Never Average Down

All traders are familiar with the maxim; ‘Never Average Down.’

Never averaging down may be an appropriate guideline when applied to long-term investing, but it often means lost profit opportunity or even losses when applied to day-trading the foreign exchange market.

Such an idea implies, for example, that you know precisely where the top or bottom of a market is, or at least that you know the direction of all future moves within your trading timeframe. Of course, anyone with an ounce of day-trading experience knows that such an idea is foolish as it’s only in retrospect that ‘tops’ and ‘bottoms’ can be identified with certainty.

Day-trading is all about discernment; discerning direction, discerning risk, and discerning the probable strength of a currency’s move. Price action often moves against your position after you’ve placed a bet (long or short), but that could offer an opportunity to improve your position by ‘averaging down’ rather than be a signal to just sit and suffer.

In other words, it depends on what other signals are indicating, and on what other currencies are doing, when the price moves against you. If you calculate that there are multiple signals/indicators moving against you, it may be best to exit immediately, or to exit and reverse your position. Again, day-trading is all about discernment.

Discernment is a function of experience. Pilots unfamiliar with certain weather conditions can make fatal decisions … and I’ve known some who did. With experience pilots can learn to safely navigate using the dials, indicators, and instruments that convey meaning to them. The same is true of traders. Inexperienced traders can make catastrophic trading decisions because they lack the acumen to discern with accuracy the risk of taking or of staying in a position.

‘Never Average Down’ is one of several misleading investment maxims that do not necessarily apply in the world of forex trading.

Trading Day 10/31/06

Wow ... what an awesome day. Immediately on the news that U.S. consumer confidence had dipped unexpectedly, everything roared nearly 100 pips up in what seemed like only a nanosecond.

I had picked up 24 pips before the news and then exited not wanting to get hit by a 'Rogue News Wave.' In retrospect, I would have been better off placing a one lot bet with a reasonable stop loss.

In any case, once the EUR rocket ship reached the top of its climb, it flittered about for a bit and then began a slow descent. I shorted the EUR and remain in that trade. It looks as if I'll pick up another 10 or more pips before I close out the day.

The rocket was a wonder to watch and while it would have been nice to have been on board, I realize I can't catch every one and I make a point of reminding myself to appreciate the fact that I had another good trading day!

Impaled

Here’s the best definition of the inner world of a trader that I’ve ever seen …

Traders are impaled on the three points of a psychic triangle.

This phrase describes perfectly the trader’s constantly changing inner state as he weighs the imperative existing at each triangle point: Which currency should I trade? How much should I risk? And, when should I enter/exit?

Certainly traders have different emotional make-ups, and while each individual handles these insistent questions in his own way, the image of a dynamic triangle in continuous straining flux is one hell of a metaphor for the emotional and decision-making balancing act that every trader must sustain during the trading day.

The image is artful in its accuracy and evokes a higher heart rate just in imagining it.

Trading Day 10/30/06

One of my favorite economic trend commentators is John Mauldin. In his most recent e-newsletter, titled, 'That Stubborn Yield Curve,' John makes the point that the yield on the 10-year bond is 43 basis points lower than the yield on the 90-day T-bill. Now, most folks know that such an inverted curve is a reliable predictor that the US economy is headed for a downturn.

While the typical longterm investment choice would be to go long bonds and reduce equity holdings, we Forex traders live in a vastly smaller time dimension ... like, what's gonna happen today?

My bet was that the EUR would fall a bit in the morning, consolidate, and then on release of the Core PCE Price Index, rise ... no matter what the number. I mean given the slowdown in the real estate sector and in GDP growth, how bad a number could it be?

So ... I bought the EUR three times as it nudged its way down before 8:30. When the news was released, EUR fell further but the 5-minute bar never closed below 1.2700, so I held on. EUR slowly recovered taking all morning to do so. I exited just after noon as I get anxious holding positions into the PM hours.

My trade was profitable, just barely, but it turned out that my thinking was fundamentally correct and the EUR kept rising.

I'm thankful that my trade made money, and I am open-minded about developing some better guidelines regarding afternoon trading ... like, don't open new trades, but stay with trades if indicators are pointing in the right direction.

As it was, the Fast Stochastic, RSI, and MACD all turned up and EUR rose an additional dozen pips ... a lesson for next time!

Trading Day 10/26/06

Was away from my trading desk yesterday (Wednesday)-- probably just as well since the Fed interest rate announcement was scheduled for 2:15 PM -- I didn't think much was likely to happen before then.

Looking back, however, it appears that traders correctly anticipated the continued pause mode of the Fed and steadily bought EUR and GBP all day long.

With both currencies up more this AM, I waited until they pushed through today's high before buying. EUR and GBP edged up and then stalled. Not wanting to suffer through a so-so move, I exited both picking up 19 pips.

Now, I'll stand aside until a definitive move appears.

Trading Day 10/24/06

Today, Tuesday, started off flat. No obvious set-ups and no signals giving a hint to which way any of the currencies would move.

So ... I did the only halfway bright thing I could do ... I stayed out!

It wasn't until around 11:00 that anything of interest went on when the EUR broke above it's high for the day. I hit the Buy key at 1.2558 ... then did the same with GBP at 1.8729. Prices moved steadily higher until just before noon and I exited when they appeared to stall picking up 13 pips on the EUR and 21 on the GBP. A total of 34 pips in about 35 minutes ... I'm done for the day!

It's About More Than Money

A fellow trader wrote recently that the trading system he had been building wasn't working, and that he was confused and suffering a rollercoaster of emotions .... I wrote the following in reply:

So the wooden building blocks you’ve been stacking up have toppled over and the castle you were building is now strewn all across the floor. Gotta tell you, Rich, it happens to all of us—and it won’t be the last time it happens!

I am suspicious that such setbacks happen more often to traders than to people who clock in and out at the same boring job everyday … but, then, it’s the clocking in and clocking out life that you want to avoid … right?

If that’s the case, and if you’re going to be true to yourself, then confusion and frustration is the price you pay for choosing the path you’re on. The fact is, suffering is inherent in life (per Gautama Buddha). And, the reality that your building blocks are little more than a scattered mess is just one of life’s lessons. Your job as a trader is to suck it up and keep on keepin’on! Winners never quit and quitters never win and all that …

Here’s a relevant question for you to think about … why do so many lottery winners end up broke?

Before I attempt an answer, here’s another question for you … do you think people who play the weekly lottery suffer through the same emotions you’re feeling every time they check the paper and come face-to-face with the fact that they didn’t win … again?

My sense is … they don’t. They’re certainly disappointed, but not confused, and not on the same emotional rollercoaster of highs and lows. The reason they don’t feel the same depth of emotion is because, other than the cost of the ticket, they have no investment in the game.

You, on the other hand, as is the case with all professional traders, have an investment that is a great deal more than monetary. What you and other traders have is an investment in a private, personal search that energizes you and infuses your existence with meaning. A trader can say, “I trade, therefore, I am.” Not so for lottery players. For traders, it’s a profession. The game for lottery players is simply a casual roll of the dice. The price you pay is higher and the pain of loss and ‘confusion’ is more deeply felt.

So back to the original question: why do so many lottery winners end up broke?

The answer, I think, has to do with the fact that they haven’t made the same investment that you’re making. Winning, in the trading game, has meaning that extends far beyond the amount in your trading account. Lottery winners, on the other hand, don’t have that emotional dimension and, therefore, have little respect for what they’ve won. “It’s only money,” is exactly the problem.

I’ve learned more from my failures than from my successes and I can only guess the same will be true for you. Success, all too often, has within it the seeds of failure. Better to learn what you can from your current state of confusion … and then, move on!

Trading Day 10/23/06

Wow, did you catch the USD rally at the London open !!??!!

My interpretation is that traders are nervous in anticipation of Wednesday's FOMC announcement. Given that core CPI is higher than the FED is comfortable with, it's just possible that the FED will be increasing rates one more time.

So ... the real question at 8:30 this morning is ... will US traders agree?

If so, then any movement is already over and you might as well take the day off!

My plan for the day is to organize my desk and watch events unfold. If I see any serious move, I'll consider a response at that time ... otherwise, my plan is to watch this game from the sidelines.

Meanwhile ... don't you wonder what the US equity markets would do if the FED raises rates? That uncertainty ... on top of the upcoming mid-term elections is enough to make any investor sweat!

Finally, I read that strong September and October equity markets during mid-term election cylcles are ALWAYS followed by a 5-10% correction in mid-November. Will the 'rule' hold this time around? You do have to wonder ....

Finally, finally, Barron's predicts the Republicans will hold both the Senate and House while the Iowa Electronic Markets predicts the Republicans will hold the Senate but lose the House. Since the IEM is the only US 'betting exchange' that, legally, can take bets with real money, you have to give it a certain degree of credibility. Notably, the IEM shows that the odds that the Republicans will hold both houses have dropped from 58% at the end of September to only 30% as of October 20th.

Opps ... US traders taking USD higher !!!

Trading Day 10/20/06

Odd opening this AM. GBP up and EUR down. These currencies have been shadowing each other closely all year so one of them is likely to reverse and catch up with the direction of the other.

After looking at the activity on JPY, CHF, and CAD, I concluded that the EUR would more than likely move in the direction of the GBP so I went long the EUR. It did ... and I picked off 12 pips in two trades.

Then I stood aside for a bit until both the GBP and EUR acted 'tired'. When USDJPY spiked up it was pretty clear that USD was strengthening ... so I shorted EUR and picked up another 12 pips.

Another good trading day with very little stress. It's Friday so I plan to stand aside early.

Action for Action's Sake

Hey, man, I'm here to trade. Just show me the 'Buy' and 'Sell' keys and get outta my way!

Sound familiar?

It's the most common refrain of new traders ... unscarred, untested, unafraid, and itching for action.

There's no doubt they'll find it. Currency trading has action in spades! Hitting either the 'Buy' key or the 'Sell' key is easy to do. It's knowing which key to hit and when that's tough! Knowing which and when can take years to figure out. But, new traders haven't learned that ... at least, not yet.

What adherents of this, "Action for Action's Sake," mentality most commonly share is a very early and very high fatality rate!

Maintaining naive exurberance in the foreign currency market is not just foolish, it's downright dangerous. It's also difficult to dispel. On the one hand, you want to encourage optimism and on the other, you want to encourage caution. Cautious optimism is the balance needed to survive the inevitable financial and emotional highs and lows that all traders endure.

Action is OK if you know well enough how to anticipate and deal with the upcoming curves and chasms and not OK if you think the ride is on a straight trajectory headed for the moon. Experience is the teacher. And experience has more to teach a trader about his or her inner emotional life than anything else. The tangible goal might be profit, but the intangible reward is the emotional maturity gained from the journey.

While exurberance is dangerous and cautious optimism is at least a more sane approach, seeking action for action's sake is a definite formula for a knock-out blow in the boxing ring of forex trading. Better to buy a ticket for a rollercoast ride ... at least the odds are better that you'll be able to walk away when the ride is over!

Trading Day 10/19/06

The morning seemed to start off quiet enough. Was successful with a CHF long that I exited when the price stalled ... thankfully, because the rest of the morning it spent stair stepping down.

Price action in the EUR led me to go long GBP thinking it would shadow the EUR. It did. A bit later price action in GBP led me to buy EUR thinking it would shadow the GBP. It did.

All in all, 3 profitable trades today for a total of 29 pips with no stress.

These trades were based on price action and shadowing the movement of one currency with another. Whether or not there are rules I can conclude from this will require more thought.

The First Goal

When I was much younger ...

... and didn't know better ... I believed the primary goal of a business was to grow. But, I was wrong. The primary goal of a business is to survive! Growth is important, of course, but survival is paramount.

And so it is with with trading. Nice to grow your account. Imperative that you not bust your account and permanently end your days as a trader!

As much as I might wish that I had a magic bullet to the 'not busting your account' problem, I don't, and can only advise that stops are an essential part of trading. Think of stops as an insurance policy to protect you from self destruction.

I make a point of training my mind to think, "Thank you for the insurance," whenever my stops take me out of a position, rather than, "Damn, wrong again!"

I can relate from painful personal experience that stops are not just important - they are essential. And yet, I understand how beginning traders may have difficulty believing this. There's something about personal suffering that carves an indelible lesson into your soul that isn't conveyed with the same sticky permanence just because someone tells you, "Hey, bud, stops are important."

Stories are useful ways to transmit lessons. My story is that because I didn't put a hard stop in place I burned through $6 million. I'm certain others have suffered larger losses, but that doesn't make my loss any less painful.

Would I have learned the lesson without the loss? Perhaps. But, more likely I would not have. The best chance for me to learn the lesson without the pain would have been for someone with real world experience to show me the error of my ways by relating their stories of unnecessary personal loss. That's one reason for this message. Hopefully, readers will accept my lesson without having to go through the pain themselves.

As I have written, the first goal, when all is said and done, is to survive. Stops give traders a chance to do that - to save themselves - and their trading accounts - when prices turn against them. My advice is - use 'em!

Mental Agility

Mental agility. Trading requires lots of it.

Sometimes the worst condition is not when you think prices are headed one way, but they do a rapid 180 degree pivot and gallop in the opposite direction. No, often that's not the worst because your stops should be in place to deal with that. The worst condition, short of busting your account, is when you think prices are poised to explode, but instead, they just sit there, arms folded, refusing to budge at all!

This is analogous to the surfer who paddles in circles waiting for the perfect wave only to see what he thought was about to be a fat ride simply dissolve beneath his board.

Often there's no explanation. The currency just doesn't do what it's done dozens of times before.

Some traders advise you to exit quickly, absorb your loss, and move on to trade a more active currency. I agree, but I don't always follow that advice. Often I'll tighten my stops and check the news to see if there's a bias I can identify. If not, it is better to exit and move on. Otherwise, you're not trading, you're not betting, you're hoping.

Frustrating? Yes-particularly if your mentally ready for and expecting rapid price movement.

This is one of the challenging characteristics of trading-and it's a charcteristic that can be deeply frustrating to a Type-A personality. Type-A personalities are accustomed to making things happen. But, guess what, traders can't make price action happen no matter what their personalities might be.

So, if you're accustomed to making things happen, then trading as a profession has a lesson or two in store for you.

Mental agility. Trading requires lots of it. How you deal with 'nothin happin' is one example.

CPI Up

Stood aside this AM until after CPI news was released. When I learned that the core CPI number was stubbornly high, meaning the Fed is unlikely to lower interest rates, I bet the USD would rise and went long CAD and short both EUR and GBP.

Trade worked out with EUR and GBP picking up 21 pips and 15 pips respectively. Still watching CAD to see if it will follow JPY and CHF on the long side.

PPI News

Was away from my trading desk during the 8:30 AM PPI announcement. My thinking was that if core PPI was strong then USD would rise and EUR would fall. For some quirky reason, however, core PPI was surprisingly strong and USD retreated and EUR rose!!??!!

Rather than scratch my head over that conundrum, I waited for the rise in the EUR to stall and then shorted both EUR and GBP. They drifted lower for the balance of the day and I closed both trades picking up 12 pips on EUR and 20 pips on the more volatile GBP. Nice trading day with practically no movement toward my stops.

Geez if only every day was as stress-free as today!

October 16, 2006

First post.

Out of the market this AM. Don't expect much activity in light of upcoming PPI report.