Strategy Rules for Proactive and Reactive Trading

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Long

1. Enter into half of the position no more than 20 minutes before a major news report will be released.

2. Place a stop 10 pips below the range low or 30 pips below your entry price, whichever is smaller.

If the economic data is in line with the initial proactive trade:

3. Enter the second half of the position 5 minutes after a major news report is released.

4. Put a stop for the entire position at 45 pips below the second entry price, and then trail by 20-day SMA.

5. Take your profit on half of the position when it moves in your favor by 45 pips.

6. Trail stop on the remainder of the position by the 20-day SMA. Short

1. Enter into half of the position no more than 20 minutes before a major news report will be released.

2. Place a stop 10 pips above the range high or 30 pips above your entry price, whichever is smaller.

If the economic data is in line with the initial proactive trade:

3. Enter the second half of the position 5 minutes after a major news report is released.

4. Put a stop for the entire position at 45 pips below the second entry price, and then trail by 20-day SMA.

5. Take your profit on half of the position when it moves in your favor by 45 pips.

6. Trail stop on the remainder of the position by the 20-day SMA.

If the economic data is not in line with the initial trade, then do not take a second position; instead, exit out of the first position.

In the USD/CAD example, the first half of the position would be initiated at 1.0081 with a stop of 1.0095 (see Figure 9.30). After the economic data report is released, the second half of the position should be initiated at 1.0015 for a blended price of 1.0048. The stop of the entire position is then lowered to 1.0060 or 45 pips away from the second entry price (this is a rule that you can alter to your own trading style). Half of the position is taken off when the trade moves in your favor by 45 pips, or hits 0.9970. The remainder of the position is then exited when the price moves back above the 20-day SMA or 0.9975. The total profit on this trade is 151 pips, and the average profit on the trade is 75 pips.

Here are two more examples of combining proactive and reactive news trading.

In the first example, we are trading the U.K. retail sales numbers on February 21, 2008. (See Figure 9.31.) The market believes that U.K. retail sales will be strong and we agree, but we think that there is a decent chance for an even greater surprise given the strength of the leading

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figure 9.30 USD/CAD Proactive and Reactive Combined Trade (Source: www.eSignal.com)
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figure 9.31 GBP/USD Proactive and Reactive Combined Trade (Source: www.eSignal.com)

indicators for U.K. retail sales that we typically follow. Therefore, we go long the GBP/USD 20 minutes before the release at 1.9470. The stop on the initial position is placed at 1.9450, or 10 pips below the range low. The U.K. retail sales number comes out more than double the market's forecast at 0.8 percent. The GBP/USD jumps 70 pips in the first 5 minutes after the release. We then enter the second half of the position at 1.9530 and move the stop on the entire position to 1.9485 (1.9530 minus 40 pips). The target or limit on the initial position is placed at 1.9575, which is reached approximately 90 minutes later. We remain in the position until the GBP/USD breaks the 20-day SMA on the 5-minute charts, which is at 1.9553. The total profit on this trade is 151 pips and the average profit on the trade is 75 pips.

In the second example, we are trading the German trade balance on April 8, 2008. The market believes that the German trade balance will deteriorate because of the strength of the euro, but we believed that it will actually be strong since new orders and manufacturing production have increased. Therefore, we go long the EUR/USD 20 minutes before the release at 1.5733. (See Figure 9.32.) The initial stop on the position is placed 10 pips below the range low of 1.5727, or 1.5717. The German trade balance report comes out stronger than expected, and we enter into the second half of the position at 1.5740 and move the stop on the entire position to 1.5700 (1.540 minus 40 pips). The target or limit on the initial position is placed at 1.5785. Unfortunately, the EUR/USD does not make it to 1.5785, but we end up exiting both lots of the position when the price breaks the 20-day

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figure 9.32 EUR/USD Proactive and Reactive Combined Trade (Source: www.eSignal.com)

SMA at 1.5754, leaving the entire trade still profitable. The total gain is 35 pips and the average profit on the trade is 17.5 pips.

If any of our proactive trades were wrong, we would lose no more than 30 pips.

20-100 SHORT-TERM

MOMENTUM STRATEGY

Although many people like to trade off of 5-minute charts, there is a big difference between trading news and using other short-term trading strategies. News trading is not for the faint of heart, because many people may find it impossible to figure out a bias for economic data, while others may find it extremely difficult to pull the trigger in reaction to a piece of news when they see that a currency pair has already moved 50 to 60 pips in their desired direction.

For those types of traders, it may be helpful to think about using other types of strategies. The main reason short-term trading is often more popular than long-term trading is because many people do not have the patience to wait days for a trade to develop. These are traders who need things to happen immediately, cringe at every 10-pip move against them, and want the trade to turn a profit within the next few minutes or else they will abandon their position. They would be more than willing to take 10 pips 10 times a day than to make 100 pips on one trade with the potential of watching the position first move 50 to 60 pips against them.

The best strategy for this type of trader is a short-term momentum strategy. Although I prefer to trade news, one of my favorite strategies is the 20-100 short-term momentum strategy. The strategy outlined here can be used independently or as a method to achieve a better entry price for longer-term strategies. The whole premise behind the strategy is that you go long or short only when momentum is on your side. This is very important because the goal is to hit your first profit target as soon as possible.

In this strategy, we use three different indicators: the 20-day exponential moving average (EMA), the 100-day simple moving average (SMA), and the moving average convergence/divergence (MACD). The 20-day EMA is the trigger for the trading strategy, and the main reason we use the EMA instead of the SMA is because it places more weight on recent movements, which is what we need for fast momentum trades. The 100-day SMA is used to make sure that we take only trades that are in line with the broader trend, while the MACD is used to help gauge momentum and to filter out lower-probability signals. We use the default settings for the MACD histogram: first EMA = 12, second EMA = 26, signal EMA = 9, all using closing prices. The trade is taken only when the MACD has turned within five candles, because we want to enter into the trade when momentum is beginning to build and not when it is maturing.

These are the rules or guidelines for the 20-100 short-term momentum strategy.

Long Trade (Using 5-Minute Charts)

1. Find a currency pair that is trading below both the 20-day EMA and the 100-day SMA.

2. Wait for the price to cross above both moving averages by 15 pips, and make sure that the MACD has turned positive no longer than 5 candles ago.

3. Buy at market.

4. Place your stop at the low of the candle that broke the moving averages.

5. Sell half of the position when the currency pair has moved in your favor by the amount risked, and move your stop on the remaining position to breakeven.

6. Trail the stop on the remaining position by the 20-day EMA minus 15 pips.

Short Trade

1. Find a currency pair that is trading above both the 20-day EMA and the 100-day SMA.

2. Wait for the price to cross above both moving averages by 15 pips, and make sure that the MACD has turned negative no longer than five candles ago.

3. Sell at market.

4. Place your stop at the high of the candle that broke the moving averages.

5. Buy back half of the position when the currency pair has moved in your favor by the amount risked, and move your stop on the remaining position to breakeven.

6. Trail the stop on the rest of your position by the 20-day EMA plus 15 pips.

Here are some examples of the 20-100 short-term momentum strategy in action:

The first example that we will look at is a long trade.

On April 10, 2008, the EUR/USD broke above both the 20-day EMA and the 100-day SMA after a long Asian session consolidation. Before taking the trade, we checked that the MACD at the time had just turned positive, and then we waited for the price to break above the moving averages by 15 pips to go long. (See Figure 9.33.) Since the moving average price cross occurred at 1.5742, we entered the EUR/USD trade at 1.5757. The stop would be placed at 1.5738, which is the low of the candle that broke above the moving averages. The first target is the entry price plus the amount risked. Since we entered at 1.5757 and our stop is at 1.5738, the amount risked is 19 pips. Therefore, the first target would be 1.5757 plus 19 pips, or 1.5776. It is hit a few hours later, at which time we move our stop on the rest of the position to breakeven. This is a money management rule that we use most often at BKForex Advisor, because having the stop at breakeven on the second half of the position means that we are trading with only our profits and are no longer vulnerable to losses. The position continues to move in our favor. Even though there are times when the price falls below the 20-day EMA, it never does so by more than 15 pips until 5:50 a.m. the following morning. At that time, our trailing stop is hit and we exit the remainder of the trade at 1.5804, which is the 20-day EMA minus 15 pips. The total gain on this position if two lots were taken would be 67 pips or an average gain of 33.5 pips.

The second example is a short trade in USD/JPY.

On April 11, 2008, USD/JPY broke below both the 20-day EMA and the 100-day SMA at approximately 6:30 a.m. New York time. Before taking the trade, we checked that the MACD at the time had just turned negative and then we waited for the price to break below the moving averages by

15 pips to go short. Since the moving average price cross occurred at 101.88, we entered the USD/JPY short trade at 101.88 minus 15 pips or 101.73. (See Figure 9.34.) The stop is placed at the high of the candle that broke the moving average, or 102.01. The first target is the entry price minus the amount risked. Since we entered into the short trade at 101.73 and our stop is at 102.01, the amount risked would be 28 pips. This puts our first target at 101.45, or 101.73 minus 28 pips. The first target is hit 10 minutes later, making it the perfect short-term trade. As soon as that happens, the stop is moved to breakeven on the remainder of the position. Then we continue to trail the stop until the price breaks back above the 20-day EMA by 15 pips. This occurs a few hours later at 10:45 a.m., when the second half of the position is eventually closed at 101.06 for a total gain on the trade of 95 pips (assuming two lots) or an average gain of 47.5 pips.

The third example is a short trade in the GBP/USD.

On April 21, 2008, GBP/USD broke below both the 20-day EMA and the 100-day SMA at approximately 2:00 a.m. New York time. Before taking the trade, we checked that the MACD at the time had just turned negative, and then we waited for the price to break below the moving averages by 15 pips to go short. (See Figure 9.35.) Since the moving average price cross occurred at 1.9992, we entered the GBP/USD short trade at 1.9992 minus 15 pips, or 1.9977. The stop is placed at the high of the candle that broke the moving average, or 1.9999. The first target is the entry price minus the amount risked. Since we entered into the short trade at 1.9977 and our stop is at 1.9999, the amount risked would be 22 pips. This puts our first target at 1.9955, or 1.9977 minus 22 pips. The first target is hit two hours later.

;GBP AQ-FX ■ BRITISH POUND STERLING COMPOSITC.5»Dynamic.!*»

UM 0240 63:00 «X« 33.03 06:30 VIM C*:0C W:M 10:03 1t:00

figure 9.35 GBP/USD 5-Minute Chart (Source: www.eSignal.com)

UM 0240 63:00 «X« 33.03 06:30 VIM C*:0C W:M 10:03 1t:00

figure 9.35 GBP/USD 5-Minute Chart (Source: www.eSignal.com)

As soon as that happens, the stop is moved to breakeven on the remaining position. Then we continue to trail the stop until the price breaks back above the 20-day EMA by 15 pips. This occurs a few hours later at 7:20 a.m., when the second half of the position is eventually closed at 1.9855 for a total gain on the trade of 144 pips (assuming two lots) or an average gain of 72 pips.

The final example is one where the trade gets stopped out.

On April 18, 2008, the AUD/USD broke above both the 20-day EMA and the 100-day SMA after a long Asian session consolidation. Before taking the trade, we checked that the MACD at the time had just turned positive within the past five bars, and then we waited for the price to break above the moving averages by 15 pips to go long. Since the moving average price cross occurred at 0.9368, we entered the AUD/USD trade at 0.9383. (See Figure 9.36.) The stop would be placed at 0.9366, which is the low of the candle that broke above the moving averages. The first target is the entry price plus the amount risked. Since we entered at 0.9383 and our stop is at 0.9366, the amount risked is 17 pips. Therefore, the first target would be 0.9383 plus 17 pips, or 0.9400. The currency pair takes hours to move in our favor, but the rally does not have enough momentum to hit our first profit target. It stops 2 pips shy before reversing sharply to stop us out for a loss of 34 pips on the trade (assuming two lots) or an average loss of 17 pips. The only thing that could have given us a clue that the trade might not have much momentum could have been the fact that the MACD dip into negative territory was very narrow and came off of a longer period above positive territory. Either way, thankfully the stops on this type of strategy tend to be small, making the loss bearable.

HIGH-PROBABILITY TURN STRATEGY_

In the currency market, trends can last for a very long time. For some people, this gives them many opportunities to join the trend, but for other people who are contrarians by nature, the longer the trend lasts, the more frustrating it becomes. Based on my years of interaction with individual traders as well as the data from the FXCM Speculative Sentiment Index (FXCM SSI), I have seen that even though most traders deny it, they are top pickers or bottom fishers by nature.

The FXCM Speculative Sentiment Index is based on the positioning of the company's most speculative clients. As indicated in Figure 9.37, traders started to short the EUR/USD when it was trading at 1.28 and as a group have remained net short from 1.28 all the way up to 1.56. There are obviously traders who drop in and out of the survey because they were

figure 9.37 FXCM SSI for the EUR/USD (Source: FXCM)

stopped out, but the chart clearly indicates that short positions were increased around 1.35 and 1.40. The FXCM SSI is published once a week on DailyFX.com.

Picking a top or bottom can be extremely difficult, and the FXCM SSI proves that many traders do it unsuccessfully. This makes finding a good way to time a turn extremely important. One of my favorite strategies is to look for extension moves, and I define an extension move as consecutive strength or weakness. There are many times that a currency pair will rally for six, seven, or eight days straight with virtually no retracement. The longer the move lasts, the more statistically significant it becomes and the higher the likelihood that the string of strength or weakness will come to an end.

Based on looking at 10 years' worth of data, I have found that rarely do extension moves in the major currency pairs like the EUR/USD, GBP/USD, and USD/JPY last longer than seven days.

Starting with the EUR/USD, we can see in Table 9.1 that over the past 10 years, the longest extension move that occurred in the currency lasted for 10 days. The table is read in the following way: There have been 10 times when the EUR/USD has moved in one direction for seven days straight, with the move extending for an eighth day only five out of those 10 times. Of those five times, only twice did the EUR/USD's move last for a ninth trading day, and only once did it then last for a tenth day. Therefore, once a rally or sell-off has continued for seven days straight in the EUR/USD, the odds for a turn within the next 24 hours increase exponentially, and those

table 9.1 Length of EUR/USD Extension Moves (10 Years)

Number of Days

EUR/USD

1

1,292

2

595

3

273

4

125

5

64

6

35

7

10

8

5

9

2

10

1

11

0

12

0

13

0

14

0

15

0

odds become even more compounded if the move lasts for an eighth day. This provides traders with a high-probability short-term trading opportunity. Please bear in mind that this strategy does not usually predict major turns, but occasionally the turn can become a meaningful one.

The next set of data is for the GBP/USD (see Table 9.2). Over the past 10 years, the longest extension move lasted for 12 days. As indicated by the data, trends in the British pound have lasted longer than trends in the euro. The longest move in the EUR/USD was 10 days. However, it is also important to realize that rarely do the moves in the GBP/USD extend for eight days; there have been only seven cases of this, which means that for the GBP/USD an eight-day extension has approximately the same statistical significance as a seven-day extension move in the EUR/USD.

The last table, Table 9.3, provides the same data for USD/JPY. The longest move was nine days in length, and that happened only twice over the past 10 years.

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