In my last post I talked about how tough trading is and proposed that the single most important factor to successful trading is timing.
Do you agree with the following statement? “I can randomly open a trade on any currency pair and given enough time, it will be a winner.” What if we allowed a 2nd trade? Allowed hedging (trading in the opposite direction)? Allowed a 3rd trade? Barred any exceptional circumstances like an economy collapsing? Chances are that if you answered “no” to the original question, you changed your answer to “yes” after one of the follow up questions. This is because given enough time any trade can be turned into a winner (assuming you believe successful trading is possible). Of course the problem, is that we don’t have an infinite amount of time or resources. If you had an infinite amount of time, that alone would be enough to be a successful trader. You could just hold a bad trade for years if necessary, accept the drawdown, and then close it when it finally turns back around into profit. Or you could successfully implement a Martingale* strategy (assuming your account is deep enough). OK, so between my last post and this one I’ve made two points: 1) It is very hard to make money trading, 2) We have an example of an ideal but impossible situation where trading would be easy and profitable. So the whole goal of trading is determining what you need to do to land somewhere in the happy zone on the poorly drawn figure below.
Before you get too excited, know that the main point I am driving to with this post is to convince you of the importance of timing in trading and what you should do to improve your trading. Unfortunately, I am not going to be able to provide you with a miracle formula or the Holy Grail itself. In the trading world, there is a lot of emphasis on indicators and I acknowledge that they are important. However, in the end, what are the indicators really telling you? They are telling you that it might be TIME to enter a trade, TIME to exit a trade, or TIME to place another trade.
When we look at the lifecycle of a trade, timing plays a role in “entry criteria” and “exit criteria.” Whatever happens between those two points is determined by the market. Once we have opened the trade, we are along for the ride until we determine that it is time to exit. You may be asking yourself, what about “trade management?” OK, let us consider a few examples of trade management. If you consider placing contingency orders on the trade (stop loss or take profit), then you are surrendering your control of the trade to the market. The trade will close when the market decides it is time. What about taking additional trades like hedging (trading in the opposite direction) or taking larger trades in the same direction? I concede that these are extremely important tools needed to become a successful trader. However, I also propose that since they are additional trades, they fall under my initial proposition which is that timing is everything and therefore when you place your second trade in an attempt to recover from a losing trade, that timing is the most important factor.
Think about the chart itself. It has two axes, time is the horizontal (or x-axis), and price is the vertical (or y-axis). If you think back to high school math, you may remember that x (i.e. “time” when looking at a chart) is the independent variable and y (i.e. “price” on a chart) is the dependent variable. That’s right, time is independent of price; price is the dependent variable. Therefore to get a certain price (really change in price) you must pick the correct entry and exit time. Also, think about which axis is usually bigger, the time axis. Coincidence? I think not.
When I first started trading, there were many times that one or two of my indicators would tell me to take a trade and I would do it. I liked to do this on Sunday evening (I’m on US Eastern Time) when the Sydney exchange opened in my time zone. I would find one or two currency pairs that had indicators telling me to trade and I would take the trade(s). I would then place a take profit and stop loss order on each trade and walk away. I would do this using 1 hour and 4 hour charts and check on the trade occasionally during the week. What would happen the most frequently is that the trade would stop out, usually before the end of the day on Monday. The hardest part of accepting the loss was not that the loss occurred but after hitting my stop loss and the trade closing automatically, the price would start moving towards my profit target. What was wrong with my trade? THE TIMING! If I would have entered the trade later it could have been profitable, if I would have exited the trade later (i.e. not used a stop loss), it could have been profitable.
Whether you buy into my philosophical argument that “timing is everything” or not, really doesn’t matter one bit. Philosophy doesn’t pay, execution does. So ask yourself, “What can I do to better manage the entry and exit timing of my trades?” Some suggestions based on what I have learned:
1. Have Patience: On a trade entry, don’t just execute an order when your indicators tell you to do so. Wait to see that the currency pair is solidly moving in the right direction (i.e. price moving towards your potential target with a subsequent rise in volume). As an alternative, don’t take the trade at all. 100% of the trades that you don’t take are not losers. For exits, don’t use stop losses. If you feel that you must use stop losses, put them so far away that only the most extreme event would trigger them. I think of stop losses like a net for a trapeze artist. They are there just in case something goes really wrong, but they should almost never come into play.
2. Use Small Trade Sizes: If your trade sizes are small, then there is no need to panic when one doesn’t initially go the way you thought it would. You can hold on to it to see if it turns around, or close it early if you feel confident that it will be a while. This also leaves you the option of taking a bigger trade on the next opportunity to offset the losses from your first smaller trade.
3. Automate: Most of us don’t have the time to sit around and wait for the perfect time to enter/exit a trade after the initial cue from the indicators. An Expert Advisor never gets bored, does exactly what you tell it to do, and never calls in sick. If you are not familiar with EA’s or don’t like the idea of an EA trading for you, consider one that you place on trades that you have opened manually. If you like trading manually, keep trading manually but consider getting an EA that will babysit your trade. An EA can be programmed to take many things into consideration, which makes it much smarter than a standard stop loss order. For example, the Expert Advisors that I program have a stop loss or “hard stop” as I call it, but they also have “smart stops.” I like to look at Force Index or even the derivative of force index and the direction of price movement. If it looks like there are large forces pushing the trade in the wrong direction, the EA will close the trade before it hits the stop loss. This allows you to have wider stop losses which means higher probability of wins and also means that your losses are smaller.
Even if you are already profitable, chances are you can always work on improving the timing of your trade entries and exits. That is what it really boils down to, entries and exits are all about timing, the indicators just tell us when it is time. I think entry is the easy part, it is the psychological effects of having an open trade (winner or loser) and how we manage it and time the exit that is the hard part. I’ll talk about trading psychology a lot more in future posts.
*Martingale: You can check out a detailed description here at Investopedia or here at Wikipedia. But here is my version. Imagine that you are in Las Vegas. You can imagine anything else you want, like who you are with, what you are drinking, and how many chips you have (make it a lot of chips). You go up to the blackjack table (or your game of choice) and lose $50 on the first hand. You know that you’ll eventually win, so you bet $100 on the second hand so that you will be up $50 if you win. However, the dealer gets blackjack and you lose again. Now you are down $150. So how much do you bet on the next hand? Well if you are already beat down and just hoping to get out even, you bet $150. But let’s say that you are dead set on finishing up, you tack that original $50 on to it and bet $200. If you win, you are up $50. If you lose again, you are down $350, so your next bet is $400. And so on… Statistically, you will eventually win. Of course this can be a very dangerous game if you don’t have the funds to back it up.
