The NZD/USD short was, so far, my trade of the week. I didn’t want to get involved in the BREXIT madness and, thus, the Kiwi caught my attention.
The Trend Rider gave the signal after the breakout below the support (marked with the black line).
I had to take some heat, but the retracement never broke the previous high and the Trend Rider remained red and gave me confidence.
I took profit at a previous demand zone (black box) and it made for a healthy profit.
Even without the Trend Rider, our premium students were able to find this trading opportunity with pure price action based systems because the pattern on the 4H does look like a dirty Head & Shoulders.
Next, my eyes are on the USD/CAD but the Trend Rider hasn’t given his signal yet. Thus, we need more patience and wait for a bullish move that will cause the Trend Rider to turn and provide the bullish signal. Patience!
However, the Kiwi shows early signs of potential weakness. After the price has dipped into the Supply zone, it has struggled to make higher highs. The currently forming right shoulder makes this even more important.
At the same time, it is worth reminding ourselves that those obvious patterns are often the hardest to trade. When everyone is watching the same scenario, fake outs happen more frequently and we have seen such a premature false breakout the last time the price was trading at the 0.6796 level. Thus, patience is your most important skill here.
Do not jump the gun and wait for the confirmation.
I will rate this analysis neutral because as long as we are trading below the top and above the last low, the price is technically still in a range.
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When it comes to risk management, the potential for improvement is still high because many traders neglect the importance of risk management or do not know where to start. This is good news because, with a few small tweaks and a better understanding of how risk management works, traders can potentially get a much better grasp of their trading and their performance.
“How can I get a better winrate?” is probably among the most commonly asked questions I get every day. I get it, a higher winrate sounds nice because you’d have fewer losing trades, less negative feedback and more winners. But will this automatically make you a better trader? No!
The winrate is an important metric, but it is not meaningful on its own. Assume that a trader has a winrate of 90%, but his losses are always 10 times larger than his winners. This is not uncommon when amateur traders cut their winners way too early and let their losses get out of hand. Furthermore, when you have an extremely high winrate, you are probably not good at dealing with losing trades because they happen so infrequently. Thus, when a loss comes around, traders easily panic, try to “avoid” it and then trade emotionally and make all the costly mistakes.
Did you know that trading systems with a winrate of 50%, 40% or lower can also make you money potentially? It is true and the graph below shows the relationship between winrate and the reward:risk ratio. For example, when your winners are twice as large as your average loss (a 2:1 reward/risk ratio), then you’d only need a winrate of 33% or higher.
Traders cannot directly control their winrate and you cannot just choose to have a higher winrate. This brings us to the next metric: the reward/risk ratio.
The reward:risk ratio is, as the name suggests, the ratio between the potential profit and the potential loss of a single trade. To determine the reward:risk ratio, a trader takes the distance between the entry and the stop loss (potential risk) and compares it to the distance between the entry and the take profit target (potential reward).
As we have seen, the reward:risk ratio and the winrate are closely linked. The good news is, the reward:risk ratio can be controlled more directly than the winrate.
A larger reward:risk ratio
A trader could choose to use a tighter stop loss or a wider target to increase his reward:risk ratio. This would also mean that he’d need a lower winrate to trade profitably potentially. However, what then will happen is that the price will more easily reach his stop loss and it has also a harder time reaching his target. Thus, tightening a stop and widening targets will lead to an overall lower winrate. This is not necessarily bad because even with a lower winrate, you can still make money when your reward:risk ratio isn’t too small.
With a reward:risk ratio of 3:1, for example, the trader only needs a winrate of higher than 25%. That sounds realistic, right!?
A lower reward:risk ratio
On the other hand, one could choose to use a wider stop loss and a tighter target. This would mean that the reward:risk ratio decreases. The price now has an easier time reaching the target and the trade would have more “room for error” because the need for accuracy is decreased with a wider stop loss. This could lead to an increase of the overall winrate too.
You see, even though the idea of a smaller reward:risk ratio doesn’t sound too appealing at first glance, it is not necessarily bad.
The holding time is directly linked to the reward:risk ratio because the wider the target, the longer it will take the price to make its way to the target. And if you have some trading experience, you will probably know that staying in winning trades is not that easy. Cutting winners too early is a common issue because traders constantly fear that the price could turn around and wipe out all their unrealized profits.
Thus, just choosing a wider target might sound like a good idea at first, but it comes with a host of issues. If you know that you struggle with letting winners run, you need to make those target-adjustment decisions very carefully and observe how you respond emotionally.
I briefly touched on this already and as we all know, emotions and trading psychology are a big part of trading. Winrate, the reward:risk ratio and the holding time are major factors when it comes to emotional issues.
The winrate determines how much positive and negative feedback you’ll get from your trading strategy. A high winrate system can be beneficial but if your system has a very large winrate, a single loss can easily throw you off when you are not used to dealing with loses.
At the same time, high winrate systems usually have a low reward:risk ratio which can also be problematic because it means that your winners and your losses have roughly the same size. Thus, it will take much longer to get out of a losing streak and recovering from losses takes time.
A low winrate system with a high reward:risk ratio is usually how the professionals trade. The professionals can stay in winning trades without emotional problems and, therefore, make full use of the benefits of a high reward:risk ratio system. When one winning trade pays for your past 4,5 or even 7 losses, the role of losses changes completely. A loss is then not that threatening anymore because you know that it only takes one good trade to make up for them.
Danger: High winrate, high reward:risk ratio
Although it sounds great on paper and most amateurs wish that they could have such a system, it is almost impossible to achieve (we have seen how reward:risk ratio and winrate negatively correlate). Furthermore, it is not even necessary either.
You can, at least on paper, make a lot of money trading a 50% winrate and a 2:1 reward:risk ratio. There is no need to go all out and try to catch huge winning trades while, at the same time, stressing about achieving a higher winrate.
Many failed traders are chasing such trading systems and then end up never making it, whereas they could have become a profitable trader much easier if they’d just taken what is realistic and attainable.
Thus, avoid trying to increase your winrate and focus on how everything is linked. Then, you can make better decisions and create a trading strategy that fits your personality.
Is trading gambling? Does it matter what you call it? And which implications does it have for you?
Gambling is the wagering of money or something of value (referred to as “the stakes”) on an event with an uncertain outcome with the primary intent of winning additional money and/or material goods. [source]
the act or practice of risking the loss of something important by taking a chance […] [source]
As a trader, you risk money (where the exact amount isn’t even predefined on the start) on an uncertain event (the movement of a financial instrument which has unlimited uncertain outcomes) with the goal to make more money (how much you don’t even know beforehand).
What is an edge?
An edge is something, a skill or a method, that allows you to tip the odds in your favor – usually just by a tiny bit. An edge makes trading, potentially, less risky because the expectancy potentially becomes positive.
Being able to read the price very effectively in order to time and manage trades can be a part of an edge; emotional stability, a high level of discipline, understanding how to manage risk and deal with variance, being able to work extremely hard, and being passionate are all parts of an edge as well.
However, even the best edge will not remove the risk and the uncertainty completely.
In trading, having an edge will not guarantee anything. Even worse, unlike other games of chance where the possible outcomes are predefined – there are only so many numbers in a roulette wheel or cards in a deck – in trading, we are exposed to ‘black swan events’ which occur completely unexpected with outcomes that no one can plan for in advance. The ways financial markets can move are limitless.
An edge is an important thing to have but it doesn’t make trading less of a gambling activity.
Our whole life is a gamble
The good news is that gambling is totally OK and you should not get too hung up on this term or the negative connotations that come with it.
All our lives, we are gambling – not always by directly wagering money initially, but usually by betting something of value, often our time, for something that we hope will put us in a better spot later on.
When we pick our subject in college, we exchange a few years of our lives and eliminate lots of other opportunities and possibilities in the future just because we think that this subject will lead to a profession that we will enjoy and bring us enough income to live a good life. Not everyone who leaves college or university will like their job though, let alone find a good job in the first place. We exchange many years of our life for studies where we don’t even know the odds of a favorable outcome. Our edge? Consulting friends and family, googling for college rankings and listening to ourselves.
When we choose a job, we, again, exchange our time and we say no to other job offers and opportunities. We then hope that the company we choose will exist long enough, provide us with a good salary, fair promotion suspects, decent retirement plans and friendly bosses and co-workers. But we have no way of knowing that and although living the 9-5 job is always seen as the ‘safe’ way, nothing is guaranteed and we are acting on hopes and with a lot of uncertainty.
Entrepreneurs and shop owners are also gambling and they provide a service, where they sell their time and resources or offer a product. They have to invest money upfront and wage it, hoping that potential customers, which they often don’t have yet, value it so much that they can turn a profit. However, the outcome is uncertain and the wager is either time or money (mostly both). The edge? Research, personal skills, hard work, endurance and the need for good sales and marketing expertise.
When we buy a house and take credit, we gamble that our job will allow us to pay off the mortgage, we decide not to buy other things with the money instead. We hope that our marriage holds, that children will follow to fill the house and that the city and environment will stay nice. Can we know any of that? Of course not but we still take the risk because we believe that the odds are good enough and the upside is worth it.
When we choose a mate, we hope that the relationship will last for a long time, allow us to reproduce our genes, have a companion that we can grow old with and support us during hardships and old age. With a marriage, we are also invested financially in a big way. Seeing the high divorce rate and the people who aren’t fully happy, this seems like a high-risk bet but many people still make it.
Gambling in trading
I could probably go on forever but I think you get the point. We gamble all our lives, even if we don’t call it that, and we have to accept that trading is one of the purest forms of gambling.
You have to accept that you are in an activity where the odds are not necessarily in your favor at all times and that the unique characteristics of trading make it essential that you have good protection and risk control mechanisms.
Good vs bad bets
Ok, let me conclude by saying that taking risks and gambling is not something you need to avoid and if the upside seems good enough for you so that you can live with the negative outcome as well, go for it by all means. Of course, there are things and bets where the odds will always be against us, or where the downside is so huge that it can’t make up for the upside, but here you need some common sense…
When it comes to trading, here are reasons for “bad bets” and “bad gambling” where the odds are not in your favor and a favorable outcome is unlikely or impossible:
A trader who keeps changing his trading system frequently
A trader without a structure, not knowing when to trade and when to sit out
A trader who does not adhere to risk management principles
A trader who cuts his winners too short and lets losses run
An impulsive trader who doesn’t have discipline
Taking (calculated) risks is what makes life fun and interesting and it is what makes trading, potentially, profitable. However, most traders are only dabbling around, engaging in bets and trades where they have no edge.
The quote “not taking any risks is the greatest risk” is so true and even if you don’t realize it and you might think that you are going the ‘safe’ way, there are always opportunity costs and you might be wagering your time – which, after all, is our most precious asset.
The CAD has shown the worst performance against the USD lately, resulting in a small recovery after the strong trend in the USDCAD .
The CAD strength is also visible when looking at the EUR. Whereas the EURCAD hasn’t moved at all, the EURNZD rallied higher significantly – the CAD is keeping the EURCAD from making a move and it’s holding against the EUR.
The GBPUSD hit a strong resistance and is turning (for now). The GBPUSD was the best mover previously – hence it is at the top of the currency strength, but it is losing ground.
The Aussie is holding against the USD and the AUDUSD is fighting off the support and trying to stay above it. So far, it is still pulling away from the previous spike.
The EUR is back below 1.15 which could mean that the breakout has failed.
The USD short breakout doesn’t seem that likely anymore as well, but as long as 95.7 holds, it is not completely off the table. The USDX is retesting previous support a resistance now.
Similarly to the USDNOK trade, the EURNOK seems to have completed its bearish run along the Donchian channel. However, for now, the price is still sticking closely to the outer channel.
The price has moved into a previous resistance zone which seems to be turning into support now. Furthermore, this price level also marks the origin of the previous bullish trend. Those creation points can be significant because they represent price areas where the balance between buyers and sellers tipped.
The EURNZD is much earlier in its Donchian development. The price has shifted from an uptrend – where the price stuck to the upper channel – to an early downtrend where the price is now pushing into the lower Donchian channel.
The price also broke its 150-period moving average which is another significant event and could show the shift towards a bearish market cycle.
The Trend Rider confirmed the post-breakout signal on the USDCAD trade with a red Momentum Finder (the box at the bottom).
During the range, the Momentum Finder gave a few pre-mature signals, but as with every trend-indicator, you need to stay away during sideways markets.
During the following trend, the indicator did what it does best: confirmed the momentum and providing confidence. I got out with a healthy 140 pips. But with the benefit of hindsight, I should have stuck around longer.
Now, the Momentum Finder is back to deep red after a sideways period where the Momentum Finder showed grey bars. However, the trend seems overextended on the 1H timeframe and you are better off looking for a different market that shows pre-breakout behavior in an early range. The GBPUSD ticks the boxes as of now.
The current Gold chart also offers an interesting perspective and while everyone seems to be looking for shorting opportunities, the Trend Rider has turned grey and indicates the range.
Just like during the pre USDCAD breakout, you should be sitting on your hands tightly now. Getting involved in such a market while the price is still trading in a tight and well-defined range is a very dangerous thing to do. Just because the price has been going up, it does not mean that it must go down too.
There is no price in trading for the one who gets in first. More often than not, you will be the victim of spikes and squeezes around the range boundaries. So once more, patience is key.
The USD Index broke out of its range this week but failed to establish a new trend. The price immediately found support at the next swing low and is now back, retesting the previous lows. If the lows now become the new highs, the mood could shift towards a more bearish oriented market. However, a successful retest could foreshadow a downward continuation.
The USD breakout also triggered my USDNOK short which has been my trade of the week so far. A classic continuation after the buyers ran out of steam. The bullish exhaustion was very obvious last weekend and I jumped on the short signal early this week.
The take profit was hit precisely and the price has been bouncing around the lows ever since. A lot depends on the USD Index now. Going forward, I would caution of getting involved in the USD/NOK because we lack the overall structural context. Traders are better off trading other USD related pairs that are closer to actual turning points. The USD/NOK does not offer high probability trading opportunities at this stage anymore.
The Overbought and Oversold myth of using those concepts to trade reversals is probably one of the most widely misunderstood things in trading. Well, it is not just misunderstood but it is plain and simple wrong.
When an indicator is in Overbought and Oversold, it has absolutely nothing to do with a market getting ready for a reversal – not even in the slightest way. Any trader who tells you that the trend is likely to be over because the indicator is in Overbought and Oversold has never taken the time to actually study the tools he is using.
I have shown previously what it takes to really understand an indicator and I urge you to take a moment or two to go through my indicator guides about the STOCHASTIC, the MACD or the RSI. Those guides show that it does not take much to use an indicator in the right way, but you really must understand the tools you are using.
When an indicator is in the Overbought and Oversold area, it only has one meaning: the current trend is extremely strong. That’s truly it and there is nothing more to it.
In the case of the STOCHASTIC, it means that the price has closed within a maximum of 20% of its previous range high. In case of an uptrend, this means that the price is currently pushing into new highs and the current price candles are closing near the highs when the indicator is in Overbought.
As you can see, Overbought just shows an extremely strong trend that is moving higher with a strong force.
Chart study 1
I marked the areas when the price entered the Overbought and Oversold conditions and each time, the price kept on trending for a LONG time. By now, you will say: of course, that’s what the indicators tell us. But the majority of traders who aren’t exposed to real indicator analysis will try and keep going against the Overbought and Oversold criteria.
A trend can and will keep going for many hundreds of pips even though the price is in Overbought and Oversold territory. Going against Overbought and Oversold will certainly result in a margin call.
If anything, use Overbought and Oversold as an additional trend continuation signal.
Chart study 2
Another example that highlights why going against Overbought and Oversold is a losing strategy. In each instance, the trend kept going. Often, the Overbought and Oversold signal is just the starting point of a strong trend. When the indicators shifts from Oversold to Overbought, for example, it shows that the price structure has shifted and whereas the price previously closed near the lows, it is not pushing higher strongly.
And, as the chart study shows, even when the indicator leaves Overbought and Oversold, it is no guarantee that the trend is over. The middle example shows this nicely and even though the STOCHASTIC wasn’t in Oversold anymore, the price kept moving lower.
Chart study – Gold right now
The chart below shows a real-world example of a current Gold chart. The price has advanced for hundreds of points over the course of the chart snippet.
Especially the last part shows how dangerous it can be to go against the Overbought condition. The indicator can stay much longer in Overbought than you can stay solvent with your trading account.
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