attempted to trade both with the trend and catch corrections earlier this year but seemed to trip myself up more than anything else. After getting faked out one too many times I reverted back to sticking to one direction at a time.

The direction in which to trade was very much based on the trend evident in the daily and weekly charts from the technical point of view along with the long term fundamental drivers in play.

When you’re trading from 2 or 4 hour charts it makes sense to deduce the long term trend from a higher time frame such as the daily chart.

The scalping I’m now doing focuses on making trading decisions on 1 or 5 minute charts, so while the long term trend is still to be found on the daily charts I’m more interested in the medium term trend which can be found on the 30 minute or 1 hour chart.

This means that I have to be prepared to be trading long one day and short the next. Previously I had been trading in a single direction for months on end, so this constant switching is relatively new for me. How well I’m able to read the medium term trend and act on it will obviously play a crucial part in how successfully I’m able to place my scalp trades. This will be a key issue that I will need to keep an eye on going forward.

One lot

The spectre of leverage being a double edged sword has been raised many times both here on this blog and in other trading circles. It is only when you have been cut deeply as a result of over-leveraged losing trades that you really understand the destructive power that can be wrought by leverage .

For many years I had a healthy respect for leverage. I knew that the 400:1 leverage being offered by some forex brokers was nothing more than bait to draw in the frenzied masses.

Knowing the good and bad that being over leveraged can bestow is not the same as experiencing it. Having respect for high leverage wasn’t enough to save me from myself.

I hope things are different now that I have first hand experience of the destruction that can befall when highly geared trades go significantly against you. I’ve seen my account bleed copious amounts of red almost to the point of being bled dry.

It is no surprise that leverage is a critical part of my trading plan. It then comes down to finding the right balance between having low enough leverage so that a string of losses won’t wipe you out while at the same time making use of leverage in a constructive way to help build your account over time.

The general rule of thumb is the lower the better. You don’t want to be using leverage high enough so that every pip move gives you a nosebleed. You’ll often see recommendations that your leverage should be low enough that you have no trouble sleeping if you have an overnight trade or two still open. I can see the sensible advice that is being imparted here but I also generally feel that if the leverage is too low then you can lose your attachment to the trade.

The trick comes in finding the biting point between leverage so high that you start to enter gambling territory (your risk of ruin chance is too high) and so low that you become completely blasé about what trades you have open.

It is also no good just looking at the gearing of any individual trade, you must also consider and make rigid plans for the maximum gearing that you will allow across multiple open trades.

You might think you’re being conservative by only using 1:1 gearing on any one trade but you can still become unstuck very quickly if you end up having 20 trades open at once.

The number of currency pairs being traded and the expected frequency of opening new trades end up being important inputs into any determination of leverage.

All of these factors have gone into my decision making to use 3:1 as my gearing ratio for scalp trades.

My preference is to have only one scalp trade open at any one time. I am not adverse to having multiple trades open at once but it needs to handled carefully. For example, I might be in a trade that went immediately into the red and price has reached a new support or resistance level that I think it worth scalping from. Similarly, I might be in a losing trade in one currency pair while I spot a good opportunity in another. I want new entries to be separated by time as well as price.

I have a money management rule now where I do not want the unrealised losses from all open trades go beyond 7% of my account equity. If that line in the sand is crossed then I am just going to close all open trades, accept the loss and move on. This means that if I have two trades open that each trade has much less room to breathe than if there was just a single trade active. This is a powerful incentive to make sure that I limit myself to only having one trade open at any one time whenever possible.

While there might seem to be powerful reasons to make it an iron clad rule to only ever have one trade open at once, there is one very beneficial reason to allow for the odd, sparing simultaneously open trades and that is the concept of keeping the scoreboard ticking. This means being able to still pull in money from winning scalp trades even while enduring drawdown on an open trade. This can be a very useful tactic if a losing trade has to be held for a protracted period of time.

The trades taken while holding the loser can help to offset an unrealised loss that is finally realised (that either hits its stop loss or is closed out manually when it is decided the trade has no chance of recovery). Alternatively, if the loser does come back and close at breakeven or even with a profit it means that time was not lost waiting for it to do so. Points (money) were added to the scoreboard (account balance) all the while. This ties in directly with the final point in the 4×1 methodology.

One percent

Perhaps the most controversial part of the BWILC method lies in how it flies in the face of some conventional trading wisdom. Instead of advocating that you let your winners run and cut your losses short you are instead advised to take your profits quickly and ride out your loses.

The ‘one percent’ component refers to targeting a one percent increase in your account equity for a winning trade. Don’t look for each winner to shoot to the moon and provide you with a big gain.

Instead look for small, frequent, steady gains that help your account balance to creep up over time.

If your trade is in the red but was taken in the direction of the long term trend then holding that trade open to see if the long term trend resumes is a valid strategy, as long as you have hard and fast rules as to know when to abandon all hope and just take the loss. I’ve discussed many times in the past how the BWILC strategy aims to offset these sorts of large losses with larger gains, so I won’t go over the same ground here again.

I have applied the same sort of mindset to my scalping approach. I shoot for small, frequent winners, often booking around 10 pips of profit, while letting my losers hang out there to see if the medium term trend will pull them back into the black.

I have a fixed stop loss in place on each trade so I know what my maximum exposure is for any one trade. This stop loss is placed where it would result in a 5-7% loss, hopefully beyond a significant support or resistance level. 7% is the maximum allowed drawdown level before booking the loss but if it can be placed in a sensible location before that then why not do that. Allowing for a little more than a 5% move provides for enough wiggle room for price to get caught in the randomness vortex before hopefully moving back in the trade’s direction as the predominant trend takes hold again.

No big winners are booked with the scalping method, so how are the big losses recuperated?

It all comes down to the increased frequency in trading. When I was trading the pure BWILC method I would generally average about two trades a week.

Although I have only been trading using the scalping method for a few weeks, it seems reasonable to estimate that I’m making 30-40 trades a week. The vast increase in the number of trades allows for loses to recuperated quickly as long as the number of losing trades is minimal.

I have some very ambitious goals for this trading strategy. For a long time I was very conservative in my trading goals. If all the professional money managers and hedge funds out there struggled to make more than 30% a year consistently, then it seemed like pure folly to aim for more than that. To that end I was happy with a 3% monthly return.

I started to get myself into trouble when I bumped up my monthly goals to 10% in August 2007. I almost doubled the leverage I placed on each individual trade and expanded the number of markets I looked at from one to three. What I didn’t do was properly manage my downside risk.

I think it’s important to keep the lofty goals as by being an active trader I’m looking to create wealth not just preserve it. Maybe I’m crazy but I think it might be worth targeting a 20% monthly return with this scalping method.

Here are the back-of-the-napkin rough figures that I’m working from.

Let’s work with an average of 5 trades a day, where each trade returns 0.3%. If all 5 trades are profitable that results in a 1.5% return for the day.

My goal is to have no more than one losing trade in a week and one that is closed out for no more than a 100 pip loss. This is a pretty big assumption right now but I see no reason why it could not be possible. Of course there will be weeks with bigger and/or more frequent losers but on the flip side there can also be weeks with no losers at all.

Anyway, let’s stick with a single 100 pip loss per week for this example. It’ll take 10 profitable trades to negate the loss, which means that two days are used up to combat the losing trade. That’s leaves the remaining three days of the week which results in a 4.5% gain for the week.

Position sizing is re-jigged over the weekend which means that weekly gains can be compounded to calculate the monthly return.

Let’s say there are just 4 weeks in a month. A 4.5% weekly return compounded over 4 weeks results in a gain of 19.25%.

A 20% monthly target is therefore not out of the realms of all possibility.

Now it’s just a case of turning this goal into a reality…

Scalping in lion country

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Since I have been investigating forex scalping for the past few weeks one thought that has entered my mind more than once is: what sort of trading method would you end up with if you tried to combine aspects of scalping with the 4×1 trading methodology that I had used for so long?

In many ways the two methods are completely at odds. Scalping is generally seen as the epitome of the trading adages such as ‘cut your losses’. When you scalp you go for small gains on each trade but you want your loses to be even smaller. The opposite is recommended for the 4×1 approach: you often look for small profitable gains and give your losses plenty of room to breath.

A key factor of traditional scalping is identifying a tradeable pattern and basing your entry on that pattern. The 4×1 method allows for far more arbitrary entry decision making. Since no indicators are generally used, an entry is often made based on intuition (which is in turn based off of plenty of screentime and experience).

It was thus very interesting to read a thread on Forex Factory called Scalpers Paradise where a trader seems to have devised a method that looks awfully close to an amalgamation of scalping and the 4×1 methodology.

The trader, Dionisios Miliaresis, mostly seems to apply a counter-trend scalping approach. He looks to scalp on retraces at round number, pivot and support/resistance lines. In contrast to traditional scalping where high leverage is employed and few trades are entered the complete opposite is the case here. Low leverage is paramount, which seems to mean no more than 3:1 gearing. Trades are entered more frequently, around six times a day with a profit target of between 5 and 10 pips.

Trades are only taken in a single direction for each currency pair traded. The decision as to which direction to trade is made at the beginning of the trading session.

A disaster stop of 250 pips is entered when the trade is first put on. A trade is given room to breath and is not cut off the second it looks like it is going the wrong way. If a trade is still in the red at the end of the current trading session then a decision is made to hold or take the loss. An individual loss should result in no more than a 5% reduction of account equity.

Multiple entries can be made in the same currency pair. For example, if an entry is made and immediately goes into the red, another entry can be made at a ‘better’ level. Since the new entry is just as much of a scalp trade as the first one it will not be around for very long if its profit target is hit, so having multiple entries in this way can not be considered to be cost averaging (in the classic sense).

If a 7% reduction in equity is reached due to having multiple losing trades open then they are all closed out and the 7% loss is booked.

This method boils down to having lots of small profitable trades and the occasional big loss.

Taking big losses can be hard for many people. For a traditional scalper if you have to take a big loss then you’ve made a big mistake. As point #17 in The 25 Point Mantra states:

Big losses prevent you from having a winning day. They wipe out too many small winners that you have worked so hard to achieve. Big losses also “kill you” from a psychological and emotional standpoint. It takes a long time to get your confidence back after taking a big loss on a trade.

If your trading plan only has you taking small losses then if you ever do have to close out a big losing trade it is sure to have a very detrimental psychological impact. But what if big losses are part and parcel of your trading plan? If they are to be expected then they are not such a shock when they do occur.

I think it ultimately comes down to the psychological makeup of the individual trader. For some people the negative impact of a loss far outweighs the positives of a win. Others are more even keeled and are able to accept both in equal measure.

I do not see myself as having a problem taking an individual loss. If a losing trade needs to dealt with I can cut it without qualms. On the other hand I do see that I gain something from having my wins far outnumber my losses. There is definite positive reinforcement in having multiple wins in a row.

In many ways I find this style of scalping, which I have rarely seen used before, to be a more natural fit for me. As a result I have switched my scalping efforts to focus more on developing a trading method around these principles than the Cyrox Simple Scalping approach.

Trading the rainbow

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I occasionally listen to Rob Booker’s Trader Radio broadcasts. A couple of months ago, Josh, one of the regular contributors and a trader who works in the same office as Rob stated that he traded off 5 second charts. I thought he was completely nuts.

The only other snippet I remember from the exchange was that he was able to rack up a sizeable trading history in a very short time due to the incredibly compressed timeframe from which he was trading from. He was able to accumulate statistically significant trading records in days and weeks rather than months. This meant that a change to a trading system could be verified as being beneficial, ineffective or detrimental in a relatively short span of time.

About two weeks ago I was aimlessly browsing the Forex Factory threads killing some time. These days I very rarely latch onto anything that is touted or debated on forex discussion forums. The signal to noise ratio is so low that it is more often than not a complete waste of time.

On this particular day something shiny caught my eye. Intrigued, I dug a bit deeper.

What had gotten my attention was a scalping approach that was incredibly discretionary. Along with some basic rules which I’ll detail in a minute, the evangelist of the system, going by the moniker of LinuxTroll, recommended trading on 5 second charts. It was probably this facet of the approach that hooked me into looking at the method further. Was this the approach that Josh was trading?

In my early trading days I spent plenty of time looking at 5 and 15 minute charts. I never even seriously contemplated scalping as brokers at that time were notorious for making sure that traders did not scalp. The brokers obviously needed several seconds to match up or offload a new trade and thus were not happy if you traded in and out of a position before they had hedged themselves successfully. If you got tagged as a scalper the broker would require all your trades to be manually vetted. This obviously resulted in massive slippage which destroys one of the key edges of being a scalper.

Over time my trading time frames moved up. I began to view the shorter time frames as pure randomness. A chaotic vortex where it is all but impossible to harness an edge.

I am now looking to seriously re-examine that belief.

Let’s examine the basic setup for scalping that LinuxTroll recommends:

  • Pick one currency pair and focus solely on it.
  • Identify and trade during a short time window.
  • Add the rainbow indicator and monitor the chart using a timeframe less than 30 seconds.
  • Identify the direction of the current move you see on the screen.
  • Scalp – enter and exit trades quickly using substantial but not excessive leverage.

Now I’ll detail how I’ve approached each of these criteria.

I have chosen to focus on scalping EUR/JPY. It is a more volatile pair than the EUR/USD pair that I normally trade which can bring both pros and cons to scalping. Bigger moves can lead to larger profitable trades but it also means larger adverse moves.

I have attempted to trade both short and long term strategies on the same currency pair before and it was never something that I was comfortable with. In evaluating scalping I knew that I had to pick a different currency pair. EUR/JPY along with GBP/JPY are often recommended for scalping. Since I have more experience monitoring the euro currency I have plumped for EUR/JPY.

When trading such an exceedingly short time frame you must be focused on every move that the market makes. If you watched every tick eight hours a day I’m sure you’d go crazy. It is much better to give the markets your undivided attention for a short, specific period of time. If you’re only going to be trading for a brief time then it makes sense to pick a period when prices are likely to move. The various market opening time periods are thus prime candidates to consider.

Since I’m based on the East coast of the United States I have to immediately discount the Frankfurt and London opening hours as I like sleeping an uninterrupted sleep. That effectively leaves the Tokyo and New York openings. The Tokyo open normally overlaps with the end of my working day, commute home and evening dinner. I can’t guarantee that I’ll be able to be in front of a computer to trade. So the New York open it is.

Having picked the New York open I started to trade from 6:00 to 7:30 EST. I felt it might be most beneficial to be able to get up and trade first thing. After my trading was done I’d be able to get on with the rest of my morning. What I have found out very quickly in the past 10 day is that the market is effectively dead between 6:00 and 7:00 EST. The Asian traders are gone for the day and the European traders are seemingly out for lunch. This leads to a listless, rangebound market. Not prime scalping territory.

I have thus switched the time I’m actively trading to between 7:00 and 8:00 EST. I’m not sure if it’s because the Europeans traders are back at their desk or the early risers in New York have made it into the office but movement is definitely better during this hour.

Since it was the pure craziness of hearing that someone was trading from 5 second charts that is the time frame that I have decided to scalp from.

The form of scalping that I am trying out is often called rainbow scalping due to the indicators that are added to the chart. A slew of WMA (Weighted Moving Average) lines with periods ranging from 1 to 156 in increments of 6 are colour coded to produce the rainbow effect. I’m not a huge fan of indicators in general, especially ones that are used to generate buy and sell signals. The rainbow is primarily used to determine the strength and direction of the current trend. It is thus not an affront to my indicator sensibilities and I am keeping it on my charts for the moment to see if I can derive additional benefits from its presence that long time users champion.

I seem to primarily focus on price action and thus the rainbow indicator acts as support or confirmation of any trading decision I might make. While the rainbow with its various moving averages presents a colourful picture of any unfolding trend it is just as easy to spot that trend with the naked eye given enough screentime and experience.

With all these pieces of the puzzle in place it is then up to the individual trader to determine their own entry and exit criteria. In such a fast moving timeframe it is imperative that any such criteria are simple. I’m a big fan of keeping things simple.

The key to the whole approach is spending enough screentime observing and learning the movements of your chosen currency pair during the timeframe you’ve picked so that you can select and hone the simple trading criteria that work best for you. You only need to have a couple of setups in your trading toolbox. After that it just comes down to patiently waiting for those setups to appear and executing your trades.

I’m excited about giving this style of trading some serious time and energy. It might ultimately not be suitable for me but I think it’ll be a hugely rewarding experience either way. It gets me out of the trading box that I have been in for a long time now. I’m still continuing to trade on EUR/USD using my more long term approach but I think it’ll be very educational to rip up the rulebook from that style of trading and try something totally different.

Probably the only persistent concern I have is how this might affect my discipline. On the one hand, flailing around trying out different systems shows a definite lack of discipline. While I haven’t gone to that degree, even just trying out a new system shows a certain lack of discipline. This is especially apparent and noteworthy when my main, longtime trading method is experiencing a drawdown. The temptation is always there to just chuck it in and try something different. To temper any discipline schism it is important to remind myself that I’m going to have to demo any new method for a considerable period of time before even contemplating going live with it – three months of consistent profits at a minimum. Even when going live I would want to start small and slowly bump up to any decent sized trades. My EUR/USD trading method is going to have to pull in the bacon for quite a while yet, and there’s no reason why it couldn’t continue to function if I decided to go live with a scalping approach.

On the flip side, learning to scalp might even significantly enhance my discipline. Patience, decisive decision-making and fast action are all critical components of scalping. Hopefully coming to grips and mastering these skills at very short time frames will aid me when making longer term trades.