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Contents
Cover
Series
TitlePage
Copyright
Dedication
Foreword
Preface
Acknowledgments
PartOne:NakedForexTrading
Revealed
Chapter1:TheFundamentalsofForexTrading
AQUICKLESSONINCURRENCIESPLAYERSOFTHEFOREX
MARKETTOOLSOFTHETRADE:FUNDAMENTALVERSUSTECHNICALINDICATORSWHATISNAKEDFOREX?
Chapter2:AvoidingaTradingTragedy
ISTHEREA“BETTER”INDICATOR?TAKINGRESPONSIBILITYFORLOSINGTRADESLEARNING
FROMMARKETBIOFEEDBACK™
Chapter3:Back-TestingYourSystem
THREEGOALSOFBACK-TESTINGMANUALBACK-TESTING
USINGBACK-TESTINGSOFTWAREAUTOMATEDBACK-TESTINGTOPTHREEBACK-TESTINGTIPS
Chapter4:Identifying
SupportandResistanceZones
ZONESAREBIGFATBEERBELLIESOLDZONES,NEWZONESHOWTOFINDZONESFIVETIPSFOR
FINDINGZONES
PartTwo:Naked-TradingMethodology
Chapter5:TheLastKiss
WHATISABREAKOUTTRADE?WHATISALASTKISS?TRADINGTHELASTKISS
Chapter6:TheBigShadow
WHATDOESITLOOKLIKE?DOESBIGGEREQUALBETTER?THESTOPLOSSENTERINGTHETRADEIMPORTANCE
OFTHECLOSINGPRICEROOMTOTHELEFTPROFITINGFROMBIGSHADOWSTHERULES
Chapter7:WammiesandMoolahs
THEDOUBLEBOTTOMTHEDOUBLETOPIDENTIFYINGWAMMIESANDMOOLAHSHOWTO
TRADEWAMMIESHOWTOTRADEMOOLAHSTIPSFORWAMMIESANDMOOLAHS
Chapter8:Kangaroo
TailsWHATISAKANGAROOTAIL?THEOPENANDCLOSEKANGAROOTAILSARELONGKANGAROO
TAILPLACEMENTENTERINGTHETRADETHESTOPLOSSPROFITTARGETSKANGAROO-TAILTIPS
Chapter9:TheBigBelt
WHATISABIGBELT?THEBEARISHBIGBELTTHEBULLISHBIGBELTTIPSTOTRADINGTHE
BIGBELT
Chapter10:TheTrendyKangaroo
WHATISATRENDYKANGAROO?TRENDINDICATORSTRADING
TRENDYKANGAROOS:RESTINGSPOTSTRENDYKANGAROOCHARACTERISTICSBEWARETHETRENDYKANGAROO
TRAPS
Chapter11:ExitingtheTrade
EXITINGWITHMONEYEXITSTRATEGIESMANAGINGEXITS
PartThree:Trading
Psychology
Chapter12:TheForexCycle
WHATISTHECYCLEOFDOOM?
LIVINGINTHECYCLEDEFEATINGTHECYCLE
Chapter13:CreatingYourTradingSystem
WHATDOYOUBELIEVE?RISKRULES
MANAGINGYOURTRADESKNOWINGYOURTRADINGPERSONALITYDEFININGYOURTRADINGSYSTEM
Chapter14:BecominganExpert
WHYDOYOUWANTTOTRADE?THESECRETOFTHEEXPERTSSIXSTEPSTOBECOMINGAN
EXPERTDOINGITAGAINBORINGTRADINGISEXPERTTRADINGASIMPLETRICK
Chapter15:GainingConfidence
THEORIGINOFCONFIDENCEISSUESCONFIDENCEINYOUREASONSFORLOSING
STREAKSTHEBADMARKETTHEORY
Chapter16:ManagingRisk
YOURRISKPROFILETRADING
PSYCHOLOGYANDRISKMANAGEMENTRISKYMONEYTRAPS
AbouttheTradingSoftwareandVideoTutorial
AbouttheAuthors
Index
Foundedin1807,JohnWiley& Sons is the oldestindependent publishingcompanyintheUnitedStates.With offices in NorthAmerica, Europe, Australiaand Asia, Wiley is globallycommitted to developing andmarketingprintandelectronicproductsand services forourcustomers’ professional andpersonal knowledge andunderstanding.
The Wiley Trading seriesfeaturesbooksbytraderswhohave survived the market’sever changing temperamentand have prospered–some byreinventing systems, othersby getting back to basics.Whether a novice trader,professional or somewherein-between, these books willprovide the advice andstrategies needed to prospertodayandwellintothefuture.
Foralistofavailabletitles,please visit our Web site atwww.WileyFinance.com.
Copyright©2012byAlexNekritinandWalterPeters.
Allrightsreserved.PublishedbyJohnWiley&Sons,Inc.,Hoboken,New
Jersey.Publishedsimultaneouslyin
Canada.Nopartofthispublicationmaybereproduced,storedin
aretrievalsystem,ortransmittedinanyformorby
anymeans,electronic,mechanical,photocopying,recording,scanning,orotherwise,exceptas
permittedunderSection107or108ofthe1976United
StatesCopyrightAct,withouteitherthepriorwritten
permissionofthePublisher,orauthorizationthroughpaymentoftheappropriateper-copyfeetotheCopyrightClearanceCenter,Inc.,222
RosewoodDrive,Danvers,MA01923,(978)750-8400,fax(978)646-8600,orontheWebatwww.copyright.com.RequeststothePublisherfor
permissionshouldbeaddressedtothePermissionsDepartment,JohnWiley&Sons,Inc.,111RiverStreet,Hoboken,NJ07030,(201)748-6011,fax(201)748-
6008,oronlineathttp://www.wiley.com/go/permissions
LimitofLiability/DisclaimerofWarranty:Whilethepublisherandauthorhaveusedtheirbesteffortsinpreparingthisbook,theymakenorepresentationsorwarrantieswithrespecttotheaccuracyorcompletenessofthecontentsofthisbookandspecificallydisclaimanyimpliedwarrantiesof
merchantabilityorfitnessforaparticularpurpose.No
warrantymaybecreatedorextendedbysales
representativesorwrittensalesmaterials.Theadviceandstrategiescontained
hereinmaynotbesuitableforyoursituation.Youshouldconsultwithaprofessionalwhereappropriate.Neitherthepublishernorauthorshallbeliableforanylossofprofitoranyothercommercialdamages,includingbutnot
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Wileyalsopublishesitsbooksinavarietyof
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products,visitourwebsiteatwww.wiley.com.
LibraryofCongressCataloging-in-Publication
Data:
Nekritin,Alex,1980-NakedForex:high-
probabilitytechniquesfortradingwithoutindicators/AlexNekritin,WalterPeters.p.cm.–(Wileytrading;534)
Includesindex.ISBN978-1-118-11401-8(cloth);ISBN978-1-118-
22435-9(ebk);ISBN978-1-118-26244-3(ebk);ISBN978-1-118-
23749-6(ebk)
1.Foreignexchangemarket.2.Foreignexchangefutures.
3.Speculation.I.Peters,Walter,1973-II.
Title.HG3821.N452012332.4′5–dc232011043306
Forallguntradersaswellasthoserudeandcutepossums
oftheworld.
ForewordThe Internet engendered theonline trading phenomenon.Onecantradeanywherethereis a connection to theWorldWide Web. The result hasalso been the creation ofinstant experts, trading guruswhooffermodernversionsofsnake-oil cures for traders.
The web is flooded withtrading alerts, systems, andblogs that promise returnsthat will lead to instantwealth.Most of the books inthe field fail to provideactionableknowledge. In thisenvironment, Alex Nekritinand Walter Peters in NakedForex: High-ProbabilityTechniques for TradingwithoutIndicatorsprovideanhonest and effective
presentation about forextrading that certainlybeginnersneed,andthatmoreexperienced traders forgettheyneed.Naked Forex makes some
powerfulpointsabouttradingforex that really apply toother markets as well. Firstand foremost, price is themost important indicator ofall.All indicatorsarederivedfrom price. Many traders
have forgotten this factbecause computerization hasmade iteasy togeneratenewindicators. Indicators workmore like trainingwheels forlearning to ride a bicycle.They are temporary in theircapacity tohelp tradersbuildtheir skills. They actuallylimit the evolution of atrader’s performance becausetheyprovideadisincentiveto“listen” to themarket.Naked
Forexgoesintodetailonhowa trading signal that isindicator-based is inferior towhatNekritinandPeterscalla“naked”signal.Anotherkeyinsightthatthe
book provides is theimportanceofknowingone’spersonality in trading.Trading systems that arebased on untested algorithmsthat are purely technical willsurely fail. Nekritin and
Peters argue that tradingsystems should reflectdecisions that traders wouldmake that are based onlooking at charts. Manualbacktesting, they suggest, isaneffectivewaytoidentifyatrading system’s strengthsandweaknesses.A third major focus of
NakedForexistheconceptofidentifying support andresistance zones. The fact is
that with the trillions ofdollars that float each hourthroughthecurrencymarkets,pricesreachcertainlevelsandstop.Onecantrytofigureoutwhy they stop rising or stopfalling. But the job of thetraderistoobserveaccuratelywhere theprice is andwhereit came from. Price zonesprovidethenakedtruthaboutmarket sentiment. If a pricebreaks through a zone, no
matterwhatthereason,itisasignal–and a more powerfulsignal than any indicator.NekritinandPeterscall thesepoints of price actionmarketscars. It is a good metaphorbecause markets havememory and so do traders.The authors introduce the“last-kisstrade”asapowerfultool in identifying whenbreakoutshaveoccurred.Thebook is filledwith gems that
provide visualizations ofprice action, such as the bigshadow, kangaroo tails, andthebigbelt.As someonewho has been
training people on how totrade forex for nearly 13years,Iwelcomethisbookasonethatstandsoutasabasicmanual on how to evaluateand trade the increasinglychaotic forex markets. I willuseitformystudents.
AbeCofnasauthorofTradingBinaryOptions(Bloomberg)and
editorofTheFearandGreedTraderNewsletter,
AgoraFinancial,Inc.
Preface
Unfortunately, most forextraders lose out. Profitabletrading is reserved for theselectfew.Expectationsdriverealityformanythingsinlife,and successful trading is nodifferent. Most forex tradershave three preconceptionsabout successful trading.
These are the threemyths ofsuccessful trading, and thestructureofthisbookisbasedoneachofthesemyths.Myth 1: Successful trading
must be indicator based. Thefirst part of thisbookdispelsthis myth. There are manyways toprofit in forex, someofthemdoinvolveindicators,but indicators are notnecessary for successfultrading. There are
professional traders aroundtheglobe,manyofthemgoodfriends of mine, who use“naked” charts to maketrading decisions. In someways, indicators delay theprogression of the traderbecause the focus is on theindicator, rather than priceaction. Indicatorsbecomethescapegoat for losing streaksand often keep losing tradersin a holding pattern. It is
much easier for the novicetrader to begin tradingwithout indicators from thebeginning.Myth 2: Successful trading
mustbecomplex.Thesecondpart of this book is aboutnaked tradingsystems.Thesesystems are incrediblysimple. Do not confusesimplicity with ineptitude.Although these systems aresimple when applied
correctly,theymayalsoyieldbig profits and buildconfidence in your trading.You may view this as themeat of the book, the mostimportant section, but Idisagree. I think the thirdsection is themost critical toyourtradingsuccess.Myth 3: Successful trading
is dependent on the tradingsystem. This is probably themost widely held belief
among traders. This isprecisely why there arethousands of trading systemson the market, all promisinggreat riches to the bravetraders who pony up themoney for the next HolyGrail. Many veteran tradersunderstand the importance oftrading psychology. Personalbeliefs and attitudes towardriskarethegreatestpredictorsof trading success, and the
trading system is not nearlyas important asmany tradersassume. For most traders,afteryearsoftrading,thisfactbecomes apparent. The thirdsection of the book concernstrading psychology and howyou may both identify andchange your thinking,because this is the realdrivingfactor inyour tradingsuccess.Manyreaderswillcontinue
to hold onto these myths. Infact,somereaders(thosewhobelieve trading successdepends on the tradingsystem) will simply read thesecond section and begintrading the naked tradingsystems. This is unfortunate.The first section is criticalbecause it offers reasons forprice action trading (a newbeliefsystem)andacourseofactionforbecominganexpert
atnakedtrading(newtradinghabits). The third section iswherebreakevenand slightlyprofitabletraderswilllearntomove into the realm of thetrue professional trader. Allsections of the book areimportant, and it ismy hopethat by reading it you willfind simple methods forextracting profits from themarket.You can trade successfully
without indicators. Formanytraders,naked trading isbothrefreshing and easy to apply.You can trade successfullywith simple trading systems.Simple systems are robustand powerful. However,ultimately, your success as atraderwilldepend,notonthetrading system, but on howyou incorporate your beliefsand attitudes about risk intoyour trading routine. I hope
thisbookwillaidyouinyourjourneytotradingsuccess.Ialsohopethatyoukeepin
touch by stopping by thecompanion web site for thisbook, complete with livemarket trades, additionaltools, and new naked tradingsystems.Youwillfindthisonthe Web atwww.fxjake.com/book.
WalterPeters,PhD
Sydney,AustraliaOctober2011
Acknowledgments
There are many people whodeserve acknowledgment forthis book. The list includesbut is not limited to thefollowing: Meg Freeborn forpatienceanduniqueabilitytoturn rough stones intopolished gems (I knowbecauseIhaveseenherdoit).
EddieKwongdeservescreditfor putting this book idea infrontoftherightpeople.SeanLydiard is living proof thatsix degrees of separation isfact.ArshiaBolour,who isatruebrotherineverysenseoftheword.AbeCofnas,forhispatience and kindness inhelping me with theconversion from trader totrading author. Evan Burtonforbelievinginthebookidea
and making it happen. ColinJessup for his uniqueperspectiveonnaked trading.My brother Ashkan Bolour,who introduced me to theworldofforexsomanyyearsago. My parents forunconditionally supportingme in every endeavor. Mydissertation committee (andDr.DavidEstesinparticular)whotaughtmeyearsagohowto write so that others could
understandme.My sister foralways being there for me.And to the first-line editorMelissa McConaghy—without your help, I amcertain this book would nothavehappened.
—W.P.
PARTONE
NakedForexTradingRevealed
CHAPTER1
TheFundamentalsofForexTrading
Gregory: “Draw thy tool…”
Sampson: “My nakedweaponisout.”—Shakespeare,Romeoand
JulietWelcome to the world offorex trading. Forex is thelargest market in the world.Forex traders exchange $4trillioneachday,but is forexthebestmarket foryou?Theanswerdependsonwhat youarelookingfor.Ifyouwantamarket that never sleeps, if
you want the opportunity totradeatanytimeoftheday,ifyou would like to make aboatloadofmoney in a shortamountoftime,forexmaybefor you (it should be notedthat you may also lose anincredible amount of moneyin a short amount of time).Traders with very littlemoney can begin tradingforex.Inforex,youmaytakerelatively large trades with
small amounts of moneybecause of the favorableleverage requirements. Therearemanyreasonstobecomeaforex trader, but beforejumping into the reasons,perhaps we should take acloser look at thecharacteristics of a forextrade.
AQUICK
LESSONINCURRENCIES
“Forex” is simply anabbreviation for “foreignexchange.” All foreignexchangetransactionsinvolvetwo currencies. If anindividual trader, a bank, agovernment,acorporation,ora tourist in a Hawaiian printshirt on a tropical islanddecides to exchange one
currency for another, a forextrade takes place. In everyinstance, one currency isbeing bought and,simultaneously, anothercurrency is being sold.Currenciesmustbecomparedto something else in order toestablish value; this is whyforex trading involves twocurrencies.IfyouandIgotothebeach
and I tell you the tide is low
rightnow,howdoyouknowthis is true?Youmaydecideto compare the currentwaterlevel to the pier. If there arestarfish andmussels exposedon the pier, youmay believemebecauseyoucancomparethe currentwater level to thepreviouswaterlevel.Inforex,we compare currencies inmuch the same way,currencies are traded in pairsand, thus, one currency is
always compared to anothercurrency.Anexamplemaybehelpful
to illustrate how currenciesare traded. If you are ahotshot forex trader, andyoubelieve that theEUR/USD isgoing to go up, you maydecide tobuy theEUR/USD.Thus,youthinkthattheEurocurrency will get stronger,and the U.S. dollar willweaken. You are buying the
EUR/USD currency pair,anotherwayto lookat this isto say you are buying Eurosand simultaneously sellingU.S.dollars.Theunique(andoften difficult to understand)aspect of forex trading tokeep in mind is this: Eachforextransactioninvolvesthebuying of one currency pairand simultaneously theselling of another currencypair.
If you have experiencebuying or selling in anymarket—the stock market, afutures market, an optionsmarket, the baseball cardmarket, or the used carmarket—thenyouunderstandmarkets. For any markettransaction a buyer wants tobuy something and a sellerwantstogetridofsomething.The forexmarket is simplyamoney market, the place
where speculators exchangeone currency for another. Inmanyways, the forexmarketisnodifferentfromthestockmarket.Themajordifferencesbetween forex and the stockmarket are as follows: Aforex transaction involvesbuyingonecurrencypairandselling another, also, thesymbols to identify forexpairs are consistent andsystematic, unlike the
symbols used to identifycompanies listed on a stockexchange.Forex traders buy and sell
countries. It is true: Forextraders are basically buying“shares” in a country, just asastocktraderbuyssharesinacompany. For example, ifforextraderEmmadecidestosell the EUR/USD, she isessentially selling theEuropeanUnion (and buying
the United States). To beevenmorespecific,wemightsuggest Emma is buying theeconomyoftheUnitedStates,and selling the economy ofthe European Union. Doesthis mean that Emma mustkeeptabsonalltheeconomicdata for all the countries thatshe is trading? The shortanswerisno,butwewilltalkmoreaboutnewsand tradingbasedoneconomicnewsand
data a bit further on in thisbook.Just as a stock has a
symbol, so do currencies.Table1.1 illustrates themostpopular currencies and theirsymbols. Do you notice apattern? There is a secretcode for currencies. Thethree-letter code for eachcurrencypair is composedofthe country (first two letters)andthenameof thecurrency
(last letter). So, for example,the Japanese yen is JPY, the“JP”standsforJapan,andthe“Y” stands for Yen. Thecurrencies listed inTable 1.1are the major currencies;these are the most widelytradedcurrencies.
Table1.1MajorCurrenciesoftheWorld
PLAYERSOFTHEFOREXMARKET
The forex market is anenormous, growing market.Forex trading doubled from
2004 to 2010, and today theamount of money traded inforex each day is staggering.The New York StockExchange, theworld's largeststock market, turns overabout $75 billion each day.Forex traders trade five timesthatamounteachday.You often hear people
claim that because the forexmarket is so large, it isrelatively easy for forex
traderstojumpinandridethetrendsinthisgiganticmarket,the world's largest market.However, most forex traderstradewhat iscalled the retailforex market; this is adifferent market (akin to aparalleluniverse)tothe“real”forex market in which $4trillion is exchanged eachday.Inessence,therearetwomarketsinforex.Thereistheinterbank market, where
banks, hedge funds,governments, andcorporations exchangecurrencies, and there is theretail market. Most forextraders trade in the retailforex market, an entirelydifferentmarket to the “real”interbankmarket.In the retail forex market,
your competition is the otherforextraderstradingtheretailforex market, and, believe it
or not, your broker. Whenyou make money tradingforex, these other traders inthe retailmarket lose, and sodoesyourbroker.Most retailforex traders do not makemoney. In fact, your forexbroker will assume that youare going to lose money inthe long run. This is aperfectly reasonableassumption, since the largemajorityof forex traders lose
money.Would you like to know
about the secret that forexbrokers don't want you toknow? Here it is: Forexbrokersdividealltradersintotwo groups. There are thewinners—these are the forextraders who make money—and then there are the losers—these are the forex traderswho lose money. Guesswhich group all new forex
traders get put into? Retailforex brokers believe that allnewcustomersareunlikelytomake money, so all newaccounts are placed into theloser group. After severalmonths of consistentlyprofitable Forex trading atradermaybeplacedintothewinnergroup.Itmaysoundsurprising,but
it is true. Ifyoustartmakingmoney trading forex over
severalmonths,youwill jointhewinners.Yourretailforexbroker will begin to hedgeyourtrades.Inotherwords,ifyou are in thewinner group,your retail forex broker willtake trades in the real forexmarket, the interbankmarket,to offset the profitsaccumulated by the winnergroup. For example, if mostof the traders in the winnergrouphavedecidedtobuythe
EUR/USD, then the brokerwillput ina trade tobuy theEUR/USD in the interbankmarket in the hopes that, ifthe winners are correct, theforex broker can use theprofits in the interbankmarket to pay the winningtraders. This is how yourretail forexbrokerdealswithwinningtraders.What about losing traders?
Since most forex traders are
losing traders, your forexbroker assumes that youwillnot make money when youopen up an account. Onlyafter you have consistentlymade money trading forexwill your broker becomeconcerned with your trading.Guesswhathappens toallofthose losing trades? Thoselosing trades fatten yourbroker's pocket. All losingtrades are “business profits”
for your broker. This isbecauseyourbrokertakestheothersideofyourforextrade.Although it is true that someretail forexbrokersmatchuptrade orders so that a traderwith a buy trade order ispairedupwithatraderwithasell trade. However, theoverwhelming majority ofretailforexbrokersdonotdothis. Unless you are aconsistently winning trader,
yourbrokerwill taketheriskon your trades, and assumethat your trades will losemoneyinthelongrun.Thisisnot something that is widelydiscussed,butitistrue.Yourforex broker wants you tolose, because your losses areyourbroker'sprofits.How would you like to
make the jump from thegroupof losing traders to thegroup of winning traders?
Would you like to join the 5percent ofwinning traders? Iknow you can join the 5percent, and Iwill show youprecisely how you can leapinto the group of winners inlaterchapters.
TOOLSOFTHETRADE:
FUNDAMENTAL
VERSUSTECHNICALINDICATORS
So, how do forex tradersdecide when to buy or sell?There are basically twoschools of traders, and youmustdecidewhichschoolfitsyour trading personality.Thefirst school is the school offundamental analysis.
Fundamental traders useeconomic reports and newsreports as the basis for theirtrading decisions. Forextraders who have afundamental approach willclosely examine worldevents,interest-ratedecisions,and political news.Fundamental traders areconcerned with properlyinterpreting news, whereasthe focus for the technical
forextraderisquitedifferent.The technical forex trader
uses technical indicators (or“indicators”) to properlyinterpretpricemovementonachart. The forex trader whoadopts a technical, indicator-based approachwill examinethepricecharts.So,whilethefundamental forex trader isconcerned with interpretingnews and world events, thetechnical trader is concerned
with interpreting price on achart.What are technical
indicators? Indicators aresimply another way oflooking at amarket price. Inmuch the sameway that it ispossibletoexaminethespeedof a car in many differentways, it is possible toexaminepricechartsinmanydifferent ways, withindicators.Justforamoment,
consider how many differentways you may measure thespeedofacar:
Measured inkilometersperhour.Measured in milesperhour.Measured in thetime it takes totravelonemile.Measured by thetime it takes toaccelerate to 60
mph.Measured by howquickly the car canstop.
Likewise, there are manyways to look at price on achart. There are moretechnical indicators thantelephone call centers inIndia.
WHATIS
NAKEDFOREX?
It can be very confusing forthe novice trader, and this isone reason why nakedtrading, trading withoutindicators, can be liberating.When starting out, manytradersfocusontheindicator.This is completelyunderstandable since nearly90 percent of the forex
trading books, the vastmajorityof forexsiteson theInternet, and forex tradingseminars focus on indicatorsandindicator-basedtrading.Indicators encourage
“secondary thinking,” whichis a real handicap for traderslooking to acquire expertise.Secondary thinking involvesanalyzing the indicator,spending time consideringwhere the indicator may go,
rather than focusing on themarket. Naked traders, bydefinition, focus on themarket, which is verydifferent.Focusingonindicatorsmay
beoneoftheprimaryreasonsthatsomeforextradersdonotmake money. Indicators canbe confusing, unhelpful, andjust plain wrong. In the nextchapter we take a look attechnicaltrading,andsomeof
the tragic trading mistakesforex tradersmake, and howtoavoidthembyadoptingthenaked-tradingapproach.
CHAPTER2
AvoidingaTradingTragedy
Out of intensecomplexities intensesimplicitiesemerge.
—WinstonChurchill
If you are reading this book,you are probably a technicaltrader. You may have spenttime, money, and effortlearning about indicators.You may have learnedthrough experience thattradingwithindicatorscanbevery difficult. In someways,tradingwithindicatorsmakesit difficult to find profits.Perhaps a close look at whyindicator-based trading
systems have difficultyfinding profits in forex is inorder.All indicators are created
frompricedata.This iswhatallindicatorsdotopricedata:Price data enters into anequation and is spit out assomething else. Sometimestheendproduct isa squigglyline, sometimes a straightline, sometimes a color or anumber; it depends on the
indicator. The end result isalways the same: Theindicator changes price datavia a formula. The form ofthis end result (the indicator)may vary, but the process isalwaysthesame.Theseverysameindicators,
based on price data, aremeant to hint at futuremovements in the market.Stated another way, anindicator will suck in price
data, massage and processthesedata,andthenspitoutagraphical representation ofthese data. Indicators offerprice data in another form.Perhaps this new form ofprice data is easier tointerpret; perhaps this newform of the price data willhint at what the market maydo in the near future. Allindicator-based tradingsystems are founded on the
idea that price data is in abetterformwhenpresentedasan indicator. Trade decisionsbased on indicators assumethatthedatainindicatorformis more valuable than rawpricedata.
INDICATORAmetricderivedfrompricedata.Historicalpricedata—such as the open, close,high,and low—areentered
into a formula to calculatethe metric. This metric isthen representedgraphically to anticipateand interpret marketmovements.
Traders want to knowwhere price will go in thefuture. Traders pay millionsupon millions of dollars foreducational seminars, DVDs,website lessons and, yes,even books such as this one.
The great hope for mosttraders is that there is avaluable indicator (or recipeofindicators)thatwillhintatwherethemarketisheadedinthe future. Millions uponmillions of dollars are spenteachyearbytraders(andalsoinvestment companies, hedgefunds, banks, etc.) because aslight edge may providemillions of dollars in profits.In forex a slight edge may
mean billions of dollars inprofits.
ISTHEREA“BETTER”
INDICATOR?Which indicator is best?Which suite of indicatorsoffers a clear edge in themarkets?Perhapsit isbest to
find out who is makingmoney in forex, and then dowhat they do. Which is themagic formula?Unfortunately, the answer tothisquestionis“Itdependsonwhoyouask.”Thismayverywell be the correct answer.As we will see later in thebook,tradingisoftenrelativeandrarely,ifever,aone-size-fits-all endeavor. Someindicators are considered
shams, others aremisinterpretedbythemasses,and still others are best usedcontrary to their originaldesign intent. Indicatorsmaybe incorrect. What if theindicator is correct, but a bitslow to hint at the directionthe market will take? Theindicator might providevaluable information, butmight also be slow to theparty, and thus not of much
value. Perhaps a slightchange to the indicatorformulawillspeeditupabit.Perhaps indicators are
similar to a wristwatch,constantly improving, morefeatures available as needed,but would it be possible totake a wristwatch, andmanipulatetimebyrunningaformula through the hours,theminutes, and the secondsdisplayed on thewristwatch?
Would the wristwatch keepbetter time once the formulamanipulated the actual timeoftheday?Usingaformulatocreatea
better time on a wristwatchmay seem weird andcounterproductive, but this ispreciselywhatindicatorsmayaccomplish by changing andmassaging price data.Indicator-based trading istaking a wristwatch and
changing the time with acomplexformulainthehopesthat the wristwatch willsomehow tell time better.Whowantsawristwatchwithsomethingother than therealtimedisplayed?Doindicators(all of which are calculatedusing price data) allow us tounderstandpricebetter?Perhaps it is best to put
aside any philosophicaldifferences with technical
indicators.Letusassumethatour indicator isbaseduponamagical formula and thisformula allows us to get aglimpse of the future. Ourindicator magicallytransforms price data intosomeothernumber, color,orline,andsuggestswherepriceis headed in the near future.Unfortunately, even if ourindicator is able toaccomplish this, difficulties
may endure with indicator-basedtrading.Indicators are inherently
slow. The market will bemoving up long before anindicatorsuggestsitistimetobuy. Likewise, an indicatorwill suggest it is time to selllong after the market hasstarted falling.This is oneofthe main complaints withindicators: they lag behindprice. This is a fair concern.
Figure 2.1 contains anAUD/USD four-hour chartwith the Relative StrengthIndex (RSI) indicator.Traditionally, there are twoRSI signals. If the RSI isabovethe70level,themarketis overbought, and once theRSI falls back down below70,aselltradeisinitiated.
Figure2.1TraditionalRSISellSignalonAUD/USD4-HourChart.
©2000–2011,MetaQuotesSoftwareCorp.
Likewise, if the RSI fallsbelow 30, the market is said
to be oversold, and,traditionally, a buy trade issignaledonce theRSImovesback above 30 (see arrow inFigure2.2).
Figure2.2TraditionalRSIBuySignalonAUD/USD4-HourChart.©2000–2011,MetaQuotesSoftwareCorp.
In these examples we seethat the RSI indicatorsuggests a trade at about the
righttime.ThemarketturnedaroundneartheRSIsignalinboth examples.However, theRSI did not signal a trade atthe precise turning point inthe market. To find theseturningpoints,anindicatorofa different type is required.One of the primary reasonswhy naked trading is soattractive to forex traders isbecausenaked tradingallowsfor early entries into trades.
Indicatorsmayalerttraderstothe fact that the market hasturned around after themarket has turned around,but naked traders may findturning points in the marketas theyoccur. Naked tradingstrategies are based on thecurrent price of the market,and, therefore, theyallowforan earlier entry. Indicator-based trade signals will lagbecause it takes time for the
price data to be processedthrough the formulas thatmakeuptheindicator.
INDICATORLAG
Significant moves in theforexmarketoccurbeforeatechnicalindicatorprovidesasignal.
Naked traders have anincredible advantage.
Entering a trade early oftenmeans the entry price isclosertothestoplossprice.Atighter stop loss may meanmore profits, the precisereason for this is examinedlater in the book. Aftermastering a few simplestrategies, naked traders finditverydifficulttomovebackto indicator-based strategiessimplybecausenaked-tradingstrategiesremovethelagtime
that is inherent withindicator-basedtrading.Here is another example,
this timewith the EUR/USDdaily chart (Figure 2.3). Inthis example the indicator atthebottomof thechart is theMoving AverageConvergence Divergence(MACD). The constructionandtheorybehindtheMACDis not important, the MACDconsists of a few moving
averages. The critical signalfor the MACD is when thetwo moving averages cross(see thedark circle inFigure2.3).A traditional buy signaloccurs when the MACD hasbeentravelinglowerforsometime and then turns around,and the faster-movingaverage crosses the slower-movingaverage.
Figure2.3TraditionalMACDBuySignalon
EUR/USDDailyChartmarkedwithacircle.©2000–2011,MetaQuotesSoftwareCorp.
InFigure2.3theEUR/USDdaily chart has been fallingfor some time.Price starts toturnaroundand tradehigher,and consequently theMACDmoving averages start tocreepupward.Finally,weseethe faster-moving average ontheMACDhascrossedabovethe slower-moving average.This signals a buy trade forthe MACD trader. Aftercrossing upward on the
MACD, the market doesindeed move higher (seeFigure2.4).
Figure2.4TheEUR/USDtradeshigherafterthetraditionalMACDBuySignalonEUR/USDDailyChart.©2000–2011,MetaQuotesSoftwareCorp.
Although this trade lookslike a nice trade, the nakedtrader would have entered
this trade earlier than thetrader using the traditionalMACD trading strategy. Thenaked trader and theMACDtrader both profit, but thenaked trader is able to enterthe trade sooner and use atighterstoploss.Tighterstopsmean more money. Thenaked trader and theMACDtradercouldhavebothexitedat the same price, but thenaked trader captures more
profits because the stop lossis placed closer to the entryprice. The money-management section of thisbook will have moreinformation on how nakedtrading strategies enabletraders tomakemoremoneysimplybecausenakedsignalsappear earlier than indicator-basedtradingsignals.TheMACDandtheRSIare
not the only indicators that
lag. All indicators lag. Thestochastic is a popularindicator used to time tradesaccording to the naturalrhythms of the market. Onetraditional stochastic tradingmethod is similar to the RSIstrategy. A sell signal isindicatedwhen the stochasticfalls below the 30 level andthen crosses higher (seeFigure2.5).
Figure2.5EUR/USD1-Hour
Chart—TraditionalBuySignalontheOversoldStochastic.©2000–2011,MetaQuotesSoftwareCorp.
PIPSA “pip” is a percentage inpoint. One pip is equal to
1/100thof1percent. Ithastraditionally marked thesmallest move a forex paircan make. Forex traderstrack trades in terms ofpips. However, manybrokers are now using“pipettes”—these are1/1000thof1percentunits.
TheEUR/USD1-hourchartshows the stochastic fallingbelow30onthestochastic.Afewhourslater,thestochasticcrosses upward and rises
above 30, a clear buy signal.The stochastic ismoving up,so price should follow.However, the market thenfalls a further 90 pips. Formost traders this tradewouldbeabigloser.Whataboutthenakedtrader?Inthisinstance,the naked trader gets a veryclear buy signal after thestochastic buy signal (seeFigure2.6).
Figure2.6EUR/USD1-Hour
Chart—NakedBuySignalversusStochasticBuySignal.Thetraditionalstochasticbuysignaloccursimmediatelybeforethemarketfalls.Thenakedtraderhasabuysignalatthemarketturningpoint.©2000–2011,MetaQuotesSoftwareCorp.
What happens after thenaked trading signal? Themarket jumps more than 40
pips immediately. The nakedtrader avoids many losingtrades bywaiting for a priceaction signal and quicklyfinds profits. Not all nakedtradesarewinners,ofcourse,butthistradeisanexampleofhow the naked trader is ableto avoid some of the verycommon indicator-basedmistakes because the nakedtraderusesthepriceactionofthemarkettodetermineentry
signals.Notice how the naked
trader avoids the drawdownwith this trade signal. Themarketimmediatelymovesinthe expected direction,upward, after the signal.Contrast this entry to thestochastic entry signal. Thecharacteristic indicator lagassociatedwith thestochasticmeans that the stochastictradernotonlyentersalosing
trade, but immediately afterthe stochastic signal themarket trades in the wrongdirection,andthetradeentersinto a protracted drawdown.In fact, it is unlikely that thestochastic trader ever hadprofit on this trade. Naked-trading strategies enable thetrader to enter a trade basedon current market priceaction, and often avoid thesevere drawdowns associated
withindicator-basedtrading.Most tradersbelievesevere
drawdowns are a part oftrading. This is simply nottrue. Severe drawdowns arecharacteristic of mistimedentry signals, and mosttraders use indicators to findentry signals, somost tradersmistimeentries.
TAKING
RESPONSIBILITYFORLOSINGTRADES
All traders experiencedrawdowns. All tradersexperience losing trades.However, naked traders takeresponsibility for losingtrades.Indicator-basedtradersoften blame their indicatorsfor unsuccessful trades (e.g.,
“the MACD looked like itwasgoingtocrosshere,”“myindicator did not loadcorrectly,” “maybe I shouldchange the settings on myindicator because the markethasbeenchoppylately,”“thatmoving average crossoverwas a fake out—whipsawedon that one,” etc.), but thenaked trader does not havethis excuse. There is noscapegoatwhenyouareusing
market data (price action) totake trades. Trading withpriceaction,thatis,theactualpriceonthechartasthebasisfor all trading decisions,means that the naked traderhas no excuse for losingtrades. This is extremelyliberatingformanytraders.The indicator-based trader
alsohas theaddedadvantageofanindicatortoblamewhenthings go awry; the naked
trader can blame no one butthe market for losing trades.This is a subtle but veryimportant difference point ofreferenceforthenakedtrader.Alltradinginvolvesanaspectof luck. All tradersexperience a lucky streak ofwinning trades and anunlucky streak of losingtrades.Without the crutch ofindicators, naked traders aremore likely to take
responsibilityfortheirtradingresults.Perhaps we should take a
close look at this idea oftrading responsibility. If youdecide to tradeanewtradingsystem,youmayhaveputthesystem through a screeningprocess. After spending timetesting the system, you haveconvinced yourself that thetrading system is worthwhileandwill indeedmakemoney
over the long run (at thisstage your research may farexceed the effort that 90percent of forex traders putintotheirtradingresearch).If,after all of your research,when you start trading liveyousee the first seven tradesturn out to be losing trades,you may be discouraged.Whatwouldyoudo?Perhapsyou decide to maintaintrading the system, and you
suffer through an additionalthree more losing trades.After 10 consecutive losingtrades what would you do?Would you stop trading thesystem? Would you create anewruletofilteroutsomeoflosing trades that you haveexperienced? Would youdecide the trading system isnolongerprofitable,andgiveup on trading the system?There are many possible
explanations for the reasonwhythetradingsystemfailedafteryoulauncheditintoliveaction.Maybethemarkethaschanged. Maybe the systemno longerworks.Perhaps the10 losing tradeswere just anunluckystreak.Your decision, after faced
withthe10losingtrades,willplace you into one of twogroups: the terrible-systemgroup or the bad-market
group(onlynakedtraderscanavoid these groups). If youare unsure about your group,pay attention to what youthinkaboutthenexttimeyouhaveastringoflosingtrades,youwill quickly learnwhichgroupisyours.Terrible-system traders,
after a string of 10 losingtrades, blame the tradingsystem. Terrible-systemtraders will say “the trading
system is not workinganymore” or “this tradingsystem must be modified toget it back on track.”Terrible-system tradersdecide to modify or give upon the trading system after alosing streak. Often, terrible-system traders will suggestadding another indicator orotherwise slightly modifingthe trading system to helpfilter out some of the losing
trades recently triggered.Theother strategy employed bythese traders is togiveuponthe trading system. “Thesystem is broken,” they say,or “This trading systemworkedwell before, but nowit is breaking down, allsystemshaveashelflife,andthis trading system hasexpired,”or“thesystemmayhavemadegoodprofitsinthepast, but it simply doesn't
workanymore.”If you find yourself saying
something similar, you areprobably a terrible-systemtrader. If you are constantlychanging trading systems,particularly after a losingstreak, you are a terrible-system trader. All terrible-system traders blame thesystem when finding profitsbecomesdifficult.Bad-market traders take a
different approach. Bad-market traders analyze thelosing trades after adrawdown and insteadconclude that themarket haschanged. Bad-market traderscan come up with manyreasons that this market isstructurally very differentfrom before, and may beheard muttering things like“the Bank of Japan'sintervention has changed the
market,” or “things havechanged with the Euro sinceSpain went bankrupt.” Theprecisereasonsmayvary,butthe essence of the argumentremainsthesame.Sometimesthebad-markettraderwillusesubtle arguments such “themarketistoovolatile,”“thereisnotenoughvolumetoday,”“my broker is unable toexecute my trades fastenough.”The latterargument
hints at a common scapegoatfor the bad-market trader—thebroker.Bad-market traders are
often identified by theirwillingness to engage inbroker conspiracy theories.The fact is that dishonestbrokers are found out, andforex traders will eventuallyabandon the dishonestbrokers. Word spreadsquickly, particularly among
intelligent, Internet-savvytraders with high-speedInternet connections. But forthe bad-market trader, thebroker offers the perfectexcuse for a failing tradingsystem. Bad-market tradersplaceblameon thebrokerorthe market, and thus have areason for abandoning alosingtradingsystem.Many bad-market traders
engage in fundamental
analysis, but not allfundamentaltradersbelongtothe bad-market camp. Theinterpretation of economicdata and engaging infundamental analysis is oftenanopportunityforbad-markettraders to further theirargument. These traders willdecidetogiveuponatradingsystemafteraseriesoflosingtrades, just as the terrible-system traders decide to
abandonalosingsystem;itisonlythereasonforgivinguponthesystemthatvaries.Theterrible-system trader placesblameonthesystem,andthebad-market trader isconvinced the market hasfundamentally changed. Bothbad-market traders andterrible-system traders willend up searching for anentirely different tradingsystem.
Interestingly, thedifferencebetween a terrible-systemtraderandabad-markettraderis often conscientiousness.The conscientious trader isusuallythebad-markettrader.This is because theconscientious trader willspend time testing andensuring that any tradingsystem employed is viablebefore risking money in themarket.Theend resultof the
system testing is confidencein the system for the bad-market trader. For the bad-market trader, the experienceof a drawdown is quiteharrowing and unexpected,because the trading systemhas been tested and seemsviable; if the system cannotbewrong,themarketmustbe“wrong.”Ourterrible-systemtraderis
unlikely to have spent the
sameefforttestingthetradingsystem. The terrible-systemtrader probably found thesystem on a forex Internetforum, purchased it from anInternet marketer, learned itfrom a friend, or perhapsheardacircleofforextradersdiscussing the system inhushed tones at a party. Theterrible-system tradermaybetrading a profitable system,butwithoutspendingthetime
testing the system, theterrible-system trader isunlikelytoholdthesysteminhighregard.So how might you avoid
fallingintotheterriblesystemor bad-market groups? Whatmightyoudo tochangeyourfate? You may want tocarefully consider adoptingnaked trading.Tradingnakedmeans trading withoutindicators, and removing
indicators from your chartwillmakeitdifficulttoadoptthe attitude of the terrible-system trader. Also, if youdecidetotradenakedyouwillbe trading on price action orthe market movements. Youcouldblame themarket forastring of losing trades as anaked trader, but that wouldbeabitlikeblamingtheriverforbeingwet.Naked traders find trades
based onmarketmovements,so, unless the market ismoving“incorrectly,”thereisnosuchthingasabadmarketfor the naked trader. Nakedtraders may only blamelosing trades on poorexecution (the trader's fault)or poor luck (sometimes youflipacoinseven timesand itlands on tails every time).Naked traders may find thattrading without indicators is
extremelyliberating.Traders around the world
have found that adoptingnaked-trading strategiesmeans letting go of a trade.There are no indicators togive false signals, there areno settings to tweak; there issimply the market price andthe trading decision. Nakedtradershavea trueadvantagebecausethefocusofthetradeis the current market price.
Thereisnobetterindicatorofthe sentiment, attitude, orexuberance of the marketthanthecurrentmarketprice.Naked traders make thecurrent market price theirindicator. In fact, for manynaked traders, the currentmarket price is a bit like abiofeedback machine. Icertainly look at the marketprice as biofeedback. Abiofeedback machine will
allow you to tune into thephysiologicalchangesinyourbody, in the hopes that youcan better control yourphysiology.Forexample, if Iam an anxious person, and Iam always suffering fromstress, I can hook myself upto a biofeedback machine.ThemachinewillalertmeifIbecome anxious (bloodpressure increases, heart rateincreases, etc. would cause
the machine to produce thesound) by sounding off analert.Icanthenpayattentionto the soundsof themachineanduserelaxation techniquesto decrease my anxiety. Themachine simply alerts mewhenIneedtorecalibratemyphysiology. Over time, Ishould be able to weanmyselfoffofthebiofeedbackmachine and reduce myanxiety on my own, without
the aid of the biofeedbackalerts.
LEARNINGFROM
MARKETBIOFEEDBACK™Itmayseemstrange,butyouwill eventually be able to dothe same thing with your
trades if you decide to adoptnaked-trading strategies. Inthe beginning, the marketprice is your biofeedbackmachine. If the market isgoing in thewrongdirection,you have valuable feedbackon your trade. Learn fromthis.Wastheentrytooearly?(Most traders I know aremuch more likely to jumpinto a trade too early than towait too late.)Was the entry
too late?Themarketwill tellyou how your trade rates.Why is it important to payattention to the marketbiofeedback? Because youwill learnmore fromMarketBiofeedback than you willlearn from any guru, anytrading book, or any onlinecourse. Another way to statethis is as follows: Payingclose attention to how themarket behaves after you
enteratradeisoneofthebestlearning tools available toyou.
MARKETBIOFEEDBACKA psychological,behavioral, and tradingresponsetothemarketpriceafter a trade has beenentered.
Market Biofeedback
involves two distinctdomains,Thefirstishowthemarket reacts (price action)after you enter your trade,and the second is how youreacttothepriceactioninthemarket after you enter yourtrade. Both parts of theMarketBiofeedbackequationare needed for you to get aclearpictureofwhatyouarelearning, and moreimportantly,whatyoushould
learn, from your tradingexperiences. You shouldlearnfromthepriceactionthemarket offers after you enteratrade.Youshouldalsolearnfrom your reaction to themarketafteryouenteratrade.Even if you do notconsciously intend to learnfrom Market Biofeedback, itis important for you torecognize that MarketBiofeedback will yield all
your important tradingdecisions.Howyouapproachyour trading, which tradingsystemsyouemploy,whetheryou give up on your tradingor go on to a long andsuccessful trading career, allthese things are determinedbyMarketBiofeedback.Most traders allow Market
Biofeedback to completelydictatetheirtradingapproach,evenwithout realizing this is
happening. For example,some tradersstartout tradingthe five-minute charts andthen slowly gravitate towardlonger timeframes, such asthe four-hour or daily charts.Whydothesetradersdothis?The answer is MarketBiofeedback. Other traders,after several losing trades,will give up on a tradingsystem and search for a newone. This change in trading
strategyis,onceagain,duetoMarket Biofeedback. Othertraders may trade the exactsame tradingsystemandwillexperience seven losingtrades insuccessionandholdsteady, knowing that thecurrent drawdown is simplyan aberration. MarketBiofeedback is thedifferencebetweenthetraderswhogiveup on a trading system andlook for a new strategy and
those traders who maintainconfidence despite the losingstreak.Howyoureactandrespond
to adrawdown, to awindfallof pips, or something inbetween is exceptionallyvaluable information. Theeasiest way to see MarketBiofeedbackistorecordyourthoughts as you trade. Youcanrecordyourvoicebefore,during,andafteratrade.You
can take screenshots of thetrade before, during, andafter. You may also recordvideo of the trade before,during, and after with adesktop-computer recordingsoftware.Here are the important
questions to answer as yourecordMarketBiofeedback:
Where has themarketmoved sinceIenteredmytrade?
If I looked at themarketnow,wouldItakethesametrade?HowdoIfeelaboutmytrade?WhatdoIlikeaboutthistradenow?What do I dislikeabout this tradenow?On a scale of 1(poor decision) to10 (great decision),
where would I rankthistradenow?If I were not in atrade now, would Itake the oppositetrade?
If you ask yourself thesequestions and record youranswers before, during, andafter the trade,youwill havebuilt up a database of yourpersonalMarketBiofeedback—an invaluable tool. More
importantly, you will bringintoconsciousawarenesshowyoureacttothemarket.Mosttraderswill trade theirwholeliveswithoutrecognizingthatMarket Biofeedback dictateshowtheyadaptandchangeasa trader. By simplyacknowledging MarketBiofeedback, you canunderstand how you react tothe market in general, andhowyourtrades,inparticular,
mold your approach totrading. Market Biofeedbackis the one area that mosttraders neglect, most tradersare not quite aware of thisprocess. By paying attentionto Market Biofeedback overtime, you will be able tobecome aware of, andeventually control yourtrading behaviors. This willallow you to take a big steptowardsconsistentprofits.
If you would like to learnmore about MarketBiofeedback, please go towww.marketbiofeedback.com.
CHAPTER3
Back-TestingYourSystem
You need to continue togain expertise, but avoidthinkinglikeanexpert.
—DenisWaitley
The consistently profitableforextrader isanexpert.Justas an expert farmerunderstands seeds and soil,and the expert mechanic canhearthedifferencebetweenablown gasket and loosemuffler, the expert forextraderknowsmarkets.Wheredoes this expertise comefrom? How does the noviceforex trader become anexpert? This is the million-
dollarquestion.Make no mistake about it,
when you step into anymarket, including the forexmarket, and decide that youwant to make money, youhavedecidedyouwilloutwitand outperform some of themost determined, intelligent,and well-resourced people inthe world. All theseimpressive people have onegoal: to take your money.
Howcanyoumakemoneyinthe markets, knowing whomyou are up against? Theanswerissimple.Perhapstheanswer is much simpler thatyouwouldbelieve.Youmustpractice.Practiceyourcraft.Practice
your trading. This is thesimple way to become anexpert.Simpledoesnotmeaneasy, because many tradersexpect to become experts
without practice, and sadlythey never achieve expertise.Consistently profitabletrading is yours if youpractice trading and becomeanexpert.You now have the secret
formula to achieveconsistently profitabletrading. Will you use thissecret? The best estimatessuggest as many as 74.8percent of traders do not use
the secret. This is because74.8 percent of forex tradersdo not consistently makemoney trading (ForexMagnatesU.S.ForexBrokersProfitability Report forQuarter 2, 2011). The 25.2percent of consistentlyprofitable traders practicetradingtogetbetteratit.Only 25.2 percent of all of
the traders reading this willdecide to practice trading to
become an expert. It is nocoincidence that about 25.2percent of all traders areconsistently profitable.Practice helps achieveexpertise in nearly everysport and vocation. It isinterestingtoseehowthevastmajority of aspiring tradersexpect to immediatelybecome successful withoutputting the effort intobecominganexpert.
Experttradersputtheeffortintobecominganexpert.Itisironic that many traders areattracted to the tradinglifestyle,thinkingthattradingwill allow passive income toaccumulate. This is certainlytrue, any trader can makemoney while sleeping, butexpert tradersaremuchmorelikely to achieve consistent,passive income from trading.Tradingis likeanyother job:
Practice and effort must bewell-placed in order to reaptherewards.Theexperttradermaybeable toquicklymaketrading decisions and placetrades,butthesedecisionsarethe fruits of many hours ofpractice, in nearly everyinstance. Traders must earntheirpipsthroughpractice.Practice means confidence.
Practicing your tradingsystem will enable you to
keeptradingyoursystem,andavoid all distractions andexcuses (e.g., terrible-systemtraders and bad-markettraders) along the way.Practicing your tradingsystem will allow you toenjoy the confidence ofknowing when you place atradehowlikelyyouaretobesuccessfulwiththatparticulartrade.Would you enjoy trading
more if you had a quiet,unshakable confidence inyour trading system? Wouldyou find it easier to walkaway from your computer ifyou knew the preciselikelihood that your tradewouldbeawinner?Woulditbenicetoknowthatyouwillavoidtheexcusesbad-markettraders and terrible-systemtraders make? What wouldhappen if, from today
onward, you maintainedconfidence in your ability toextract profits from themarket even through the upsanddownsthatareinevitableinanytrader'slife?Consistently profitable
traders, otherwise known asexperttraders,haveonethingin common: They test theirtrading systems. Thesetraders practice their tradingsystems. There are many
methods for testing a tradingsystem. Each of them hasadvantages anddisadvantages.Depending on your
personality and how youapproachyourtrading,oneofthese approaches is likely toresonate with you more thanthe others. Decide which ofthe three methods you willadopt to become an experttrader.
Each of these methods areback-testing methods. Back-testing is a common termused in trading that simplymeans “testing a tradingsystem through historicaldata.” All traders know thatusinghistoricaldataisnottheperfect solution to testing atradingsystem.Amuchbetteralternative would be to havefuturedatatotestour tradingsystems. Failing that,
historicaldataisthenextbestthing.Therearemanypitfallsandproblemsassociatedwithtesting trading systems onhistorical data; however, theconsequencesassociatedwithtrading a system in livemarket conditions when it isnot tested on historical dataaremuchmoreproblematic.
THREEGOALS
OFBACK-TESTING
Your back-testing will allowyou to do two things: First,youwillidentifyhowsuitablethetradingsystemisforyou.This does not mean you arediscovering whether thetrading system is profitable,but,rather,youareexaminingthe fit between you, thetrader, and the rules of your
trading system. Second, youwilllearntotrustyourtradingsystemand learn to let goofyourtrades.Youmaytradeina more relaxed manner onceyou have taken thousands oftrades over years of marketdata. The confidence gainedby trading your systemrepeatedlywillshowupintheformofarelaxedapproachtoyour live trading. Third, youwill gain expertisewith your
trading system. This mayonlyhappenifyoutakemanytrades, and back-testing is aquick way to accumulatemany trades.A close look ateachofthesethreegoalsmayhelp you to get themost outofyourback-testing.
IstheSystemSuitable?
How suitable is your trading
system? The first goal ofback-testing is to find outhow suitable the tradingsystem is for you. I have agood friend, who introducedme to forex, named AshkanBolour. Bolour is a well-known forex trader,youmayhave read about him in theMillionaire Traders book byKathy Lien and BorisSchlossberg. Bolour tradesthe three-minute and five-
minute charts. He doesexceptionally well tradingthese charts. No matter howmanytimesIwatchhimtradehissystemsonthesecharts,IalwaysfailwhenItrytotradeashedoes. I failbecausehistrading system does not fitwithmyviewofthemarkets.Ipreferthedaily,weekly,andfour-hourcharts. Ihavegreatdifficultywatchingmytradesfluctuate, which is precisely
what Bolour does when hetrades.Ihavelearnedtotradesystems that make sense tome. I am better at extractingprofits from the longer-termcharts.Yourjobistofindouthow you should be trading,and trade only what makessensetoyou.Perhaps you have traded
severaltradingsystemsinthepast. Most of these systemsprobably looked outstanding
at first glance. Maybe youpaid for the trading system,andthewebsiteyouboughtitfrompaintedthesystemasaninvincible profit-collectingmachine.Ormaybeyou readabout the system on anInternet forum. Or perhaps afriend told you about thetrading system. No matterhowgood the trading systemappears, it isremarkablehowyour trading results often
differ fromyour expectationsof the system. How can aperfect,profitablesystemfallapartinyourhands?Whyisitthat a system that soundsgooddoesnotworkonceyoustarttradingit?The answer is fit; if a
systemdoesnotfityourviewofthemarkets,yourapproachto trading, your ability toexecute trades, it will notmake money for you. A
system must fit with yourunderstandingofthemarkets.Ifyoubelievethefive-minutechart is “random noise,” youmay be better suited to tradethedailychart.Ifyoubelievemoving averages are uselessindicators, you will not becomfortable with a moving-average-based system. If youthink that the USD/JPY is aterrible pair to trade, you arenotgoingtotradeasystemon
the USD/JPY. Your beliefsabout trading must fit yourtradingsystem.Your lifestyle will also
determine the types ofsystemsyoumaytrade.Ifyouhave a full-time job, andspend 10 hours of the day atan office where youwill nothave access to your tradingplatform, you probably willbe drawn toward longer-termcharts.Daily,weekly,orfour-
hour charts may be best foryou.Thisway,youmay takeyourtradesandmanagethemby checking the charts onceortwiceeachday.Your makeup as a trader
will also determine how youshould trade. Perhaps youfreak out when you are in atrade on the lower-timeframecharts, such as the five-minute charts. Perhaps it istorture watching the profit
andlossfluctuategreatlywitheach pip gained or lost ontheselower-timeframecharts.If this is the case, you willprobably want to tradehigher-timeframe charts. Ifyou are risking the samepercentage of your accountoneachtrade,it islikelythata tradeona lower timeframechart will risk more per pipbecausethestoplossisclosertotheentrypricethanatrade
on a higher-timeframe chart.Your back-testing experiencewith the trading system willshowyouwhetheryouwillbeable to find profits with asystem. Testing will alsoshow you whether yourlifestyle will fit with thesystem. Perhaps most of thetrade signals for a tradingsystem occur during theEuropeanmarket,andyouarefast asleep during that time;
this may mean that thetradingsystemisnotforyou.
ConfidenceIsLettingGo
After you have found asystem that fits yourpersonality, your view of themarkets, you need to getcomfortable trading thissystem. This will be thesecondstepyoutakeonyour
way to consistent profits inforex.Thekeyhereistogainexperienceoverabroadrangeof market conditions.Relaxing while you are in atrade will often help youmanage the trade better. Justthe simple fact that you arerelaxedmeansyourdecision-makingwillbebetter.Relaxation will come for
you once you haveconfidence in your system, a
confidence gained by tradingyour system repeatedly, overyears of market conditionsandavarietyof signals.Youwilllearntotrustyourtradingsystemand learn to let goofyour trades. Micromanagingtrades, particularly trades onhigher timeframes, is acommon mistake of novicetraders.Ifyoucanwalkawayfrom your computer aftermaking a trade, you have
confidence in your system.This confidence is onlyavailabletotraderswhohaveback-testedextensively.Accelerate your learning
curvebyback-testing.Itdoesnot matter your method ofback-testing; it only mattersthat you do it. Testing overthousands of trades willenable you to be betterprepared to make a decisiononyourtradingsystem.Once
you deem your systemprofitable, you can begin toget comfortable with thesystembytestingextensively,slowlybuildingyourdatabaseoftradingexperiencewiththesystem. Your next step willbe to become an expert withyoursystem.
YouAretheExpertThe number-one reason
traders fail in forex is this:Most traders do not haveexpertise.Most traders begintrading a system withoutmuch experience trading asystem.When the first bumpin the road appears (e.g. anextendedlosingperiod,alackof signals for a week, acoupleofdifficult-to-interpretsignals, etc.) the system isabandoned. The traders whoconsistently pull profits from
the market are experts,withoutexception.To become an expert at
anything, you must do it atleast 10,000 times. If youwant to become an expert inyour chosen trading system,youcould take10,000trades,whichwillprobablytakeyouyearstoachieve,oryoucouldback-test your system. Byseriously testing your systemoverthousandsoftrades,you
willquicklyachieveexpertisewith your system. Seriouslytesting your system meansmaking trades just as youwouldwithyourliveaccount:trading from the right-handedgeofthechart,withoutthebenefit of hindsight bias,using a strict application ofyourtradingrules.The naked trader has an
advantage over traders whotrade “normal,” indicator-
based systems.A traderwhois trading a systemincorporating sevenindicators must view andinterpret all seven indicatorsforeachtrade,before,during,and after every signal isinitiated.Thisiscumbersomeand slow. The naked traderhasachartwithnoindicators,a very clean chart. Thesechartsareeasytointerpret.Infact, the naked trader gains
experience with his systemeverytimeheseesachartinanewspaper,ontelevision,inabook, regardless of market.This is because the nakedtrader can see, at a glance,whether the chart suggests abuysignal,asellsignal,ornotrade signal. A chart on thenightlynewshelps thenakedtrader march towardexpertise. In this way, thenaked trader has a distinct
advantage over traders usingindicators. Expertise willcome more quickly, moreeasily, and allow the nakedtrader to interpret any chart,inanymarket,atanytime.Experts in cognitive
psychologyagreethatexpertsat the highest level find itdifficult to teach theirexpertise.Expertsknowwhatto do, in fact, because theirexpert behavior is automatic.
Theydonotthinkaboutwhatthey do, they just do it.Novices spend a lot of timethinking about theprocedures, setting things upcorrectly, and so forth.Experts spend time thinkingabout how they interpretinformation—averydifferentapproach.Sowhatdoesthismeanfor
your trading? It means youshould back-test extensively.
Your goal should be to pulloutof thenovicetraderstageand into the expert level asquickly as possible. The fastwaytoachieveexpertiseistogain experience trading yoursystemviatesting.Allnovicetraders spend a goodproportion of time inorientation, “Is this a goodsignal?” “Does this set-upqualify as a valid trade set-up?” “Should I take this
trade? I am not sure if thisconstitutes a good signal…”Expert traders spend moretimeevaluatingthetradeonceit is initiated. Inotherwords,experts are concerned withMarket Biofeedback, andnovice traders are concernedwith understanding thesystem rules. This isunderstandable, novicetraders spend time thinkingabout possible trade set-ups,
novice traders are stilllearning the trading system.Expert traders spend moretime managing trades andfocusingonmakingsure thatopen trades are managedefficiently, to extractmaximum profits from themarket once those profitsbecomeavailable.One of the true paradoxes
of expertise is this: Expertsfind it difficult to verbalize
the decision-making process.Expert traders are oftenunable to adequately explainhowtoduplicatetheirresults.This is frustrating for thenovice.Experts often relyonunconscious thinking, or a“gut feeling” when makingdecisions. The subtle cuesexperts use to make adecision are ingrained androte, often inaccessible toconscious consideration, and
this is frustrating for novicetraders who are seekingexpertise. Novice traders arebetter off spending timegaining experience throughtesting, building towardexpertise,ratherthantryingtofindashortcuttoexpertisebymirroringexperts.Unlessyouwanttoallowa
computertodoallthetradingfor you—in other words youtrade only fully automated
trading systems—youprobablywillwanttoachievetrading expertise. Yourshortcut to trading expertiseis to back-test. Although itmayseemlikehardwork,thefact is you can simplyaccumulate years ofexperience over hours whenyoudecidetomanuallyback-test. It is, quite simply, thebest shortcut to tradingsuccess. The very successful
traders, who are consistentlyfinding profits in themarket,who are trading for a living,all of them share onecharacteristic: They back-testtheir systems and earn theirpips on their back-testingsoftware. Why not join thissuccessful group of traderstoday?
MANUAL
BACK-TESTING
Manual back-testing is themost readily available formof back-testing available.Most traders understand it ispossible to manually back-test their tradingsystems,butmost traders choose not tomanually back-test. Manycharting packages make iteasy to back-test. The vast
majority of charts will allowthe historical price, so thatyou may advance priceslowly and “trade” the chartasitunfolds.Forexample,inMetaTrader™yousimplyhittheF12keyonyourkeyboardto advance the charts onepricebaratatime.Thisisallthat is needed for manualback-testing.
CANDLESTICKThecandlestickisapopularchart that displays theopening price, the closingprice,thehighpriceandthelow price for a marketduringagiven timeperiod.Each candlestick clearlyrepresents the importantmarket activity for thegiventimeperiod.
Tomanuallyback-test, yousimplyscrollbackintimeand
recordyour trades, the tradesyou would have taken hadyoubeen trading the chart inlive market conditions. Youcan advance the candlesticksslowly, one at a time, recordyour entry price, the numberof lots traded,yourstop loss,and your profit target. Youmay be concerned thatmanual back-testing involvesa lot of notes, spreadsheets,and recordkeeping. It is a
meticulous, involved, andlaborious method of back-testing. It is also extremelypowerful. If you aspire totrade by looking at a chartand making a tradingdecision, you are nearlyduplicating the tradingprocess with this form ofback-testing.Most traders employ
discretionarytradingsystems,so it follows that manual
back-testing is the mostappropriate form of back-testingformosttraders.Obviously manual back-
testing will take some time,and it is sometimes difficultto avoid “cheating”with thistype of back-testing.However,youmust takecaretoavoidgoingforwardonthechartandthenreversingbackin time to take a trade youwouldhavetaken.Thekeyis
to trade as if you are in thatmoment in time, with noinformationofthefuture.Theexperience gained withmanual back-testing ispriceless. You can quicklyaccumulate experience withyour trading system if youback-test correctly. Manualback-testing will yieldstatistics to help youunderstandthenatureofyourtrading system. These
statistics, aswewill see laterin this book, will becomeinvaluable for determininghowyoushouldtradeastheymay be utilized to projectyourresultsintothefuture.Anoteaboutmanualback-
testing—itmayseemtedious,it will take some time, youmaywant togiveupwhen itprogresses slowly,particularly when you arelooking to accumulate
hundredsoftrades.Resistthetemptation to avoid manualback-testing. Make progressin small chunks, an hour oftestingperdaycangiveyouahugeadvantage.Thepayoffisgreat and your experiencetestingyoursystemwillallowyou to gain “experience”trading the system throughdifferent market conditions.Each trade during manualback-testing will march you
closer to expertise. Thisexpertise may be thedifference between youabandoning your tradingsystem during the inevitabledrawdown, and maintainingconfidence in your tradingsystem through a drawdown.However, there are pitfallsassociatedwithmanualback-testing.The most common pitfall
traders fall into with this
testing is engaging in futuretrading by advancing thechart, either by accident orintention, and then decidingthat a tradewouldhave beentaken. Traders at times havedifficulty discerning whenfuture price data creeps intomanual back-testing. Traderswho are strict about notallowing trades after futuredata is viewed will avoidcontaminating back-testing
data. By trading only fromthecurrentcandlestickonthechart, serious back-testersavoidgoingforwardintime.Hindsight bias is a critical
killer that may creep intoyour manual back-testing ifyou allow it to happen. Agood rule of thumb is toadvance the charts slowlyduring your testing, and ifyou accidentally advance thechart too quickly, you must
keepyour trades to theright-handedgeofthechart.Ifyouadvancethechartandthengoback to take a trade, you areleaving yourself open to thehindsightbias.
HINDSIGHTBIAS
The tendency tooverestimate thepredictabilityof themarketafter the future outcome is
known.
Evenifyouonlytaketradesduring testing by advancingthechartonecandlestickatatime, hindsight biasmay stillsneakintoyourtesting.Ifyouare testing historical data onthe EUR/USD in 2008, andyouhadexperiencetradingin2008, you may have aproblem. Your subconsciousmay be pulling up the 2008
EUR/USD chart and you areobviously not even aware ofit. To fight hindsight bias,take trades on the right-handedge of the chart, do not goforwardonthechartandthenreverse back, and if you doaccidentally go forward,resign yourself to skippingover any signals that pop upand stick to trading on theright-handedgeofthechart.
USINGBACK-TESTING
SOFTWAREBack-testing software is astep up from manual back-testing.Mostforextradersarenot even aware of the factthat manually back-testingyour trading system ispossible. Back-testingsoftware is an
underappreciated tool, onethat will allow you tomanually back-test yourtrading system at anaggressive pace. Manualback-testing software recordsyour trades for you andenables you to quickly taketrades as you advance thehistorical charts. In manyways, manual back-testingwith software is not muchdifferent from manual back-
testing. The advantages tousingsoftwareareasfollows:Software will allow fastertesting, so you mayaccumulate experiencequicker; the softwarewill dotherecordkeepingforyouandallow you to concentrate onthe trade signals; you mayeasily export your data foranalysis; and softwarediscourages cheating—manual back-testing software
isahindsightbiaskiller.Of themanymanual back-
testing software packagesavailable, my favorite isForexTester.ForexTester isa manual back-testingsoftware package that willallowyoutoimportanydata.You may decide to importforexdata,futuresdata,stockdata—any data will work.Forex tester will record yourtrades and allow you to
export your trading data intoa spreadsheet, after youhavecompleted your testing, foranalysis. The beauty ofsoftware-based testing is thatit allows you to concentrateon trading your system. Inmany ways, it mirrors livetrading with an accountplatform.Ifyouwouldliketosee a video demonstration ofForex Tester please go towww.fxjake.com/book.
There are many traders,myself included, who willspendmore timeback-testingwith software because it ismuch easier than manualback-testing. Back-testingwith software helps tradersgain years of tradingexperience in a few hours.However, the real work inback-testing is examining theresults. Exporting andanalyzingthedatafromback-
testing is where serioustraders validate tradingsystems, find behavioralpatterns, and developstrategies to augmentprofitable trading strategies.These data are gold for theserioustrader.Yourback-testingdatawill
help you determine yourtradingpatterns (Doyoufindprofits more easily on thedaily charts? Are most of
your winning trades initiatedduring theEuropean session?Doyoutradeparticularlywellwith your system on theCAD/JPY?),andthiscanleadto more fruitful back-testingsessions.Youwillalsoknow,afterback-testingyoursystemover several hundred trades,if the system makes moneyfor you. In fact, before youeverriskonecent,youshouldmake hundreds of trades
while back-testing to verifythat your trading systemwillcapture profits and also togain expertise with yoursystem.Manual back-testing with
software is not withoutproblems.Youmust lookoutfor the same pitfalls thatcreep up with manual back-testing, namely hindsightbias. Manual back-testingsoftware makes it easier to
avoidhindsight bias, but youstill must be careful to onlytake trades if you have notadvanced forward on thechart.Cheatingisnotallowedwhen back-testing; your goalis to generate realistic traderesults during your back-testing. Also, because it isvery easy to quickly executetrades with the testingsoftware,youmustwatchoutforsubpar trades.Tradesyou
would not take on a livetrading account should bebypassed no matter howtempting it may be to takethemduringback-testing.Tryto back-test as if you haverealmoneyatrisk.Thisistheonlyway to ensure that yourstatistics and experience inback-testing will closelymatch your live trading. Ifyou remain vigilant andconscientious during testing,
your results will be moremeaningful.
AUTOMATEDBACK-
TESTINGAutomatedback-testingisthemostwell-knownmethod fortestingatradingsystem.Mostforextradersareawareofthe
fact that it is possible to dosome automated testing on atrading system. However,most forex traders usediscretionary, or manual,tradingsystems,soautomatedback-testing is not the idealmethod for back-testing; itdoesnotcloselyduplicatethediscretionary trading mosttraders engage in. There aremany reasons fordiscouragingautomatedback-
testing for discretionarytraders:
There may be toomuch humaninterpretation in thetrading system.Automated back-testing does notallowforthehumaninterpretation oftradesignals.The trading systemmay involve
variables that arenot available on theprice chart (newsreleases, economicdata records,interpretation ofworldevents,etc.).It is impossible toautomatethetradingsystem (fuzzy logic,parameters difficulttodefine,etc.).Youmaynotbeable
to articulate yourtrading system.Automated back-testing is onlypossible for tradingsystemswithclearlydefinedrules.
Most forex traders shouldnot use automated back-testing. Automated back-testing is appropriate forthose traders who useautomated trading systems.
Automated trading systems,known as trading robots, orexpert advisors, are popularwith forex traders. However,most traders are morecomfortable withdiscretionarytradingsystems.So, while it may be possibleto use automated back-testing, it may not beappropriateformosttraders.Here is a test to help you
decide whether automated
back-testingisforyou.Ifyouturn on your automatedtradingsystemandcanallowittotradewithoutanyofyourinterventionforamonth,thenautomated back-testing maybe for you. If your systemneeds your input for anyreason, then you are adiscretionary trader, and youshould use manual back-testingormanualback-testingwithsoftware.
There are otherdisadvantages to automatedback-testing.Itdoesnotallowyou to gain experience withthe trading system. You willnotgaintheexpertisethatyouwould ifyoumanually testedthe system because thecomputer takes all of thetrades over the course of theback-testing. Automatedback-testingwillnotgiveyouexperience trading your
system throughmanymarketconditions. Automated back-testing will probably nothighlight the weaknesses ofyour trading system; theseweaknesses will be readilyapparent when manual back-testing is done. However,with automated back-testing,theweaknessesareabitmoredifficult to identify. In short,automated back-testing isreallyonlyanoptionforthose
traders who are not using adiscretionarytradingsystem.There are unique pitfalls
associated with automatedback-testing. For example, itisquiteeasytousetoomanyvariables in an automatedtrading system. Using toomany variables often impliesthat there are too manyindicators in the tradingsystem. Seasoned tradersunderstand how simple
trading systems are robust,andmay be applied tomanymarkets over varyingtimeframes. (All of thenaked-trading systems in thisbook are incredibly simpleand robust.) It is difficult forsome automated-systemdevelopers to keep theirtrading systems simple androbust; the temptation to addmore indicators and rules isgreat.
It is exceptionally easy forautomated traders to use toomany indicators whendeveloping and testing asystem. Adding too manyvariables to any tradingsystem increases the chancesthat the trading system willwork quite well on one datasetbutwillnotworkwellonanother. With too manyvariables the system is likelyto do exceptionally well
during some marketconditions and then breakdown and perform poorlywhen market conditionschange. This is a very realrisk with automated back-testing. It is almost too easyfor a trader to decide to addmore conditions andindicators to the tradingsystem, which will increasetheprofitabilityofthetradingsystemoverthecourseofthe
historical data in the back-test,oftenmaking thesystemlook very good. However,theseresultsoftencompletelyfallapartafteryouapply thisverysametradingsystemtoadifferentdata set or to futuremarket conditions. In a veryreal sense, the Achilles heelof automated back-testing isthatitistooeasy.Becausetheautomated back-tests can begenerated so quickly, the
automatedback-testerwillgooverboard tweaking andtesting the system. The endresult is often a system thatworks exceptionally well onthehistoricaldataintheback-testbutfallsapartcompletelyinlivemarketconditions.There is another issue that
often comes up withautomated back-testing. Thisis the postdictive error, afancy way of saying that a
trading system uses futureinformation to make adecision in the present time.This is actually somethingthatisrelatedtothehindsightbias. Traders back-testingautomated trading systemsmust be extremely careful. Itispossiblefortheback-testerto pull data from the futurewithout knowing about it.This is obviously a very bigproblem, because as a rule,
future data is not generallyavailable, despite any claimsto the contrary by technicalindicator salespeople(psychics and palm readersare the obvious exceptions).When future data is used inan automated back-test, thesystem looks incredible, butonce the trading system isapplied to real marketconditions, without thecritical (future) data, the
systemfallsapart.There is one advantage to
automated back-testing, thatis, it allows you to quicklydetermine whether anautomated trading strategy isviable. The back-testmay bedone in seconds, which is atrue advantage for theautomated trader.Remember,the automated traderwill notgain the same expertise andcomfort level as the trader
who uses manual back-testing. This is the biggestweaknessofautomatedback-testing, the back-tests arecheap.Thereisnoexperiencegained each time a back-testis run. The manual back-testing trader accumulatesexperienceeverytimeatradeset-up is executed. Thisexperience should not bediscounted. An automatedback-test may clarify the
worthiness of an automatedtrading system, ofteninvolving hundreds, orthousands of trades, butremember the trades are alltaken by computer and willnotleadtotraderexpertise.Inthis sense the trades arewasted, the trader does notaccumulateexperienceduringthe back-testing, this is onlypossible with manual back-testing.
If you use automatedtrading systems, then,perhaps, automated back-testing is appropriate, but ifyou use manual tradingsystems, it may be best toavoidautomatedback-testing.
TOPTHREEBACK-
TESTINGTIPS
There is one distinguishingcharacteristic between thosetraders who continuallystruggle to find consistentprofits and those traderswhoconsistently pull profits fromthe market. The traders whoare still looking forconsistency, who are stilllookingforprofits,aretraderswho usually do not back-testtrading systems. Thesetraders fall in love with a
systembeforeestablishingtheveracityof thesystem.Thesetraders often move fromtrading system to tradingsystem, hoping that the newsystem will yield betterresults than the previoussystem. The consistentlyprofitable traders take adifferent approach. Thesetradersknow that theyhaveaprofitable system becausethey back-test their system
extensively. These tradershave seen their system workoveryearsofmarketdataandknow precisely the type ofdrawdown they are likely tocomeupagainstinthefuture.The choice is yours; you
maydecide to join thegroupof struggling traders whojump from system to system,never really finding comfortwith any trading system, oryou may decide to join the
successful traders, theprofitable group who spendtime back-testing theirsystems.Ifyoudecidetojointhe latter group, I have threeback-testing tips for you.Thesetipsweredevelopedbyworkingwithtradersjustlikeyou, around the world. Thekeyistoapproachyourback-testingasyouwouldanyskillyou are working toward. Ifyouwerelookingtolearnthe
bass guitar, you wouldprobablywanttotakelessonsand spend time playing yourguitar to hone your skills.However, it is important thatyou play the bass guitar inyour own style. Back-testingismuch the same.Youmustapproachitseriously,butyoumust also keep this in mind:You will consistently findprofitsonlyifyoustaytruetoyourtradingstyle.
ConsiderYourStyleUse a back-testing methodthat fits your trading style. Ifyou are an automated trader,then use automated back-testing; if you are adiscretionary trader, usemanual back-testing. Themostimportantthinginback-testing is to duplicate yourtrading style. Back-test in away that will be meaningful
and bring you closer toexpertisewithyoursystem.
TakeTimetoTestThere is a real temptation,particularlywhenengaginginmanual back-testing withsoftware, to do it much tooquickly. Back-testing is alearning process. Just as youwouldnotexpecttocompletea 16-week course in a day,
you will need to break upyour back-testing sessions,particularly if you are doingmanual back-testing. Try tokeep your sessions short—undertwohours—sothatyouapproacheach sessionwithafresh mind and you areunlikely to get sloppy.Back-testing for six ormore hourswill usually lead to poorresults simply because youwere not as sharp for your
last trades as you were foryourfirsttrades.
MistakesArePartofBack-Testing
Makingmistakes is also partof the learning process. Wehave a natural tendency toavoid mistakes. So when atrading mistake pops upseveraltimes,itistemptingtomodify the trading systemso
that it accounts for thismistake.However, this is theroad that leads to too manyvariables ina tradingsystem.Avoid too many variables.Trytokeepyoursystemrulessimple.Itmaybetemptingtoaddanewruletoavoidsomelosing trades, but this mayblunt the effectiveness ofyoursystem.If you are interested in
naked trading, trading
without indicators, then youare likely to avoid the “toomany rules”mistake. This isanother reason why nakedtrading allows traders torealizetheirfullpotential.Nakedtradingalsoinvolves
using the history of themarket. If you ask anypsychologist how to bestlearnaboutsomeone,youwillhear that it is best to followthat person around.
Psychologistsdonothavethetimetofollowpeoplearound,so questionnaires are used todetermine what somebody islike—their personality, theirhabits, and their history.Likewise, the naked tradermay use the history of themarket to determine what islikelytohappeninthefuture.Everyonehasdonesomethingandsaid,“WhydoIdothat?”People like tobelieve in free
choice, butmost humans arecreatures of habit. Likewise,the market is a hugeamalgamation of habitualtraders.Themarketisnothingmore than a community ofcreatures of habit. Peoplemake up the market. Thenaked trader uses this to hisadvantage, by closelyfollowing historical turningpointsinthemarket.Wewillget into this issue in detail
laterinthebook,butfornowit is important to rememberthat the naked trader equatesthe market to a herd. Herdswilloftenfollowoneanotherforsafety.Membersofaherdwill also fall on one anotheras they run off a cliff. Thenaked trader uses specifictools to tune into and takeadvantage of the herdbehavior that we call themarket.
CHAPTER4
IdentifyingSupportand
ResistanceZones
There's an old sayingabout those who forget
history. Idon't rememberit,butit'sgood.
—StephenColbertYou have to pay closeattention to one thing on thechart if you trade naked:price.Priceisking.Pricewilltellyouallyouneedtoknow.The wonderful thing that allmarkets have is this: ahistory. The market will tellyou where the sweet spot ison the chart. These sweet
spots will be the foundationfor everything you do as anakedtrader.Asweetspotonthechartis
asupportandresistancezone.Youmaybefamiliarwiththeconcept of support andresistance, however, supportand resistance zones aredifferent from what manytraders characterize assupport and resistance. Iwillcall these support and
resistancezonesbyoneword—zones.Theeightimportantcharacteristicsofzonesareasfollows:
1.Zonesareanarea,notapricepoint.2. Zones are like finewine; theygetbetterwithage.3. Zones are spots on thechart where pricereverses,repeatedly.4. Zonesmay be extreme
highsorlowsonthechart.5.Zonesarewherenakedtraders find tradingopportunities.6. Support and resistancezones rarely need to bemodified.7. Line charts help nakedtradersfindzones.8.Zonesareoftenseenbymanytraders.
You may want to take acloser look at each of these
eight characteristics. It isincredibly important that youunderstand how to drawzones, why you should drawzones on your charts, andunderstandwhen these zonesbecome critical for yourtrading.
ZONESAREBIGFATBEER
BELLIESA zone is simply a big fatbeerbelly.Manytradershavemisconceptions concerningzones. Traders may befamiliar with the concept ofsupport and resistance butunfortunately,manymisapplythis concept to technicaltrading. The naked traderunderstandsthatzonesareanarea on the chart. This is a
very distinct concept to asupportandresistanceline.Asupport and resistance lineindicates a specific price onthe chart, but zones aresomething different. Zonesarenotaspecificprice.Thesezones are, instead, an area, arange, or, as I prefer, a beerbelly.Letme explain. I prefer to
think of these zones on thechart as if they were beer
bellies. Before you disregardthis idea, consider what abeer belly is:A beer belly issomewhat firm, maybesomewhat repulsive, and hassome predictablecharacteristics. My friendJason has a beer belly.He isquite proudof it; he tellsmeitisquiteexpensive,ashehaspaidgoodmoneyforthewineand beer that have enabledhim to grow this belly. If I
weretopushintoJason'sbeerbelly with my fist (I wouldnever push into a beer bellywithout permission, and Isuggest you, too, first obtainpermission before pushinganybeerbellies),eventuallyIwouldfindresistance.Evenifat first I did not findresistance, eventually therewouldbeapointatwhichthesquishybeerbellywouldstopmefrompushingfurther.This
is acritical characteristic, forI know that Imaybe able topush a little bit into the beerbelly,buteventually thebeerbelly will offer someresistance.Perhaps you may also
decide to push into Jason'sbeerbellywithyourfist.Youmay have a differentexperience. Perhaps, whenyou start topush into Jason'sbeer belly, you become
somewhat unsettled anddecidetopullbackafteronlyslightly brushing the haircovering his beer belly. Thisiscompletelyreasonable,andI am sure that many otherswill have the same reaction.However,theimportantthingtonotehere is thatyouandIare pushing into the samebeerbelly,Jason'sbeerbelly,but we find resistance atdifferent spots on the beer
belly.This isasignificant feature
of zones. Zones are just likebeer bellies. Zones are spotson the chart where price haspushed and probed, and thenreversed. Naked traders lovebeer bellies. They love thesezones.Nakedtraderswaitforprice to reach these zonesbefore initiating a trade. Thezone is the sweet spoton thechart for the naked trader. It
is absolutely critical that thenaked trader identifies thezones on the chart. Thesezones are the foundation ofnakedtrading.
OLDZONES,NEWZONES
The age of zones, and theimportance of the age of azone,isahotlydebatedtopic
among traders. Some tradersbelieve that only those zonesthat have been establishedrecently are important, andother traders believe thatzones that were establishedlongagoarejustasimportantas the newlyminted zones. Ibelieve that zones arerecycled.If you take a look at any
chart for any currency, youwill find historical price
levels. What you will noticeisthatpricehasatendencytoreverse at the same levelsrepeatedly. This is adistinguishing trait of zones,and you may use thischaracteristic to define anddiscover zones on yourcurrencycharts.
HotPizzaandZonesWhenIwasayoungchild,at
aboutsix,Iusedtowatchmymother in the kitchen. Itwasfun.Infact,someofmyveryfirst memories are of mymother singing to me in thekitchen.Oneday,whileinthekitchen, I had a terribleaccident. On this day mymotherwasbakingpizza,andit smelled delicious. In fact,you may find it hard tobelieve,but to thisday I stilllove pizza. My mother was
busy chopping up theingredients for the pizza,making the sauce, becauseshe had several pizzas tomake.Iwanderedovertothefirst pizza. It was still on ahot pan because it had onlyjust been removed from theoven.Now, my mother had
warnedme tobewaryof thehot pizza pan. I had eitherforgotten or disregarded her
warning, and I decided tograb the pizza pan becausethepizzasmelledsogood.Asyou may imagine, Icompletelyburnedmyhand.Istill remember it beingextremely painful and stillhavethescars.Ilearnedalessonthatday.I
stilllovepizza,butIamwaryofhotpans.Itwasavaluablelesson I learned, and issomething that I think about
every time I look at acurrency pair on the chart, Ithink about that pizza day.Every time I see a chartapproaching a zone, Iconsider that themarketmayrememberthelasttimeitwasburnt at that price level, atthatzone.
DoZones=MarketScars?
TakealookattheFigure4.1.This is thedailychartfor theEUR/CAD currency pair.Note that this pair foundsupportatthecriticallevelof1.4350 back in July andAugust of 2006 (up arrow).The pair repeatedly foundsupport at this level overmany weeks. Then, inSeptember and October of2006, the pair trades back tothiszoneandfindsresistance
onthreeseparateoccasionsatthe 1.4350 level (downarrow).
Figure4.1Support/ResistanceZoneontheEUR/CADDailyChartin2006.ThemarketfindssupportinJulyandAugust2006at1.4350,andtheninSeptemberandOctoberof2006themarketfindsresistanceontheverysamezoneat1.4350.
©2000–2011,MetaQuotesSoftwareCorp.
Nowtakealookatthenextchart, same pair, the
EUR/CAD in Figure 4.2.Here the pair has foundresistance back up at the1.4350level,fouryearslater.The market moves back tothis critical 1.4350 level,finds resistance there andpromptly falls. The chart hasa memory! This is a veryclear zone for this currencypair. Do you think thatknowing where price mayturn around is an advantage
foryou,asanakedtrader?
Figure4.2Support/ResistanceZoneontheEUR/CADDailyChartin2010.Aftertradinghigherandhigher,themarketfindsresistanceatthe1.4350zoneandpricefallslower.©2000–2011,MetaQuotesSoftwareCorp.
Perhaps you may bethinkingthatothermarketsdonothaveamemoryforzones.
Maybe this EUR/CADexample is just an exceptionratherthantherule.Ifyouarethinking this, please take afewmomentstolookatafewcharts for yourself. AnotherexampleinFigure4.3, this isthe USD/CHF daily chartfrom July 2008. Notice howthe market came down andtouched the 1.000 zone(arrow) and then rocketedhigher.
Figure4.3TheUSD/CHFdailychartshowsadistinctzoneatthe1.0000wherethemarketfindssupportin2008.©2000–2011,MetaQuotesSoftwareCorp.
Over a year later, in 2009the USD/CHF falls backdown to the same 1.0000
level and finds support onthree occasions, as you canseeinFigure4.4.Themarkettradedsharplyhigherafterthethird touch on the 1.0000zone. Again, the market hasmade a critical reversal at aprice that has historicallyserved as a turning point.This is what zones are,historicalturningpoints.
Figure4.4In2009,theUSD/CHFagainfinds
supportonthecritical1.0000zone.©2000–2011,MetaQuotesSoftwareCorp.
Another example is shownin Figure 4.5. This time it istheEUR/USDdaily chart. In2003 this pair topped out at1.1930, there were severaltouches on this zone (seethreearrows).
Figure4.5ThedailyEUR/USDhasaclearzoneatthe1.1930levelin2003.Themarketfindsresistancethreetimesinquicksuccession.©2000–2011,MetaQuotesSoftware
Corp.
Years later the EUR/USDwasfreefallingfromahighofover 1.5100 and the pair
eventually found support3000 pips lower, on a verycriticalzone(seeFigure4.6).The 1.1930 level served ascritical support seven yearslater. The chart has amemory!
Figure4.6ThedailyEUR/USDfallsover3000pipsandeventuallyfindssupportatthe1.1930zonein2010,sevenyearsafterfirstfindingresistanceonthis
zone.©2000–2011,MetaQuotesSoftwareCorp.
Thesezonesarecritical forthe naked trader; once pricereaches a zone, the nakedtrader is on alert for apossible trade set-up. Whywould the naked trader wanttoknowonceprice reachesazone? Because price hasrepeatedly turned around atthesezones!Knowingwhatamarkethasdoneinthepastiscritical for the naked trader,not because the naked trader
assumes themarketwill turnaroundagain,butbecausethenaked trader is on high alert,and the market may turnaround again. Some tradersare literally on alert, if youwouldliketoseeafreevideoon how you can set up pricealertssothatyourchartssendyou an e-mail when pricereaches a zone, go towww.fxjake.com/book.The naked trader does not
take trades based on pricereaching a zone, the nakedtrader uses several tools todecide when to take a trade.However, the naked traderwill not take a trade unlesspricehasreachedazone.Thisis the first step (pricereaching a zone) for thenakedtrader,whensettingupatrade.
HOWTOFINDZONES
Zones are those spots on thechart where price hasrepeatedly reversed.However, it may be difficultat first for you to find thesezoneson thechart.Thereareseveral sneaky shortcuts thatyou can use to help developan eye for finding zones.Some zones are extremely
obvious and easy to find.Other zones are a little bittrickier and may be difficultforyoutoidentifyifyouhavenot had experience findingzones on the chart. Pleasekeep in mind these threeshortcuts when you aredrawing your zones on thechart.
1. Start with a highertimeframechart.2.Usea linechart tofind
thezonesonthechart.3.Ignoreminorzones.
UseaHigherTimeframeChart
Question: When you meetsomeone new, how do youdecide what they are like?You learn their history, youask people about them, youtry and decipher what theyhave done in the past, in the
hopes of understanding thembetter. Why do you do this?The implicit assumption isthat they will do the samethings they have done in thepastinthefuture.Marketsarenodifferent.Whenthemarketis on a runaway uptrend,traders look to the oldercharts to see where thecriticalzonesareonthechart.This is also where we seehistoryrepeat itself,overand
overandoveragain.This shortcut for finding
zones on the chartwillworkregardless of the timeframeyouaretrading.Simplymoveup one timeframe. This is avery powerful method forfinding the most importantzones on the chart.Examining the highertimeframe chart will enableyoutoidentifyzonesthatwillbe the most critical areas on
the chart for the timeframeyou choose to trade. A fewtouches on the highertimeframechartwill translateinto many touches on thelower timeframe chart. Thistechnique will work on anytimeframechart.Take a look at Figure 4.7,
theGBP/USDone-hourchart.This pair has made anextreme low at the 1.6291level. This touch at 1.6291
suggeststhemarkethasmadea significant low, and thislevel may become importantlater. You may recall thatextreme touches (lows orhighs)arealsocritical zones.Although most zones willhavetouchesfromaboveandbelow(supportandresistancetouches), touches at extremelevels are also very critical,such as the extreme low inFigure 4.7. Later, themarket
willoftencomebacktotheseextremelevels.
Figure4.7The1.6291levelontheGBP/USDone-hourchartappearstobeanextremelow,soazoneisassumedatthislevel.©2000–2011,MetaQuotesSoftwareCorp.
A month later, theGBP/USD four-hour chart(Figure 4.8) suggests two
very interesting conclusions.First, the market has indeedfound support and resistanceon the 1.6291 level; themarket has a memory.Second, the four-hour chartshows a very clearperspectiveforthismarket.
Figure4.8Themarketcomesbacktothe1.6291zoneonemonthlaterontheGBP/USDfour-hourchart.Noticetherepeatedtouchesfromabove
andbelow.©2000–2011,MetaQuotesSoftwareCorp.
Moving up to a higher
timeframeisanexcellentwayto gain perspective.Only themost important zones willbecome evident on a higher-timeframe chart. If you areusingMetaTrader™foryourcharts, you will have thefollowing time framesavailable: one minute, fiveminutes, 15 minutes, 30minutes,onehour,fourhours,daily, weekly, and monthly.Thus, if you are trading the
one-hourchart, amoveup tothe four-hour chart will helpto identify the critical zones.The GBP/USD zone at1.6291 is clearly a criticalzone, as the market touchesthiszonemorethansixtimesoverthecourseofonemonth(Figure4.8).Thisbringsupanimportant
point about zones. Theimportance of a zone isdirectlyrelatedtothenumber
of touches on that zone. So,for instance, if a daily chartshows a zone with fivetouches over the past year,this would indicate a verycriticalzoneonthatparticularchart. Here is anotherexample: Notice on Figure4.9, the EUR/CAD dailychart, that the 1.4350 zonehasservedasresistancethreetimesovertwomonths.
Figure4.9ACriticalZoneat
1.4350ontheEUR/CADDailyChart.©2000–2011,MetaQuotesSoftwareCorp.
Moving back a bit further,weseeinFigure4.10thatthe1.4350 area was an area ofresistancesevenmonthspriorto the recent touches on thezone.
Figure4.10Sevenmonthsprior,theEUR/CADfindsresistanceatthe1.4350zone.©2000–2011,MetaQuotesSoftwareCorp.
Ifwegobackevenfurther,we can see in Figure 4.11how there are many touches
on this very same zone, the1.4350 zone, as price hasfound both support andresistanceonthiszone.Thesetouchesoccurredonthisverysamecriticalarea, the1.4350area,almostfiveyearsprior.
Figure4.11Nearlyfiveyearsprior,theEUR/CADrepeatedlyfindsresistanceandsupportatthe1.4350zone.©2000–2011,MetaQuotesSoftware
Corp.
Some traders will say thatold zones no longer matter.
Traders say things like“things have changed,” or“with inflation these oldlevels do not mean as muchanymore,”or“whywouldthemarketrememberalevel thatit has not been to in over adecade?”Ifthisiscurrentlyyourway
of thinking, I wouldencourageyoutotakeacloselook at the zones on a chart15yearsago.Justscrollback
on the chart, do not considerthe current price. Draw yourlines on the chart based onwhere you find support andresistancezones15yearsago.If your chart doesn't go back15 years, try to go back atleast 5 to 10 years. Youshould be able to identifycritical areas on the chartfrom a long time ago. Nowscroll forward and you willsee that price in the future
bounces off of these supportand resistance zones. Thechart has a memory. Asamazingasthismaysound,itis true: Price has a memory.This is true for any market,onanytimeframe.Ihopeyougo out and see this foryourself. Please do—yourfuture as a naked tradermaydependonit.Themarketsdoremember the critical zones,thisiswhyitisimportantfor
you, too, to remember thesecriticalzones.
TheLineChartIsYourFriend
Marking the zones on yourchart isas simpleasdrawinga lineon thechart.However,if you have not looked atchartsintermsofsupportandresistance zones before, itmay be a bit difficult to find
precisely where these zonesare located. It is importantthat, as a naked trader, you“see” these zones. Onebrilliant method for findingzones on the chart, and thisworks particularly well forthose traderswhoarenew tofindingzoneson thechart, istomovetoa linechart.Mostcharting packages will allowyou to view themarket on aline chart. A line chart is a
chart thatoffersacontinuousline, connecting the closingprices. Rather than showingthe open, the high, the low,and the close, such as acandlestick chart, or a barchart, the line chart simplyconnectstheclosingprices.Take a look at the daily
GBP/CHF chart (Figure4.12).Wherewouldyoudrawthezone?
Figure4.12Sometimeszonesarenotveryobvious,suchasonthisdailyGBP/CHFchart.©2000–2011,MetaQuotesSoftwareCorp.
Now,takealookattheline
chart in Figure 4.13. Wherewouldyoudrawthezonesonthischart?
Figure4.13Alinechartwilloftenmakezoneseasiertospot.©2000–2011,MetaQuotesSoftwareCorp.
ItisveryobviousinFigure4.13 that a zone should bedrawn at 2.2713, and this is
the beauty of the line chart.The line chart allows you tofind those areas on the chartwhere price has “bent”—thelinecharthelpsusto identifyzones because the line chartshows where price hasrepeatedlybent,eachbendonthe line chart is a potentialzone.Thoseplacesonthelinechart with several bends arezones.Line charts may also be
extremely useful for thosecharts where price doesn'tseemtoberespectingazone.TakealookattheNZD/USDfour-hour chart in Figure4.14. See how market pricesareallovertheshopandpricedoesnot seem to respect anyzone? Perhaps there is asupport and resistance zonehiddenonthechart.Maybeitis there, but it is notimmediately obvious where
thiszoneislocated.
Figure4.14Sometimeszonesarenotveryobvious.PriceseemsverychoppyonthisNZD/USDfour-hourchart.©2000–2011,MetaQuotesSoftwareCorp.
When a chart looks likethis,itmaybedifficulttospotthe zone. Perhaps there is no
zoneon this chart?For thesecharts, the line chart maycome to the rescue. A linechart may save you fromsloppy price action on thecharts.Alinechartmaymakeclear what is otherwisemuddled and difficult todecipher. Line charts areabsolutely critical for thenaked trader.Notice how thepricemovement on the chartinFigure4.15 becomes clear
andthezoneisnowobvious.Because the line chart takesinto consideration only theclosing price, it is a verysimple way to view priceaction.
Figure4.15ThelinechartfortheNZD/USDfour-hourchartsuggestsaclearzoneat0.6937.Noticethatthereareseveralbendsinthelinechartatthiszone.©2000–2011,MetaQuotesSoftware
Corp.
WhytheClosing
PriceIsImportantNow,youmaywonder,“Whylookatachartthatonlytakesintoconsideration theclosingprice?”Thelinechartismadeup of only closing prices.This is true, but the closingpricesare themost importantprice. It is important to notethat the closing price for theforex market is usuallyconsidered the end of the
North American tradingsession, at 5:00 P.M. NewYorktime.Everyday,thereisa battle between the bulls(buyers) and bears (sellers).Traders run through the fullgamut of emotions and oftenswingfromfear togreedandbackagainduringthetradingsession. However, once theend of the day approaches,traders begin to concentrateon answering this one
importantquestion:“ShouldIhold this trade through totomorrow or should I closethis trade now?” This isprecisely why the closingprice is critical, and not onlyinNorthAmerica.The traders in Europe also
seetheclosingprice,andmayreact to it. This is animportant point because theclosing time may be only10:00or11:00intheevening
in Europe, depending on thecountry. Traders in theAmericasandEuropespendagood portion of the daytradingduringthesametime.Thisisasignificantaspectofforex, because European andNorth American marketscapture the overwhelmingmajority of the volume inforex. Therefore, this closingprice, the last price for theNew York session, is
extremely important. Bothtraders in the Americas andthe European Continentinfluenceit.Afterthisclosingprice, themarketslowsdownconsiderably and shifts intothe interbank market, a veryslow trading periodpunctuated by occasionalbank-to-bank transactions. Ina very real sense, the NorthAmericanclosingpriceis thelast price of the day before
Asia wakes up and starts anewtradingday.
ZonesonaLowerTimeFrameChart
Youmaywonderattimesifazone is important enough todraw a line on the chart.Sometimesitmaynotbeveryclear,perhapsthereareafewtouchesonanarea,butitmaynot be a strong area of
supportandresistance.If thisis the case, you are probablyseeingwhat iscalledaminorzone. A minor zone isnothing more than a supportand resistance zone on thenext-lower-timeframe chart.These zones are veryapparent on the lowertimeframe chart, and withpractice you will spot themon the higher timeframechart,buttheyarenotcritical
areas. Marking minor zonesonyourchartwillonlymakethechartconfusing.
MINORZONES
A support and resistancezonethatisapparentonthetimeframe one step lowerfromthetimeframeyouaretrading.
Later we will look at the
importance of minor zones,butfornowit is important tonote that, although theymaybe apparent, they are notcriticalandtheyshouldnotbemarked on your chart. Theonlyzonesthataremarkedonyourchartarethosezonesonthe timeframe you aretrading, and the timeframeonestephigherfromthechartyou are trading. Any of theotherzonesarenotimportant
for defining your trade setups.InFigure4.16,youcansee
anobviouszoneatthe113.85level on the EUR/JPY four-hourchart.
Figure4.16Thefour-hourEUR/JPYcharthasanobviouszoneatthe113.85level.©2000–2011,MetaQuotesSoftwareCorp.
However, the minor zonesmaynotbesoobvious.Thereis also a minor zone on the
EUR/JPY four-hour chart inFigure4.17.Thisminorzonemay be identified by thecandlestick lows and thecandlestickhighs.Itmaytakesome practice to see theseminorzonesonthechartyouaretrading.
Figure4.17Aminorzoneonthefour-hourEUR/JPYchartismarkedbythearrowat114.90.Minorzonescanoftenbeidentifiedby
candlestickhighsorlows.©2000–2011,MetaQuotesSoftwareCorp.
However,itisquiteeasytosee this minor zone on theEUR/JPYchartbyexamininga lower timeframe. Movingfrom the four-hour chart totheone-hourchartisonewayto clearly identify thisminorzone. In Figure 4.18, theminor zone on the EUR/JPYone-hour chart is clearlyidentified at 114.90, themarket finds support at114.90 for several one-hour
candlesticks before fallingthrough the level, and thenlater, the market trades backup to 114.90 and findsresistance. This minor zone,whichwasdifficult to seeonthe four-hour chart, is noweasier to see because thetouches from above andbelow are more clearlydefined. Minor zones arecritical for managing trades.Minor zones are hurdles,
spots where price may getstuck for some time. Whentrading the higher timeframechart, the only importantzonesarethosemajorsupportand resistance zones, thestandardzones.
Figure4.18Theminorzoneat114.90iscleartoseeontheone-hourEUR/JPYchart.©2000–2011,MetaQuotesSoftwareCorp.
If you find that you havetoo many zones drawn onyour chart, then youmay be
identifying minor zones onyour chart. Too many zoneson your chart will mean thatyou will find it difficult toidentify trade set-ups andprofit targets for your trades.Zones may appear at anyplace on the chart. Somenaked traders will attempt toonlydrawzoneson thechartat round numbers, such as1.3500 on the EUR/USD.This is not necessary. Zones
may appear anywhere. If azoneisidentifiedat1.1097,itmaybeacceptable tomark itas 1.1100, but it is notnecessaryforallzonestofallonaroundnumber.Mostofthetimeyourzones
will be scattered throughoutyour chart. Therefore, it isimportant to note that youmay have two significantzones nearby, but in generalyour zones should be spread
out throughout the chart (seeFigure 4.19). Here are a fewexamples. In this chart, thereare several hundred pipsbetween zones. On a dailychart, this is common.Usually zones are separatedbyabout100pipsormoreonadailychart.
Figure4.19ThedailyEUR/AUDcharthaszonesthatareapproximately100–200pipsapart.
©2000–2011,MetaQuotesSoftwareCorp.
The higher the time frame,the more separation between
zones.Here is theEUR/USDweekly chart in Figure 4.20,and the zones are severalhundred pips apart. Onaverage, there are about 500pipsbetweenzones.
Figure4.20TheweeklyEUR/USDcharthaszonesthatareabout500pipsapart.©2000–2011,MetaQuotesSoftwareCorp.
Zones are critical for thenaked trader. It is importantfor you to become
comfortable identifying andworking with zones. Zonesarewheretheactionisforthenakedtrader.Atfirstyoumayhave difficulty with zones;listed are five commontrouble spots and solutionsforeach.
FIVETIPSFORFINDING
ZONESFirst, you may not knowwheretofindyourzones(seeFigure 4.21). If you arehaving difficulty identifyingthe zones on your chart, theeasiest solution is to simplyload a line chart. The linechartwillshowallthezones,because the zones will beidentifiedbythebendsintheline (see Figure 4.22). At
each spot where you seerepeat bends in the line, youare probably looking at azone.
Figure4.21ThisisthedailyUSD/CHFchart.Doyouseeazoneonthischart?©2000–2011,MetaQuotesSoftwareCorp.
Figure4.22ThisistheUSD/CHFdailylinechart.Theobviouszoneat1.2685is
nowapparent.Themarketrepeatedlyfindsbothsupportandresistanceonthezone.©2000–2011,MetaQuotesSoftwareCorp.
Second, you may have toomany zones drawn on yourchart(seeFigure4.23).Ifyou
have too many zones drawnyour chart, then you willprobably experience twolikely problems. The firstproblem is that you willnotice many tradeopportunities. If you aretrading the daily chart andnotice that you have a tradenearly every day, youprobably have too manyzones drawn on your chart.Thezonesshouldbemoreor
lessevenly spreadout, and itmay take some time for themarket to reach these zones,and trigger a trade. Patienceis important for the nakedtrader.Zonesarecriticalareason the chart, and price doesnotalwaysreachthesecriticalareas—zones—every day.Thesecondproblemthatyouwill likely have is that youwill notice many trades endup being losers. This is
because the zones on yourchart are not solid zones;perhapsthereareminorzonesidentified on your chart. It isimportant for you to drawcritical zones only, thosespotsinthechartwherepricehas repeatedly reversed. Byonly identifying those zoneson the chart where price hasrepeatedly reversed, the oddsare inyour favor. It isnearlyalways better to err on the
side of caution. To do this,simplydrawfewerzones(seeFigure 4.24). If you markonly those zones on yourchart where price hasrepeatedly reversed, youwillavoid identifying the minorzones.Youmaymiss out onsome trades, but the tradesyoudomakeshouldbegreatopportunities.
Figure4.23Toomanyzonesareidentifiedonthisdaily
USD/CADchart.Themarkettouchesazonenearlyeverydayonthischartbecauseseveralminorzonesaremarkedonthischart.©2000–2011,MetaQuotesSoftwareCorp.
Figure4.24ThisistheUSD/CADdailychartagain,withonlythemajorzones
identified.Noticehowthemarketdoesnottouchazoneeveryday.©2000–2011,MetaQuotesSoftwareCorp.
Thethirdcommonproblemyou may incur when dealingwith zones is this: It often
becomes very difficult todetermine precisely where azoneshouldbedrawn.Thisisthe nature of the zone. Thezone is squishy, it is fat, itidentifies an area on thechart,andnotaspecificpoint(seeFigure 4.25). Rememberthatyoudohavesomeleewayindrawingyourzone.Itisnotessential to nail down thezone toa specificpricepointonyourchart,but rather it is
important that you identifythe area on the chart whereyou will look for a reversal.The toucheson thezonewillnot beperfect. Some toucheswill come close to the zone,other touches will extenddeepintothezone.
Figure4.25ThedailyCHF/JPYcharthasaclearzoneat89.35;themarkethasfoundresistanceatornearthiszoneonseveral
occasions.Noticehowsomeofthevalidzonetouchesareadeepintothezoneandothersarenearthezone.©2000–2011,MetaQuotesSoftwareCorp.
Notice how the 89.35 zonein Figure 4.25 has providedresistance for the daily
CHF/JPY trade on severaloccasions. The market hasfallenafterreachingthiszoneeach time, but the first twotouches extended deep intothe zone, and the third touchcame near the zone. This isvery common with zones;sometimes the market willbrush against the beer bellyandatother timesthemarketwillpushintothebeerbelly.The fourth problem that
manytraderscomeupagainstwhen drawing zones is thatthemarketseemstodisregardzones.When this occurs, ourtrustyfriendthelinechartcanoftencometotherescue.Theeasiest way to illustrate thisissue is to take a look at anexample. Take a look at thischart inFigure4.26,andyouwill notice that it appears asthough the market is notrespecting the area at 81.83,
whereazonecouldbedrawnon the chart. However, thesame chart viewed as a linechart(seeFigure4.27)showsthe important touches asbendsinthelinechart,anditisobviousthatthemarkethasrespectedthiszone.
Figure4.26Theone-hourAUD/JPYcharthasseveralcleanreversalsaroundthe81.83zone;however,thereareseveralsloppytouches
markedwitharrows.Themarketdoesnotappeartorespectthezoneduringthesetouches.©2000–2011,MetaQuotesSoftwareCorp.
Figure4.27Thelinechartclearsuptheconfusingpriceactionaroundthe81.83area
ontheAUD/JPYone-hourchart.Thelinechartindicatesthatthemarketfoundresistancetwiceandsupportonceonthe81.83zone,soitisawell-placedzone.©2000–2011,MetaQuotesSoftwareCorp.
The fifth problem that youmay come up against whentrading with zones is this: If
themarket trades beyond thezoneitdoesnotmeanthatthemarket has broken the zone.This is an important andcritical point for the nakedtrader. Remember zones arebeerbellies,theyaresquishy,they are fat, and they consistofawide rangeon thechart.This means that sometimesthemarketwill push into thezone,anditmaylooklikethemarkethasbrokenbeyondthe
zone, this is often not thecase.TakealookatthedailyNZD/CHF chart in Figure4.28, the market findsresistance at the 0.7590 zoneat least five times betweenNovember 2009 and March2010.
Figure4.28TheNZD/CHFdailychartshowsatleastfivetouchesonthe0.7590zone;sometouchesgobeyondthezone,othersarejustbelow
thezone.©2000–2011,MetaQuotesSoftwareCorp.
The NZD/CHF chart from
November 2009 to March2010showsaclearlydefinedzone at 0.7590, the marketfinds resistance at this levelon at least five occasions.Fromlefttoright,thereareatleast five touches on the0.7590 zone. The first touchisanearmiss;thepricecamevery close to 0.7590, butultimately found resistancejust below this price. Theremaining touches are a bit
beyondthezone,buteacharevalid touches on the zone.The second touch includesthree daily candlesticks insuccession; each day themarket pushes a bit beyondthe 0.7590 zone. Ultimately,the market closes below thezone,andafterthethirddailycandlestick falls, the markettrades lower once again. Thethird touch occurs five dayslater and includes a piercing
kangarootailcandlestick(seechapter 8 for more on thekangaroo tail), clearly themarkethastradedbeyondthe0.7590zone,butthemarketisunable to close above thezone, and it falls down afterthistouch.Thefourthtouchismadeupof twocandlesticks,the first on the 0.7590 zoneand the second pushes a bitfurther beyond the zone, butitisstillavalidtouch.(There
isanothernearmissafterthistouch, not marked on Figure4.28, but the market doescomeveryclosetothe0.7590zone.) The fifth and finaltouch again penetrates thezone before falling sharply;notice how the market wasonceagainunabletocloseontheothersideofthezone.Attimes,themarketmaytouchazone and then close brieflybeyond the zone before
movingback,butmostofthetime if the market touches azone,itmaytradebeyondthezone, but it will not closebeyondthezone.Havealookatsomecharts.
You will notice how pricewill often push into andbeyond a zone, only toeventually turn around. Thisis a common behavior. It isalso the reason why mostnaked traders find it much
easier to trade reversal set-ups than breakouts. Reversalset-ups are based on themarket turning around at azone,andbreakoutsarebasedonthemarkettradingbeyonda zone. Perhaps you aresimilartomosttradersinthatyou find it a very trickyproposition to determinewhen themarket hasmade abreakoutandtradedbeyondazone. If this describes your
experience,youmayconsideravoiding breakout trades andfocusing on reversal trades.Theeasiestandsafestwaytotrade breakouts is covered inChapter 5, The Last-Kiss. Ifyouareinterestedinbreakouttrading, the last kiss may bethetradeforyou.Once you begin to closely
attend to the clues in themarket, your trading willbecome more consistent.
Once the market reaches azone, the naked traderwatches carefully, and if acatalyst appears, a trade istriggered. The key tosuccessful trading is to waitfor the very best tradingopportunities. Theseopportunities occurwhen themarketreachesawell-definedzone and then prints acatalyst. These are goldenopportunities. The next
section is all about tradingcatalysts, how to identifythem and specific rules fortrading each of the highprobability, naked-tradingset-ups.
PARTTWO
Naked-TradingMethodology
CHAPTER5
TheLastKiss
Tome,thereisnogreateractofcouragethanbeingtheonewhokissesfirst.
—JaneaneGarofaloAll of the naked-trading
strategies in this book havethree parts: The first is toidentify the support andresistance zones, the secondis to wait for the market toreachoneofthesezones,andthe third is to take a tradeonce a catalyst prints on oneofthesezones.You now understand how
tofindzonesonthechart,andyou are ready to learn aboutcatalysts. Catalysts are
powerful price patterns.These simple price patternssuggestwhat themarketmaydooncethemarketreachesazone.Thesecatalystsareonlyuseful when they print on azone; catalysts that are notlocated on a zone are simplyinterestingpriceformations—they are not high-probabilitytrade set-ups. A very simpleand extremely powerfulcatalystisthelast-kisstrade.
Ifyouhavebeentradingforsometime,youhaveprobablyseenenoughofthemarketstoknowthattherearetwobasicmoods of the market, andthese moods will be seen inany market in the world.There is the calm, drifting,directionless, choppy marketasisevidentinFigure5.1.Attimes, the market will alsoexhibit strong, powerfulexplosions characteristic of
thetrendingmarketascanbeseen in Figure 5.2. Themarket is always in one ofthesetwomoods.
Figure5.1ThisEUR/USDfour-hourchartisintheclassicconsolidationphase.Noticepricemovementischoppy,anddirectionlessanddoesnotseemtogoanywhere.©2000–2011,MetaQuotesSoftwareCorp.
Figure5.2AnotherEUR/USDfour-hourchart,herethemarketis
consistentlymovingupwardinastrongtrendingphase.©2000–2011,MetaQuotesSoftwareCorp.
Continually, the marketmoves between these twostates: the hyperactivetrending market and therelaxed, drifting market (seeFigure 5.3). Just as there arelow tides and high tides, hotdays and cool days, themarket also projects days oflaziness (choppy markets)and days of overwhelmingactivity (trending markets).Traders take advantage of
these two moods in themarket.
Figure5.3TheEUR/USDfour-hourcharttransitioningbetweenadirectionless,driftingmoodtoastrongtrendingphase.©2000–2011,MetaQuotesSoftwareCorp.
Most trading systems willtake advantage of either thechoppy market or the strong
trending market. This meansthatmosttradingsystemswillperform exceptionally wellduring either the choppymarketor a trendingmarket,but never in both types ofmarketmoods.For example, if you decide
to trade the trendy kangarootail,butinsteadofwaitingfora strong trend, you decide toapplythetrendykangarootailtoadirectionlessmarket,you
may find that the trendykangaroo tail does not offerthe type of profit potentialyou are looking for in atrading system (the trendykangaroo tail is a nakedtrading set-up for trendingmarkets,describedindetailinChapter 10). This is simplybecause the trendy kangarootailsystemisdesignedtotakeadvantage of a strongtrending market. Applying
thissystemtoadirectionless,choppy market that isn'tinterested in going anywherewilllikelyleadtoundesirableresults. This simple factmeans that youmust keep inmind which type of marketyourchosentradingsystemisdesignedtoworkwellin,andtry to restrict the applicationofyourchosentradingsystemtoonlythistypeofmarket.Thereis,however,oneage-
oldstrategythatworksontheprecipice of the transitionfrom the choppy,directionless market to thestrong trending market. Thisis thebreakout strategy.Thistrading strategy is extremelycommon; there are manyversions of the breakouttrade.
WHATISA
BREAKOUTTRADE?
The breakout strategyinvolvestwophases.Thefirstphaseinvolveswaitingforthemarket to consolidate. Aconsolidatedmarket becomesvery choppy anddirectionless,thetraderwaits,andwatches themarket. Thebreakout trader is a patienttrader.Thisstrategyislargely
basedonpatienceandtiming.Perhaps you have traded a
version of the breakout tradein the past. There are manyversions of this trading set-up, so you might know thedrill:Youwaitandwatchthemarketwhen it is calm.Youare waiting when the marketistradingwithinatightrange.Then, eventually the marketbreaks out and extendsbeyond the restricted range
and rockets off in onedirection for a strong,sustainedtrendingmove.Thisiswherethewell-placedentrywill capture a quick profit atthe very least, andmay evenafford an early entry into astrong,sustainedtrend.
IdentifyingtheTransition
Asabreakouttraderyoutake
advantage of the naturalrhythmof themarket and, inparticular, the transitionbetweentheboring,restrictedmovementoftherange-boundmarket and the fierce strongmovesofthetrendingmarket.Whenwillyouknowthat themarket is changing?How doyou determine that theconsolidation period is over?Will the market offer a cluewhenitisabouttomoveinto
atrendingphase?Is it possible to determine
when the market ends thedirectionless phase andbegins the strong trendingphase?Theanswerisyes,andyouwill use your old friend,the support and resistancezone. The support andresistance zone will be thethresholdbywhichyoujudgethe movement of the marketonce again. This time the
support and resistance zonewillmarkthelineinthesandfor the naked version of thebreakout trade—the last-kisstrade.The first step of the last-
kiss trade is to identify theconsolidation zone.Onewayto visualize a consolidationzone is todrawaboxon thechart. This box will containthechoppymovementsofthedirectionless market. This
box should encompass themarket movement during thechoppy,drifting-marketphase(seeFigure5.4).
Figure5.4ThisboxontheUSD/JPYfour-hourchartmaybeusedtocontainthepriceactioninthemarketduringthedrifting-marketphase.©2000–2011,MetaQuotesSoftwareCorp.
The important thing toremember here is that thebox, which contains the
market activity, is formedbyboth a support zone and aresistance zone. This box ofmarket activity should popoutonthechart—itshouldbeobvious that the market isstuck between both of thezones. Typically, there willbe several touches on eitherside of the zones. In Figure5.5weseethattherearethreetouches at the topof thebox(marketfoundresistance)and
two touches at the bottomofthe box (market foundsupport).
Figure5.5Theconsolidationzoneshouldbeveryobvious.Noticehowthemarketbouncesoffofthesupportzoneandtheresistancezoneseveraltimesonthefour-hourUSD/JPYchart.Twicethemarketfindssupportatthebottomoftheboxandthreetimesthemarketfinds
resistanceatthetopofthebox.©2000–2011,MetaQuotesSoftwareCorp.
The consolidation phaseinside of the box maycontinue for some time.However, once the marketbreaks out toward either thesupportzoneortheresistancezone,thelast-kisstradertakesnotice. For many breakouttraders, the move outside ofthe consolidation box willtrigger a trade.However, thelastkisstradeisnottriggeredatthisstage.
A close examination of atypical, standard breakouttrade may be in order. Thetypical breakout strategywillfollow a series of events.First,themarketconsolidates,andaboxisdrawnaroundtheconsolidation. Second, themarket pushes beyond eitherthe support zone or theresistance zone to trigger atrade(seeFigure5.6).
Figure5.6Thisfour-hour
chartontheUSD/CHFshowsastandardbreakouttrade.Thetradeistriggeredoncethemarketmovesbeyondeitherthesupportzoneortheresistancezone.Inthisexample,themarketbreaksouttotheupside,signalingabuytrade.©2000–2011,MetaQuotesSoftwareCorp.
Thismovebeyondthezoneis the trade signal. In fact,standard breakout traders
often place buy stop ordersabove the resistance zone,andsellstopordersbelowthesupport zone in anticipationofthebreakout.Thereare,ofcourse, varying degrees ofdifferences among breakoutstrategies; however, the coreprinciplethatguidesbreakoutstrategies is this: Once themarket breaks out beyond azone,atradeistriggered.However, the standard
breakout strategies have averycommonproblem.Manybreakout trades end up aslosingtradesbecausetheyaretriggeredbyafake-out.Whatisafake-out,youask?
TheFake-OutThe fake-out is the breakouttrader's nemesis. This is thebiggest problem with mostbreakout trading strategies.
Many breakout signals offerexcellent tradingopportunities, but others aretriggered by fake-outs. Afake-out isamoveoutsideofthe consolidation zone thatappears tobeabreakout,butinstead of continuing on inone direction a strong trend,the market retraces backinside of the consolidationzone. The fake-out alwaysends up with the market
eventually fallingback insidethe zone defined by both thesupport and the resistancelevels (back inside the box).The USD/CHF four-hourchart in Figure 5.7 is anexample of a fake-out. Thestrong move outside the box(seearrow)isassumedtobeabreakout, but the marketretraces and eventually fallsbackinsidethebox.
Figure5.7Thisfake-outis
markedwiththearrowontheUSD/CHFfour-hourchart.Themarkettradeshigherthanthetopofthebox,butlaterquicklyfallsbackinsideofthebox.Formoststandardbreakoutsystemsthiswouldbealosingtrade.©2000–2011,MetaQuotesSoftwareCorp.
Thus, a fake-out is abreakout trade that istriggered by a convincing
candlestick that extendsbeyond a support orresistancezone.Thisactionisfollowed by the marketmoving back inside theconsolidationbox(seeFigure5.8).Oncethemarketretreatsback into the consolidationbox after a fake-out, pricewilloften languish inside theboxforsometime.
Figure5.8Anotherfake-out,thistimeontheAUD/USD
dailychart.Themarkettradesbeyondthebottomofthebox,triggeringaselltrade,butthenthemarketquicklyjumpsbackupinsidetheconsolidationbox.Thiswouldbeafailedbreakouttradeformostbreakouttradingsystems.©2000–2011,MetaQuotesSoftwareCorp.
The fake-out is actuallyquite common, and a quicklook at the charts will show
howoftentheydooccur.These failed breakouts, the
fake-outs, are the primaryreasontradersfinditdifficulttoconsistentlyapplybreakouttrading systems. Breakoutsystemsaresimplywrongtoooften. Breakout systemsmayoccasionally grab a greattrend early, but fake-outssignal many losing trades.Why is this the case? Whyarefake-outssocommon?
Ask any trading guru thequestion“howoftendoes themarket trend?” and,depending on the guru, youwill be told that the markettrendsabout15to30percentof the time.This is preciselywhy conventional breakoutsystems often fail. Most ofthe time, themarkets are notready to start trending; theyspendthemajorityofthetimedrifting without direction.
This is why breakout tradesoftenfail.Would it be nice if you
could tellwhenabreakout isgoing to continue onwardbeyond the consolidationbox?Whatiftherewasawayto avoid the dreaded fake-out?Wouldyoulikeatradingsystem for identifying thebreakouts most likely tocontinue onward in thedirection of the trend? There
is such a system, and it iscalled the last-kiss trade.Thelast kiss is a specific type ofbreakout that suggests abreakout will develop into astrongtrendingmove.
WHATISALASTKISS?
The last kiss is a catalystspecificallydesignedtoavoid
the fake-out. If you havetraded breakout systems inthepast,youknowhowoftenthese fake-outs will occur.Although the last kiss is notguaranteed to avoidall fake-outs, itwillprovideyouwithavaluablemethodoffilteringout many of the very worstfake-outs that fizzle quickly.Thelast-kisstradeisasimplemethod that confirms thevalidity of the breakout
signal, and it is based on asound naked-tradingprinciple. This is known astheretouchprinciple.
THERETOUCH
Themarkettradesbeyondazonebeforereturningtothezonefromtheotherside toconfirm the importance ofthezone.
Aclose examinationof thelast-kiss trade will illustratehow this trade incorporatesthe retouch principle. Take alookatthechartinFigure5.9where a breakout candlestickprints after themarket tradesbetween two zones for sometime.
Figure5.9TheconsolidationboxformsontheEUR/GBPdailychart,followedbyabreakoutcandlestick.
©2000–2011,MetaQuotesSoftwareCorp.
The last-kiss trade is nottriggered on this initial
breakout candlestick but is,instead, triggeredmuch later.The standard breakout tradeis initiated when the marketmoves beyond one of thesupport and resistance zones.The last-kiss trade is nottriggereduntillater.Whyisitimportanttowait?Take a look at the losing
tradeson thepreviouspages.Do you notice a commontheme? The previous charts,
theUSD/CHFfour-hourchartin Figure 5.7 and theAUD/USD daily chart inFigure 5.8 illustrate theproblemwithmany breakouttrades. These trades oftenquickly fizzle as the marketmoves back inside of theconsolidation box. Not onlythat, but the market oftenmoves back inside theconsolidation box quickly.This tendency, the tendency
for failed breakouts toquickly jump back inside theconsolidation box, is thepeculiar behavior that isimportant to the last-kisstrade.Mostofthefailedbreakouts
willquicklyjumpbackinsidethe consolidation box.However, a true breakout—those trades that extendbeyondtheconsolidationboxand then keep travelling—
will often move back to thesupport and resistance zonesfor a retouch. The last-kisstrade is a specific subset ofthebreakout trade.Noteverybreakout trade is a last-kisstrade,buteverylast-kisstradeisabreakouttrade.Inotherwords,thelast-kiss
trade is based on the retouchprinciple. The market willoften come back to asignificant zone once the
market has expanded beyondthe zone, and the last-kisstrade is designed to takeadvantage of this typicalmarket behavior (once themarket retreats and movesbacktowardtheconsolidationbox). The reason for waitingfor the market to come backto theconsolidationbox is toconfirm that themarketwill,indeed, respect theboundaries that were formed
by the consolidation box. Inthisway,thetraderwilljumpon the trade only when themarket comes back to kiss aconsolidationbox(seeFigure5.10).This is why the trade is
known as the last kiss. Thetrade is initiated only whenthe market returns to theconsolidationbox tokissoneof the support and resistancezones that formed during the
consolidation. This isobviously a very differententrytothestandardbreakouttradingstrategy.
Figure5.10Thelast-kisstradeissignaledontheEUR/GBPdailychartoncethemarketreturnstotheedgeoftheboxforaretouch.©2000–2011,MetaQuotesSoftwareCorp.
Thebestwaytogetasensefor the last-kiss trade is toexamine a couple of
examples.Take a look at theEUR/USD daily chart inFigure5.11.
Figure5.11TheEUR/USDdailychartshowstwofake-outsprecedingthelastkiss.Thelastkissistriggeredoncethemarketbreaksoutabovetheconsolidationbox,andthenreturnstotheedgeoftheboxforaretouch.©2000–2011,MetaQuotesSoftwareCorp.
Herewesee theEUR/USDhas had two failed breakoutspriortothelastkissinFigure
5.11. The first fake-out is afalse breakout to the upside,but the market quickly fallsbackinsideofthebox.Thereisalsoabrief fake-out to thedownside, but the marketdrifts back inside of the boxsoon after that fake-out. Thelast break out is a truebreakout,anditisalsoalast-kissset-up.Themarkettradesoutsidetheboxtotheupside,and then returns to the edge
of the box to find supportbefore continuing onward inthe direction of the breakout(seeFigure5.12).
Figure5.12ThemarketcontinuestrendinghigherafterlastkissontheEUR/USDdailychart,noticehowtheretouchisanicebullishcandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Notice how the marketprints a very nice bullishcandlestickat theedgeof the
consolidation box in Figure5.12. It isnot enough for themarkettosimplyre-touchthezone and then pause; themarket must print a strongcandlestickinthedirectionofthebreakouttotriggerthelastkiss.Bigshadowssuchasthelast-kisscandlestickinFigure5.12arecoveredinChapter8.
TradingtheRetouch
Once the market returns tothe edge of the consolidationbox, it must print a strongcandle in thedirectionof thebreakout. Therefore, if thebreakoutisabullishbreakout(up), then the retouchcandlestick must be a strongbullish candlestick. A buystop is placed above (seearrow)thehighofthisbullishcandlestick(seeFigure5.13).
Figure5.13Forbullishlast-
kisstrades,abuystopisplacedabovethehighofthebullishretouchcandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Likewise, for the bearishbreakouts, when the marketcomes back to retouch the
edgeoftheconsolidationbox,the market must print abearishcandlestick.Theentryfor the last kiss is a sell stopplaced below the low (seearrow) of the bearishcandlestick,justasyouseeinFigure5.14.
Figure5.14Forthebearishlast-kisstrades,suchasthisoneonthedailyCAD/JPY,asellstopisplacedbelowthelowofthebearishretouch
candlestick.©2000–2011,MetaQuotesSoftwareCorp.
Once the market tradesthrough the entry price, thelast-kisstradeison.Therearetwo stop loss signals for thelast-kiss trade. The first stoploss is the emergency stoploss,and this isplacedat themidpointof theconsolidationbox. Under mostcircumstances this stop losswillnotbehit.The calculation of this
emergency stop loss is
simple.1.Subtract the resistance-level zone from thesupport-levelzone.2. Record the number ofpips; this is the width oftheconsolidationbox.3.Dividethewidthoftheconsolidationboxby2.4.Add thisamount to thesupport-levelzone.
This price level is youremergencystop (as shown in
Figure5.15).The CAD/JPY four-hour
last-kiss trade makes for agreat example (see Figure5.16). First, subtract supportzone, 85.95, from theresistancezone,88.23(85.95-88.23=228pips).Dividethisamountby2(228pips÷2=114pips).
Figure5.15Theemergencystoplossforthelast-kiss
tradeisplacedatthemidpointoftheconsolidationbox.ForthisCAD/JPYfour-hourlast-kisstrade,thestoplosswouldbeat87.09.©2000–2011,MetaQuotesSoftwareCorp.
Figure5.16Calculatingtheemergencystoplossforalast-kisstradeonthe
CAD/JPYfour-hourchart.©2000–2011,MetaQuotesSoftwareCorp.
Next, add 114 pips to the
support zone, 85.95 to findthe value for the emergencystop loss. 85.95 + 114 =87.09,so theemergencystopis placed at 87.09 for theCAD/JPY four-hour last-kisstrade(seeFigure5.17).
Figure5.17Theemergencystoplossforthefour-hourCAD/JPYlast-kisstradeis87.09.©2000–2011,MetaQuotesSoftwareCorp.
There isanotherexitsignalfor the last-kiss trade that ismore likely to be triggered
thantheemergencystoploss.If the market closes backinside the box after the last-kiss trade is triggered, thetrade is exited. This willusually mean taking a muchsmaller loss than theemergency stop loss (seeFigure5.18).
Figure5.18Thisisalast-kisstradeontheGBP/USDweeklychart.Thefirstarrowmarksthelast-kiss
candlestick,wheretheselltradeisentered.Thesecondarrowmarksthecandlestickthatclosedinsidethebox,triggeringtheendofthetrade.©2000–2011,MetaQuotesSoftwareCorp.
This exit signal is usuallytriggered for a much smallerloss than the emergency stop
loss. The GBP/USD weeklychart in Figure 5.18 shows alast-kiss trade that prints thisexit signal. The trade is overonce a candlestick closesback inside the box.Most ofthefailedlast-kisstradeswillbe exited with this rule.Undermost circumstances, itisunlikelythattheemergencystop loss at the midpoint oftheconsolidationboxwillbehit. The second stop loss is
much more likely to be hit,whichmeansthattheaveragelosing trade for the last-kisstradeisquitesmall.Thisisanattractive feature of the last-kiss trade. Many nakedtradersenjoytradingthelast-kisstradebecausethissecondstoplosssignificantlyreducesthesizeofthelosingtrades.
FindingProfitafter
KissesOne very simple exit forprofitablelast-kisstradesistoexitthetradeatthenextzone.There are other, moresophisticated methods forexiting the last-kiss tradecoveredinChapter11.
TRADINGTHELASTKISS
The last-kiss trade is a niceway to trade high-probabilitybreakout trades.Here are thestepsforthelast-kisstrade:
Wait for price toconsolidate inaboxbetweentwozones.The box shouldhave at least twotouches on bothzones.Wait for price tobreakbeyondoneof
thezones.Once price returnsback to theconsolidation box,wait for the marketto print a last-kisscandlestick on theedgeofthebox.Forselltrades,asellstopisplacedbelowthe low of the last-kisscandlestick,andforbuytrades,abuy
stopisplacedabovethe high of the last-kisscandlestick.Emergencystoplossis placed in themidpoint of theconsolidationbox.The profit target isthenearestzone.
Testthelast-kisstrade;youmaybesurprisedathowwellthis tradingsystemfiltersoutfake-outs. To see live last-
CHAPTER6
TheBigShadow
Neverfearshadows.Theysimply mean there's alight shining somewherenearby.
—RuthE.Renkel
The big shadow is a two-candlestick, reversalformation and an importantcatalyst for the naked trader.The big shadow appears onsupport and resistance zones,precisely where the nakedtrader looks for highprobability trade set-ups.Once the big shadow printsonazone,wehaveavaluablehintthatthemarketmaysoonturnaround.
Two candlesticks make upthebigshadowformation.Aswith most naked tradingcatalysts, they must print onzones to be valid trade set-ups. Big shadows are onlyvalid when they appear onzones. A big shadow mayprint on top of the zone (themarket is finding support onthe zone, a bullish bigshadow), or the market mayprint below the zone (the
market is finding resistanceon the zone, a bearish bigshadow).Theimportantthingis this:The big shadowmustprintonazone.
WHATDOESITLOOKLIKE?
Sometradersmayrefertothe
big shadow as an engulfingcandlestick, but it is morethanthat,astherearespecificrules associated with the bigshadow, including how totrade it, and specificoptimizersforthetradingset-up. The big shadow isessentially a two-candlestickformation in which thesecond candle completelydwarfs the first candlestick.This second candlestick is
known as the big-shadowcandlestick. The definingcharacteristics of the big-shadow candlestick are asfollows: The big-shadowcandlestick is much largerthanthepreviouscandlestick,the big-shadow candlestickhasawiderange,andthebig-shadow candlestick is thelargestcandlestickthemarkethasseenforsometime.Figure 6.2 shows another
example of the big shadow.This one is another bearishbig shadow, this time on theEUR/GBPdailychart.
Figure6.1ThisbearishbigshadowontheCAD/JPYdailycharthasamuchlargerrangethanthepreviouscandlestick.©2000–2011,MetaQuotesSoftwareCorp.
DOESBIGGER
EQUALBETTER?
If you spend some timewatching the charts, youwillnoticethatsomeshadowsarelarger than others. The idealbig shadowwill have awiderange. Look at the examplesinFigure6.1 andFigure 6.2;bothbig shadowcandlestickshaveaverywiderange.Bothof these big shadows are the
largestcandlestickthemarkethas seen in some time. InFigure 6.1 the bearish bigshadow is the largestcandlestick the market hasseen in several weeks.Likewise, thebigbearishbigshadowinFigure6.2isaverylarge candlestick, the largestcandlestick inoveroneweekoftrading.
Figure6.2Thebearishbigshadowhereisonthe
EUR/GBPdailychart.Noticehowtherangeofthebig-shadowcandlestickismuchlargerthanthepreviouscandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Ideally, the big shadowshould have the greatestrange of the previous five
candlesticks. Smaller bigshadow candles may betempting because the stoploss is closer to the entryprice, but historically, theverylargebigshadowshaveamuch higher success rate.Back-test this for yourself tosee if the very large bigshadows you trade have ahighersuccessrate.
THESTOPLOSS
The big shadow stop loss isplaced beyond the bigshadow. For a bullish bigshadow, the stop loss isplaced a few pips below thelow of the big shadowcandlestick (see Figure 6.3).For the bearish big shadow,the stop loss is placed a fewpips above the high of the
big-shadow candlestick (seeFigure6.4).
Figure6.3ThisisabullishbigshadowonthedailyGBP/CHFdailychart.Thestoplossisplacedafewpipsabovethehighofthebearishbig-shadowcandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Figure6.4ThisisabearishbigshadowonthedailyGBP/AUDchart.Thestop
lossisplacedafewpipsabovethehighofthebearishbig-shadowscandlestick.©2000–2011,MetaQuotesSoftwareCorp.
ENTERING
THETRADEThesafestwaytoenterabig-shadow trade is to wait forthe market to push into anexpected direction. This willmean using a buy stop forbullishbigshadows,orasellstopforbearishbigshadows.For example, if you wouldlike toenter a sell tradeonabearishbigshadow,youmayconsider placing your sell
stopbelowthelowofthebig-shadow candlestick.Likewise, for those bullishbigshadows,placeabuystopa fewpips above thehighofthebig-shadowcandlestick.Ifthe market moves in theexpected direction, your buystop order will be triggered(seeFigure6.5).
Figure6.5Abuystopentryisthesafestwaytoenterabullishbig-shadowtrade.
Here,themarkettriggersthebuystopofthebullishbigshadowonthedailyUSD/CHFchart.©2000–2011,MetaQuotesSoftwareCorp.
Manytraderslooktoenteratrade on retracements, whenthe market moves against a
trading set-up. Although thismay seem like a good idea,becauseitenablesanentryata “cheaper” price, it is alsorisky. Remember that mosttraders find it difficult toachieve consistent profits.One of the reasons for thismay be because all failedtrade set-ups will retrace inthe opposite direction, butvery few failed trade set-ups,such as the big shadow, will
take out a new high (forbullishbigshadows)oranewlow (for bearish bigshadows). This is why sellstops and buy stops arerecommended for trading thebig shadow (and all naked-tradingstrategies).SeeFigure6.6 for an example of how asellstopavoidsalosingtradeon a CAD/JPY four-hourbearishbigshadow.
Figure6.6Asellstopentry
ontheCAD/JPYfour-hourchartavoidsalosingtrade.Themarkettradeshigherandnevertriggersthesellstopentry.Sellingthisbearishbigshadowatahigherpricewouldhaveresultedinalosingtrade.©2000–2011,MetaQuotesSoftwareCorp.
It may seemcounterintuitive to enter a
tradeatapoorentryprice,butifyoudecidetousebuystopsand sell stops to enter yourtrades, you will eliminatemanylosingtradesfromyourrecord. This is an extremelysimple method for avoidinglosingtrades.
IMPORTANCEOFTHE
CLOSINGPRICE
Theclosingprice is themostimportant price for the big-shadow candlestick. A bigshadow may completelyengulf the prior candlestick.Abigshadowmayprintonabrilliant zone. A big shadowmay even be the largestcandlestick, with the widestrange for a particularmarket
inaverylongtime.However,if the closing price is not inthe correct location for thebig-shadow candlestick, thetrademayfailmiserably.Theidealclosingpricefora
bullish big shadowcandlestick is the high. Thebig-shadow candlestick has avery good chance of successif the candlestick closes onthehigh.Obviously,itisrarefor the closing price of a
bullish big-shadowcandlesticktobeequal to thehigh. The closer the closingprice is to the high for thebullish big-shadowcandlestick, the better thetrade signal. Bullish bigshadows with closing pricesnear the midpoint of thecandlestick are very poortrading set-ups. The nakedtrader is only interested inhigh-probabilitytradeset-ups,
so if the bullish big shadowhasaclosingpricedownnearthe midpoint of thecandlestick,thetradeset-upisprobablynot good enough totake(seeFigure6.7).
Figure6.7ThisbullishcandlestickonthedailyUSD/JPYcharthasaclosingpricedownnearthemidpointofthecandlestick.Thisisnotabullishbig-shadowcandlestickformation.Notice
howthistradeisaloser;themarkettradesbelowthestoploss.©2000–2011,MetaQuotesSoftwareCorp.
Figure 6.7 is an interestingbullish candlestick, but it isnot a bullish big shadowbecause the market nevertradeshigherthanthehighofthe candlestick. Recall thatone of the rules of the bigshadow is that the marketmust trade higher than thehigh to trigger the buy stopwhich is placed a few pipsabovethehigh.Applyingthisentry rule would havemeant
avoiding this losing trade.Therefore,thetradeinFigure6.7 has two faults: Themarket fails to trade higherthan the high of the bullishbig-shadow candlestick, andclosing price of the bullishbig-shadowcandlestickistoolow.Forbearishbigshadowset-
ups, the closing price of thebearish big shadowcandlestick is also important.
Theidealbearishbigshadowwill have a closing pricedown near the low of thebearish big-shadowcandlestick. A bearish big-shadow candlestick with aclosing price near themidpoint is a subpar set-upand should be disregarded(see Figure 6.8). The verybest bearish big-shadow set-upswill have a closing pricedown near the low of the
candlestick.
Figure6.8ThisbearishcandlestickontheAUD/NZDdailychartisnotanidealbearishbigshadowbecausetheclosingpriceisnotnearthelowofthecandlestick.Thistradeendsupaloser.Themarketpusheslowerthanthelowofthebigshadowtotriggerthetrade,butthreecandlestickslaterthemarkettakesoutthestoploss.
©2000–2011,MetaQuotesSoftwareCorp.
ROOMTOTHELEFT
Would you like to find thetrade that captures a criticalturning point in the market?You're probably like mosttraders: You would like tomakea trade thatcatches themarketjustasitstartstoturnaround and never returns totheturningpoint.
If you study these criticalturning points in the market,youwillnoticeonething:Allthese turning points have asimilarlook.Thepriceactionat these turning points is,generallyspeaking,extendingbeyondwherethemarkethasbeen trading prior to theturning point. These turningpoints are typicallyexhaustion turning points,that is, places where the
markethasjustgonetoofar.There is a far simpler way
of characterizing theseturning points in the market.These turningpointscome intwo flavors: all-time highs,where the market trades at avery high price, beforefalling,andneverreturningtothat high, and all-time lows,placeswhere themarket fallsmuchlowerthanmostmarketparticipants had anticipated,
and thenrockethigher,nevertoreturntothedepthsofthatlow. Traders around theworld stare at these spots onthe chart, wishing that theyhad entered a trade at theseprecise prices, to capture awindfallprofit.There is something that all
these turning points have incommon.Thesecriticalpricesare usually stabbed by themarket—an exploratory stab,
a probe into no man's land.Look to the left of theseturning points, and you willfindacommontheme.Nearlyalltheseall-timelowsandall-time highs have one thing incommon: There is no priceaction to the left. Go aheadand take a look right now.Pull up your chart and see ifyoucanfindanypriceactionto the leftof theverycriticalall-time highs and all-time
lows. Obviously, bydefinitionyouwillnot findalower price than an all-timelow,andneitherwillyoufindahigherpricethananall-timehigh. What you will find isthat the price patterns are allalone. To the left of thesepatterns is wide-open space.Haveyounoticedthisonyourcharts?Youdonothaveto lookto
all-time highs and all-time
lows;youcansimply look tocritical turning points—placeswherethemarketdoesnot return to for years. Thespots will also have thischaracteristic: The marketdoes not return to thoseplacesonthechartwherethemarketrarelytrades.So,ifwelook to take our reversal set-upsatthosespotsonthechartwhere the market has nottraded in some time, we are
puttingtheoddsinourfavor.The easiest way to
conceptualize this idea is tolook to the left of your pricepattern. Ifyouseewide-openspace on the chart to the leftofyourcatalysts,youmaybelooking at a critical turningpoint(seeFigure6.9),agreatopportunity for you toparticipate in a long-lasting,profitable trade. The generalruleisthis:Themoreroomto
the left, the more likely thisspot is a long-term high orlong-termlow.
Figure6.9TheEUR/USDweeklychartprintsabearishbigshadow.Theformationhasmuch“roomtotheleft”—themarkethasnottradedatthiszoneinover74weeks.Afterthisbig-shadowformationprinted,themarkedspentover22weeksawayfromthisprice.
©2000–2011,MetaQuotesSoftwareCorp.
Sometimes the market willprintabigshadowonazone
thathas recently seenmarketactivity. For example, inFigure 6.10 we see theGBP/JPYweeklychartprintsa bearish big shadow.Because the market has notprintedonthiszoneforsevenweeks,thereissomespacetothe left of the bearish bigshadow.Althoughitwouldbebetter if the market had notprintedonthiszonefor20or30 candlesticks, the fact that
themarkethasnotprintedonthis zone for sevencandlesticks is perfectlyreasonable,andthusthistradequalifies as having “room totheleft.”
Figure6.10TheGBP/JPYweeklychartprintsabearishbigshadowwith“roomtotheleft.”Themarkethasnotprintedonthiszoneforsevenweeks,givingthisbigshadowsomereasonable“roomtothe
left.”©2000–2011,MetaQuotesSoftwareCorp.
When choosing a big-shadow trade, or any otherreversaltrade,looktotheleftof the catalyst. If you seeopen space to the left, thenperhaps the set-up willcapture a critical turningpointinthemarket.However,ifyoulooktothe
left and you see recent priceaction at the same level,perhaps the market has notreached theexhaustion stage.
Figure 6.11 illustrates abearish big shadow on theGBP/USD four-hour chartwithvirtuallyno room to theleft. These set-ups are rarelyidealbig-shadowtrades.Mostnaked traders will onlyconsider taking a reversaltrade if the market has notprinted on the zone for atleast seven candlesticks.Reversalsetupswithroomtothe left usually have a much
highersuccessratethanthosethat print in an area on thechartwithrecentpriceaction.
Figure6.11AbigshadowsuchasthisoneontheGBP/USDfour-hourcharthasprintedonazonewithalotofrecentpriceaction.Perhapsthemarkethasnotreachedaturningpointyet.©2000–2011,MetaQuotesSoftwareCorp.
An easy way to visualizethis“roomto the left” rule isto draw a rectangle on your
chartthatcapturestheareaofthechartthatisuniquetothetwo-candlestick big-shadowformation and extend thisrectangleasfaraspossibletotheleft.
TWO-CANDLESTICKFORMATIONApricepatternmadeupoftwo candlesticks. The
definition and validity ofthe price pattern isdependent uponcharacteristics of bothcandlesticks.
It is important to note thatthebig-shadowformationisatwo-bar formation. Thismeans that any unique spaceoccupiedbythiscatalystmaybe occupied by bothcandlesticks. Contrast this toother catalysts such as the
kangarootail(Chapter8)andthe big belt (Chapter 9)—these single candlestickformations mayindependently occupy uniquespace on the chart.Remember, the further thisrectangle extends beforerunning into othercandlesticks, the better. Thevery best big shadows willprint at an area on the chartwhere the market has not
recentlytraded.Takealookattheone-hour
CAD/JPY chart in Figure6.12.Youcanseethemarkethasprintedthebigshadowonan area on the chart that hasnotseenrecentpriceactioninavery long time.Thebox tothe left of the big shadowrepresentsallofthe“roomtothe left” for this tradeset-up.The market moved 200 pipshigheraftertriggeringthebuy
stop on this bullish bigshadow.
Figure6.12Waitingforbigshadowswithspacetotheleft,suchasthisbullishbigshadowontheCAD/JPYone-hourchartwillaidyouinpickinghigh-probabilityreversaltrades.©2000–2011,MetaQuotesSoftwareCorp.
PROFITING
FROMBIGSHADOWS
There are many methods forexiting the big-shadow trade,many of these methods areexplored in Chapter 11. Avery simple method forexiting the big shadow is tosimply place a take-profittargetatthenearestzone.Forbullish big shadows thiswould mean placing a profit
target a few pips below thenearest resistance zone, andfor bearish big shadows thatwould mean placing a profittarget a few pips above thenearest support zone (seeFigure6.13).
Figure6.13Thenearestzonemakesforaveryclearprofittarget.ThebearishbigshadowontheEUR/USDfour-hourchartisanexcellentsellsignal.Themarketfalls
171pipsdowntothenextzoneat1.3200.©2000–2011,MetaQuotesSoftwareCorp.
THERULES
Thebig-shadowtrade iseasyto identify, and it oftensignalsacriticalturningpointin the market. Here are therules associated with the bigshadowtrade:
Big shadows aretwo-candlestickformations.The secondcandlestick of theformationisthebig-shadowcandlestick.
The big-shadowcandlestick has ahigher high and alower low than thepreviouscandlestick.Big shadows mustprintonthezones.Bigshadowsprintatextreme highs orextremelows.Bearish big-shadowcandlesticks have a
closing price nearthelow.Bullish big-shadowcandlesticks have aclosing price nearthehigh.Big-shadowcandlesticks havewider ranges thanthe nearbycandlesticks.For bullish bigshadows, the stop
loss is placed a fewpips below the lowof the big-shadowcandlestick.For bearish bigshadows, the stoploss is placed a fewpips above the highof the big-shadowcandlestick.The very best big-shadow candlestickshave room to the
left.There are also several
optimal characteristics thatthe best big shadows share;thesefeaturesinclude:
The two-candlestickformation prints atan extreme high orlow on the chartwhere the markethas not traded in atleast sevencandlesticks.
The big-shadowcandlestick has agreater range thanthe previous 10candlesticks.For bullish bigshadows, thecandlestickfollowingthebullishbig shadow triggersthe buy stop orderplaced above thehigh of the big-
shadowcandlestick.For bearish bigshadows, thecandlestickfollowing thebearish big shadowtriggersthesellstoporder placed belowthe low of the big-shadowcandlestick.For bullish bigshadows,theclosingprice for the big-
shadow candlestickiswithin a fewpipsofthehigh.For bearish bigshadows,theclosingprice for the big-shadow candlestickiswithin a fewpipsofthelow.
Many traders do extremelywell trading only the big-shadow trade. If you wouldliketobecomeanexpertwith
this trading system, spendtimetestingitsothatyougetcomfortable trading bigshadows.Ifyouwouldliketofollow along with live big-shadow trades, go towww.fxjake.com/book.
CHAPTER7
WammiesandMoolahs
It's like déjà-vu, all overagain.
—YogiBerraThe market moves up, the
market moves down. If youare a naked trader, you willprobablynotethattheturningpoints in themarketcoincidewith the support andresistance zones. Theseturningpointsarerarelysharpand quick and are, instead,often rather slow to unfold.(Thereareobviousexceptionssuchasbigshadows,coveredin Chapter 6, kangaroo tails,which are examined in
Chapter 8, and big beltsexplained in Chapter 9.) Themarketusuallypreferstohitazone several times beforemovingawayfromthatzone.Wammies and moolahs takeadvantageofthistendencyinthemarkets.There are five steps to
understanding wammies andmoolahs. Each of these stepsiscoveredinthischapter.Bythe end of the chapter you
will understand the theorybehind these two trading set-ups, and you will knowpreciselyhowtotradethem.First, the basic double-
bottom and basic double-topformations are defined.Second, you will learn thecritical characteristics uniqueto wammies, which are aspecial case of the double-bottom formation.Third,youwill learn all about the
moolah, a special caseof thedouble-topformation.Fourth,youwillseemarketexamplesof both wammies andmoolahs so you may clearlyunderstand the idiosyncrasiesunique to these formations.Fifth, you will see what anoptimal wammie or moolahtradelookslike.Bytheendofthis chapter, youwill have aclear understanding of bothtrade set-ups, which are
invaluable for the nakedtrader who is interested infinding important turningpointsonthecharts.Before you jump into the
world of wammies andmoolahs, it is important tounderstand both the double-bottom and the double-topformations.
THEDOUBLE
BOTTOMThe double bottom is aclassic formation known tomany technical analysts. Thedoublebottomiswellknownbecause it occurs quitefrequently in the markets.Take a look at the chart foranymarketandyouwill findmanyexamplesofthedoublebottom; these are places onthe chart where the market
touches a zone from aboveand finds significant supportafterbothtouches.
DOUBLEBOTTOM
A price patterncharacterized by twotouches from above on azone. The market falls tofind support on a zonefollowed by a rally higherand then the market againfalls to find support on the
same zone. After thissecond touch of the zone,themarket begins a steadyclimbhigher.
Many critical marketturnaroundsbeginasadoublebottom. A double bottomoccurs when the marketmoves downward for sometime, the market reaches asignificant support andresistance zone, the marketpauses at this zone and then
turnsaround tobegin tradinghigher.Themarketeventuallystalls and starts to movedownward again untilreaching thezoneonceagainand finding support on thezone.Onceagain, themarketstarts to trade higher andcontinues trading higher forsome time. This is thetraditionaldoublebottom.Take a look at Figure 7.1;
this is a typical double-
bottom formation. Noticehow the market reaches azone twice and each time itturns around and starts tradehigher. It is only after thesecondtouchofthezonethatthe market starts a newuptrend. This is the definingfeature of the double bottom—the market begins a newuptrend after finding supportwith the second touch of thezone.
Figure7.1ThedoublebottomisindicatedonthisdailyGBP/CHFchartbythemarkettouchingthezone,tradinghigher,andthentouchingthezoneagain.©2000–2011,MetaQuotesSoftwareCorp.
This GBP/CHF daily chartin Figure 7.1 is a typicaldouble bottom. After trading
lower and lower for sometime, the market touches thecriticalzoneat1.5890beforetrading higher for a shortperiod of time, the marketonce again falls down andfinds support on the 1.5890zone and bounces higher.After the second touch, themarketbeginsanewuptrend.This double-bottom
formation is reliable; undermost circumstances, if the
market falls down to animportant zone and findssupport on the zone twice, itwillbelikelytotradehigher.These double bottomformations are prevalentacross markets, much moreubiquitous than the “singlebottom.” A single bottom is,of course, a single touch (ofsupport) on an importantzone. Although the singlebottomdoesoccur from time
to time (single bottomssometimesprintasbullishbigshadows, bullish big belts,and bullish kangaroo tails),the double bottom is muchmorecommoninthemarkets.The market will usually falldown to the zone to test ittwice before turning aroundandmarchingupward.Figure 7.2 illustrates
anotherdoublebottomontheUSD/CADdailychart.Notice
howeachtouchonthe1.5105zone is distinct. The marketfallsdown, touches thezone,andthenbrieflytradeshigherbefore falling down onceagain to find support on thevery same zone. This is thedefining characteristic of thedouble bottom: There is abrief interlude between eachtouch.
Figure7.2Thestandarddouble-bottomformationis
createdwhenthemarketfindssupporttwiceinquicksuccession.TheUSD/CADformsadoublebottomonthedailychartwhenthemarketfallstwiceto1.5105tofindsupport.©2000–2011,MetaQuotesSoftwareCorp.
The USD/CAD traded 715pips higher after the doublebottomonthedailychart(see
Figure 7.2). This is the kindof move traders dream ofcapturing. However, not alldouble bottoms will yield agiantpileofpipssuchasthisone. Some double bottomsendupaslosingtrades.In Figure 7.3, the
EUR/GBP makes a doublebottomat0.8800onthedailychart. The market tradeshigherafter the second touchon the zone at 0.8800, a
classic double-bottomformation.
Figure7.3Adouble-bottomformsontheEUR/GBPdailychart.Themarkettwicebouncesoffthezoneat0.8800.©2000–2011,MetaQuotesSoftwareCorp.
Soonafterthesecondtouchat 0.8800 zone, the moveupwards stalls, and the
market falls through the0.8800 zone, as shown inFigure 7.4. This trade wouldhave been a loser for manytraderslookingtofindprofitson this classicdouble-bottomformation.
Figure7.4Themarkettradesashighasthe0.9020areabeforefallingbackdown.ThisclassicdoublebottomontheEUR/GBPdailychartwouldhaveendedupasa
loserformanytraders.©2000–2011,MetaQuotesSoftwareCorp.
This is the problem with
double bottoms, while manyof them identify excellenttradingopportunities,someofthem are losing trades.Perhaps you have traded thisformation in the past andhave experienced somewinning double bottoms andsome losing double bottoms.You may have decided thatthe double bottom is not areliable trading formation. Ifyou have dismissed the
double bottom, please waituntil you learn about thewammie trade, because youmay find that there is stillhope for the double-bottomtrade, or at least for a veryspecific type of the doublebottom.Nextupisthedoubletop, the mirror image of thedouble-bottomformation.
THEDOUBLE
TOPThe double bottom has asister formation, the doubletop.
DOUBLETOP
A price patterncharacterized by twotouches from below on azone. The market rises uptofindresistanceonazonefollowedbyafallandthen
the market again rises tofindresistanceon thesamezone. After this secondtouch of the zone themarket begins a steadymovelower.
The standard double toplooks like thechart inFigure7.5:Themarkettradeshigherfor some time before findingresistance on a zone. Themarket briefly trades lowerbefore once again rising up
and finding resistance on thezone, and then the marketbegins to trade lower andlower.Thedefiningfeatureofthe double top is that themarket begins a newdowntrend after the secondtouchofthezone.
Figure7.5Thestandarddouble-topformationiscreatedwhenthemarketfindsresistancetwiceinquicksuccession.TheUSD/CHF
formsadoubletoponthefour-hourchartwhenthemarkettradesupto0.8500twicetofindresistance.©2000–2011,MetaQuotesSoftwareCorp.
Doublebottomsarereversalformations, and they aremuch more common than
other reversals, such as thebig belt or kangaroo tail.Markets love to touch zonestwice before turning aroundand moving in the oppositedirection. This is why thedouble top has becomewell-known in the tradingcommunity over the years. Itisaclassicchartformation.The problem with this
classicchartformationisthis:It often fails.The double top
will often print on the chartsand then completely fallapart. Some double topssimply do not behave. Thedouble top in Figure 7.6 is aclassic example of a doubletop gone bad. Some doubletopssimplylose.
Figure7.6TheUSD/CADfour-hourchartprintsaclassicdouble-topformation.Themarketdoesfallafterthesecondtouchatthe1.0450
zone,butsoonafterthemarkettradeshigherandhigher.©2000–2011,MetaQuotesSoftwareCorp.
Perhaps it is possible totrade a classic double-topformation,eventhoughmany
double tops endup as losers.Mighttherebecharacteristicsthat winning double topsshare? Is there a way todiscriminate those doubletopswhicharemorelikelytofail from those double topswhicharemorelikelytofindpips?The moolah trade is a
specific type of double-topformation. A closeexamination of the definition
ofthemoolahwillenablethenaked trader to decidewhether this specific type ofdouble-top formation mayimprove on the success rateof the classic double-toptrade.
IDENTIFYINGWAMMIES
AND
MOOLAHSWammiesandmoolahsoccuron any timeframe, in anymarket, so thesecatalystsaresimilar to most of the othernaked tradingpatterns in thisbook.Wammiesandmoolahsare unique versions of thedoublebottomanddouble-topformations, respectively.Youwill learn how to filter outsubpar double-bottom and
double-top trades.Concentrating on only thosedouble bottoms and doubletops with optimal tradecharacteristics (such aswammies and moolahs) willallowyoutotradeonlythosedouble bottom and doubletops that offer the highprobabilityofapayoff.Wammiesandmoolahsalso
fit into the general categoryof reversal patterns. Naked
traders who enjoy enteringtradesatturningpointsinthemarket will find wammiesand moolahs particularlyinterestinganduseful.Beforewe jump into these pricepatterns, it may be useful tolist several important markettruths. We will incorporatethese seven market truthswhen we look at tradingwammiesandmoolahs.
1. If themarket touchesa
zone twice in succession,it will often move awayfromthezone.2.Twotouchesonazonefrom above suggests amarketbottom.3.Whenthemarketmakeshigher lows, it will oftencontinueupward.4.Twotouchesonazonefrom below suggests amarkettop.5.Whenthemarketmakes
lower highs, it will oftencontinuedownward.6.Abullishcandlestickona support zone suggeststhe market will tradehigher.7. A bearish candlestickon a resistance zonesuggests the market willtradelower.
Wammies andmoolahs arebased on these marketobservations. If you agree
with these marketobservations, then you mayenjoy trading wammies andmoolahs.
HOWTOTRADE
WAMMIESAs a naked trader, you getpaid to observe market
patterns,testthesepatternstovalidate their usefulness, andthen execute trades based onthese patterns. These nakedtrading patterns occur overand over again, in manymarkets, on manytimeframes. Wammies are aspecificsubsetofthedouble-bottomformation.Just like the standard
double bottom, the wammieformation includes two
touches on the zone,suggesting that the marketfinds support on the zone.The market will drift higherbetweenthefirsttouchonthezoneandthesecondtouchonthezone.Thewammiediffersfrom the standard doublebottom because the depth ofthe touches on the zone iscritical.Awammieformationis identified by a secondtouch that is higher than the
first touch on the zone. Inother words, a wammie isdefined by a higher low.Recall that a higher low isone way to determine if themarket is in an uptrend, thiswas one of the sevenmarkettruths. This subtle differencebetween a wammie and astandard double bottom mayseeminsignificant,but this isa critical characteristic of themarket'sturningpoints.
In Figure 7.7 we see anexample of a wammie trade.The AUD/USD four-hourchartprintstwotouchesinthe1.0560 zone. The secondtouch on the zone is higherthanthefirstby34pips.
Figure7.7TheAUD/USDfour-hourchartprintsawammieinthe1.0560zone.Noticethesecondtouchishigherthanthefirst.Themarkettraded456pipshigher
afterthissecondtouch.©2000–2011,MetaQuotesSoftwareCorp.
The entry strategy for the
wammie is as follows: Oncethe market prints a strongbullish candlestick on thesecond touch, a buy stop isplacedabove thehighof thiscandlestick.Usingabuystopensures that the trade willonly be triggered if themarket tradeshigher than thebullish candlestick. In Figure7.8, the market prints abullish candlestick on thesecond touch of the 1.0560
zone.Thebuystopisplacedafew pips above the high ofthe bullish candlestick. Oncethemarket tradeshigher thanthe bullish candlestick, thetradeistriggered.
Figure7.8TheAUD/USDfour-hourwammietradeistriggeredoncethemarkettradeshigherthanthebullishcandlestickonthesecondtouch.©2000–2011,MetaQuotesSoftware
Corp.
The stop loss for thewammie trade is placedbelow the low of the first
touch (see Figure 7.9).Placing the stop loss hereensures that if the market isbeginninganewuptrend, thestop loss will not betriggered. If the market ismovinghigheritwillnottakeout the lowest low of thewammieformation.
Figure7.9Thestoplossforthewammietradeisafewpipsbelowthefirsttouchonthezone.Ifthemarketbegins
anewuptrend,thestoplosswillnotbehit.©2000–2011,MetaQuotesSoftwareCorp.
Wammie trades aredesigned to capture strongtrends. There are severalcluesprovidedby themarketwhen awammie tradeprints.First, the market has twicefound support on a criticalzone.Second, themarkethasmadeahigher low.This is acritical characteristic of thewammie, because it suggeststhedownsidemomentummaybe dying out. Third, the
market has printed a strongbullish candlestick on thezone and the market hastraded higher than thisbullish candlestick, a stronghint that the market may beready to trade higher. Takenindividually, each wammiecharacteristic is indicative ofa market likely to tradehigher, but collectively thesecharacteristics suggest amarketreadytotakeoff.
Takea lookatFigure7.10.Thisisanotherwammietradeon theGBP/USDdailychart.Theimportantfeaturesofthistrade are marked with thenumbers1,2,and3.At1,thebuystopisplacedafewpipsabove the first bullishcandlestick after the secondtouch on the 1.9400 zone.Notice that the previouscandlestick is not a bullishcandlestick, because this
candlestick closed near themidpoint.Thisiswhythebuystop isplacedabove thenextcandlestick, the firstcandlestickwith a close nearthehighofthecandlestick.At2, the stop loss is placed afewpipsbelowthefirsttouchon the 1.9400 zone. Placingthe stop loss here improvesthechancesthatthetrademaysurvive another touch of thezone. At 3, the market falls
back down and touches thezoneonce again.Notice herehow the trade survives thisthird touch on the zonebecause the stop loss isplaced below the first touch.This third touch on the zonewill occur after somewammie trades, so it isimportant to place the stoploss below the lowest (first)touch. If the stop loss isbeneaththesecondtouch,this
trade would have been alosing trade.With thecorrectstop-lossplacement,thetradesurvives this third touch andcollects716pips.
Figure7.10TheGBP/USDdailychartprintsawammietradeset-up.1.Thebuystopisplacedafewpipsabovethefirstbullishcandlestickafterthesecondtouch.2.Thestoplossisplacedafewpipsbelowthefirsttouch.3.The
marketunexpectedlyfallsbackdownandtouchesthezoneagain,butthestoplossisnottriggeredandthemarketsoonaccelerates716pipshigher.©2000–2011,MetaQuotesSoftwareCorp.
The simplest way to profitfrom the wammie trade is tosimplyplaceaprofittargetat
the nearest zone. Morecomplex exit strategies arecoveredinChapter11,butfornow it is important to notethat taking profit at the nextzoneisagreatwaytomanageexitswiththewammie.In Figure 7.11 we see
another wammie on a dailychart, this time it is theAUD/JPY. There are fiveimportant tradecharacteristics, each of them
marked in Figure 7.11. At 1themarket first finds supportonthe75.00zonewithanicebullish candlestick; the closeof the candlestick is up nearthe high. At 2, the secondtouch is a few pips higherthan the first touch, whichqualifies this double bottomas a wammie. At 3, the buystop is placed a few pipsabove the second bullishcandlestick after the second
touch. Notice that there areseveral candlesticks after thesecond touch, but the buystop is placed above the firstbullish candlestick with aclosingpricenearthehighofthe candlestick. Only thesecond bullish candlestickafter the second touchqualifies as a valid wammieentry candlestick. Thewammie buy stop should beplaced a few pips above the
first strong bullishcandlestick. At 4, the stoploss is placed a few pipsbelow the first touch for atotal risk of 150 pips. At 5,themarketachievestheprofittarget at the next zone at78.20foratotalof235pips.
Figure7.11TheAUD/JPYwammietradeonthedailycharthasallofthetypicalwammietradecharacteristics.©2000-2011,MetaQuotesSoftware
Corp.
One final note about thewammietrade:Itisimportant
to only take those wammietrades that touch the zoneonce, move away from thezone,andthentouchthezoneagain.Movingawayfromthezone after the first touch iscritical, and this iswhy thereis a rule for the number ofcandlesticks between the twotouches. A wammie trade isonlyvalidifthereareatleastsix candlesticks between thefirst and second touches. If
there are fewer than sixcandlesticks, it is likely thatthemarketmaybegearingupfor a push beyond the zone.This is because breakoutsoften occur when themarketrepeatedly touches the zonein quick succession. Take alook at the charts, you willprobably notice that manybreakouts occur after themarket repeatedly touches azone (see Figure 7.12 for an
excellentexampleofthis).
Figure7.12Therearemultipletouchesonthe0.9400zoneontheUSD/CHFfour-hourchart.Thisisahintthatthemarketislikelytopushthroughthezone.©2000--2011,MetaQuotesSoftwareCorp.
The very best wammieswill not have very quicktouches on the zone, but
rather the market will touchthezone,starttotradehigherfor some time, and then fallbackdown to touch the zoneagain. Be wary of wammieswith quick touches on thezone,as thismaysuggest themarket is going to pushthrough the zone in theimmediatefuture.The wammie trade is a
simple but powerful trade.Nowgobackandtakealook
at the charts in the doublebottom section of thischapter. Do you noticeanything about the twodouble-bottom trades?Compare the double bottominFigures 7.1 and 7.2 to thedoublebottom inFigures 7.3and 7.4.What do you noticeabout those trades?Formoreon these set-ups and otherlive wammie trades, go towww.fxjake.com/book.
WammieCharacteristics
Thesearethesevenimportantcharacteristicsofthewammiepattern.
1.Themarkettouchesthesupportzonetwice.2. The second touch ishigherthanthefirsttouch.3. There are at least sixcandlesticks betweentouches.
4. The market prints abullish candlestick on thesecondtouch.5. The trade is enteredwithabuystopafewpipsabove the bullishcandlestick.6.The stop loss is placeda fewpipsbelow the first(lower)touch.7. The profit target is thenext zone above thewammie.
HOWTOTRADE
MOOLAHSNow you understand thewammietrade,itwillbeveryeasy for you to understandhow to apply the sameprinciples to the moolahstrategy. The moolah issimply thewammie tradebutin reverse. So, where the
wammie is a special case ofthe double bottom, themoolah is a special case ofthe double top. Like thewammie, the moolah hasseveralcharacteristicsthatarecriticaltotheidentificationofthe moolah set-up. Also, themoolah has specific rules formanaging the stop lossandasellstopentryforthistrade.The moolah is simply a
double top on an important
support-and-resistance zone.See Figure 7.13 for anexample of themoolah tradeon the daily USD/JPY chart.The importantaspectsof thistrade are marked withnumbersinFigure7.13.At1,the market makes the firsttouchonthe119.75zoneandthensoon falls lower.This isalso where the stop loss isplaced,afewpipsbeyondthefirst touch at 1 on the chart.
Themarkettradeslower,thenmakesanotherrunhigherandtouches the119.75zone, thistime lower than the firsttouch,atthespotmarked2inFigure7.13.Noticethattherearemorethansixcandlesticksbetween the candlestick thatfirsttouchesthezoneandthecandlestick that touches thezone again at 2 on the chart.At3, thesellstopisplacedafewpipsbelowthelowofthe
first bearish candlestick afterthesecondtouch.Themarkettriggers this sell stop on thenext candlestick and falls tothe first zone at 118.15, butbecause this zone is only 67pips lower than the entryprice(andthestoplossis108pipsfromtheentryprice),thetradeisheldallthewaydowntothenextzoneat117.50,at4on thechart, for anoverallprofitof133pips.
Figure7.13MoolahtradeontheUSD/JPYdailychart.Theimportantcharacteristicsofthistradearemarkedwithnumbers1through4.©2000–2011,MetaQuotesSoftwareCorp.
The moolah trade is asimplebutpowerfultrade,therules are simply the same as
for the wammie trade, butreversed for double tops.Take a look at the charts inthedouble topsectionof thischapter. Do you noticeanything about the twodouble-top set-ups?Comparethedouble top inFigures 7.5and 7.6.What do you noticeaboutthosetradeset-ups?Fora video about these specifictradeset-upsandlivemoolahtrades, go to
www.fxjake.com/book.
MoolahCharacteristics
Thesearethesevenimportantcharacteristics of the moolahpattern.
1.Themarkettouchestheresistancezonetwice.2. The second touch islowerthanthefirsttouch.3. There are at least six
candlesticks betweentouches.4. The market prints abearish candlestick afterthesecondtouch.5. The trade is enteredwithasellstopafewpipsbelow the bearishcandlestick.6.The stop loss is placeda fewpips above the first(higher)touch.7. The profit target is the
next zone below themoolah.
TIPSFORWAMMIES
ANDMOOLAHS
It may be tempting to takeevery wammie and moolahthat appears on your charts,
butitisimportanttonotethatsome wammies and moolahsare better than others. If youwant to pick only the verybest wammies and moolahs,trytodothefollowing:
Choose the set-upswith manycandlesticksbetween touches.Six candlesticksbetween touches isnice to see, but 20
candlesticksbetween touches isbetter.Take trades withcatalysts on thesecond touch. If thesecond touch is abig shadow or akangaroo tail, theodds are probablystrongly in yourfavor.Picktradesthathave
a second touchmuch further fromthe zone. Figure7.13 is a greatexampleofthistypeoftrade.Thesecondtouch is a full 22pips lower than thefirst touch,suggesting that themarket is runningoutofsteam.Only choose
wammies andmoolahs that are instrong, well-definedzones.If thezoneisnot an importantone,thenthemarketmay only tradeaway from the zonebriefly beforebreakingbeyondthezone.Find set-ups thathaveveryfewzones
nearby. This willenable you to placea profit target veryfar from the entryprice and maximizeprofits.Trade thosewammies andmoolahs that have“room to the left.”This idea iscoveredin the kangaroo tailchapter (Chapter 6).
Major reversalsoftenoccuratplaceson the chart withvery little priceaction to the left ofthetradeset-up.
CHAPTER8
KangarooTails
Whenever you find thatyouareonthesideofthemajority, it is time toreform.
—MarkTwain
The kangaroo tail is anextremely powerful catalyst.It is an obvious clue to thenaked trader that the markethas gone too far. There aremany traders around theworld who simply trade thisone simple yet powerfultradingsetup.
WHATISA
KANGAROOTAIL?
A kangaroo tail is a distinctprice pattern. It is onecandlestick that is easy tospot. Once you becomefamiliarwiththiscatalystyouwillseethemeverywhereandoften at reversal points.Kangarootailsmayprintbuysignals—bullish kangarootails---and bearish kangaroo
tails, which are sell signals.The kangaroo tail has twoparts: thekangaroobodyandthe kangaroo tail. Allkangaroo tails are single-candlestickformations.
SINGLE-CANDLESTICKFORMATIONApricepatternmadeupofa single candlestick. The
definition and validity ofthe price pattern isdependent oncharacteristics of thecandlestick relative to thesurroundingcandlesticks.
Ideally, thekangarootail ismuchlongerthanthebodyofthe kangaroo. The bestkangarootailshaveverylongtailssuchasthekangarootailin Figure 8.1. The long tailsuggests that the market has
extended too far into a zoneandislikelytoreverse.Thereare other characteristicsunique to the kangaroo tail,and all kangaroo tails mustmaintain all thesecharacteristics. If you see aprice pattern that does notinclude all thesecharacteristics, it may be avery interestingpricepattern,but itwill not be a kangarootail.
Figure8.1ThiskangarootailontheAUD/USDdailychartisanidealkangarootailbecausethetailismuchlongerthanthebody.©2000–2011,MetaQuotesSoftwareCorp.
THEOPEN
ANDCLOSEAll kangaroo tails have anopen and close near theextreme end of thecandlestick. For bearishkangaroo tails (sell signals),the open and close of thecandlestick should be in thebottom third of thecandlestick (see Figure 8.2).Iftheopenorthecloseisnotin the bottom third of the
candle, it is not a kangarootail.Thereisasimilarruleforbullish kangaroo tails: Thesebuy signals must have theopenand theclose in the topthird of the candlestick (seeFigure8.3).Iftheopenorthecloseisnotinthetopthirdofthe candle, it is not akangarootail.
Figure8.2ThisisavalidbearishkangarootailontheAUD/USDone-hourchart
becausetheopenandthecloseofthekangarootailarebothinthebottomthirdofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Figure8.3ThisisavalidbullishkangarootailontheEUR/GBPweeklychart
becausetheopenandthecloseofthekangarootailarebothinthetopthirdofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.
The open and the close ofthe kangaroo tail should benear the extreme end of the
candlestick.Thekangarootailis a reversal signal, so whenwe see a long tail on akangaroo tail, and the openandcloseofthekangarootailare at the extreme oppositeend,weknowthatthemarkethas moved too far. Thekangarootailisacluethatthemarket has extended beyonda zone, perhaps a bit too farbeyond the zone. Mostkangaroo tailswillprintafter
surprisingnews;forexample,kangaroo tails printed in theforex market during thetsunami in Japan in 2011.Kangarootailsalsoprintedinthe forex market during theglobal financial crisis in2008. Kangaroo tails do notonly print during extremelysurprising news. However,they will often appear whenthemarkets get very excited,and this isoftendue to some
extremely unusual events intheworld.
KANGAROOTAILSARE
LONGMost kangaroo tails arelonger candles. This meansthat thekangaroo tailwill bea bit longer than the
surrounding candlesticks.Longerkangaroo tailshaveatiny body and a long tail.Take a look at the kangarootailontheUSD/CHFmonthlychart inFigure8.4.The longtail is ideal. The bestkangaroo tailswillhaveverylong tails and very shortbodies.
Figure8.4ThisisanicebullishkangarootailontheUSD/CHFmonthlychartwith
averysmallbodyandaverylongtail.©2000–2011,MetaQuotesSoftwareCorp.
Why is it important for akangaroo tail to have a longtail?Alongtailsuggests thatthemarkethasgoneabit toofar when testing a zone,whereas a short tail maysuggest that the marketsimply brushed up against azone. Remember, as a nakedtrader, you want to look fortrade opportunities on zones.Zones,asyourecall,arethosespots on the chart where the
marketrepeatedlyreverses.Akangaroo tail is a valuableclue, a particularly valuablecluewhenitoccursonazone.Thekangarootailwithaverylong tail suggests themarkethasbecomeextremelyexcitedbefore reversing sharply. So,akangarootailonazoneisahigh-probability reversalcandle at a spot on the chartwhere the market hashistoricallyreversedtimeand
timeagain.Here you see how this
kangaroo tail penetratedthrough the zone, suggestingthat the market became veryexcited when pushing pricethrough the zone, and thenretreated for the close of thekangaroo tail (Figure 8.5).This is a common kangaroo-tailformation.Mostkangarootails will push through thezoneandthencomebackand
closeon theothersideof thezone.
Figure8.5Kangarootailsoftenpenetrateazonebeforeclosingontheothersideofthezone.ThisbullishkangarootailontheGBP/JPYdailychartpenetratesthesupportzonebeforeclosingbackabovethezoneat167.00.©2000–2011,MetaQuotesSoftwareCorp.
The kangaroo tail is acatalyst that suggests themarket has gone too far, and
has quickly reversed course.Recall that zones are thosespots on the chart where themarket has reversedrepeatedly. Therefore, akangaroo tail on a zone is areversal candle on a reversalzone. It is important toremember that as a nakedtrader you are using pricepatterns that are clues---hintsabout where the market maybe headed. By trading these
price patterns only on thosespots on the chart where themarket has repeatedlyreversed,theoddsareinyourfavor.Kangaroo tails exhibit
extreme market behavior.Kangaroo tails often pushthrough a zone briefly (seeFigure 8.5) before returningtotheothersideofthezone.This is typical of the
kangaroo-tail formation, and
it is good to see. It is a signthat themarkethastestedthezone and rejected this level.Exceptionally long-tailedkangaroo tails arewonderful,as they suggest that themarket,afterpushingthroughthe zone, has gone too far,and then settles back on thezone.Very small tails on
kangarootailsarenotideal.Asmall tail suggests that the
market may come back andtest thezoneonceagain.TheUSD/CAD daily chart inFigure 8.6 is an excellentexample of what oftenhappens after small-tailedkangarootailprints.
Figure8.6ThisbullishkangarootailontheUSD/CADdailycharthasaveryshorttail.Noticehowthemarketcamebackdownafterthekangarootailtotest
the1.0450zone.©2000–2011,MetaQuotesSoftwareCorp.
The long-tailed kangaroo
tails are often better tradesignals than the very smallkangaroo tails.The long tailssuggest that the market hasmadeagoodtestofthezone,and then, the zone rejects it.(SeeFigure8.7).
Figure8.7ThekangarootailontheAUD/USDfour-hourchartisexceptionallylong.Thissuggeststhat,althoughthemarkethaspushedthroughthe1.0000zone,it
hasbeenstronglyrejectedbythe1.0000zone.Themarketmovesover600pipshigherafterthekangarootail.©2000–2011,MetaQuotesSoftwareCorp.
When the market prints along-tailed kangaroo tail, thesuggestion is that themarket
hasgonetoofar.Eventhoughthe market went through thesupport and resistance zone,in the end, themarket closedon top of the zone.This is ahint—averystronghint—thatthe zone will likely hold themarket.A smaller tail on thekangarootaildoesnotinspireasmuch confidence, becauseahalf-heartedtestofthezonesuggests that themarketmaydecide to come back for a
good test of the zone again.Also, during runawaymarkets, kangaroo tails mayprint, but smaller kangarootails are often simply weakpauses in the market (seeFigure 8.8 and Figure 8.9).They often have very smalltailsandwillprintinbetweensignificant zones; in otherwords they are not reliablesignals.
Figure8.8TheGBP/CHF
four-hourchartisinaverystrongdowntrend.Noticethesmall-tailedkangarootailinbetweenthezones.Thisisnotareliablekangarootailtrade.©2000–2011,MetaQuotesSoftwareCorp.
Figure8.9OntheEUR/USDdailychartabearishkangarootailprintsinthemidstofa
stronguptrend.Alongertailonthiskangarootailwouldhavebeenabettersellsignal.©2000–2011,MetaQuotesSoftwareCorp.
KANGAROO
TAILPLACEMENT
Kangarootailsshouldbenearthe previous candle. If akangaroo tail is too far fromrecent price action, it maysuggest a “runaway” market,suggesting the market is notready to reverse.Oneway toquantify whether a kangarootailisnearrecentpriceactionis to look at the open and
close relative to the nearestcandle. If the open and closeofthekangarootailareinsidethe range of the previouscandlestick, thekangaroo tailis valid (Figures 8.10 and8.11).
RANGEThe range of a candlestickis the distance in pipsbetween the high and lowofthecandlestick.
The easiestway to see thisrule inactionis to lookatanexample.
Figure8.10ThisAUD/NZDfour-hourcharthasabearishkangarootail.Noticetheopenandcloseofthekangarootailarebothcontainedbytherangeofthepreviouscandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Figure8.11ThiscandlestickontheNZD/USDfour-hourchartisnotavalidbullish
kangarootail.Thecloseofthekangarootailisbelowtherangeofthepreviouscandlestick.©2000–2011,MetaQuotesSoftwareCorp.
The kangaroo tail on thefour-hourAUD/NZDchartinFigure 8.10 is an ideal
example.Noticetheopenandthecloseofthekangarootail;both are inside the range ofthepreviouscandlestick. It isimportant for the open andclose of the kangaroo tail tobe inside the previouscandlestick's range becausethis suggests that the marketis not in a runaway trendingphase.Sometimes themarketwill print a kangaroo tailduring a very strong trend.
When this occurs, you maysee the market pause at azone, but often the marketeventuallypushesbeyond thezone. The four-hourNZD/USD chart in Figure8.11 shows an example of arunawaymarket.Notice howthe closing price on thekangarootailisoutsideoftheprevious candlestick's range.This is therefore not a validkangaroo tail. The very best
kangaroo tails will have theopen and close of thecandlestick well inside therange of the previouscandlestick. Othercandlestickswithanopenandclose not inside the previouscandlestick's range are notvalidkangarootails.
LooktotheLeftTake a look at the chart in
Figure 8.12. Notice how inthis case the market, theAUD/USD weekly chart,prints a kangaroo tail at anarea on the chart that is anextremehigh.Themarkethasnottradedhereinsometime,infact,onthechartwecannotsee the last time that themarket traded at this level.We could say that thiskangaroo tail has much“roomtotheleft.”
Figure8.12TheAUD/USDweeklychartprintedakangarootailatanareaonthemarketchartwherewehavenotseenpriceactioninover20years.Thus,wecansaythatthiskangarootailhasmuchroomtotheleft.Thepairfellover3,000pipsafterthiskangarootailprinted.©2000–2011,MetaQuotesSoftwareCorp.
Why is room to the leftimportant?Why is it that thenaked trader seeks outreversal signals that print onthe chart on areas that havenotseenpriceactioninalongtime? The answer is simple:Thenakedtraderislookingtocatch extreme reversals,trades that will capture largemoves in themarket. Ideally,the naked trader will take atrade just as the market is
turning around, at places onthe chart where the marketwill not comeback for sometime. Remember, the nakedtrader is not held hostage toindicators,sothenakedtraderhas the ability to be nimbleand jump into a trade just asthemarket is turning around,the naked trader does nothave towait for the indicatorto rolloveror to indicate themarket is turning around.
Obviously, the naked traderneverknowsforcertainwhenthe market will make anextremehighorextremelow.The naked trader does,however,knowthatwhenthemarket turns around at anextreme high or an extremelow,ataspotonthechartthathas not seen recent priceaction, themarket oftendoesnotquicklyreturntothatspot(seeFigure8.13).
Figure8.13TheweeklyEUR/USDchartprintedakangarootailinJulyof2001.Thiskangarootailhasplentyofroomtotheleft,aftertradinghigherthanthekangarootail,themarkethasnotbeenbacktothiszonesincethiskangarootailprinted.©2000–2011,MetaQuotesSoftwareCorp.
BewareofGiantCandlesticks
When the market is in arunawaytrend,kangarootails
oftenlooksmallcomparedtothe surrounding candlesticks.Take a look at Figure 8.14.Thiskangaroo tailprintedonthe EUR/USD daily chart onabrilliantzone.Additionally,the open and the close areinside the range of theprevious candlestick, theopenand thecloseare in thebottom third of thecandlestick, and there isplentyof room to the left; in
fact it hasbeenover46dayssincethemarkethastradedatthiszone.
Figure8.14AlthoughthisappearstobeanidealkangarootailontheEUR/USDdailychart,thegiantbullishcandlestickspriortothekangarootailhintthatthestronguptrendmaycontinue.©2000–2011,MetaQuotesSoftwareCorp.
Is this an ideal kangarootail? Unfortunately, it is notan ideal kangaroo tail. The
big bullish candlesticks priorto the kangaroo tail hint thatthe market may have furtherupsidemomentum.Thus,thisis not an ideal kangaroo tailsimply because themarket isprinting giant bullishcandlesticks immediatelyprior to the kangaroo tail.Many failed kangaroo tailsfollowlargecandlesticks.Thebest kangaroo tails have averylargerange,oftengreater
than the candlesticksimmediately prior to thekangarootail.Figure 8.15 illustrates
another example of a bullishkangaroo tail. Notice thelarge bearish candlesticksprior to the kangaroo tail,these candlesticks offer aclue---downside momentummay remain in the market.Optimal kangaroo tails willhave a large range, usually
greater than the range ofthose candlesticksimmediately prior to thekangaroo tail. Be wary ofsmall-tailedkangaroos.
Figure8.15ThisbullishkangarootailontheAUD/JPYfour-hourchartwouldhavebeenalosingtrade,ashintedbythegiantbearishcandlestickspriortothekangarootail.©2000–2011,MetaQuotesSoftware
Corp.
ENTERING
THETRADETheobviousentry trigger forthe bullish kangaroo tail is abuystopafewpipsabovethehigh of the kangaroo tail.Once the market pushesthrough the high of thekangaroo tail, it will triggerthe buy stop, triggering anentry for the trade. For thebearish kangaroo tails, asimilar entry works well: a
sellstopafewpipsbelowthelowofthekangarootail.Many traders wonder if a
differententrytechniquemaylead to greater profits.Specifically, some traderswish to enter the kangarootail after the market hasretraced or traded in thewrong direction. This mayseemlikeagoodideabecausetheentrymaybeclosertothestop loss and, therefore,may
reduce the risk on the trade.However, the suggested buystoporsellstopentrystrategyis a much safer strategybecauseitwillavoidmanyofthelosingtrades.Oftenafailedkangarootail
will never see the markettrade beyond therecommended entry price.For bullish kangaroo tails, ifthe market keeps fallinglower, it may never trade
higher than the high of thekangaroo tail (see Figure8.15). Likewise, for bearishkangaroo tails, if the marketkeeps trading higher, it willusually never trade lowerthan the lowof thekangarootail(seeFigure8.16).Thus,itis much safer to enterkangarootailswithabuystop(forbullishkangarootails)ora sell stop (for bearishkangaroo tails). Using a buy
stop above the high (forbullish kangaroo tails) or asell stop below the low (forbearish kangaroo tails) willdelaythetradeentryuntilthemarketmovesintheexpecteddirection. This simple tradeentry technique will avoidmanylosingtrades.
Figure8.16ThisisaclassicfailedbearishkangarootailontheUSD/CHFfour-hourchart.Noticehowthemarket
nevertradeslowerthanthelowofthekangarootail.Usingasellstopbelowthelowofthiskangarootailenablesthenakedtradertoavoidacertainloss.©2000–2011,MetaQuotesSoftwareCorp.
THESTOP
LOSSThe stop loss for thekangarootailisplacedontheother side of the tail, just afewpipsbeyond the tail (seeFigure8.17).Thisemergencystoplossisthemaximumstoploss for the trade. Theemergency stop loss is themaximumlossforakangarootail trade. Ideally, the nakedtrader will close out a
kangarootailtradeifthetradeis in a drawdown andmoves75 percent toward the stoploss.Closing the tradebeforethestoplossishitwillreducethe average losing trade, avery desirable outcome forthenakedtrader.
Figure8.17Thestoplossisplacedafewpipsbeyondthetailofthekangarootail.ForthisbullishkangarootailontheweeklyNZD/USDchart,
thestoplossisplacedafewpipsbelowthelowofthebullishkangarootailat0.5480.©2000–2011,MetaQuotesSoftwareCorp.
PROFIT
TARGETSChapter 11 covers exitstrategies. There are manyexit strategies in that chapterthat are compatible with thekangaroo tail trade. Onesimple way of managing thekangaroo tail trade is to takeprofit at the very next zone(seeFigure8.18).
Figure8.18Averysimpleandpowerfulexitstrategyfor
thekangarootailisthis:Takeprofitattheverynextzone.AfterthebullishkangarootailontheNZD/USDweeklychart,themarkettradeshigherandeventuallyfindsthe0.6600zoneforaprofitof853pips.©2000–2011,MetaQuotesSoftwareCorp.
KANGAROO-
TAILTIPSThere are several optimizersassociatedwiththekangaroo-tail trade. If you have thepatience to wait for only thevery best kangaroo tails,watch for the followingcharacteristics:
Kangaroo tails withaverylongtails.Kangaroo tails withmuch room to the
left. The idealkangaroo tails printat an area on thechart that has notseen price action inalongtime.Bullish kangarootails with a closingprice that is higherthan the openingprice.Bearish kangarootails with a closing
price that is lowerthan the openingprice.The candlestickafter the bullishkangaroo tail tradeshigher than thehighofthekangarootail.The candlestickafter the bearishkangaroo tail tradeslower than the lowofthekangarootail.
Kangaroo tails witha greater range thanthe previous 10candlesticks.Kangaroo tails thattrigger the buy stoporsellstopentryonthe first candlestickafter the kangarootail.
There are also several redflags,sowatchoutforthese:
Kangaroo tails with
veryshorttails.Kangaroo tails thatdo not print on azone; these are notvalidkangarootails.Kangaroo tailspreceded by giantcandlesticks. Thissuggests that thetrend may continue,and the kangarootail may only be apause.
When the open andthe close of thekangaroo tails arenotcontainedbytherange of thepreviouscandlestick.
If you back-test thekangaroo tail, you may findthat this trade set-upconsistently identifies keyturning points in the market.Go to www.fxjake.com/book
for live market kangaroo-tailupdates.
CHAPTER9
TheBigBelt
It isgreat tobeablonde.Withlowexpectationsit'svery easy to surprisepeople.
—PamelaAnderson
There are a few moments inlife that eclipse all others.Some of them are obvious,and you anticipate them: thebirthofyour first child, youradventures at an exoticfaraway land, meetingsomeone who will becomeone of the most importantpeople in your life, and soforth.Othermomentsseemtocome from nowhere, out ofthe blue, but they are often
just as critical and just asimportant.The first timeyourealize you will become aprofitable as a naked tradermay be one such moment.The tricky thing about thesesurprising moments is this:You never know when theywilloccur,andwhentheydo,it is important to seize them.These critical, beautifulmoments come and go, butyoumustbereadyforthemat
anytime.
WHATISABIGBELT?
This next catalyst, the bigbelt, is much like a brilliantpeakexperienceinlife.Abigbelt is a very significantoccurrenceinthemarket.Bigbelts rarely occur, and whenthey do they will nearly
always occur on a supportand resistance zone. The bigbeltwill nearly always occuron the very first day of thetradingweek,afterthemarkethas had some time to thinkabout a fair price over theweekend.Unfortunately,manytraders
areabittooexcitedwhenthemarketstartstradingagainforanewweek.Manytradersarethinkingaboutwhathappened
the previous week. Becausetradersarethinkingabouttheworld events of the previousweek,themarketoftenmakessome extreme jumps on thefirst tradingdayof theweek.Unfortunately, this earlyexcitement is oftenmisplaced, and pushes themarkettoaplacethatisabittoo far. When this occurs abig belt will often appear onthechart.
There are two types of bigbelts: bearish big belts andbullish big belts. Once youunderstand the basics of thebearish big belt, you caneasily apply your knowledgeto the bullish big belt, sincethe trade set-ups are simplyopposites.
THEBEARISH
BIGBELTAbearish big beltwill occuratamarkethighandabullishbig belt will occur atmarketlow. In both cases the beltswillprintonazone.InFigure9.1we see a bearish big beltontheAUD/USDdailychart.Thedefiningcharacteristicofthe bearish big belt is thejump in the market price. Inforex,bearishbigbeltsnearly
always surface on the firsttradingdayof theweek.Themarket opens much higherthan the closing price of theprevious week and thensteadily trades lower,eventually closing near thelow of the candlestick. Thus,the candlestick has a beltlikeappearance. The openingpriceisnear thehighandtheclose is near the low.Naturally, bearish belts will
also stick out above recentprice action. Notice that thebearish big belt prints on the0.9335zone.Thisisacriticalzone because the marketreversed here after touchingthe zone four months prior.Bearish big beltswill alwayshave an opening price nearthe high of the candlestick,and the closing price will benear the low of thecandlestick.
Figure9.1ThisisabearishbigbeltontheAUD/USDdailychart.Thecandlestickprintsonanimportantzone,thebearishbigbeltopenshigherthanthepreviouscandlestick,openisnearthehigh,andthecloseisnearthelow.©2000–2011,MetaQuotesSoftwareCorp.
A bearish big belt has anentryverysimilartoabearishkangarootailorabearishbigshadow.Asellstopissimplyplaced just below the low ofthe bearish big belt. Placingtheentryhereensuresthatthemarketmustmakeanewlowbefore the trade is triggered.This will, of course, enableyou to avoid many losingtrades, particularly thosesignals that follow a rising
market. If the market neverfalls to the entry price, thetradewillnotbetriggered.Bearish big belts often
occur at critical turningpoints, when the market hasbecome extremely excited.This excitement is translatedintoabearishbigbelt; it isasignal that the market hasgoneuptoofar.Ifyoutakealook at the bearish big beltson your charts, you will see
that, historically, the dailybearish big belts have anexceptionally high win rate.Test this for yourself; scrollthrough the historical chartsand record the marketmovement after big belts, ortest themina forex tester,oryourchosenprogramforbacktesting.Youmaybesurprisedwith the win rate of the bigbelttradingset-up.Although it is common to
seebearishbigbeltsonlowertimeframes,suchastheone-hour chart and the four-hourchart, sticking to the dailychartsonlywillenableyoutomaintain a high win ratewhen trading this set-up. So,although it may be temptingto multiply your trades bytaking big belts on a lowertimeframe, it is probably abetter idea to either stick tothedailychartsforthisnaked
trading set-up or be veryselective with the trades thatyou decide to take on thelowertimeframes.Aswithmany of the other
nakedtradingset-ups,aneasyway to exit your bearish bigbelttradeistosimplywaitforthe market to reach the verynext zone (see Figure 9.2).This isoftenasimplewaytocapture a large chunk of themove. Again, remember that
the bearish big belts oftenprint at criticalmarket highs,so they offer an excellentopportunity foryou to take abiteoutof abigmove in themarket.
Figure9.2AnotherbearishbigbeltontheGBP/USDdailychart.Aprofittargetatthenextzonecaptured385pipsonthistrade.©2000–2011,MetaQuotesSoftwareCorp.
Thestoplossforthebearishbig belt is placed above thehighofthebelt.Ifthemarket
tradeshigherthanthehighofthe bearish big belt, then,obviously, the belt has notidentifiedakey turningpointin themarket.Takea lookatthe bearish big belt trade inFigure9.3.
Figure9.3ThisisthebearishbigbeltontheGBP/USDdailychart.Noticethesellstopisplacedbelowthelowofthebeltcandlestickandthestoplossisabovethehigh.
Theprofittargetatthenextzonecaptured163pipsonthistrade.©2000–2011,MetaQuotesSoftwareCorp.
The bearish big belt is anexcellent trade set-up, yousimplyhave towait for them
tooccur. Ifyouarewatchingonlythemajorcurrencypairs(EUR/USD, USD/CHF,USD/JPY, GBP/USD) youmay occasionally luck into abearish big belt trade. But ifyou expand your scope, andlook at many of the othercurrency pairs (NZD/JPY,EUR/CAD, GBP/CAD, etc)you obviously have a muchbetterchanceofcatchingoneof these bearish big belt set-
ups.Backtestthebearishbigbelt onyour own to seehowprofitable and successfulthese tradesmay be for you.All you have to do to bereadyforthedailybearishbigbelt is to watch the marketafterthecloseoftheveryfirsttradingdayoftheweek.
THEBULLISH
BIGBELTThe other big belts are, ofcourse, the bullish variety,bullishbigbeltsareimportantcatalysts that hint at themarket moving higher. Abullish big belt will oftenprint at an important marketlow on a zone. The bullishbig-belt candlestick has anopening price much lowerthan the closing price of the
previous candlestick. Thebullish big belt will have anopening price down near thelow for the candlestick, andthe closing price will be upnear the high of thecandlestick. In Figure 9.4 abullish big belt is on theEUR/CAD daily chart. Thisbullish big belt prints on the1.3430zone.Thisisacriticalzone because the marketreversed here after touching
the zone three months prior.The bullish big belts willalwayshaveanopeningpricenear the low of thecandlestick, and the closingpricewillbenear thehighofthecandlestick.
Figure9.4AbullishbigbeltontheEUR/CADdailychart.Thecandlestickprintsinanimportantzone,the1.3430zone.Noticehowthebullishbigbeltopensmuchlower
thanthecloseofthepreviouscandlestick,theopenisnearthelow,andthecloseisnearthehigh.©2000–2011,MetaQuotesSoftwareCorp.
The bullish big belt on theEUR/CADdailychart(Figure9.4) is an excellent examplebecause the bullish big beltdailycandlestickprintsontheimportantzoneat1.3430.Theinteresting thing about thisparticular bullish big belt isthatthelowofthecandlestickis a bit lower than theopening price. This is notideal, but themost importantcharacteristic of the bullish
bigbeltcandlestickholdstruein this example. The closingprice is very near the highprice, and this is absolutelycriticalforthebullishbigbeltset-up(justasitiscriticalforthe bearish big belt set-up tohave a close near the low ofthe candlestick). Take a lookat the chart again in Figure9.5,hereyouwillseethatthestop loss is down below thelowofthebullishbigbeltand
the buy stop is placed a fewpips above the high of thebullish big belt candlestick,the trade is triggered onlyoncethemarkettradeshigherthanthebullishbigbelt.Thistrade easily achieved theprofit target at the very nextzone, the 1.3885 area for aprofitof313pips.
Figure9.5TheentrypriceforthebullishbigbeltontheEUR/CADdailychartisa
fewpipsabovethehighofthebullishbigbeltcandlestick.Thestoplossordertradeisbelowthelowofthebullishbig-beltcandlestick.Theprofittargetistheverynextzoneat1.3885,aprofitof313pips.©2000–2011,MetaQuotesSoftwareCorp.
Although the bullish bigbelttradeisanexcellenttradeandmany traders will find a
high win percentageassociated with this trade,therearelosingtrades,justasthere are for all tradingsystems.ThenextbullishbigbeltexampleisinFigure9.6,this is a weekly USD/CHFchart.Note that the stop lossisplacedbelowthelowofthebullish big belt candlestick.The candlestick has goodform, the open of thecandlestick is down near the
low of the candlestick, andthe closing price is up nearthe high. The buy stop entryisplacedafewpipsabovethehigh of the candlestick, andthis entry price is easilytriggered during the nextcandlestick, in fact, themarketpushesall thewayuptotheverynextzone.
Figure9.6TheweeklyUSD/CHFbullishbelthasastoplossbelowthelowand
thebuystopentryisabovethehigh.Themarketdoesreachthenextzone,butsoonafterquicklyfallsbeyondthestoplossprice.©2000–2011,MetaQuotesSoftwareCorp.
However, the risk on thistrade is 210 pips (from thebuystoptothestoploss),and
thefirstzoneisonly180pipsaway. Therefore, sometraders may be morecomfortable with a profittargetplacedatthenextzoneat 1.2450, a full 425 pipsaway. This further profittarget obviously allows for amuchmore favorable rewardto risk ratio. Exit strategiesare covered in Chapter 11,where scenarios such as thisoneareexamined.Fornow,it
is important to note thatalthoughthemarketdidgointheexpecteddirection,itonlywentashighastheverynextzone.Yourwin ratewith thebullish big-shadow strategymay depend on howaggressive you arewith yourprofittargets.Take some time to test the
bullish big belt strategy. Aswith all these catalysts, youmay decide to use this
strategyalongwithoneoftheexit strategies from the exitchapter(Chapter11).
TIPSTOTRADINGTHE
BIGBELTThe rules for the bearish bigbelt and the bullish big beltare essentially the same, but
in reverse. The importantthings to remember for thiscatalyst are as follows: Allbullish big belt candlestickshaveanopeningprice that islower than the closing priceof the previous candlestick;likewise, allbearishbigbeltshaveanopeningprice that ishigher than the closing priceof the previous candlestick.The bullish big belt musthave an opening price near
the low of the candlestick,and it must also have aclosingpricenearthehighofthe candlestick (see Figure9.7). The reverse is true forthe bearish big belts: Theopening price must be nearthe high of the candlestick,andtheclosingpricemustbenear the low of thecandlestick (see Figure 9.8).Even more critical, the bigbeltcandlestickmustprinton
a zone. If the big beltcandlestick is not on a zone,theoddsofthetradeworkingout fall considerably.Likewise, the very best bigbelts have room to the left,similar to the ideal kangarootail. Those big belts that donot have much space have alow rate of success (seeFigure9.9).
Figure9.7Bullishbigbeltsmusthavetheopeningprice
nearthelowofthecandlestickandtheclosingpricenearthehighofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Figure9.8Bearishbigbelts
musthavetheopeningpricenearthehighofthecandlestickandtheclosingpricenearthelowofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Figure9.9Bigbeltsmustprintonazone,andtheyshouldhaveroomtotheleft.Thosebeltsthatdonotprintinazoneanddonothaveroomtotheleftareunlikelytosucceed,suchasthisEUR/USDweeklybullishbigbelt.©2000–2011,MetaQuotesSoftwareCorp.
In summary, big belts areextremely powerful catalystsprovided they print at the
right spot on your chart. Inthe list that follows,youwillfind a summary ofcharacteristics of both thebearish big belts and thebullishbigbelts.Characteristics of the
bearishbigbelts:Theopeningpriceishigher than theclosing price of thepreviouscandlestick.
Theopeningpriceisnear the candlestickhigh.The closing price isnear the candlesticklow.The big belt printson an importantzone.The big belt shouldhave room to theleft.The stop loss is
placed above thecandlestickhigh.The sell stop isplaced below thecandlesticklow.The closest zone istheprofittarget.
Characteristics of thebullishbigbelts:
Theopeningpriceisnear the low of thecandlestick.The closing price is
near the high of thecandlestick.The big belt printson an importantzone.The big belt shouldhave room to theleft.The stop loss isplaced below thecandlesticklow.The buy stop isplaced above the
candlestickhigh.The closest zone istheprofittarget.
Everyweekwe takea lookat big belt trades as theyunfold in real time. To jointhisfreeonlinewebinargotowww.fxjake.com/book.
CHAPTER10
TheTrendyKangaroo
Thosewhotrytoleadthepeoplecanonlydosobyfollowingthemob.
—OscarWilde
Attimesthemarketwill takeoff in a strong trend. Thesetrends make for pretty-looking charts. The marketmight be marching upward,with very few pauses alongtheway, or themarket couldbeinafreefall,stoppinghereandthereonthewaytolowerlows.Any traderwho scrollsback through the charts willnotice these exciting timesandmaywishforamethodof
capturing easy profits fromthese trending markets. Thetrendy kangaroo is one suchmethod. This is a way foryou, the naked trader, toidentifythetrendandcapturehealthy profits from atrendingmarket.
WHATISATRENDY
KANGAROO?The trendy kangaroo is aspecial caseof thekangaroo-tail trade. This is a specificmethod for jumping ontrends.Thispricepatterndoesinvolve a kangaroo tail, butthe overall set-up in relationto the nearby candlesticks isvery different from thestandard kangaroo tail. Infact, the defining feature of
the trendykangaroo is that itmust print during a trendingmarket.Obviouslyitdoesnotmatter if the market istrending upward ordownward; the keycharacteristic here is that themarketistrending.Itseemsnearlyeverytrader
hasadifferentdefinitionofatrending market. The largemajority of technicalindicatorsareusedtoidentify
atrendingversusnontrendingmarket.Naturally,asanakedtrader, you have no need forindicators,evenwhenyouaredetermining whether anymarket is trending. Todetermine whether anymarket is trending, you willneedaconsultant.
TREND
INDICATORSYouwill need several thingsto identifya trendingmarket.First, you will need somecookies or otherwise tastytreats (maybe somestrawberries, some chocolate,oranapple).Secondyouwillneedyour favorite charts, setto a line chart. Third, andfinally, you will need aconsultant. This consultant
shouldbebetweentheagesof6 and 10 years. You mayneed to call around to find aconsultant of the appropriateage,butthisiswellworththeeffort. Friends, neighbors,and distant relatives may beinvaluable in aiding you onyour search for yourconsultant. Once you haveyour consultant, you arereadytodeterminethetrend.Pleasedonotbetemptedto
purchase a fancy technicalindicator to determine if amarket is trending. All youreally need is an eight-year-old. All you have to do ispoint to a line chart and askyourconsultant thisquestion:“Is this linegoingmostlyup,mostly down, or mostly upanddown?”Your consultant will tell
you all that you need toknow.Afterthisbriefsession
youmaypayyourconsultanttheagreed-onfeeandgoforthwith your trading. I wouldencourage you to use thismethod whenever you areunsurewhether themarket istrendingorinaconsolidationphase.Obviously, you must
choose the chart carefullywhen you do this. If youmostly trade thedaily charts,make sure that your
consultanthasagoodlookatthedailychart.Ifyoumostlytrade the one-hour charts,make sure that yourconsultant provides anassessment of the one-hourchart. The market is alwaystrending in one timeframe oranother, so the question thatyou present to yourconsultant should be limitedto the market and timeframeyouareinterestedintrading.
If your consultant hasidentified that the market istrending, you are now readyforthetrendykangarootail.
TRADINGTRENDY
KANGAROOS:RESTING
SPOTSOnce your consultant hasfiled his report, you willknow precisely if themarketistrending.Ifyourconsultantreports that a trend hasformedonthecharts,it'stimeto look for trendykangaroos.Trendy kangaroos are placesonthechartwherethemarkethaspausedtotakearest.You will know the market
is resting when you seeseveral (usually 3–10)candlesticks in a smallconsolidation zone. This isunlike the consolidation boxused for the last-kiss trade,because this consolidationcanbesomethingassimpleasthree small candlesticks thatdo not seem to go very far.The market is resting aftersome strong trending movesupward(seeFigure10.1).
Figure10.1ThisisamarketpauseduringanuptrendontheAUD/USDdailychart.Noticehowallfourcandlestickstradeinsidethebox.©2000–2011,MetaQuotesSoftwareCorp.
If themarket is in a strongdowntrend, a market pausewill look much the same.
There will be severalcandlesticks (again, usuallybetween3and10)alltradingwithin a tight range. This isyour clue to get readybecause a trendy kangaroomayappear(seeFigure10.2).
Figure10.2ThemarketisinastrongdowntrendontheUSD/CADdailychart.Noticehowthecandlesticksarerestrictedtoatightconsolidationrange.Allthe
candlestickstradeacrossthesamepricerangeduringthemarketpause.©2000–2011,MetaQuotesSoftwareCorp.
TRENDY
KANGAROOCHARACTERISTICSThe critical characteristic ofthe trendy-kangaroo-tradingset-upis,ofcourse,thetrendykangaroo candlestick. Thiscandlestick will stick outbeyond where the marketpaused. It is critical for thetrendykangarootoprintawayfrom the other candlestickswhich are stuck in the box.
Because the trendy kangaroois always in the direction ofthe trend, it is impossible forthetrendykangarootohavealarge amount of room to theleft.This is incontrast to thestandard kangaroo-tail trade.The trendy kangaroo isjudged by how far the tailsticks out beyond the recentmarket pause. If there ismuch of the tail sticking outinanareaonthechartwhere
the recent candlesticks havenot traded, then the trendykangaroo is deemed anexcellent trading set-up. InFigure 10.3 we see theAUD/USDdailychartwithatrendykangaroowhich sticksoutbeyond therecentmarketpause. This is an excellenttrendykangarooset-up.
Figure10.3ThetrendykangarooappearsontheAUD/USDdailychart.The
trendykangaroomuststickoutbeyondthemarketpause.Itisimportantforthetrendykangarootostickoutbeyondwheretherecentmarketpausehastraded.©2000–2011,MetaQuotesSoftwareCorp.
The same holds true for atrendykangaroo thatpopsupduring a downtrend. The
trendy kangaroo has a longtail that sticks out above themarket pause. The trendykangaroo will never havemuchroomtotheleftsimplybecause it prints during astrong trend. However, thetrendy kangaroo shouldalways print away from therecent consolidation. Themore the candlestick printsaway from the market pausethebetter.Takea lookat the
chart in Figure 10.4—theUSD/CAD daily chart printsan excellent trendy kangarooduringastrongdowntrend.
Figure10.4ThisdailyUSD/CADtrendykangarooisanexcellentexampleofhowthiscandlestickshouldstickoutbeyondtherecentmarketconsolidationrange.©2000–2011,MetaQuotesSoftwareCorp.
Bearish trendy kangarootrades are traded much likestandard bearish kangaroo
tails. The sell stop is placedbelow the low of the trendykangaroo candlestick. Oncethis sell stop is triggered, thestop loss is placed above thehigh of the trendy kangaroocandlestick. See Figure 10.5for an example of a bearishtrendy kangaroo-tail trade ontheUSD/CADdailychart.Bullish trendy kangaroo
tails are similar to standardbullish kangaroo-tail trades.
Once the market prints thetrendy kangaroo, you maymanage this trade justasyouwould a normal bullishkangaroo tail trade.Youmayplace the buy stop above thehigh of the trendy kangaroo.The stop loss goes on theothersideofthetail.Soforabullish trendy kangaroo tail,the stop loss is placed belowthelow(seeFigure10.6).
Figure10.5Thetrendy
kangarooismanagedinmuchthesamewayasastandardkangaroo-tailtrade.Thesellstopisplacedbelowthelowofthetrendykangaroocandlestick.ThestoplossisplacedabovethehighforthisbearishtrendykangarooontheUSD/CADdailychart.Themarketfellover1000pipsafterthistrendykangarootailprinted.©2000–2011,MetaQuotesSoftware
Corp.
The trendy kangaroo tailwill often print on an
important zone. Take a lookat the four-hour GBP/CHFchart in Figure 10.6. Themarketpausesat the0.96500zone. Several candlesticksfind support on the 0.96500zonebeforethebullishtrendykangaroo tail prints. Thistrendy kangaroo tail offers aclue; the market is ready tostart marching higher again.After the trendy kangarooprints the market moves 317
pipshigheroverthenexttwodays.
Figure10.6ThisbullishtrendykangaroocandlestickonthedailyAUD/USDchartsuggeststhemarketwillsoonmovehigher.Withintwodaysthemarketmoves175pipshigherthantheentryprice.©2000–2011,MetaQuotesSoftwareCorp.
A few more examples ofthe trendy kangaroo set-upwill help you to identify the
difference between a goodtrendy kangaroo and a poortrendy kangaroo. In Figure10.7, themarketprintsanicebullish trendy kangaroo onthe four-hour GBP/CHFchart.Noticehow this trendykangaroohasall thestandardkangaroo tail features exceptforthe“roomtotheleft”rule.Thetailsticksoutbeyondthenearby candlesticks, butbecause the market is in a
strong downtrend, there islittle room to the left for thetrendy kangaroo tail. Trendykangaroo tails will rarelyhaveroomtotheleftbecausethey occur during trends, sothere will always be priceaction to the left. The trendykangaroo tail should,however,stickoutbeyondtherecent choppy price action.Otherwise, the standardkangaroo tail rules apply.
Noticetheopenandthecloseof the trendy kangaroo arebothinthebottomthirdofthecandlestick.Theopenandtheclose of the trendy kangarooare inside the previouscandlestick's range. The verynextcandlesticktradeshigherthan the high of the trendykangaroo, triggering the buystop. The trendy kangaroomaintains all thecharacteristicsofthestandard
kangaroo tail trade; the onlydifference is that it printsafter a pause during a strongmarkettrend.
Figure10.7Thisbullishtrendykangarooonthefour-hourGBP/CHFcharthasmanyofthestandardkangaroo-tailcharacteristics.©2000–2011,MetaQuotesSoftwareCorp.
You may notice that thedaily AUD/JPY trendykangarooset-up(Figure10.8)
isnotona zone.Thismakesthetrendykangaroounique;itisanaked tradingset-up thatis not always found on azone. However, under mostcircumstances a minor zonewill be seen at the marketpause immediatelybefore thetrendy kangaroo.Notice howthe highs of thesecandlesticks cluster near thebottom of the trendykangaroo tail. Thus, the
consolidation of candlesticksbefore the trendy kangarootail establishes aminor zone,and the bearish trendykangaroo tail extends abovethis minor zone. Obviously,ideal trendy kangaroo setupswill line up with a majorzone, but this is notnecessary.
Figure10.8ThisbearishtrendykangarootailonthedailyCHF/JPYdoesnotprint
onazone.However,thecandlesticksimmediatelytotheleftofthetrendykangarootailhavesimilarhighs,andthustheydefineaminorzone.
BEWARETHE
TRENDYKANGAROO
TRAPSOnceyouget thehangof thetrendy kangaroo, you maywant to trade them all thetime. These trades do notoccur frequently simplybecause the market does nottrend that frequently. Becareful. There are many
trendy-kangaroo-looking set-ups that are not ideal. Hereare a few of the commonmistakes naked traders makewhen looking for trendykangarooset-ups.Trendy kangaroos must
stick out from theconsolidation range. If thetrendy kangaroo candlestickdoesnothaveatailthatsticksout from themarketpause, itis not an ideal trendy
kangaroo(seeFigure10.9).
Figure10.9Trendykangaroosshouldstickoutfromrecentpriceaction.Trendykangaroosamongothercandlesticksarenothighprobabilitytrades.ThiscandlestickontheAUD/JPYdailychartdoesnotstickoutbeyondtheconsolidationrange,soitisnotanidealtrendy-kangarootrade.©2000–2011,MetaQuotesSoftware
Corp.
The best trendy kangarooswill print during a pause in
the market trend. If a trendykangaroo prints after a largecorrection, it may be a signthatthetrendisover.Bewareoftrendykangaroosthatprintafter a large correction, theymay not be ideal trendykangaroo trades (see Figures10.9and10.10).
Figure10.10Theone-hourUSD/CHFcharthasabullishtrendykangarootail.However,themarkethas
fallentoofar.Thebesttrendykangarootailsprintafterapause,thistrendykangarootailisnotidealbecauseithasprintedafteraseveremarketcorrection.©2000–2011,MetaQuotesSoftwareCorp.
Trendy kangaroos are agreatwaytojumponastrongtrend.Herearesomethingsto
keepinmindwhenlookingattrendykangaroos.Characteristics of the
bearishtrendykangaroo:The market ismoving in adowntrend.The market pausesand severalcandlesticks print ina smallconsolidationrange.A trendy kangaroo
prints above theconsolidationrange.The stop loss isplaced above thecandlestickhigh.The sell stop isplaced below thecandlesticklow.The market tradeslower than the lowofthebearishtrendykangaroo.The closest zone is
theprofittarget.Characteristics of the
bullishtrendykangaroo:The market ismoving in anuptrend.The market pausesand severalcandlesticks print ina smallconsolidationrange.A trendy kangarooprints below the
consolidationrange.The stop loss isplaced below thecandlesticklow.The sell stop isplaced above thecandlestickhigh.The market tradeshigher than the lowofthebearishtrendykangaroo.The closest zone istheprofittarget.
Optimal trendy kangarooshavethesecharacteristics:
The tail of thetrendy kangaroosticks out from theconsolidationrange.Thetrendykangarooprints on a majorzone.Themarketdoesnotmake a largecorrection beforeprinting the trendy
kangaroo.Live trendy kangaroo-tail
updates are atwww.fxjake.com/book.After some testing, you
may become comfortablewith the trendy kangaroo.Remember that the goal forthe trendy kangaroo is tocapture a market trend afterthe market decides to pause.Ifyoukeepthisgoal inmindyou will find that the trendy
kangaroo is an excellentmethod for jumping on astrong trend. In Chapter 11you will learn other exitstrategiesforcapturingprofitsduring trending markets;these may be ideally suitedfor trendy kangaroo-tailtrades.
CHAPTER11
ExitingtheTrade
There's a trick to theGraceful Exit. It beginswith the vision torecognize when a job, alifestage,arelationshipisover—and to let go. It
means leaving what'sover without denying itsvalue.
—EllenGoodmanTherearesixstagesforeverytradeyoutake.Thefirststageis the analysis: You take alook at the charts and decidewhether a trade should betaken.Thesecondstageistheplanningstage:Youdecideifyouwilltakeatrade,andnowis the time to develop a
trading plan. You will placeyour order to enter this tradeat a certain price, and youwill place your exit for thetrade at a certain price,whetheritbeatalossorgain.Thethirdstageofeverytradeinvolves the entry: the priceat which you begin yourjourney on the trade. Thisprice may have beenpredetermined;youmayhavedecided that you will enter
thetradeifthemarketgoestoa certain price, or perhapsyou just use a market orderand enter the tradeimmediately at the currentmarketprice.Thefourthstageinvolves managing the trade,this is where MarketBiofeedback™comesin,andyou are anticipating andreacting to the market datathat comes back to you viathe chart while you are
holding your trade. The fifthstage is the exit. This is themost important stage of thetrade.Youmakeyourmoneywhenyoumakeyourexitandyour paycheck is received.Thesixthand final stage isalearningphase.This iswhereyouexamineyour tradefrombeginning to end and giveyourselfagrade.Thismaybeautomated learning (yousimply dump your trade
information into aspreadsheet such as the oneavailable for you atwww.fxjake.com/book) or itmay be a more discretionaryexamination of your trade inthe form of the tradingjournal, a place where youcan write down your ideasaboutyourtrade.In each of the six stages,
you have an important goal(Table 11.1). In the first
stage, your goal is todetermine if therisk isworththe reward. In the secondstage,yourgoalistocreateatrading plan that you willsticktoforthedurationofthetrade. In the third stage, youare attempting to enter thetrade at a point where theoddsareinyourfavor.Inthefourthstage,yourgoalshouldbe tomaintain an openmindand to learn from themarket
information available on thechart. In the fifth stage yourprimary purpose is to makemoney. In this chapter weexamine several ways ofmaking money on profitabletrades;someofthesemethodsmay make sense to you andothers may not. It isimportant for you to chooseone that fits with your ideasaboutthemarket.Inthesixthstage, the goal is to improve
yourtradingbylearningfromeach of the previous fivestages. In this way you canidentifywhichofthepreviousfive stages is yourweakness.Many traders find the fifthstage incredibly challenging.Formosttraders,decidingonan exit strategy (and, moreimportantly, sticking to thisexit strategy while managingthetrade)isthemostdifficultaspectofsuccessfultrading.
Table11.1SixStagesoftheTradeStage Action Goal
OneIdentifythetradeopportunity
Weighrisktoreward
TwoCreateatradingplan
Followtradingsystemrules
Three Enterthetrade
Enterthemarketatapricethatconfirmsthevalueofthetradeopportunity
Four Managethetrade
UseMarketBiofeedbacktoadapttonewmarketinformation
Five Exitthetrade Makemoneyfromthetrade
Learnfrom Identifyweaknessesin
Six thetrade stages1–5
EXITINGWITHMONEYThetradeexitisthefunpart;this is where your money ismade.Asatrader,thisisyourpayday. When it comes toexits,alltradersfitintooneoftwo camps, runners andgunners. Runners and
gunners are competingphilosophies, and mosttraders will clearly identifywith one or the other. It isimportant for you to deciderightnowbeforeyoureadanyfurther whether you identifywith the runners or thegunners. The easiest way todetermine which camp youfallintoistothinkaboutyouranswer to this question: Is itmore important for you to
have a high win rate or is itmore important for you tohavehugewinningtrades?If youwould rather have a
high win rate, then you willprobably have relativelysmallwinners.Youmayhaveahighpercentageofwinners,buttheaveragewinningtradewill probably be relativelysmall. If this is your style oftrading, then you are agunner.This is in contrast to
the runnerbecause ifyouarea runner, then you prefer tohave huge winning trades.Thismeansthatmanyofyourtrades may end up as losingtrades, or break-even trades,but the few giant winningtradeswillmakeupfor theselosing trades. Runner orgunner, it does not matterwhichisyourstyle.Itisonlyimportant that you stick toyour chosen style of trading,
stick with what you believe.You must trade in a mannerthatmakessensetoyou.
RunnersThe runnersare those traderswho are looking out for thenext big thing. These traderswanttocapturealargechunkof profit every trade. Thesetradershaveastrongsenseofconfidence. This confidence
is unwavering and will notdiminish in the midst of alosingstreak.Therunnersarealways hopeful that the nexttrade will end up as abeautiful, long-lasting trade.The long-running trades arewhat make profitable tradingpossible for the runners.Runners look at strongtrending charts and think“now that is a trend that Iwouldlovetocapture.”
Runners understand thatmost of the time the marketwill not run in an extendedtrend.Runnersareawarethata trading system may nothaveahighwinrate.Runnerswish to capture as muchprofit as possible, but theyadmitthatitisunknownhowfar the market may moveafter entering a trade.Runnersacknowledgethatthemarket may not move very
far, but once in a while themarket may go very far andaccelerate in a trendingmarket. Therefore, the winrateisnotthemostimportantstatistic for runners. Runnersaremuchmoreexcitedabouttheprofitsthatcomewiththelong-lasting trades thatcapture a trending market.The patience exhibited byrunners is extremely difficultfor the other group to
understand.Gunners have analtogether differentperspectiveontrading.
GunnersGunnersareadifferentbreed.Winning is everything togunners. Perhaps manygunners have a difficult timesittingthroughlosingstreaks.Or, it may be that gunnersfind it difficult to watch a
trade go from profit to abreak-even result. It may bethat gunners are moreimpatientthanrunners,butinthe end it really does notmatter.Gunners may also find
profit in naked trading.Gunners, like runners, maydecide to trade the kangarootail,thebigbelts,oranyothernaked-trading strategy.However, gunners are
interested in quicksatisfaction.Patiencemaynotbe one of the defining traitsfor gunners. Gunnersunderstand thatundernormalcircumstances the market isoften moving up and down,up and down. Gunnersbelieve the chances ofcapturing a strong trend areoften quite minimal. This iswhy gunners are fine withsmall, consistent profits that
theyextract from themarket.After all, gunners understandthat these small profits willquicklyaddup.
EXITSTRATEGIES
By now, you understand therespective philosophies ofrunners and gunners. It doesnot matter if you decide to
adopt the gunner philosophyand find consistent quickprofitsinthemarketorifyoudecide to side with therunners and try to capture atrending market for hugeprofits.Theimportantthingisthat you understand whatmakes sense to you and thatyou adopt and maintain thisexit strategy in your trading.The first two exit strategiesare for the gunners: the zone
exit and the split exit. Thesecondtwoexitstrategiesarefor the runners: themodifiedsplit exit and the three-barexit.
ExitsforGunnersGunners are interested inquick profits. Gunners wantto get in and out of a trade,and gunners love winningtrades.The zoneexit and the
splitexitaredesignedtotakeprofits at the most importantspotsonthechart—thezones.Recall that the zones arethosespotsonthechartwherethe market repeatedlyreverses. There is anothercharacteristic of the zonesthatisimportantforthenakedtrader.Zones are also magnets:
The market tends to beattracted to these places on
the chart. In other words,zones are simultaneouslyprice barriers and pricemagnets. Exits based onzones take advantage of thefactthatzonesattractprice.
ZoneExitThezoneexitisthebasicexitfor the naked trader. Thenaked trader looks to initiatetradesatzones,andthenakedtrader looks to exit trades at
these same zones. The basicphilosophy of the nakedtrader is this: The markettends to bounce off zonesrepeatedly, like a pinball.Therefore, it is perfectlyreasonable to look to thesezones as potential profittargets. These zones are themost important places on thenakedtrader'schart.Takea lookatFigure11.1,
a one-hour chart on the
EUR/JPY. By now, you willrecognizethisasabearishbigshadow.Asellstopbelowthelowofthebearishbigshadownetted 48 pips using thesimplezoneexit.Notice,also,that it only took twocandlesticks to achieve thisprofittarget.
Figure11.1ThisisabearishbigshadowontheEUR/JPYone-hourchart.Usingthezoneexit,thistrademakes48
pipswithintwocandlesticks,averyquickprofit.©2000–2011,MetaQuotesSoftwareCorp.
Here is anotherexampleofazoneexit, thistimeit isthe
GBP/JPY four-hour chart inFigure 11.2. Again, you willnowbefamiliarwiththetradeset-up. In this case it is abullish kangaroo tail.With abuy stop entry placed justabove the high of the bullishkangaroo tail, the target isachieved within fourcandlesticks.Thistrademade86pips.
Figure11.2Thebullishkangarootailonthe
GBP/JPYfour-hourchartmakes86pipsfourcandlesticksafterthetradeistriggered.Noticehowthemarketimmediatelyreversedafterreachingthiszone.Thezoneexitenablesthenakedtradertoavoidmanylosingorbreak-eventradessimplybecausetheprofittargetisoftenclosetotheentryprice.©2000–2011,MetaQuotesSoftwareCorp.
It is important to note thatthe zone exit is extremelyeasytoimplement,anditmaybe applied when the trade is
initiated. Inotherwords,youwill know when you placeyour trade order exactlywhere the exitwill be.Thereis no managing the trade,there isnoneed towatch thetrade,and, therefore, this isanice tradeexit foryou ifyoudo not sit and watch thecharts.Sometimes the market will
getverynearazone,andthentradeawayfromthezone.For
thisreasonitisimportantthatyou place the profit targetnear thezone,withsufficientcushion. For sell trades, theprofittargetshouldbeseveralpips above the nearest zone,and for buy trades the profittarget should be several pipsbelowthenearestzone.InFigure11.3 you can see
where this rule enabled thenakedtradertoexitthistradewithaprofit.
Figure11.3TheAUD/USDfour-hourchartshowsanicebullishkangarootail.Thistrademade69pipsbecausetheprofittargetwasafewpipsbelowwherethiszonewasdrawnonthechart.Placingaprofittargetpreciselyonthezonewouldhavemeantmissingoutonaprofitandwatchingthemarketfalldownandgoagainstthetrade.
©2000–2011,MetaQuotesSoftwareCorp.
Thezoneexitisapowerfulexit,andmanygunnersfindit
easy to apply this exit. Thesplit exit will often enable aquickprofit, so it is ideal fortraders who do not have thepatience to wait through alongtrade.
SplitExitThe problem with the zoneexit is that often the marketwillgomuchfurtherthanthefirst zone, and thismay leadto frustration. Even gunners
liketohavetradesthatextendforalongtime.Thesplitexitis, therefore, a compromisethatgunnersmayusetoallowfor the market to go a bitfurther than the first zone.Like the zone exit, the splitexit may be used by thosenaked traders who areinterested in hands-freetrading.To use the split exit, the
naked trader must divide the
trading position into separatepositions.Onesimpleway todo this is to divide the tradein half. So, for instance, if atradehas six lots, a split exitwouldmean using one targetfor three lots and a differenttargetfortheotherthreelots.This is how a split exit is
executed: The first zone, thenearest zone to the entryprice,isusedasaprofittargetfor half the position, and the
nextclosestzoneisusedasaprofittargetfortheremainingposition. Once the marketachievesthefirstprofittarget,at the nearest zone, the stoploss is moved to break evenfor the remaining position.This obviously reduces therisk for the remainingposition. The position willeither hit the second profittargetor itwillbestoppedatbreakeven.
An example will illustratehow the split exit should beused.InFigure11.4thereisabearish kangaroo tail on theAUD/JPY one-hour chart.The market quickly falls tothe first zone, 30 pips away,and so half the position bags30 pips. The remaining halfof thepositionbecomes risk-free because the stop loss isnowmovedtotheentryprice.Themarket does retrace, but
itdoesnotmakeitbacktotheentry price. The marketinstead falls further, all thewaydowntothesecondzone,where the remaining positionexitedforaprofitof65pips.
Figure11.4TheAUD/JPYone-hourchartprintsabearishkangarootailonanimportantzone.Usingthesplitexit,thenakedtraderisabletofind33pipsofprofitonthefirstzone,andan
additional65pipsofprofitatthesecondzonebelowtheentryprice.©2000–2011,MetaQuotesSoftwareCorp.
The split exit will not
always make additionalprofit. Some of these tradeswill end up with a smallerwin simply because themarket will come back andclose out the remainingposition at breakeven. InFigure 11.5, the AUD/NZDdaily chart offers a bearishkangaroo tail on a zone.Using a split exit with thistrade,thenakedtraderfindsaprofitof73pipsatthenearest
zone, but afterwards themarketmoveshigherandhitsthebreakevenstoploss.
Figure11.5TheAUD/NZDdailychartprintsabearishkangarootailonanimportantzone.Thesplitexitenablesthenakedtradertomake73pipsatthefirstzone,butthemarketretracesbeyondtheentrypointforabreak-evenresultontheremainingtrade.©2000–2011,MetaQuotesSoftware
Corp.
The split exit will requiremore patience than the zoneexit. The fact remains thatsometradeswillbestoppedatbreakeven when following
the rules of the split exit.However, obviously, sometradeswillalsomakeittothesecond zone, and, therefore,the average size of thewinning trades will increase.Thesplitexitis,inessence,acompromise, a compromiseforthegunners.Mostgunnerswill be unable to apply theexit strategies that areappropriate for the morepatientrunners.
If you are a gunner butwouldliketoincreasethesizeof your average winningtrade,thesplitexitmaybetheexit for you. If you arethinking that both the zoneexit and the split exit do nottake advantage of the strongtrending moves that youobserve in the markets, youare probably thinking like arunner.Read thenextsectionto see how runners approach
theirtradingexits.
ExitsforRunnersRunners see things a bitdifferently. Runners lovebagging the big trade.Runners have incredibleconfidence in their tradingsystems.Runnersareinitforthe long haul. Runners useexit strategies to takeadvantage of trending
markets.The first exit for runners is
similartosomeofthegunnerexits. This exit is called theladder exit. The second exitfor runners is a little bitdifferent because it is notbased on the zones. Both ofthese exits are classified astrailing exits, which simplymeans that they takeadvantage of trendingmarkets.
TRAILINGEXITS
An exit strategy that isdynamic,withnofixedexitprice. The exit priceconstantly adjusts with themovement in themarket tomaximizeprofit.
All trailing exits are acompromise. There are twoparts to the trailing exit. Thetrailing exit must allow a
cushion so the market maymove against the position,and the trailing exit musthave a line in the sand tocapture the profit once themarketmoves too faragainstaposition.Boththeladderexitandthe
three bar exit do best duringtrending markets. The ladderexit uses zones to identifyprofit targets, whereas thethree-barexitusesanentirely
differentapproach.
LadderExitThe ladder exit is similar tothe previous exits in thatzones are used to identifyprofit targets.Thedifference,however, is that each zone isapotentialprofittarget.Whenusing the ladder exit, thenaked trader never knowswherethefinalexitpricewillbe; this is because the ladder
exit allows the market somebreathingroom.This is how the ladder exit
works: Once a trade isinitiated, the stop loss ismoved in accordance withhow far the market hasmoved. So, for example, ifthe market moves from theentry price to the closestzone, then the stop loss ismoved to breakeven. Oncethe market moves further to
thesecondclosestzonetotheentry price the stop loss ismovedfrombreakeventothefirst zone, and so forth. Theeasiest way to see how theladder exit is executed is tolookatanexample.Figure 11.6 is the
GBP/USDfour-hourchart.Abearish big belt prints on the1.6460 zone. The markettrades down to the 1.6270zone, so the stop loss is
moved from the high of thebig belt candlestick tobreakeven. Then the markethits the next zone at 1.6135,so the stop loss is moved tothe 1.6270 zone. Themarketturns around and trades backup to the1.6270zone,wherethe trade is exited for a gainof128pips.
Figure11.6ThisisabearishbigbeltontheGBP/USDfour-hourchart.1.Thestop
lossisabovethehighofthebearishbigbelt.2.Thestoplossmovestobreakevenoncethemarketreachesthefirstzone.3.Thestoplossmovestothefirstzoneoncethemarketreachesthesecondzone,thisiswherethetradeisexitedfor128pips.©2000–2011,MetaQuotesSoftwareCorp.
Patience is needed toemploy the ladder exit. Takea lookatFigure11.7.This isanotherexampleoftheladderexitontheEUR/USDweeklychart. Here we see a bullishkangaroo tail. The market
immediately trades higherthan the kangaroo tail andreaches the first zone at0.8750 quite easily. At thisstage, the stop loss ismovedto breakeven. The markettrades higher to reach thezone at the 0.9100 level.Here, the stop loss ismovedto the first zone down at0.8750. Next, the marketmakes a move higher andreaches the next zone at
0.9330, so the stop loss ismoved to the second zone atthe 0.9100 level, and this iswherethetradeisexitedforagainof575pips.
Figure11.7TheladderexitonaweeklyEUR/USDbullishkangarootail.1.Thestoplossisfirstplacedbelowthelowofthekangarootail.2.Thestoplossismovedtobreakevenoncethemarketreachesthe0.87500zone.3.
Themarkettradesuptothenextzoneat0.9100,sothestoplossismovedto0.8750.4.Themarketreachesthenextzoneat0.9330,sothestoplossismovedto0.9100,andthisiswherethetradeisexitedfor575pips.©2000–2011,MetaQuotesSoftwareCorp.
Using the ladder exit willallowthemarketa“cushion”of one zone. This may seem
frustrating, to allow themarkettocomebackandstopoutatradeforlessprofit,butthis is the nature of thetrailingexit.All trailingexits(including the three-bar exitdescribedfurtheron),havetoallow some breathing room,or “cushion” in order tocapture the large profitsavailableintrendingmarkets.
Three-BarExit
Thethree-barexitisauniqueexit because, unlike theprevious exits, it does notinvolve zones. The three-barexitgetsitsnamebecausetheexit is based on the priceaction of the most recentthree bars (or candlesticks).The exit is a simple trailingexit based on the lowest lowof the previous threecandlesticks (for buy trades),or the highest high of the
previous three candlesticks(forselltrades).The naked trader locks in
profits by trailing the stoploss behind the lowest low(for buy trades) of theprevious three candlesticks.Taketheexampleontheone-hour GBP/AUD chart. Thistrade is obviously a bullishtrendy kangaroo on anexcellent zone at 1.5868 (seeFigure11.8).Theinitialstop-
loss placement is below thelowofthetrendykangaroo.
Figure11.8ThestoplossfortheGBP/AUDone-hourtrendykangarooisfirstplacedbelowthelowofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Once the market printsthree candlesticks after thetrendykangaroo,thestoplossis moved below the low ofthe lowest candlestick. Thelowest of the threecandlesticks inFigure11.9 is
the third candlestick, thecandlestick immediately afterthe trendy kangaroocandlestick. The stop loss ismoved to just below the lowof the candlestickimmediately following thetrendykangaroocandlestick.
Figure11.9Thethree-barexitappliedtotheGBP/AUDone-hourchart.Oncethemarkethasprintedthreecandlesticks,thestoplossis
movedbeneaththelowestlowofthemostrecentthreecandlesticks.©2000–2011,MetaQuotesSoftwareCorp.
In Figure 11.10, the three-bar exit is applied to
GBP/AUD one-hour trendykangaroo. One morecandlestickprints, and so thestop loss is moved higher,this time it is placed belowthe third most recentcandlestickbecauseithasthelowestlowatthisstageofthetrade.
Figure11.10Thethree-barexitappliedtotheone-hourGBP/AUDtrendykangarootrade.Themarketmoves
higher,andthestoplossisplacedjustbelowthelowestlowofthethreemostrecentcandlesticks.©2000–2011,MetaQuotesSoftwareCorp.
In Figure 11.11 themarket
moveshigheronceagainafteranother one-hour candlestickcloses. The GBP/AUD one-hour trendy kangaroo istrendingnicely,andthethree-bar exit is locking in profitsasthemarkettradeshigher.
Figure11.11Onemorecandlestickprints,andthethree-barexitisadjustedonceagain.Thistimethethirdmostrecentcandlestickisagainthecandlestickwiththe
lowestlow,sothestoplossontheGBP/AUDtrendykangarootradeisplacedbelowthethirdcandlestick.©2000–2011,MetaQuotesSoftwareCorp.
The one-hour chart for the
GBP/AUD changesdrastically as the marketmakes a strong movedownward(seeFigure11.12).At this stage, the candlestickwith the lowest low is themost recent candlestick, soaccordingtothethree-barexitrules the stop loss must beplaced a few pips below thismostrecentcandlestick.
Figure11.12Themostrecentcandlestickontheone-hour
GBP/AUDchartmakesastrongmovedown.Thestoplossisplacedbelowthiscandlestickbecauseithasthelowestlowofthemostrecentthreecandlesticks.©2000–2011,MetaQuotesSoftwareCorp.
One more candlestickprints, and the trade survivesby a whisker. The newcandlestick is slightly lowerthanthepreviouscandlestick,so the stop loss is placedbelow this most recentcandlestick (see Figure11.13).
Figure11.13TheGBP/AUDone-hourtrendykangarootradesurvivesafterthenextcandlestickprintsonthe
chart.Thismostrecentcandlesticknowhasthelowestlow,sothestoplossisplacedafewpipsbelowthiscandlestick.©2000–2011,MetaQuotesSoftwareCorp.
The next one-hourcandlestickontheGBP/AUDone-hour chart (see Figure11.14) prints slightly higher.The stop loss remains at thesame location because thissecond candlestick still hasthe lowest low of the mostrecentthreecandlesticks.
Figure11.14Thestoplossfortheone-hourGBP/AUDtrendykangarootraderemainsthesamebecausethe
mostrecentcandlestickdoesnotpresentalowerlow.©2000–2011,MetaQuotesSoftwareCorp.
The one-hour trendykangaroo trade on theGBP/AUDchartisclosedout
on the next candlestick (seeFigure 11.15). The mostrecent candlestick pushesthrough the stop loss, and sothe trade is closed for amodestgainof13pips.
Figure11.15Thenextcandlesticktriggersthethree-barexitstoploss.Themostrecentone-hourGBP/AUDtradeslowenoughtohitthestoploss,andsothetradeisoverafteragainof13pips.
©2000–2011,MetaQuotesSoftwareCorp.
Someof the trades that aremanaged according to thethree-bar exit will end upwith similar results to thisGBP/AUD one-hour trendy
kangarootrade.Thethree-barexit is ideal for a strongtrending market, but if themarket does not continuemoving with a strong trend,the three-bar exit will onlycapture minimal profits.Although this may seemdiscouragingforsometraders(particularly gunners), forrunners,whotakealong-termperspective, a few losingtrades or minimal gains are
acceptable. Runnersunderstand that the largegainswillcomefromtime totime and make the three-barexit a worthwhile exitstrategy.Another example of the
threebarexitisinorder.Thistime,itistheAUD/JPYdailychart,andthetradeset-upisabearish big shadow (somenaked tradersmay argue thatthisset-upisnotabearishbig
shadow, but something else;go to www.fxjake.com/bookto watch a video about thistrade).Theoriginalplacementforthestoplossisjustabovethe high of the bearish big-shadow candlestick (seeFigure11.16).
Figure11.16Theinitialstop-lossplacementforthedailyAUD/JPYbearishbigshadowisjustabovethehighofthebigshadow.
©2000–2011,MetaQuotesSoftwareCorp.
The stop loss remainsabove the high of the bigshadow until three morecandlesticks print after the
bearishbigshadow.Thestoploss is moved a few pipsabove thehighesthighof thethree most recentcandlesticks.AsFigure11.17illustrates,thehighesthighofthe previous threecandlesticksisthecandlestickimmediately following thebigshadow,sothestoplossisplacedabovethiscandlestick.
Figure11.17Accordingtothethree-barexit,oncethe
thirdcandlestickprintsthestoplossmaybeadjusted.Inthiscase,thefirstcandlestickaftertheAUD/JPYdailybearishbigshadowhasthehighesthighofthethreecandlesticks,thusthestoplossisplacedafewpipsabovethiscandlestick.©2000–2011,MetaQuotesSoftwareCorp.
The next chart (see Figure11.18) shows fourcandlesticks after the bearishbigshadow.Thehighesthighof the most recent threecandlesticks becomes the
most recent candlestick.Therefore, the stop loss isplaced a few pips above thehigh of the most recentcandlestick. It is important tonote that according to therulesofthethree-barexit,thecandlestickmustclosebeforethestoplossmaybemoved.
Figure11.18ThemostrecentcandlestickonthedailyAUD/JPYchartbecomesthecandlestickwiththehighest
high.Thus,accordingtothethreebarexit,thestoplossisplacedafewpipsabovethehighofthemostrecentcandlestick.©2000–2011,MetaQuotesSoftwareCorp.
Another candlestick printsand the candlestick with thehighest high remains thesame. The stop loss is notmoved because the secondmost recent candlestick still
has the highest high (seeFigure11.19).
Figure11.19Usingthethree-barexit,thestoplossplacementontheAUD/JPYdailybearishbigshadowtraderemainsthesameafteronemorecandlestickprints.©2000–2011,MetaQuotesSoftwareCorp.
The next day, the markettakesanother fall (seeFigure11.20).Thestoplossremainsthe same, above the thirdmost recent candlestick. Thetwomore recent candlesticks
have lower highs, and,according to the three-barexit, the stop loss placementis above the highest high ofthepriorthreecandlesticks.
Figure11.20Themarketmakesanothermovedown,butthestop-lossplacementontheAUD/JPYdailybearishbig-shadowtraderemainsthesame.Thestoplossremainsafewpipsabovethehighofthethird
candlestick.©2000–2011,MetaQuotesSoftwareCorp.
This time the stop loss forthetradeismovedonceagainas shown in Figure 11.21.
The next candlestick printsandthehighesthighbecomesthe third most recentcandlestick,sothestoplossisplaced a few pips above thehigh of that candlestick.When using the three-barexit, if thestoplossisplacedabove the third candlestick,thenitisknownthatafterthenext candlestick prints, thestoplosswillbemoved.
Figure11.21Themarket
printsanothersmallcandlestickandtheAUD/JPYtradehasanewstoplossplacementabovethethirdmostrecentcandlestick,accordingtothethreebarexitrules.©2000–2011,MetaQuotesSoftwareCorp.
Another candlestick prints,and the highest high is onceagain the third most recentcandlestick,sothestoplossismoved a few pips above thehigh of this third candlestick
as is seen in Figure 11.22.Again,sincethestopisabovethe third candlestick, therewill be another stop-lossadjustment once the nextcandlestickprints.
Figure11.22Afteranewcandlestickprints,thestoplossisplacedafewpipsabovethethirdmostrecentcandlestick,thecandlestickwiththehighesthighofthepreviousthreecandlesticks.
©2000–2011,MetaQuotesSoftwareCorp.
One more candlestickprints, and the new highesthigh is the most recentcandlestick,sothestoplossis
placed a few pips above thiscandlestick (see Figure11.23).
Figure11.23Themostrecentcandlestickhasthehighesthighofthethreemostrecentcandlesticks,soaccordingtothethree-barexit,thestoplossisplacedabovethiscandlestick.©2000–2011,MetaQuotesSoftwareCorp.
The market has finallytriggered the three-bar exitshown in Figure 11.24 andthe trade is over. The mostrecent candlestick takes outthestoploss.Thisbearishbig
shadow on the AUD/JPYdaily chart has netted 137pips by using the three-barexit.
Figure11.24Themostrecentcandlesticktradesthroughthestoploss.Thebearishbig-shadowtradeonthedailyAUD/JPYcharthascaptured137pips.©2000–2011,MetaQuotesSoftwareCorp.
The three-bar exit worksbest when the marketaccelerates into a strongtrend. As long as the threemost recent candlesticks arefollowingthetrend,thethree-
bar exit will trail slightlybehind the advancingcandlesticks, capturing profitalong the way. This exit isideal for runners who areinterested in capturing largeprofits.At times, the three-bar exit
may be frustrating, sometrades will end up as losers,other trades may give backmuch profit, but if usedconsistently, this trailing exit
will capture big moves. Thekey to this exit is to use itconsistently, for every trade.Runners are like all traders:They never know when thenext big trend will pop up.But gunners who applytrailing exits such as thethree-bar exit are ready tocapture profits from the nexttrendinthemarkets.
MANAGINGEXITS
A common problem fortraders isre-trading themostrecent trade. This issue isextremely common fortradersstrugglingwithanexitstrategy. Traders will take aclose look at a recent trade,see where improvementscould have been made, andthen decide to change things
for the next trade. Theproblem with this strategy isthat every trade is different.The previous trade hasnothing to do with the nexttrade. Every trade is anindependent event. Whentraders fall into this trap ofre-trading theprevious trade,badthingsoftenhappen.If you have found yourself
adjusting your strategy ingeneral,orchangingyourexit
strategy in particular, basedon what occurred in theprevioustrade,youarefallingintothistrapaswell.Perhapsyou take a trade and themarket runs for severalhundred pips in the expecteddirection,longafteryouhaveexited the trade. This mayencourageyoutochangeyourexit strategy on the nexttrade. The problem with thisis thenext trademaynot run
for severalhundredpips, andmayonlygotothenextzone,which means that you willreduceyourprofitabilityevenfurther.Decidewhichtypeoftrader
you are going to be. Eitheryouwill be a runner, or youwillbeagunner.Sticktooneexitphilosophy.Decidewhatmakes sense to you. If youareagunnerdonotgetupsetif the market runs for 500
pips after you exit the trade.Ifyouarearunnerdonotgetupset when you get stoppedout after the market goes inthe expected directioninitially. It is important tostay true to your tradingbeliefs. The best way to dothisistoavoidre-trading thelast trade. In fact, re-tradingthe last trade may send youinto a cycle of doom—neverafunplacefortraders.Inthe
nextchapterweexamine thiscycleindetail.
PARTTHREE
TradingPsychology
CHAPTER12
TheForexCycle
Insanityisdoingthesamethingoverandoveragainbut expecting differentresults.
—RitaMaeBrown
It is true thatmost tradersdonot consistently find profits;the vast majority of forextraders lose moneyconsistently. Because of this,many traders find it difficulttostickwithatradingsystem.The vast majority of tradersarealways lookingforanewandimprovedtradingsystem.The trading system gets theblameforallthelosses.Mosttraders are, therefore,
constantly searching for abettertradingsystem,lookingforasolutiontotheconsistentlosing.Theironicthingisthatthesolutionhasnothingtodowiththetradingsystem.Anexplanationofthecycle
ofdoomwillhelpyou to seehowyoucanbreakoutofthiscycle if you are currentlyfinding it difficult to reachconsistentprofits.
WHATISTHECYCLEOFDOOM?
Thecycleofdoomconsistsofthree phases. The first phaseis the search. The secondphase is the action. And thethird and final phase is theblame. A close look at eachof these phases reveals thatthe cycle of doom
characterizes a logicalapproach to trading. Tobecome a successful trader,however, you will have tobreak out of the cycle ofdoom.Howdoyoubreakthecycle
of doom?The first step is tounderstand the cycle. Onceyou understand the cycle ofdoom, you may break freefrom thecycleofdoom. It isimportant for you to
understandwhatishappeningso that you may identify it,and then move beyond thecycle of doom and into theworldofconsistent,profitabletrading.
Phase1:TheSearchIn this phase you aresearching for a tradingsystem. You may look foryourtradingsystemintrading
books, in online tradingforums, trading educationwebsites, or you may findyour trading system fromspeakingtoanothertraderataconferenceormeeting.Intheend,itisnotimportantwhereyou find a trading system,only that you find a tradingsystem that appears to besuccessful.If you are unable to find a
trading system that you are
comfortablewith, thenyou'reprobablyinphase1.Youwillleave phase 1 only once youfind a trading system that istruly exciting, a system thatyou look forward to trading.In fact, phase 1 of the cycleofdoomiscompleteonceyoufindatradingsystemthatyousimply cannot wait to trade.Thedefiningfeatureofphase1isthatthetradingsystemisthe solution. Once you have
foundatradingsystemthatisexciting, you will movebeyondphase1.
Phase2:TheActionPhase 2 is the action phase.Thisisthefunpart;youbeginto trade your system. If youarelikemosttraders,youwillleap into phase 2 with justabout every trading systemthat looks decent. The
excitement of using a newtrading system isirreplaceable.Thisexcitementcomes from the unknown(more about this later). Willthis new trading systemwork? Will you become abillionaire trading thissystem? Is it everything youhopeittobe?Amid this excitement you
begintotradethesystemwithhigh hopes. It is highly
unlikely, given that you areextremely excited to starttradingyournewsystem,thatyou would have time to testyour trading system. Theproof for your new tradingsystem is so overwhelmingthat there is no need to testthe trading system. If youdodecide to test your tradingsystem before jumping intothe action phase,congratulations, you are a
member of the cautiousminorityoftraders.This is the exciting phase
because you're able to putyour trading system to thetest. You may not havedecided to test your tradingsystem before moving intotheactionphase.Infact,onlya small percentage of tradersdo test a trading systembeforemovingintotheactionphase. This action phase is
punctuated by excitement. Itis exciting to trade a newsystem, not knowing whatmay happen. You may findthat the trading system doeswellforanextendedperiodoftime. Perhaps you find thatoptimism abounds.However,at some stage things lookbleak.Maybe profits pour inearly, but eventually thelosingtradespileup.A drawdown eventually
appears. There are severallosing trades in a row.Thesetradesmayhaveappearedjustasyoudecide to increase theriskpertrade.Obviously,thiswasan ill-timedmodificationto your trading system. Justasyoudecidedtoincreasetheriskper trade, the systemraninto a bumpy road. Thisdrawdownisthebeginningofthe end of phase 2. Thisdrawdownwillmeanthatyou
lose faith in your tradingsystem, and begin to moveintothenextphase.
Phase3:TheBlamePhase 3 is the blame. Theblame is the phase in whichthe trading system isscrapped.Becausethetradingsystem has not foundconsistentprofits, youdecideto dump the trading system.
Thetradingsystemisatfault.Thetradingsystemfoundthelosing trades. The tradingsystem must be responsibleforthedrawdown.Frustrationsets in because the systemthat looked so fool-proofended up being a loser. Youdecide it is time tomove ontoanewtradingsystem.
ReturntoPhase1
The cycle of doom ispunctuated by a return tophase 1 after phase 3. Onceyouhavecompletelygivenuponyoursystem,youdecidetofind another system, a bettersystem. The search is onagain.Thecyclerepeatsitselfonceagain(Figure12.1).
Figure12.1Mosttradersfinditdifficulttobreakoutofthecycleofdoom.
The cycle of doom makessense to the trader who isconvinced that profits comefrom trading systems. Theproblemisthis:Profitsdonotcome from trading systems.Profits come from traders.
Traders find profits in themarkets,andthetool(tradingsystem) used to extract theseprofits is not as essential asthe trader's execution. Thefatalmistakethatmosttradersmake is to assume thattrading systems areresponsibleforprofits.
LIVINGIN
THECYCLEThe cycle of doom may befamiliartoyou;itiscertainlyfamiliartome.Iwasstuckinthe cycle of doom for years.Losingconsistentlyisnofun,I shouldknow, Idid itoften.Itmaybedifficulttobelieve,after spending years tradingand losing, that it is possibleto reach the land of profits;however, it is possible to
achieve consistent profitstrading forex. The first steptoward profitability isidentifying that you havebeen stuck in the cycle ofdoom.Acloseexaminationofhow
many traders approachtrading reveals that the cycleofdoomisduetohowtradersapproach their trading, andnot the viability of a tradingsystem.
Anotherwaytolookatthisistoconsiderthattwotradersmay be trading using thesame system. One trader isconsistently findingsuccessful, profitable trades,and the other trader isconsistently losing money.What is the differencebetween the two traders?They both trade using thesame system. The differenceisinthetrader.
The key to breaking thecycle is to recognize that thetrading system is notresponsiblefortradingprofitsorlosses.Youareresponsiblefortradingprofitsandlosses.
DEFEATINGTHECYCLE
It is possible to defeat thecycleofdoom.Ihavedoneit,
andmanyothernakedtradershave also broken the cycle.You can certainly defeat thecycle of doom. You mustwant to become aprofessional trader. If youwant to trade consistently,and if you want to findprofits,itmaybebestforyouto stick to a trading systemthatyoubelievein.Onewaytogainconfidence
in your trading system is to
back-test it. You alreadyknowthis.Haveyoudoneit?Have you tested any of thetradingsystems in thisbook?If you have not, perhaps youare not ready to defeat thecycle. But do not lose hope,for there may be anotheropportunity for you to findconfidence in your trading.There may be a very goodreason why you have notback-tested any of these
systemsatthisstage.It may be that you are
waiting for a trading systemthat resonates with you.Perhaps once you find thistrading system you will beable to go and test itextensively, and build yourconfidence in this tradingsystem before using it in alive market. If this soundslike you, then the nextchapter is for you. You are
the type of trader who mustcreate your own tradingsystem. You must trade asystem that is completelyyours.Thisisfine,youareingood company, and there aremany traders who, like you,musttradeonlyahomegrownsystem. Trading your ownsystem may be the best wayto avoid the cycle of doom,and this is explored in detailinthenextchapter.
CHAPTER13
CreatingYourTradingSystem
My parents taught mehow to listen toeverybody before Imadeup my own mind. When
youlisten,youlearn.Youabsorb like a sponge—andyour life becomes somuch better than whenyou are just trying to belistenedtoallthetime.
—StevenSpielbergYears ago, I met a tradernamedMiguel.He,likemanyothers before him, wasinterestedinbecomingafull-time forex trader. We spokeabout trading psychology,
trading systems, reasons forbecoming a professionaltrader, and we talked abouthow boring trading is. Myfriend was a professional inthe finance world, whoworked at a bank inSwitzerland. He reallywanted to learn how to tradeforconsistentprofitsinforex.I told him that once helearned to be an efficienttrader, his trading would
become very boring.Hewasshockedtohearthis.Itistrue,successful trading often isboring. He did not believeme, but nevertheless hethought it would be great ifhe became a boredprofessionalforextrader.Manyyearslater,myfriend
has left his job at the bank,moved from a chilly countryto a nice, warm tropicallocation,andhenowtradesa
few times each month. Hewrote to me to say, “Now Iknow what you mean whenyou said that ‘trading willbecomeboring.’”Ihopethishappens for you. I hope thattrading becomes boring. Ihope that you do the samethingoverandoverandoveragain,andfinditveryeasytopull profits out of the forexmarket. If you work hard,your trading may become
boring. The key is to definewhoyouareasatrader.Onceyou do that, you may put aplan to action thatwill allowyour trading to becomeboring.So, how will you define
yoursystem?Theanswerliesinwhoyouare.Whoyouarewill define how you trade.Whatmakessensetoyouasatradermaynotmakesensetome. This is fine. There are
manyways to find profits inforex. If a trader tells youthereisonlyonewaytomakeprofits in forex, he iswrong.There aremany ways to pullconsistent profits in forex.Yousimplyhavetofindyourway.
WHATDOYOU
BELIEVE?Your beliefs will drive yourtrading. If, for example youbelieve it is impossible tomake money scalping, thenyouwillhaveaverydifficulttimemakingmoneyscalping.Ifthisisyourbelief,focusonlonger-termcharts.
TheRulesThe rules of your trading
system will define how youinteract with the market. Itmay seem like this is a verysmall detail, but in fact it isthe definition of the game.Those traders who do nothaverules—andmanytradersenterthemarketwithoutrules—are simply gambling. It isimportant for you to definewhatyoursystemrulesare,ifonly for the fact that havingtheminfrontofyouwillhelp
toremindyouthatyouhaveamethodforextractingprofits.Beyond that, it is importantforyoutorememberthatyoursystemrulesalsodefinewhatyou should do in anysituation. Your entries, yourexits,yourtrademanagementandyour risk strategyshouldall be contained in yoursystemrules.Itmaybetemptingtocreate
a system without precisely
defined rules, but know this:A well-defined tradingsystem is more likely towithstand your personalpsychological attacks againstyour trading system. Lessinterpretation often meansbetter trading, and the best-defined systems are “just-this” resistant. If you haveexperience trading you knowhow tempting it is tomodifyyour trading system just this
time, or perhaps you havefound yourself willing tooverride a trade signal yoursystem offers just this time,or maybe just this time youhave decided to move yourstop loss to give a trade alittle more breathing room.Just-this trading leads todisasters, and it is importantfor you to develop a tradingsystem that is just-thisresistant.
AreYouaMarketSpecialist?
The first decision to makewhen designing your systemis to decide which pairs,which markets you will betrading. All the systemscontained in this book willwork on many markets, andmost timeframes. Thequestionbecomesthis:Whichtype of trader are you? You
may decide between twobasictraderprofiles.Thefirstis themarket specialist.As aspecialist you willconcentrate on one market.There are many successfultraders who do just this.Perhaps you only want totrade the EUR/USD. If youdecide to be a EUR/USDspecialist, you will learn theintricacies of the pair. Eachmarkethasapersonality,and
asaEUR/USDspecialist,youwill learn the personality ofthe euro. You might alsolearn the correlationsassociatedwiththepair,whenthe pair is reacting in anunusualway,andsoforth.Atthetimeofthewritingof
this book, Ashkan Bolour, aprofessional forex traderwhois very familiar with theEUR/USD market, haddiscovered a very peculiar
correlation. Bolour has beenexploiting this correlationwith a scalping strategy forover one month. He haddetermined that theEUR/USD had been closelyfollowing the Dow JonesIndustrial Average. Bywaiting for the Dow toestablish a direction for thetrading day, he knewprecisely which direction toscalptheEUR/USD.Hesaid,
“I don't know how long thecorrelation will last, but fornowitdoesmakeaconsistentprofit.”Nowit is important tonote
that, as a market specialist,you will probably uncoversimilar relationships such asthis one in your trading.Remember that theserelationships will not alwayslast; they are transient.Althoughitisgreattoexploit
these relationships, youmustalways be on your guardwhentheystarttofallapart.As amarket specialist, you
will discover relationshipssuch as the one Bolour usedin his trading. You willbecome familiar with themarket,youwillknowwhatitdoes around the nonfarmpayrollreport,youwillknowwhen the interest-rateannouncements are for your
market, and you will beaware of what the currencypairislikelytodo.Ingeneral,youwillhavea feel foryourchosen market. This is thegreatadvantage.Some traders begin trading
withthebeliefthattheymusttrade everymarket available,and that simply is not thecase. Market specialists aresome of the most profitabletraders on the planet, and
many of them have anexceptionally high win rate.This comes with theunderstanding of the marketand having an intimaterelationship with the market,the factors that affect themarket, and a method fordetermining the mood of themarket. If you think thatbecoming amarket specialistis for you, then make surethat you back-test your
chosen trading systemextensively on your market.Youmaybesurprisedatwhatyoufind.Market specialists will
sometimes use severaldifferent trading systems onthesamemarket.Perhapsyoudecideyouwant tobecomeamarket specialist and workonlywiththeGBP/USD.Thismaymean thatyouareusingseveraltradingsystemsonthe
GBP/USD.For example,youmay decide to trade dailykangaroo tails on theGBP/USD. You may alsodecide that you are going totake last-kiss trades on four-hourGBP/USDcharts.As amarket specialist, you
may even find that you aresimultaneouslylongandshort(buying and selling) yourcurrencypair,simplybecauseyou are trading multiple
timeframes and strategies.This may seem confusing orunlikely,butifyouchoosetofollow the path of thespecialist, you may find itmakes sense to follow theshort-term and long-termimpulses of your chosenmarket simultaneously.Perhaps buying your marketon the one-hour chart, andsellingitontheweeklychart.These seemingly
contradictory positions makesense only to the marketspecialist, the traderwhohasintimate knowledge of themarkethetrades.
AreYouaTradeSpecialist?
If the idea of trading onemarket does not appeal toyou, then you may want toconsider the alternative:
becoming a trade specialist.Asatradespecialist,youwillfocusononetradingset-up,itmay be the moolah trade orbig belts, or perhaps trendykangaroos. The set-up youchoose does not matter, youmust simply be comfortabletrading the system. You willgaincomfort trading this set-up across markets by back-testing. Obviously, this willinvolve back-testing. It is
onlythroughback-testingthatyou can accumulateexperience and confidence inyourtradingset-uptoapplyitacross markets consistentlyand repeatedly for profits.Additionally, to become atrade specialist,youmustgetcomfortable with all phasesofthetrade.All trades are similar to a
good story, they have abeginning, middle, and an
end. In the beginning, thequestion is: Do you want totakethistrade?Istheriskforthis trade worth it in yourmind?Haveyouseensimilarset-ups in the past that haveworked out? If you feel asthough you simplymust takethe trade, because it is toogood to be true, then youshould take a trade. Thebeginning, in some ways, isthe most difficult part of the
trade.Thebeginningphaseofyourtradeiswhenyouactasa filter. You are filtering outthose subpar trading set-ups.You, as a trade specialist,know precisely what thosegrade-A set-ups look like.This will obviously comefrom your back-testing. Youwill have gained experiencethroughyouraccumulationofknowledge; this only comeswith exposure to charts,
which only comes withtrading live accounts anddemo accounts and back-testing.Basedonyourtradingexperience, you will knowwhich trades to filter out.This is the most importantandcriticalphaseofthetradeasatradespecialist.Thesecondpartofthetrade
occurs when you aremanaging the trade. This iswhereMarketBiofeedback™
comes in. Does the marketprovide any criticalinformation about the trade?How do you feel about thetrade, given the price actionthathasprintedafterenteringthe trade? When the markettells you what to do, makesure you are ready to act onthis information.Disregarding marketinformation is stubborntrading.Ifyoujointhegroup
of stubborn traderswhoholdonto beliefs despitecontradictory marketinformation,youtoomayfindthem to be very expensivebeliefs (see Chapter 16 formoreonexpensivebeliefs).The third and final part of
the trade is the exit. Now,your style of exit strategy isobviously something that isunique and special to yourpersonality.Yousimplymust
trade and exit in a way thatmake sense to you, and fitswith your view of themarkets.Theexitiswherethemoneyismade.Exitsliterallydiscriminate traders; traderswho consistently makemoney know how to applyexits. Those traders whoconsistently lose moneyusually have great difficultywithexits.If you doubt that exits
control your trading destiny,then consider this: Have youtaken the exit challenge?(Learnhow to test thepowerof exits atwww.fxjake.com/book). Ifyou have, you have seen thepowerofexit.Byapplyinganexit strategy, you are able toconsistently pull profits,regardless of why you haveentered.Ifyouhavedonetheexit strategy challenge, then
you know how powerful aproperexitstrategy,ifappliedconsistently,will bring homemoney consistently. It is nottoolatetodotheexitstrategychallenge, so if youhavenottried it, please do it. It is agreat way to put the exit inperspective.As a trade specialist you
will become familiar witheach phase of the trade foryour chosen strategy. You
willlearnhowtodiscriminategood set-ups from poor set-ups, you will learn how todiscern if a trade is goingwell,orifitisnotgoingwell,and you will learn how toapply your chosen exitstrategy consistently. (Notethatalltradesmayexperiencea drawdown, but theexperienced trader, a traderwho understands MarketBiofeedback,willknowwhen
topulltheplugonatradethatispoorlyperforming)You will have to back-test
your chosen specialty, tobuild your confidence, andbecome an expert with yourtrading system. Experiencetrading your system across abroad range of markets isimportant if youare to applythis system confidently andconsistently. You may find,for example, that, as a
specialist trading the last-kisstrade,itworksextremelywellon the four-hour charts andthedailycharts,butwhenyouapply it to the one-hourcharts,thewinrateplummetsfor you. This is valuableknowledge, and instead oftrying to fight the system,knowing how you trade it,and which timeframes areeffectiveareimportantpiecesof information that you can
use to improve your tradingandaidyoursuccess.
ChoosingYourTimeframe
Choosing your market isimportant—just as importantas choosing your timeframe.There are three questions toanswerwhen considering thetimeframe you are willing totrade. First, what type of
personareyou?Yourtradingpersonality will go a longway to determine thetimeframe that you will feelcomfortable trading. Second,howmuch time do you haveduring your day? Traderswho have considerable timeto trademaybeable to tradelower time frames (such asthe five-minute or fifteen-minute charts), but peoplewithverybusydaysmaynot
be able to trade anythingother than the highertimeframe. Third, are you apatient trader?Patient traderswill be able to endure theinevitable fluctuations inlonger-term trades, butimpatient traders find it verydifficult, and end up tradingshorter timeframes. In fact,impatient traders make verygoodscalpers.Before you decide on your
chosen timeframe, rememberthesetwoprinciples:First,theshorter the timeframe youdecide to trade, the moreintenseconcentrationyouwillneed to sustain to beconsistently profitable.Second,asarule,traderswhostart out trading longertimeframes and trade thosetimeframes successfully formonths (or years) have amuchhighersuccessratethan
those traders who jumpstraight into the five-minutecharts. So choose yourtimeframecarefully.
RISKRULESTrading is simply a game ofmanaging risk. How manytrades will you take at anyone time? How large willyour trading positions be?When thinking about risk,
there are three key aspectsyoushouldconsider:(1)yourrisk appetite, (2) maximumdrawdowns, and (3)correlatedtrades.
RiskAppetiteThe simplest rule to apply isto think about your sleep. Ifyouareabletoputatradeon,place the orders in yourplatform, and then go to
sleep, this is the trade sizethat fits your risk profile. If,however, when you place atrade you find it difficult tosleep, you find that you arealways thinking about thetrade while away from yourcomputer, then the trade istoo big. You need to reduceyour trading to the sleepingpoint, thepoint atwhichyoucan place a trade, accept therisk, and get a good night of
sleep.
SLEEPINGPOINT
Thepointatwhichyoucanplace a trade, accept therisk associated with thetrade, andget agoodnightof sleep. If a trade isconstantlyonyourmindorif you find yourselfchecking a trade at oddhours in the night, there istoo much risk associatedwiththetrade,anditshould
be reduced to the sleepingpoint.
MaximumDrawdown
Your appetite for risk willhelp determine the size ofyour trade, but so will yourmaximum drawdown. Themaximum drawdown is theamount you are willing toloseoveraperiodoftime.An
easy way to track themaximum drawdown is tolook at it from the point ofviewofonetradingweek.Forexample, you may risk1percentofyour accountoneach trade. If you set yourweekly maximum drawdownto 5 percent, you canwithstandfivelosingtradesina row. After five losingtrades, you have hit yourmaximum drawdown for the
week. You may decide tostop trading once yourmaximumdrawdownishit.How you decide to apply
themaximumdrawdownrulemaydependonthetimeframeyoudecidetotrade.Youmaydecide to have a maximumdrawdown per month if youtrade a longer timeframe. Ifyou tradeshorter timeframes,you may decide to have amaximum drawdown amount
foroneday.Itisuptoyoutodecide. Note that yourmaximum drawdown willaffect how many trades youare able to take at any giventime.For example, you may
decide to have a maximumdrawdown of 5 percent foreach trading week. If youhavesixdailytradesignalsonthe first trading day of theweek, andyou risk1percent
on each of these trades, youcould have a drawdown of6 percent should all thosetrades go bad at once. Theimplication,ofcourse, is thatyou should reduce your riskso you are unable to reachyour weekly drawdown onthefirstdayoftheweekifallof the trades end up losers.So, if you have a 5 percentdrawdown rule per tradingweek, and you have six
trading signals in one day,perhaps instead of risking1 percent per trade you risk0.65 percent per trade for anoverall risk of 3.9 percent.This way, you have another1.1percent to risk therestofthe tradingweekshouldall6tradesbecomelosers.Another critical question
you must ask about yourtrading system is this: Howwill you deal with
drawdowns? Will you use astop-trading rule? How willyou recharge your batteriesand jump back into tradingafter a drawdown? Perhapsyoubelievethata“drawdownretreat” is a good idea. Youmaydecidetogetawayfromthe charts, and, if possible,get away from your tradingstation and take a trip out oftown after experiencing adrawdown.Thetheorybehind
this is if you get away fromtrading for a while you will(1) avoid revenge trading (aquick way to blow up youraccount), and (2) come backto the charts with a freshperspective.Thebestwaytocomeback
tothechartsfreshistosimplyfollow a planned sequencewhenever you experience amaximum drawdown. Forexample, you may decide to
follow this five-stepsequence: (1)Go away. Youwill get away from yourtradingstationandawayfromyour home or trading office.Evenifonlyfor theweekendor couple of days. It isimportant to remove yourselffrom the place where youhave experienced thedrawdown.(2)Back-testyoursystem. This should be apredetermined number of
trades (e.g., 200 trades) or aset time period (e.g.,EUR/USD daily chart from2009 through 2011). (3)Evaluate your tradingstatement. What has beenworking well? What has notbeen working well? Is thedrawdown due to bad luck?Or is thedrawdowndue to alack of discipline; are youfollowing your trading rules?Perhaps there are a few
currencies that account for85 percent of your losses?Take a good look at yourtradingstatement toseewhatseems to be working andwhat needs improvement.Make sure that you go backfar enough with yourstatement to see what wasworking for you before thedrawdown.(4)Decideifyoursystem still works. You haveback-tested and you have
examined your tradingstatement. If your tradingstatement reveals nothingmore than bad luck, andback-testing suggests yourtrading system still works, itis time for another test. Testyourtradingsystemonrecentmarket data. This way youcan be sure that your tradingsystem no longer works. Ifyour drawdown has occurredover the past three weeks,
take a close look at recentmarket data from the pastthree months to see if thesystem is profitable. If youhavefoundthat thesystemisno longer profitable, itmightbe best to stick to a demoaccount when you begintradingagain.
DEMOACCOUNT
Short for “demonstrationaccount”—many forexbrokers offer free practiceaccounts, also called demoaccounts. These accountsallow forex traders tobecome comfortable withthe trading platform (thebroker's trading software),and they also allow traderstotesttradingsystemswithreal markets. Theseaccountswillkeep trackofwinning and losing tradesbecause they are fundedwith an amount ofsimulated money such as
$50,000.
Demo trading will ensurethatyoudonotlosemoneyifthe trading system no longerfinds consistent profits. Youmust be careful of jumpingback into the cycle of doomwhen doing this. If yourtrading system no longerturns a profit (and you areapplying the rulesconsistently),itistimetofind
another system. (5)Work onyou.Youarethemostcriticalaspectofyourtradingsystem.When your confidence isshaken after a seriousdrawdown you shouldtransition back into tradingcarefully.Thegoalshouldbeto build up confidence. Thetwo easiest ways to buildconfidence are to back-testyour system (see it workingover historical data) and to
create a positive mindset.(Specific tools for improvingyour trading psychology arecoveredinChapter16.)Decide and plan for your
approach to a drawdown.Nearlyeverytraderwillhaveto sit through one of thesedifficult times. Professionalforex trader Ashkan Boloursuggests that there is alwaystimeformakingmoneyinthemarkets. He says, “If
something is not working,step away, re-analyze yourtrades,andthencomebacktothe markets. Stepping awayfrom the markets will giveyour mind and your bodytime to rest, and youwill bemuch better for it when youcomebacktothemarkets.”Comingoutofanextended
drawdown your goal shouldbe to slowly build up yourconfidence. It is necessary to
havearegimentedroutineforgetting through thesedrawdowns.Withoutastrongstructure, without rulesdesigned to keep you fromemotional revenge tradingafter a drawdown, you'realmost certain to fall intoundisciplined trading and totakeonexcessiverisk.Designa plan today so that if adrawdown appears, you arereadyforit,becauseyouwill
not feel like designing adrawdown plan in the midstofadrawdown.
CorrelatedTradesCorrelated trades are perhapsthe most obvious threats toyour trading account. Forexample, from time to timethe markets may print dailykangarootailsonmanyoftheyen pairs. If I decide to take
thedailykangarootailontheUSD/JPY, AUD/JPY,NZD/JPY, CAD/JPY,EUR/JPY, and GBP/JPY, Imust be careful. What willhappenifeachofthesetradesareavailableonthesameday,and I have a maximumdrawdown limit of 5 percentfor theweek?With a risk of1percentper trade, Iquicklyreach my weekly drawdownlimit simply by taking these
trades should theyall endupaslosingtrades.One obvious solution is to
reduce the per-trade riskwhen several correlatedcurrency pairs offer tradingset-ups. If you have abackground in statistics, youunderstandwhatacorrelationis, but if you do notunderstand correlation verywell, take a look at thecorrelation video at
www.fxjake.com/book. Youwilllearnhowtomeasurethecorrelation between any twocurrency pairs. Once youhave determined that twocurrency pairs are correlated,thenextstepistoreduceyouroverall risk for correlatedtrades.Here is an example of a
planformanagingcorrelated,simultaneoustrades.
Bullish kangaroo tails
print on the daily chartsforthefollowingpairs:USD/JPY, AUD/JPY,NZD/JPY, CAD/JPY,EUR/JPY,andGBP/JPY.The standard risk pertradeis1percent.The maximum weeklydrawdownis5percent.For simultaneous tradeswith a correlation of 0.65and above, the risk isreducedto0.5percentper
trade.The correlations are runon the six currency pairsand all are correlatedabove the 0.65 level, sotheoverallriskpertradeisset to 0.5 percent, for anoverall risk of 3 percentontheday.Even if all six trades endup as losers, thedrawdown will only be3percent,sotherewillbe
2 percent of additionalriskavailablefortheweek(two standard trades at1percentriskeach).
Decide how you willmanagetheriskoncorrelatedpairs. As with every otheraspectofyourtradingplan,ifyoudecideonaplanofactionbeforeyouareinthemidstofa high-pressure tradingdecision, you and yourtradingaccountwillbemuch
betteroff.
MANAGINGYOURTRADESThe way you manage yourtrades is completely apersonal decision. There aretwo parts to managing thetrade. The first part ismanagingtheentryprice.Thesecond is managing the exit.
Both decisions may bepersonalized depending onthe way you decide toapproachyourtrading.Asfortheentryprice,there
are several possible methodsof entering a trade.Youmaytake a market order(executing the trade at thecurrent market price). Youmay take a limit order(executing the trade after themarket retraces, or moves in
the “wrong” direction). Oryou may decide to use therecommended buy stops (orsell stops for sell trades),executingthetradeentryonlyoncethemarketmovesintheexpected direction.Additionally, you may alsodecide to use an alternativeentrystrategy:Youmaywaitforthemarkettoofferaclue.In other words, you enteryour trade once you receive
market feedback, once themarket suggests it willmoveintheexpecteddirection.Managing the exit is also
critical. There are many exitstrategies available to you,many of them listed inChapter 11. However, youmay also decide to manageyour exit based on marketactivity.Some traders believe that
all trading decisions should
be made before the trade istriggered. Inotherwords, theentry price, the stop-lossplacement, and the profittargets are all determined inthe beginning, before thetrade is initiated. This way,there is no thinking after thetrade is triggered. Traderswhoadheretothisphilosophyattempttogetoutoftheway,and allow the market to ratethetradeasawinnerorloser.
Some traders take thisapproach because they havejobs outside of trading. Thisrestricts their availability formanaging the trade. Thislimitedexposuretochartscanbe a good thing. Sometimestradersgetintheway.Tradersmaygetintheway
during the analysis of themarkets, when decisions aremade concerning whichtrades to take. Many traders
have found that too muchmarket analysis iscounterproductive. It is ofteneasier and more efficient tohave a quick look at themarkets, decide on a courseof action, and then to simplysetthetradesandforgetthem.Abe Cofnas, a renowned
traderwhodeals inbothspotforex and forex options, hasthis to say about marketanalysis: “It is so fascinating
to see—but for me I oftenfind my best trading resultsoccur when I do minimalanalysis, and let my visualsense of price action let mereact to and not anticipateconditions.”Cofnas is certainly not
alone.Therearemanytraderswho follow this samephilosophy. Sometimestraders can simply out-thinkthemselves, and it may also
comeduringtheexitphaseofthe trade. Colin Jessup, anaked forex trader inCanadahas this to say aboutmanaginghistrades:“Ifpriceaction retraces more that61.8percenttowardsmystop,I will close the trade tominimize the loss. Usuallythe70percentlevelismylinein the sand if I'mwatching atrade live. That said, due tomy schedule, my trades
usuallyeitherhitmytargetorstopmeout.”Decide for yourself how
much management you willdo when trading. Stick tothese rules. Try to duplicateyourback-testinginyourlivetrading. Thiswill ensure thatyour live trading results willresemble your back-testingresults.
ManagingStopsand
ProfitsHow will you take losses?Will youwait for themarketto hit your stop loss or willyou close out the trademanually before your stop ishit? Will your profit targetsbeachievedautomatically,orwill you wait to see if themarket can push through azonebeforeexiting?Are you a runner or a
gunner? If you are a runner,yourstoplossandyourprofittarget may be one and thesame(forexample,ifyouareusing the three-bar exit). Ifyou are a gunner, will youleave your profit targets inyour trading platform andwalkaway?Your disposition and your
lifestylewillprobablyanswerthese questions for you. Ifyou are at work during the
dayandareunabletomanageyourtrades,youmayneedtolet your trading platform dothe managing for you. If,however, you are a full-timetraderorhave access toyourchartsnearlyallday long,becareful. It may seem like agoodideatobeabletowatchthechartsallthetime;itmayseemlikeagoodideatohaveyour tradesavailableonyourphoneatalltimes.Sometimes
watching your trades unfoldmay mean you exit a tradeprematurely. The rule ofthumb here is to trade yoursystem just as you back-testit. You must make sure thatyour back-testing duplicateshow you will trade in youreverydaylife.Ifyougetverynervouswatchingyourtrades,then it is probably best thatyou walk away. It may bebest for you to let your
tradingplatformmanageyourtrade if you find yourselfmaking poor decisions whenwatchingthelivemarkets.Theforextradingplatforms
today are brilliant, and theyoffer many opportunities fortrailing exits, the ability tomove a stop loss based onmarket action, and so forth.Know who you are as atrader, and what yourweaknesses are. If you find
yourself doing better,capturing more profits whenyou step away to allow yourtrades to either hit the takeprofitorthestoploss,withoutyour intervention, perhapsyou should stick to thishands-off approach tomanaging your trades.Perhaps you are able tomanage your tradessuccessfully and cut yourlossesbeforetheyhitthestop
loss. The important thing toremember is that a few poortrades do not mean youshould redesign your tradingsystem (beware the cycle ofdoom).
UsingMarketInformation
The market is constantlysending information tomarket participants. What
will you do with thatinformation? Will you takemarket data and use it toadjust your entry strategy?Willmarket informationhelpyoutomanageyourexits?For example, if you're
looking at taking a bullishkangarootail,youmaydecidetoplaceyourbuystopabovethehighof thekangaroo tail.Butwhat if themarket tradesdown to the stop loss level
before the buy stop entry istriggered? Does this meanthat you will disregard thistrade and remove yourpending buy stop order? SeeFigure13.1foranexampleofthis scenario on a one-hourGBP/USD kangaroo tail set-up.
Figure13.1TheGBP/USDprintsakangarootailontheone-hourchart.However,insteadofpushingthrough
thebuystoporder,themarketfallslowerthanwherethestoplosswouldbe.Mostnakedtraderswillcancelthebuystopinthissituation.©2000–2011,MetaQuotesSoftwareCorp.
If the market pushesthrough where the stop losswouldbe, itmaymakesense
to cancel the trade. This isusing market information tomanage your trades, evenbefore they occur. You mayalso use market informationtomanageyourexits.Ifyouareinatradeandthe
market prints a reversalsignal,howwillyoureact?Ifyouareinaselltradeandthemarket prints a buy signal,will you exit a trade?Will itdependonwherethereversal
signal prints? Some nakedtraderswillonlycloseatradeifthemarketprintsareversalsignalonazone.Othernakedtraders will simply close atrade as soon as price actionoffers a counter signal, asignal in the oppositedirectionof the trade.Decidehow you will manage areversalsignal.Ifyouareinabuy trade and the marketgives a sell signal, will you
exit?Take a look at the daily
NZD/USD chart in Figure13.2. This is a sell signal, abearish kangaroo tail on the0.7590 zone. The markettriggersthetradeandfalls,asexpected. However, once themarket reaches the zone at0.7430, an interestingcandlestickprints.Thisisnota bullish kangaroo tailbecausetheopenisnotinside
of the previous candlestick'srange. Nevertheless, thecandlestick does suggest thatthemarkethas foundsupportdownhereat0.7430,andthusthe naked trader may decidetocloseouttheposition.
Figure13.2ThedailyNZD/USDchartprintsabearishkangarootail,suggestingthemarketmayfall.Themarketdoesfall,butonceitreachesthenextzone
at0.7430,abullish“almostkangarootail”prints,suggestingthemarketmaymovehigher.©2000–2011,MetaQuotesSoftwareCorp.
Decide how you will usemarket information. If youare very comfortable
interpreting price action,perhaps you will use marketinformation to adjust yourtradeasthecandlestickprintsonthechart.Formanytradersand those new to nakedtrading, it may be easier tosimplystickwithyourtradingplan and let your trade reachthe profit target or the stoploss.
KNOWINGYOUR
TRADINGPERSONALITYThemost important factor indetermining how you willtrade is your tradingpersonality. What is yourtrading personality? How doyou knowwhat you do best,
andhowdoyouknowwhatisuncomfortable for you? Thebasic distinction amongtraders is the one thatdistinguishes short-termscalpers from longer-termswing traders. You probablyalready know which campyou belong to. If you find itdifficult to go to sleep orwalk away from your chartsknowing that you havemoneyatrisk,thenyoueither
(1)have toomuchat risk foryour tradeor (2) you are notfit for trading longer-termcharts.Likewise,ifyoufinditnearly impossible to sitthrough a trade on the five-minute charts,watching yourequityseesawbackandforth,you are probably best suitedto the longer-timeframecharts. What makes sense toyou?Do you like to take trades
with the flow of the market,ordoyouliketofindreversalpoints? Take the TradingPersonality Quiz to find outwhich trading systems fityour view of the markets atwww.fxjake.com/book.Typically traders fall into
oneoftwocategories:(1)“gowith the flow” trend tradersand (2) reversal traders. Thetrendtradersaredrawntotherunners’ exits in Chapter 11,
and the reversal tradersoftenenjoy trading for profittargets. You may rememberthisgroupfromChapter11—the gunners. Remember thatyou may not have thepatience to stick with thetrade and ride out a long-lasting trend if you are areversal trader, quick profittargets may be more yourstyle.Ifyouareatrendtraderyouwillhavetolearntodeal
with those trades that fallbackandendupasbreakevenor losing trades, even aftertheystartoutinprofit.Tradewhatmakes sense to
you.Ifyouthinkitiseasiertofind turning points, tradereversals. If you think it iseasier toridethetrend,makesure you get good atidentifying and riding strongtrends.
YourLife,YourTrading
How often you trade is anabsolutely critical decision,Trading can deplete yourpsychological andphysiological energy. If youdon't believe this, thenconsider this: The next timeyou have an exceptionaltrade, a trade that bagsseveral hundred pips, once
you close the trade try toimmediately make anothertrade.Willyoufinditeasytomake another trade? Ofcoursenot!Thereasonisthattrading is draining, and youmusttakecareofyourself.As a trader, you must be
physicallyfit.Ahealthybodyequals a healthy mind. Tostay healthy, you must getmore than adequate sleep,you must take good care of
your body. You must try tolimit your time in front of acomputer screen. If you failto do these things, yourtrading will suffer. You canevenmake a game out of it.Perhaps you decide that youare only able to trade if youdo some exercise that day.Or,perhapsyoudecidethatifyoudonot get at least sevenhours of sleep, you are notallowedtotradethefollowing
day. The idea here is to setgoals to encourage goodhabits.One habit to avoid as a
traderisdrinkingandtrading.It may seem like an obviouspitfall, but if you do drink,avoid trading under theinfluence. Just as you wouldnotwanttodrinkalcoholandgo for a drive, you certainlydonotwant to drink a bottleof wine and then decide to
scalptheGBP/USDforafewhours.As a forex trader, youarewellawareofthefactthatthe market is nearly alwaysopen.Formanytradersitcanbe tempting to trade into theweehoursofthenight.Ifyouare under the influence, it isbest to avoid making anytradingdecisions.Good habits should extend
into the psychological realm.Ifyouenjoyself-hypnosisor
meditation,youmayfindthatyour trading improvesdrastically when youconsistently find time eachday to practice self-hypnosisor meditation. (There aremore resources for you atwww.fxjake.com/book if youwould like to learn moreabout meditation or self-hypnosis.) Perhaps youdecidetotakesometimeeachday to mentally recharge
beforeyoumakeyourtradingdecisions, before you sitdownandanalyzethecharts.If you are thinking right
now “I do not need to spendanytimebeingquiet;Ijustdonothavetimeforthat,”pleaseat least consider a newapproachtoyourtrading.Forone month try using self-hypnosis, meditation, or justsomesimplequiet timealonebefore you jump into your
tradingroutine.Youmayfindyour trading results improve.Somethingassimpleassomequiettimealonecanrechargeyour psychological batteries,andbetterbatterieswillmeanbettertradingresults.Trading will suck the
psychological energy fromyouifyouallowittohappen,so be careful. Trading sixplushoursperdayispossible,but probably only for those
people who are full-timetraders. If you are trying toworka jobandtradesixplushours each day, you areprobably going to be aninefficient trader. You maymake mistakes, find itdifficult to concentrate, andfind it difficult to stayconsistently profitable if youare working a full-time jobandworking as a trader full-time. It may seem as though
trading is a wonderful,carefreelife,butitiswork.
HowSubjectiveIsYourTrading?
The last important facet ofyour trading system is howmuch room for interpretationyou are allowing in yourtrading system. Do youdecide to take only thosetrade set-ups that look right?
Or do you take only thosetradesthatarestrictlydefinedbyyourtradingsystem?Eachtradertakesadifferent
approachtotheapplicationofthe trading system. Forexample, perhaps traderElliott decides to trade thebig-shadow set-ups on thedaily charts. Elliottwill onlytakethosebig-shadowset-upsthat look to be very high-probability set-ups. The
bearish big-shadow set-upsmusthaveaclosedownnearthe low, and the bullish big-shadow set-ups must have aclose near the high.The big-shadow candlesticksmust beverylargeandElliottdecidestoonlytakethosebig-shadowset-ups that trigger the entrypriceon thenextcandlestick,and he takes profit at thenearest zone. Elliott maybelievethatheisusingavery
strict, well-defined tradingsystem,butifyouaskMolly,shemightdisagree.Trader Molly decides to
also trade only daily big-shadow trades. Trader Mollytakes a different approach.Trader Molly will only takebig shadows that are largerthan the previous fivecandlesticks by at least15percent.TraderMollyalsodecidestoonlytakethosebig
shadows with the closingprice within 15 pips of thelow(forbearishbigshadows)or the high (for bullish bigshadows).Molly consistentlyapplies the three-bar exit toherstrategy,knowingthatshemay have some losing tradesand small winners, but shewill also have a few largewinners.Where do you fall on the
continuum? Are you more
likeElliott?Doyouprefer totrade with a little bit ofsubjective analysis? Or areyou more like Molly?Perhaps you share her desiretohaveclearconcretetradingrules so it is very clearwhatyou should be doing whenfollowing your tradingsystem.
ChoosingYour
PlayingFieldInmanyways, the timeframeyou choose to trade isdetermined by your lifestyle.Ifyoudon'thavefourorfivehours a day to sit down andwatch the charts, it will bedifficult foryou tobea five-minute chart scalper. Unlessyou have an automated exitfor your shorter-timeframetrading,itisunlikelythatyou
will be able to trade theshorter-timeframe chartswithout several hours ofscreentime. Even if you dohave an extra four or fivehours each day, you may bebetteroffavoidingtradingtheshorter-timeframe charts.Manytradershavefounditismuch easier to simply take alookatthechartsonceaday,put in your trading orders,and then walk away.
Sometimes, after a fewyearsof this sort of trading,successful traders will movedown to shorter timeframes.A general rule of thumb isthis: Trading shortertimeframes means a smallermarginforerror.Trading the shorter
timeframe means that youmust be precise and decisivewhen executing your trades.An example will best
illustratewhythisisthecase.If you decide to trade thefive-minute EUR/USD chartin the hopes of pulling10 pips of profit from themarkets, thenyou are payinga high price to trade. Thespread (the differencebetween the price for buyingthe EUR/USD and the priceforselling theEUR/USD)ontheEUR/USD is likely to bequite tight,perhaps twopips,
soyoumustmake12pips tobag10pipsofprofit.Thisisacommission of 16 percent(2 pips divided by 12 pips =16 percent). This is a heftycommission.If, instead, you are trading
the daily EUR/USD chart,you may be looking to gain100 pips and will need tocapture102pips tocover thespread, so this is an overallcommissionof1.9percent—a
significant reduction in thecommission cost. Longer-term trading is not onlycheaper,itiseasiertoexecutesuccessfully. If you initiate adaily chart trade and enteryour trade at a poor price,perhaps you miss your entryprice by 3 pips, you may,instead,make 97 pips, ratherthanthefull100pips.Thisisa reduction of profits by3 percent; not great, but
certainly something yourtrading account can probablywithstand. If this same typeof poor execution isassociated with a short-termtrade,a3pipslipupbecomesa reduction in profits by30percent(3pipsoutof10is30 percent). A consistentreduction in profits by30percentmaytipthetradingsystemoverintotheabyssofunprofitablesystems.
It is your choice, youmustdecideifyouhavethetradingexperience, the time, and themental toughness toconsistently execute short-timeframe trades. If you donot have all three, it may bebest to stick to the longer-timeframecharts.
YourTradingLifestyle
Asyoucansee,thereismuchmore to your trading systemthat simply deciding onwhether you prefer to tradethe last kiss or trendykangaroos, whether you liketotradetheone-hourchartorthe weekly chart. It isimportant for you to decidenotonlywhatyouwill trade,butalsohowyouwilltradeit,andtodefinethepreciserulesyou will use to trade your
system. Defining all thesevariables for your system upfrontwill help youdown thetrack when you have toendure difficult times.Drawdowns, losing streaks,and bad luck are all moremanageablewhenyouhaveawell-defined trading systeminfrontofyou.One last note should be
made about your successes.When thinking about your
tradingsystem,muchofyourplanning may involvereducing exposure to risk.However, you should alsothink about your successes.What will you do when youhaveanexceptionalrun?Willyou take time off tocelebrate?Willyoupullsomeof your profits out to buysomething nice for yourself?Remember to celebrate yourwins.
DEFININGYOUR
TRADINGSYSTEM
In summary, creating yourtrading system involvesseveral aspects. Thefollowinglistwillhelpyoutorefine your trading systemand define the rules so that
you are ready for anysituation before it arises. Ifyour trading system answersall these questions, you havedone well, and you have atruetradingsystem.
Are you a marketspecialist or a tradespecialist?Howmanyhoursofdailyscreentimedoyouallowyourself?Which trading
session (European,Asian, or NorthAmerican) do youtrade?Which timeframeswillyoutrade?Which trading set-upsdoyoutrade?Which exitstrategies do youuse?How muchinterpretation do
you have whenplacingtrades?How muchinterpretation doyou have whenexitingtrades?What is yourmaximum risk pertrade?What is yourmaximum weeklydrawdown?What is you
maximum monthlydrawdown?How do you dealwithdrawdowns?Howwillyouregainconfidence after amaximumdrawdown?Whatwillyoudotoensure you arephysically fit totrade?Whatwillyoudoto
ensure you arepsychologically fittotrade?
CHAPTER14
BecominganExpert
Far too many people—especially people withgreatexpertiseinonearea—are contemptuous of
knowledge in other areasor believe that beingbright is a substitute forknowledge.
—PeterDruckerForex traders around theworld are making moneyeveryday.Thesetradershaveone thing in common—asecret. This secret maysurprise you. If you are likeme, when you first startedlearning about trading you
thought all the traders whowere making money werecomputer science,mathematics, or physicswizards with lightning-fastcomputers deploying secretalgorithms. Trading was thedomain of the well educatedthathadthecomputingpowerto crack the market code. Iwas convinced that only byduplicating these effortswould I be able to
consistently rackupprofits. Iknew that trading had to becomplex, and perhaps youfeelthinksameway.Thisisnottrue.Some of the very best
traders in the world share asimple secret: They useextremely simple and yetpowerful, trading systems.Thebest traders in theworld—hedge fund traders, banktraders, private millionaire
traders you will never hearfrom—all have one thing incommon: These people areexperts.Theydoonething.
WHYDOYOUWANTTOTRADE?
This may seem like a funnyquestion, but why do you
want to trade?Ifyouwant totrade because you want tomakemoney,perhapstradingis for you. If, however, youwant to trade because youwantexcitement,oryouwantto be able to tell people thatyou are a trader, or becauseyou love the excitement ofhaving money at risk, thenperhapstradingisnotforyou.If you want excitement tryskydiving, or hunting wild
boars. If you want to tellpeople that you are a trader,youcandothat,butifyouarenotquiteconsistentwithyourtrading, just trade a verysmall account, that way youcan get the recognition ofbeingatraderforasmallfee.Ifyou love theexcitementofhaving money at risk, youshould try gambling.Gamblers are honest. Theyrisk their money, and they
recognize the inherent risk intheir occupation, they are upfront about it. This is anhonorable approach togambling because gamblersadmit that their money is atrisk and admit that luck willguide theirwinnings.Traderscanbegamblersindisguiseiftheyaretradingforthewrongreasons.You probably know a
gamblerortwodisguisedasa
trader. This is the differencebetween a trader and agambler: A gambler has norisk management, and agambler is willing to loselarge amounts of moneyquickly. A trader treats eachtradeasacalculated riskandmanageseachtradeaccordingtohissystemrules.Gamblerscan lose all the money atonce,andtradersloseonlyasmuch money as their system
willallow.Thedistinguishingfactor is that a gambler doesnot follow risk managementrules, whereas a traderfollows strict riskmanagementcontrols.Experttradersdomorethan
simply follow strict riskmanagement controls; theyalso concentrate on onetrading technique.This is thereal secret of expert traders:They focus on one market,
onetradingsystem,oneedge,andtheyusethisedgeintheirtrading repeatedly. Profitabletrading is boring. Profitabletraders are experts, and theseexpert traders do one thingoverandoveragain.
THESECRETOFTHEEXPERTS
Why do profitable traderslimitthemselves?Theansweris simple: Profitable tradersknow what makes money.Profitable traders trade tomake money. If you wouldlike to make money as atrader, do what the expertsdo. Become good at tradingone system. You know howtodo thisnow.Allyouneedis in this book. You simplyneed to put the work in,
practice, and become anexpert with a trading systemthatmakes sense to you, andthentradethattradingsystem.Trade your system over andover again until tradingbecomes boring (and veryprofitable).All the very successful
traders are doing one thing.Thismay seemunbelievable,but entire hedge funds arebuiltononeidea.Hedge-fund
traders often have one edge,andtheyusethisedgeintheirtrading. Now, some hedgefunds may have severaltraders, each with his ownedge, but to be a successfultrader you simply have tohave one thing that you areverygoodat,andthenyoudothis one thing over and overagain.Themostsuccessfultraders
I know follow this rule. The
traders that struggle, thetraders who have difficultyfindingconsistentprofits, arethe ones who repeatedlychange their systems,reanalyzing and reorganizingtheir trading rules. In otherwords, they are still stuck inthecycleofdoom.Thekeytobreakingthecycleofdoomistodecidewhatmakessensetoyou, which of the tradingsystemsinthisbookresonate
with you. Once you havechosenone, you simplyneedtotestitoverandoveragain.Then apply this system,concentrateonfollowingyoursystemrules, andwatchyourconfidencegrow.Youcando the same thing
hedge fund traders do. Youcanbejustlikeabanktrader.You can be a professionaltrader.Butbeforeyougopro,youmustdecidehowyouwill
make your money in themarkets. What is yourexpertise? Which tradingsystem fits your beliefs?Once you align your beliefswith a trading system, yousimply need to gainexperience and confidence inthe trading system, and youwill never look back. Yourexciting journey is ahead ofyou;soonyouwillbecomeanexperttrader.
SIXSTEPSTOBECOMINGANEXPERT
Although it may seem thatbecominganexpert isaverydifficult thing to do, it isreally rather simple. As withmanythingsinlife,ifyouputthework into it, youwill beabletoreaptherewards.Hereare six steps to becoming an
expert.
StepOne:GetintheComfortZone
The first step is to becomecomfortable drawing zoneson your chart. Zones are thebasis for your tradingdecisions.As a naked trader,allyourtradingdecisionswillbe based on zones, so it isvery important that you have
these zones drawn correctlyonthechart.Itismucheasierto draw fewer zones,providedthosezonesareverystrongandwelldefined, thanit is to draw toomany zonesonyourchart.Ifindoubt,erron the side of using fewerzonesonyourchart.Asanakedtrader,youwill
spend a lot of time waitingfor the market to hit yourzones.Thisisfine;thisispart
of what it means to be anaked trader. If you findyourself feeling as thoughyou need to take action,perhaps you should back-testyour trading. Test one year'sworth of data (on a shortertimeframe), and then test alower frequency tradingsystem on longer-timeframecharts. Compare theprofitabilityofeachback-test.Areyousurprisedatwhatyou
find? Sometimes makingmoneyiseasierwhenyoudonot trade. Sometimesavoiding trades is just asimportant as taking tradeopportunitieswhentheyarise.
Goal: Learn to quicklyidentify zones on anychart.
StepTwo:DecideonaCatalyst
The second step towardexpertise is foryou todecideon which catalyst you willuseinyourtrading.Youhavelearned about severalcatalysts (and there aremoreat www.fxjake.com/book),and hopefully by now youhave back-tested some ofthem.Sowhichoneresonateswith you?Do you prefer thesimplicity of the kangarootail?Ordoyouliketheadded
confirmationof the lastkiss?Perhaps you find the trendykangaroo to be an excellentmethodforcapturingtrendingmarkets. It does not matterwhich catalyst you havechosen. What does matter isthat you trade a catalyst thatfits with your view of themarkets.You must trade a catalyst
that fits with your beliefs.Choosing a catalyst that fits
with your beliefs will helpyou to rideoutanybumps inyour equity curve and avoidthecycleofdoom.
Goal: Choose the onetrading catalyst that youwant to build yourexpertiseon.
StepThree:Back-Test
Bynowyouprobablyhavea
goodunderstandingofall thebenefitsassociatedwithback-testing your trading system.Back-testing will verify thatyourtradingsystemworks.Itwill help to build yourconfidence in your tradingsystem.Itwillhelpyouwhenyou are experiencingdrawdowns, it will help saveyoufromfallingbackintothecycleofdoom.Inshort,back-testingiswhatseparatesthose
consistentlyprofitable tradersfrom those traders who areforever stuck in the cycle ofdoom.Ifthereisoneideathatyou
take from this book let it bethis: Back-testing yourtrading system is the onething that you can do toaccelerate your trading. Thisone thing is the mostimportant habit that you candevelop in an effort to
becomeaprofessional trader.Back-testing is thatimportant.You should have a clear
goalinmindwhenyouback-test your trading system.Tryto tripleyour tradingaccountwith a small percentage atrisk for each trade (e.g. 1percent or 2 percent at risk).Triplingyour tradingaccountwill help you to believe inyourtradingskills.
Goal:Risking2percentorless, triple your back-testingaccount.
StepFour:ForwardTest
If you have back-tested yourtrading system, and you arehappywiththeresults,you'reready for the next step. Thenext step is to employ yourtrading system in real time.
Unfortunately, this is a veryslow stage. You will beunable to speed up time asyou can when you are back-testing, but you will closelymirrorthelivemarkettradingexperience.Create a goal for your
forward testing. Try to tripleyour demo account. Becauseyou will be trading in realtime, it will probably takelonger to triple your account
than it did when you tripledyour back-testing account.However, in some ways,demo trading much moreclosely resembles “real”trading because you cannotquicklyadvance thecharts tosee if you have made thecorrect trading decisions.Embrace the time it takes toaccumulate expertise withyourforwardtesting.Toforwardtest,yousimply
need to open up a demoaccount. These accounts areofferedbyanyforexbroker.
Goal:Risking2percentorless on each trade, tripleyourdemoaccount.
StepFive:TradeaSmallAccount
Afteryouhavefoundsuccessback-testing and found
success forward testing, it istime to start trading a liveaccount. Live trading cannever really be duplicated.Back-testingiswonderfulandadds to your confidence;forward-testing is also greatbecause it closely resembleslive trading. However, theonlythingthatmattersislivetrading profits. Begin with avery small trading account.Whatissmalltoyoumaynot
be small for someone else.The size of your accountshould be made up of 100-percent risk money. This ismoneythatyouarewillingtorisk for this exercise. Neverrisk more money than youcanaffordtolose.Once you triple this small
account, you are ready. Youhavebuiltyourconfidencebytrading (back-testing withhistorical data, livedatawith
your demo account, and,finally,youhave tripledyoursmall live account). At thisstage, you probably cannotwait to begin trading yourstandardliveaccount.
Goal:Risking2percentorless on each trade, tripleyoursmallaccount.
StepSix:TradeaLiveAccount
Most traders do not do whatyouhavejustdone.Youhavebuiltyourconfidenceoverthepreviousfivesteps.Nowyouare ready. It is time to putintopracticewhatyouknow,andby this stageyouwillbeexcited. Make sure that youmaintain your discipline andcontinuetodothesamethingthat you have been doing.Theimportantthinghereistofollow your system, without
regard to whether you are inthemidstofaluckystreakoran unlucky streak.)Remember, you have thepower of your trading, andyou understand that youwillsuccessfullypullprofits fromthemarket.Themostimportantthingat
thisstageistoduplicatewhatyou have been doing. Justbecause you are trading astandard account does not
mean anything changes.Concentratingonyourtradingsystem rules will yieldpositive results. Thinkingabout themoney involved ineach trade will probably bedistracting and will likelythrow you off track. Keepdoingwhat you dowell, andyouwillbecomeanexpert.
Goal:Risking2percentorlessoneachtrade,stick toyour trading rules. Focus
solely on following yourtradingsystemrules.
DOINGITAGAIN
Is it possible to duplicatethese steps with anothertrading system? If you havedecided to follow thepathofthe market expert, youprobably will add more
systems to your repertoire. Itis not necessary that you doso.Itmaybeeasierforyoutotradeonesystemcomfortablyfor at least eight monthsbefore attempting to becomean expert with anothersystem.Eventually,youmaydecide
to do what many profitabletradersdecidetodo.Youmaywanttogainexpertisewithanadditional trading system. It
isnotnecessarytodoso,andit may be tempting to jumpheadfirstintoanothersystem,but you should first giveyourself time to get boredwithyour first system.Thereare at least two reasons forbecoming an expert with anewtradingsystem.Thefirstis that trading the profitablesystem is boring. Perhaps itseems crazy to you that youmay one day become bored
with consistent tradingprofits, but it may happen.You may want to expandyour horizons, and addanother tool to your tradingtoolchest.Thesecondreasonforbecominganexpertwithanew trading system is basedon risk management. Bydiversifying your tradingstrategy, youmay reduce thelikelihood of an extendeddrawdown. All trading
systems have drawdown, butifyouhaveacomplementarytrading system, one that islikely to make profits whilethe other is struggling, thenyou have the makings of asolid trading strategy. Manyprofessional traderseventually get to the stagewhere trading diversifiedtrading strategies makessense. It is not necessary, ofcourse, but it is possible for
you to become an expert alloveragainwithanewtradingstrategy. This is a great waytoreduceyourrisk.
BORINGTRADINGISEXPERTTRADING
If you find yourself bored
with your trading, you areprobably consistentlyprofitable. The desire forchangeoranewchallenge isoften the biggest threat toprofitabletrading.Exciting trading is often a
signofoneof twoproblems.Either the trading system isnewandunproven(notback-tested) or there is too muchrisk on each trade. If thesystem is unproven, the
excitement is due to theunknown.This is not a goodthing. Exciting trading isexciting because it is akin togambling. Gambling isexciting. This is preciselywhyriskingtoomuchonanygiven trade is exciting.Trading shouldbe fun,but ifit isexciting. It isa sign thatthesystemisunprovenoryouareriskingtoomuch.Remember the story about
Miguel? He is an experttrader, and by his ownadmission, his trading isboring.Embrace theday thatyour tradingbecomesboring.It may still be very fun tomakemoneyconsistently,butit does not have to beexciting.
ASIMPLE
TRICKRight nowyouknowhow tobecomeanexpert.Youknowwhat you can do to get toexpertise, it involves work,but if you choose to take thepath of the expert, it is nowavailabletoyou.Theproblemwith the steps to expertise isjust that; there are steps, andit takes time to achieve thisexpertise.Obviouslypatience
is needed to get there. Theworkandeffortiswellworthit, but the fact remains, itdoes take time to get there.What if you could use asimple trick to gaininvaluable experience?Wouldyou like tobeable tolearntoseethemarketsasanexpertoverthecourseofonlyafewhours?Thatiswhatthistrick will give you, this isanother means of gaining
expertise. This is a truefavorite of mine, a way foryou to “see” the markets forwhat they are, an ebb andflowofbuyersandsellers.Set aside several hours for
thisexercise.It isgreat todothis over four hours, but youcandoitwithlesstimeifyouwish. The length of theexercise isdeterminedby thetimeframeofthecharts.Soifyou are looking at the 30-
minutechartsthiswilltake30minutes, if you're looking atfour-hourchartsthiswilltakefour hours. The four-hourchartsaremy favoritecharts,so I love to do this exerciseoverfourhours.Openachart,andwaitfora
new candlestick to appear. Ifyou are watching a shortertimeframe chart, such as the30-minute chart, after a fewminutes, about three minutes
orso,takeascreenshotofthecandlestick. The idea is thatyou are taking snapshots ofthecandlestickasitiscomingto life. While you are doingthis, you should considerwhat you think is going tohappen. It does notmatter ifyouarecorrectornot,itonlymatters that you make aguess.Youshouldtakeatleastsix
snapshotsofyourcandlestick
atequaltimeintervals.Ifyouare watching a 30-minutecandlestick, you should takesix snapshots at five-minuteintervals.If,however,youarewatching a four-hourcandlestick,youshouldtakeasnapshot at 40-minuteintervals,andsoforth.Aftereachsnapshot,answer
thefollowingquestions:Is the candlesticknow trading higher
or lower than theopeningprice?Do you think thecandlestickwillstarttrading higher orlower between nowand the nextsnapshot?Willthiscandlestickclose as an up(bullish) or as adown (bearish)candlestick?
Do this for all of thesnapshots. Watching thecandlestickprintlikethisisalot like watching your childgrow up. Maybe in someways you may be able toanticipatethefuture,buttherewillbeturningpointsthatarecritical, and by recording thecandlestick at regularintervals you will be able tosee how well you cananticipate the market. The
pointofthisexerciseisnottoshow you how unpredictablethe markets are, or toencourageyoutogetintouchwith your inner psychic. Thepoint of this exercise is that,by watching themarket, youearnvaluableexperience.Justas working in a forex testerwillhelpyoutogettradesonyour belt, it is also true thatwatchingacandlestickunfoldina livemarket is invaluable
experience.At the end of the exercise
youwill have a slow-motionrecord of the lifespan of acandlestick. Once thecandlestick has finishedprinting, answer thesequestions.
How does thesecondscreenshotofthe candlestickdiffer from the lastscreenshot of the
candlestick?Did the candlestickstart moving up ordown?Did the candlestickclose in that samedirection, or did itendupclosingintheoppositedirection?During whichtrading session(Asian,European,orNorth American)
didyouchoosetodothisexercise?Do you think theresults may havebeendifferentifyouhad chosen adifferent tradingsession?Did the candlestickafter the one youobserved close inthe same directionas the candlestick
youobserved?Based on the firsttwo screenshots ofthe candlestickwould you havebeen able to predictwhatthecandlestickended up lookinglike?
If you are interested inreally accelerating yourtrading, do this exerciseoften. It is quite different to
the back-testing in that youare watching the marketunfold in real time, just asyou would during a livetrading session. The mostimportantthingyoucanlearnfromdoingthisexerciseistheimportance of the closingprice.Theclosingpriceisactually
critical to the expert nakedtrader.Thinkaboutthis:Iftheclosing price is not in the
right spot, do you get akangaroo tail? If the closingpriceisnotintheprecisespotfor a bullish big shadow, doyouhave a valid buy signal?If the closing price for abearishbigbeltisnotnearthelow, but rather near themiddleofthecandlestick,isita valid sell signal? Theclosing price is absolutelycriticaltothenakedtrader.The real secret to this
simple trick is that theopening price of thecandlestickdoesnotmatterasmuch as the closing price.Where the candlestick printsduring the first two or threesnapshots is not as importantaswherethecandlestickendsup,wheretheclosingpriceis.A slight difference in theclosing price can drasticallychange the look of a pricepattern,andis,therefore,why
this exercise is so critical,why you can watch acandlestick and see that thebeginning of the candlestickis not nearly as important astheclosingprice.Thinkabouthowmuchyou
learned since you beganreading this book. Now youshould be able to look at achart and immediately knowwhether you can take a buytrade,aselltrade,ornotrade.
Now, you know how tobecomeanexpert trader.Notonlythat,butyouknowwhatto focus on to become anexperttrader.Now,youknowhow important the closingpriceistoyournakedtradingsetups.Youshouldbefeelingmore confident now. Youknowprecisely the steps youneed to take to beginfollowing the path to experttrading. In the next chapter,
wewillexploreconfidenceinyourself, confidence in yoursystem,whattodowhenyouexperience confidenceproblems, and why losingtradesshouldhavenothingtodowithyourconfidence.
CHAPTER15
GainingConfidence
Inactionbreedsdoubtandfear. Action breedsconfidence and courage.If you want to conquer
fear,donot sithomeandthinkaboutit.Gooutandgetbusy.
—DaleCarnegieImagine you have thefollowing:
A trading systemyou are comfortabletrading.A trading systemwithaveryhighwinrate.
An incredibleamountofmoneytotradeyoursystem.All the time youneedtotrade.The best computerand a fast internetconnection.
Is this all that you need totrade successfully? Will youfind consistent profits withonly these things? Theanswerisno.Youneedmuch
more than this to tradesuccessfully. To findconsistentprofitsyouneedtohave confidence. In fact,confidence is the mostimportant ingredient fortrading success. Confidencewill help you profit with anaverage trading system, butwithout confidence you willbe unable to find success,even with a brilliant tradingsystem.
Youwillfindthattherearetwo different types ofconfidence problems forforex traders: (1) a lack ofconfidence in the tradingsystem, or (2) a lack ofconfidenceinyourself.
THEORIGINOF
CONFIDENCE
ISSUESAll traders will have losingstreaks. Losing streaks mayleadtofeelingsofinadequacyanddisparity.However,ifthetrading system is a validwinningtradingsystem,ithasbeen tested, and is profitableover the long run, there isprobably nothingwrongwiththesystem.Mostof thetime,a losing streak is due to the
wrong application of thetrading system. In otherwords,mostlosingstreaksaredue to the misapplication ofthe system (caused by thetrader), and not the systemitself.There are several common
issuesthatmanytradershave,all of which may lead tolosingstreaksandconfidenceissues.
Risk-ManagementIssues
The next chapter willexamine risk in detail. Fornow, it is important only tonote that without properapplication of riskmanagement rules, a tradingdrawdown may beexacerbated and, therefore,may be very difficult tohandle for many traders.
Traderswhohaveissueswithriskmanagementwillusuallymultiply their drawdown andfind it difficult to makemoney consistently. Normal,everyday losing streaks areunfortunate and difficult formany traders to endure, butwhen these drawdowns areaccentuated by poor riskmanagement, the results areoftendisastrous.
ProblemswithDiscipline
Discipline problems arecommon. Many traders atbanksarenotbrilliant traders(in fact, many retail forextraders are much bettertraders than bank traders).Bank traders do not have asixth sense for the markets.These traders do not haveaccesstosecretalgorithmsor
indicators. Many traders areconsistently profitablebecause there is a built-indisciplinesystematthebank.Bank traders have a risk
manager. The risk managerensures that the bank tradertrades with discipline. Thebankhires intelligent traineestobecomedisciplined traderson the forex desk. The riskmanager ensures that thebank traders do not risk too
muchontheirtrades.All the bank traders must
followone simple rule:Theymust not takemore risk thanthey are allowed. Each banktrader knows how much hemay risk, every bank traderhas a number, and his riskcannot exceed this number.Theriskmanagerontheforexdesk oversees the riskassociated with each of thetradestakenbythetraders.If
a trader takes on too muchrisk, the trader is warnedonce. If a trader makes thismistakeagain,thetraderloseshis job. These are the rules.Eachbank traderunderstandsthis, and the forex tradingdesk is set up to tightlymanagerisk.The interesting thing about
thissystemis thateventhosetraderswhoareexceptionallyprofitable—the traders who
makemillionsforthebank—even these traders are shownthe door if they take on toomuch risk. Banks understandtrading isagameof risk.Allthe bank traders must bedisciplined traders. Anytraderwhostepsoutoflineisasevereconcernforthebank.Retail forex traderssuchas
you and I do not have a riskmanager. However, it ispossibletore-createthebank
system. This is how you cando this: become accountableto someone. Find a tradingbuddy, your partner, arelative, anyone you respect.Offer them your tradingstatement eachweek. This isyour report card. Report therisk for each trade. Beaccountable to this person. Ifyou take on too much risk(win or lose), your riskmanager should reprimand
you. Perhaps your “riskmanager” will change yourtrading platformpassword soyou are unable to trade foroneweek if you take on toomuchrisk.Youmustlearntokeep risk manageable if youwant to consistently extractprofitsfromforextrading.
ChangingSystemsIf you have a losing streak,
you may become too carefulor too reckless with yourtrading system. This is acommon reaction to adrawdown. This often leadsto a downward spiral. It isimportant to keep track ofwhatyouaredoing.Therearemanyways todo this,butbemostcommonwayistokeeptrack of your trading. Tomake sure that you are notchanging your trading rules,
dooneofthefollowing:Takescreenshots of your tradesbeforeyoutakethetrade(thesetup), during the trade, andafterthetradeisclosed.You may also want to
create a trading journal. Thisjournal should includeinformation suchaswhyyoudecided to take the trade, thesystemyouemployed for thetrade,your feelingsabout thetrade, the result of the trade,
andaratingonhowwellyouapplied the rules of yourtrading system to thatparticulartrade.Alternatively, you may set
up a video journal; there aremany software options forthis, some of them freelyavailable on the Internet, buta popular one is called Jing,whichwill allowyou to takea quick recording of yourtrade.Afinaloptionwouldbe
to look over your tradingprintouts—in other words,your trading record. This isanotherplacewhereyoumaynotice what is happening,why you are changing yourtrading,andwhatexactlyyouare doing that is different toyoursystem.The key to combating this
problem is to become aware,more self-aware ofwhat youaredoingasatrader.Justasa
professional gardener doesnot mow the lawn the sameway every single week, youmaynotbetakingyourtradesthe same way even thoughyou are trading the samesystem. Taking records ofwhat you are doing isinvaluable for self-assessments later, in order tolook at exactly how you areexecuting your trades andwhat changes you might be
making.
MissingOutTraders may end up with alosing streak simply becausetheymissoutonsometrades.Thisisaparticularlydifficultproblemforthosetraderswhohave a low win rate. It isobviously possible to be asuccessful and profitabletrader—in fact to be a
professional trader—with atradingsystemthathasaverylowwin rate.Theproblem isthat if winning trades do notoccur that often, it isimperative that all trades aretaken to make sure thewinnersarecaptured.If you trade a system that
has a low win rate, and youmiss out on some of thetrades, and these trades endupbeinglargewinners,itcan
be disheartening. Obviously,if you trade a system with avery low win rate, you needlarge winning trades tomaintain profits.Missing outon these winners can bepsychologicallydemoralizing; it can bedifficult to maintain yourconfidence in a tradingsystem with a low win rate.There is an easy solution,however.
If you want to make surethat you do not miss out ontrades,ormissoutontradinginformation so that you canmanage trades, technologymay be your answer. Today,there are many technicalsolutionsforthenakedtrader.Technology today allowstraderstobealmostanywhereandstillmanagethetrades.Thekeyistobeprepared.It
is possible for the naked
trader to simply trade fromaphone. With well-equippedphones,nakedtradersareabletonotonlytoplacetradesandmanage trades, keeping tabson live market charts, theycan also set alerts. If themarket goes to apredetermined price level,traderswillreceivee-mailsoralertsontheirphones.On the Internet, there are
services thatallowyou toset
price alerts, so that once themarket crosses a price levelyou receiveane-mail. Ifyoureceive e-mails on yourphone, you should knownearly immediately if themarket reaches apredetermined price. Formore information aboutsetting alerts about yourchartsonyourphone,seethevideo on creating automatedalerts at
www.fxjake.com/book.
CONFIDENCEINYOU
Yourconfidencemayebbandflow; this is part of trading.There are some easy tricksyou can do to keep a steadystream of confidence in yourtradinglife.Youcandothreethings, and if you practice
these consistently they willhelp to maintain yourconfidence.
StepOne:TheReasonsforYour
SuccessIn order to be confident as atrader, you must consistentlyexecute your trading systemas it was outlined in yoursystem rules. More
importantly, youmust know,without a doubt, the reasonwhy you have chosen toexecute your trading system.In other words, your beliefsmust align with your tradinggoals.Thisisaforeignconceptto
most traders. Many tradersassume that they want tomakemoney, and if they arenotmakingmoney,thereasonis that they have not found
the trading system that willallow them to make moneyconsistently. Notice how theemphasis for most traders ison the system. The systemyieldsthereward.Thesystemis responsible for profits.Unfortunately this emphasisonthesystemisincorrect.Theonlytraderswhodonot
have to concern themselveswith the psychology oftradingare those traderswho
use automated tradingsystems.You are influencingyourtradingresultsregardlessof whether you acknowledgethis fact. Unless you aretrading a purely mechanicalsystem—a pure automatedtrading system, you areinfluencing each and everyoneofyourtrades.(Hereisatesttoseeifyoursystemisapurely automated system. Ifyou can be away from the
Internetforamonthandyoursystem will still trade andmakemoney for you, then itis a purely automatedsystem.)Your thoughts, yourbeliefs, and whether youbelieve you are deserving ofprofit all influence how youtradeyourtradingsystem.Think about and write
down your answers to thefollowing:
How many wealthy
peopledoyouspendtimewith?Do you think thatyou will one dayhave a lot ofmoney?When somethinggoes wrong withmoney,doyouthinkthatthisis“justyourluck?”When you see awealthy person,
whatdoyouthink?Do you think thatwealthy people aregoodpeople?If you becomeextremely wealthy,areyouworriedthatyour personalitymaychange?
To learn more about youranswers to these questionsand your attitudes towardmaking money, go to
www.fxjake.com/book.Aligningyourtradinggoals
with your financialpersonality is important andsomething that will occurregardlessofwhetheryouareconsciouslyawareofthis.
StepTwo:TheRewardsofRoutineThe trading system youemploydependsonyou.You
must identify and executetrades. You must apply therisk management rules toeachofyourtrades.Youmustremain vigilant and ensurethat you take all the tradesthatyoursystemidentifiesashigh probability trades. Inorder to achieve all this, youmust have an establishedroutine.This routinemust bewritten down, and it mustinclude all the important
variables for your tradingsystem.The rules for your trading
system must include yourtrading routine. Define whatyou will do, and what youwill not do regularly. Thiswill be your trading routine.Adherence to your tradingroutine is the closest thingyouhavetoinsuranceagainstsloppy trading. Sloppytrading involves missing
trades, trading the wrong lotsize, placing the stop loss atthe wrong price, or poorexecution when entering atrade.Ataminimum,thisiswhat
you should have writtendownforyourtradingroutinerules:
Whenwillyou lookfortrades?How will youcalculate your trade
size? (There is arisk-free calculationspreadsheet, a greattool for calculatingyour trade size, atwww.fxjake.com/book.)How often will youcheckthecharts?How will you bealerted to tradingopportunities?How will you bealerted when you
need to manageyourtrades?
Defining your tradingroutine is important because,over time, as you begin toconsistently capture profits,you will gain confidence inwhat you do. The simple actofenteringyourtradeintotherisk calculation spreadsheetwill often bring ananticipation of profits tocome.Thereisgreatpowerin
routine.
StepThree:TheMachine
If you have aligned yourpersonal beliefs with yourtradinggoals,andifyouhavedesigned a well-plannedtrading routine that you canadhereto,youarenowreadyto put into place fail-saferules and tools so you may
quickly regain yourconfidencewhenitwavers.The fastest way to regain
your confidence is to back-testinaforextester.Alosingstreak can be put into properperspective after you havetraded the GBP/USD overthree years and foundconsistent profits in a forextester using the very samesystem that has you in adrawdown. Back-testing in
general is a one-size-fits-allremedy.Not onlydoesback-testing help your confidenceduring a losing streak, but italsohelpsyou toconcentrateonwhat is important in yourtrading system. The simpleact of taking 50 trades in aforex tester (or your chosenback-testing software) addsanother 50 trades under yourbelt. You will have honedyour skills to identify valid
trade set-ups and executevalid trades within theconfinesofyoursystem.Spreadsheets can also help
you. If you can, make somespreadsheets with the datafrom your back-testingsessions.Thesedatawillhelpput drawdowns intoperspective. There is a greattemplate for you atwww.fxjake.com/book.Download the spreadsheet
there and enter your back-testing data into thespreadsheet. The spreadsheetwill calculate for you thestatistics of your tradingsystem. Having the statisticsin front of you is evidencethat your trading systemworks, and youmay need totrot these data out when youare experiencing a losingstreak,toremindyourselfthatwhat you are doing is
successfultrading.Inthenextchapteryouwill
see how confidence and riskare related. For now, it isimportant to note that if youarenotfollowingyourtradingsystem, that is, if your riskmanagementdoesnotfitwiththe rules of your tradingsystem, you may find itextremelydifficult toexecuteyoursystemproperly.
REASONSFORLOSINGSTREAKS
Therearemanyreasonsthatatrade may not make money.These reasons include thefollowing:
Poor systemexecution(mistakes,sloppy trade entry,humanerror,etc.).
Changing market(trading system nolongerworks).Bad technology(slow computer,poor Internetconnection,etc.).Dishonest broker(marketmanipulation, baddata feed, frozentrading platform,etc.).
Trading system notflexible enough(unusual marketactivity, newsreport,etc.).
All these reasons have onething in common: They areincorrect. These are notreasons for a losing trade;they are excuses. Confidentnaked tradersunderstand thatthese excuses will not aid inthe collection of profits from
the markets. These reasonsforfailedtradingareexcuses;each offers a reason forfailure. If you find yourselfusingthesereasonsforlosingtrades,pleasereconsideryourthinking. Changing yourthinking about what ispossible and what is underyour control will helpimproveyourconfidence.Losingtradesarereallydue
toonething—badluck.Luck
will come and go, as youknow, so the drawdown youare experiencing will betemporary,andaslongasyoudonotchangeyourrules,youwillgetitbackontracksoon.Bad luck is thereasonwhyatrade ends up a loser. Badluck is the reason you neverknow if a trade will makemoney or if it will losemoney.Thepossibilityofbadluck is the reason why
responsible traders place thesameamountofriskoneverytrade.If you follow your trading
system and all your tradingrules, you will have theconfidence of knowing thatonly one thing can lead to alosing trade—bad luck.Luckcan neither be accounted fornor can you anticipate yourluck. Armed with back-testing data and your trading
record (from your liveaccount), you may have averygoodideaofthechancesthatyournexttradewillbeanunluckyone.The probability that any
giventradeisalosingtradeiscalculatedasfollows:
Ifyourtradingsystemhasa59percentwinrate,thenyouhavea41percentchancethatyour very next trade will be
anunlucky(losing)trade.
Thinking about your nexttradeintermsofprobabilitiesmay help you to re-focus onwhat is important: followingyour trading system.Worryingaboutanyonetradeor emphasizing reasons whyyour trade lost money is notimportant. The big picture isimportant, the overallprobabilityofawinningtrade
is important.Aspecific tradeisnotthatimportant.
THEBADMARKETTHEORY
Some traders are concernedthat very good tradingsystems will change themarket. The theory goes
somethinglikethis:Ifalargeproportion of traders startusingthekangarootailonthedaily forex charts, eventuallythe daily forex charts willstop printing reliablekangaroo tails because toomany traders are usingkangaroo tails to find high-probability trades. Althoughthe story sounds good, it isincorrect.Even if all the retail forex
traders (traders like you andme)tradedthedailykangarootails,wewouldnotaffect themarket.Therearetworeasonswhy this is true. First, everytrader views the marketdifferently, so what is aworthwhile kangaroo tail tomemaynot be aworthwhilekangarootail toyou.Second,retail forex traders make upsuchasmallproportionoftheforexmarketthatevenatruly
coordinatedtradeexecutedbyall retail forex traders wouldnot have an effect on themarket. The majority of thevolume in forex is from thebanks and private funds, notthe retail traders. The retailtraders make up about1 percent of all the forextradingvolumeeachday.The great thing for the
naked trader is that nakedtrading systems are based on
market psychology. Thenaked trading systems youhave learned in thisbookarebased on the psychology ofthemarketparticipants.Theyare likely to hold for as longas humans participate in themarkets. Any downturn inperformance is likely due tobad luck if you have beenfollowing your system rules.This means that the profitswill likely return to normal
again, after the bad-luckstreakisover.Finally, the possibility
remains that your tradingsystem completely falls apartand stops working. The wayto test this is to takea recentsample of all the trades forthat system and compare thewin rate to thehistoricalwinrate. If you are concernedabout a recent losing streakfor your trading system,
compare your historical winratetothewinrateofthepast50trades.Ifthehistoricalwinrate differs greatly from thecurrent win rate, the tradingsystem may be losing itspotency.
CHAPTER16
ManagingRisk
Yes, risk taking isinherently failure-prone.Otherwise, it would becalledsure-thing-taking.
—JimMcMahon
As you progress as a traderyouwill become involved inthinkingandprobablyreadingabout trading psychology.Trading psychology is abroad term that encompassesthe studyof traders and theiremotional issues abouttrading. Trading-psychologyliterature takes its cues fromscientific study ofpsychology, common sense,and the experience of traders
and trading gurus. If you areinterested in tradingpsychology, it probablymeans that you are furtheralong in your tradingeducation.Ifyouareoneofthetraders
with an interest in tradingpsychology,youhavemovedbeyond looking for theperfect trading system. Younowunderstandtheimportantrole emotions play in trading
results. One thing that manytradersfailtorecognizeistheintricate relationshipbetweenwhat you risk and theemotions you experienceduring trading. In fact, riskand trading psychology aretwosidesofthesamecoin.
YOURRISKPROFILE
Everybattleiswonbeforeitiseverfought.
—Sun-TzuSome would say your lot inlife has been decided. Theending balance of youraccount is already known. Ifthiswerethecase,wouldyoulike toknowwhoknows thisnumber? Why not ask thispersonnowtofindoutifyoushouldspendsomuchofyourtime trading? Who knows
what your final balance willbe? Who is this person whocan tell you what the futureholds? Who knows howmuch money you will make(orlose)duetoyourtrading?You!Thispersonisyou!Youaretheonewhoknows
whether you will makemoney or not, even thoughyou may not have consciousaccess to this information.Most traders do not
acknowledge this fact: Yourbeliefs drive your behaviors.This includes your tradingbehaviors. Ifyoubelieveyouareworthyof tradingprofits,you will be able to makemoney. Ifyoudonotbelieveyour trading will lead toprofits,youwillnotbeabletoconsistently make money. Itdoesn'tmatterifyoudecidetowork in business or intrading.Yourbeliefs,whether
they are accessible to youconsciously, will drive yourbehaviors.This is exactlywhy people
who win the lottery end upbroke a few years later. Thisis a very common story.Perhaps you heard aboutthese people. Once they winthe lottery, things shouldchange for these luckywinners, but, in fact, it justdelays the inevitable result.
The end result is, of course,no money. (See the featuredstory “The Man WhoAuctions off His LotteryWinnings.”)
TheManWhoAuctionedoffHisLotteryWinnings
WilliamBudPost,IIIhadadifficult life. His mother
died when William waseight, and his fatherabandoned him and latersent him to an orphanage.As an adult, he driftedbetween meaningless jobs,workingas a spraypainter,laborer, cook, and truckdriver for the circus. Hewas unable to afford ahome and even spent 28days in jail forwritingbadchecks. Even his love lifewascursed.Hewasmarriedanddivorcedsixtimes.Then, his luck took a turnfor the worse. He won the
lottery.One day, in 1988, he hadno jobandwas receivingapaltry monthly disabilitycheck.Hehadonly$2.46inthe bank, so he sold a ringto apawnshop for$40andasked his landlady (whowas also his on-again-off-again girlfriend, AnnKarpik), to buy 40 lotterytickets with the cash. Oneof the tickets she boughtwas thewinning ticket.Hewon$16.2million.The lottery payments wereto be made over 26 years,
and totaled $497,953.47each year. He spent over$300,000 after receivingthe first payment. Budbought a liquor license, atwin-engine plane (he didnothaveapilot'slicense),arestaurant for his brotherand sister, andhebought aused-car lot for his otherbrother. He was $500,000in debt three months afterhisfirstlotterypayment.In quick succession, thingsgotworse forMr.Post.Heused his second annualpayment to purchase a
mansion for $395,000 inOil City, Pennsylvania,with the hopes ofrefurbishing it. But hisformer landlady, AnnKarpik, suedhim,claimingthattheyagreedtosplitanywinnings, a claim thatBuddenied.ThecourtruledthatBudowedAnnone-thirdofhis winnings. Bud wasunable to pay, so the courtorderedhimtogiveAnnhis1992 annual payment. Herefused, so the judge frozehis future payments.Understandably, visitors to
his Pennsylvania mansionnoticed that the estate wasin disarray, showers weremissing, the securitymalfunctioned(andchirpedevery60seconds),thepoolwas filled with garbage,there was an old car onblocks in the weedy yard,and the windows werecoveredwithplywood.Mr. Post was quicklyfalling into debt, so hehatchedaplan.Hedecidedto sell the ailing mansionfor$65,000andauctionoffhis 17 remaining lottery
payments in the hopes ofscratching out of debt. Hehoped that this planwouldallow him to hold ontosomecash.His plan failed.Within theyear, he had bought acouple of large screentelevisions, two homes,three cars, a truck, twomotorcycles, somecomputers,acamper,anda$260,000sailboatheleftinBiloxi,Mississippi.(Hehadhoped to start a charterfishing business with theboat.)
He was tracked down andarrested on that boat forrefusing to serve a prisonsentence.Hewasconvictedof assault. Apparently,Mr.Post fired a shotgun at amanwho tried to collect acar-repair debt back inPennsylvania.Post was quoted as saying“Once I'm no longer alottery winner, people willleavemealone.That'sall Iwant. Just peace ofmind.”He said, “I was muchhappierwhenIwasbroke.”Post got his wish: After
serving his sentence forassault, he was back toliving on his $450-per-monthdisabilitycheck.
WhyYouWin(orLose)
Youwin(or lose)becauseofyour beliefs. Specifically, ofcourse I am talking aboutyourwinningor losinginthefinancial game. It does not
matter if you are anentrepreneur, looking atestablishing a new business,or if you are a salesman,looking to cultivate a streamof customers, or, perhapsmore likely, if you are aburgeoning trader, looking toestablish reliable tradingmethod to pull profits fromthe market. The sameprinciplesapply toallpeoplelookingtomakemoney.Your
beliefsaboutmoney,andhowworthyyoubelieveyouareofmoney will determinewhether or not you makemoneytrading.Perhaps you don't agree.
Perhaps you believe that youonly need a good tradingsystem in order to find atrading success. If that is thecase, then why is it that oneprofitabletradingsystemmaybe offered to 10 people, and
those 10 people will havevarying degrees of success?There are some excellenttrading systems in this book.However, not everyonereading this book will takethese trading systems and goforward and make money.Whyisthisthecase?If you believe you are
worthyof tradingprofitsyouwill find they come muchmoreeasily.If,however,you
believe you do not deservetrading profits, you maynever find a trading systemthatworksforyou.Themostcriticalaspectofyourtradingsystemisyou.
YourMoneyAttitudes
Before you do anything else,do this.Get a piece of paperand a pen. Answer these
questions quickly and astruthfully as possible. Theimportant thing here is thatyou do this now. Be honestand be quick; use your gutreaction to answer in everycase.
True or False?Richpeople are goodpeople.True or False?Moneyistherootofallevil.
True or False?Money comes tothose who helpothers.Money is a_______.Mostrichpeoplearemore _______ thanmostpoorpeople.Those with moneyalsohave_______.Poor people arebetter _______ than
richpeople.If I had moremoney, I mightbecome more_______.
Your beliefs about moneycan determine how muchmoney comes your way. Ifyou believe money is goodandyouareworthyofwealth,moneyismorelikelytocomeyour way. However, perhapsyou believe something
different;perhapsyoubelievethat rich people are selfish.Maybe you think that mostwealthy people found wealththroughimmoralbehaviors.Ifyou thinkwealthypeopleareunethical,youareunlikely todesiretobecomewealthy.Some traders believe
wealthypeoplearenefarious,and thus these traders areunlikely to ever achieve realwealth. Why should they
become wealthy if wealthypeople are despicable. Othertraders think that rich peoplesimplymake loads ofmoneybecause rich people are verymotivatedto…makemoney.These tradersaremuchmorelikely to join the wealthycrowd.Seeing yourself making
money is the first step totrading success. If youbelieve wealthy people are
moralandgood,youaremorelikelytobecomeoneofthesepeople.Likewise,ifyouknowthat you will be makingmoney, if you are confidentthat you have the skills toachieve wealth, you are onyour way to becomingwealthy.
TRADING
PSYCHOLOGYANDRISK
MANAGEMENTThere are very few laws fortrading, but this is one ofthem: Improper riskmanagement leads toemotional trading problems.Win or lose, if you risk toomuch on a trade, you willendureemotionalproblems.It
is not only with the losingtrades that improper riskmanagement rears its head.Improper riskmanagement—riskingtoomuchonatrade—leads to emotional issues,evenifthetradeissuccessful.Iftoomuchriskisplacedinatradeanditendsupawinner,overconfidence, irrationalexuberance, and sloppy tradeexecution may be the result.Iftoomuchriskisplacedina
trade that ends up being aloser, any number of resultsmayoccur: tradingrulesmaybe ignored, psychologicaldespair may result, and themanagementofthetradewillalmost always beexceptionally poor. There isno way around this law oftrading.
EmotionalTrading
Emotional issues are alwaysrelated to your confidence intrading, the current trade inplay, or your confidence inthetradingsystem.Emotionalissues will creep into yourtrading regardless ofwhetheryoulikeit.Youthinkthatyoukeep your emotions out ofyour trading, but, for mosttraders, this is not true.Mosttraders get extremely upsetafter a losing streak, or a
losing trade, or missing outon a great trade opportunity.Under most circumstancestraders have a very difficulttime removing emotion fromtradingdecisions.However, is it important to
remove all emotions fromyour trading? Is it abad ideatotradeunemotionally?Afterall, if it is impossible toremove emotions fromtrading, perhaps you should
embrace your emotions. Thestandard opinion aboutemotionaltradingtoday,mostgurustellus,isthatemotionaltrading is destructive.This isnottrue.Theonlydestructivetrading is trading that is notaccording to your rules. Sowhether it is emotionaltrading or logical trading, ifyou trade in amanner that isnotconsistentwithyourules,you are trading in a
destructivematter.Emotional trading is the
result of improper riskmanagement. When the riskbecomes too much, rationalreaction to the market isimpossible. If you have everhadatradeinwhichyoutooka large position—too large aposition—and the trade wentagainstyou,youknowwhatitis like to try and thinkwhenyour emotions are running
wild.The antidote to this is to
apply proper riskmanagement to your trades,use a well-rehearsed set oftradingrules,andapplytheseover and over again in yourtrading.
Worst-CasePlanningWorst-case planning meansplanning for the maximum
lossoneach trade.Thisway,the maximum loss cannothurt you. Over time, byplanning for the same loss(your maximum loss, whereyourstoplossisplaced),youwillbecomemoreefficientinexecutingyourtrades.Thisisthe magic of consistent riskmanagement. If each tradehas the same risk associatedwith it, over time you willbuild up valuable experience
withthisrisklevel.If you keep your risk the
same,theworst-casescenarioforeachandeverytradeisthesame. If you walk outsidebarefoot on a hot day on theasphalt, your feet may burn.However,ifyouwalkoutsideevery day when it's hot, theasphalt slowly becomesbearable. The same principleapplies to drug addicts; overtime, drug addicts must take
more and more of the samedrug to get the same high.This principle of tolerancealsoappliestotraders.It'sthetendency for tradingexecution to become moreprecise over time when thesame amount of money is atrisk on every trade. Byrisking the same percentageof your trading account onevery trade,youwillbecomeusedtotheamountofmoney
at risk. You will becomeimmune, over time, to theequityswingsinyouraccountwith each losing trade, oreachwinningtrade.Whatwillhappen,overtime,isthatyouwillbegintofocusonwhatisimportant—executing yourtrades, and you will notconcentrate on the moneygainedorlostoneachtrade.
TRADINGTOLERANCETrading tolerance is thetendency for tradingexecution to become morepreciseover timewhen thesameamountofmoneyisatriskoneverytrade.
EncourageTradingTolerance
This is how you mayencourage trading tolerance.First, calculate your worst-casescenario.Thisshouldbethe dollar loss if your stoploss is hit. Second, add 20percenttothisamount.Third,use this figure whencalculating the risk for yourtrades. You should assumethis (percentage) risk for allof your trades. Finally, usethisformulatocalculateyour
risk for each trade. Beforelong, you will becomeaccustomed to risking thisamount. Be prepared to losethis amount. Be prepared forthese losing trades, and beprepared for a sequence oflosingtrades.Before long, the amount of
money will not seemsignificant, and you willbegin to focus on tradeexecution. This is where the
moneyistobemade.
RISKYMONEYTRAPS
Why do most traders fail?Why is trading forconsistentprofits so difficult? Tradersare simply people who lookto buy something when it ischeap, and look to sellsomething when it is
expensive.Tradersgetpaidtobe bargain hunters and agilemarket participants.However, there are so manypeople in the markets whofind extreme difficultyattempting to extract profitsfromthemarkets.Aclose lookat the reasons
that traders fail—the riskymoney traps—and how toovercomeeachof these trapswillprepareyouforentryinto
the markets. Remember toconsider the other marketparticipants. Many of thesepeople are well capitalized,and they have intelligentpeople behind theconstructionandexecutionoftheirtradingstrategies.Ifyoufind it difficult to overcomeyour own issues, if you fallinto one of the risky moneytrapsbeforeyouhaveenteredthe markets, you are at a
significantdisadvantage.
YourAccountIsUnprotected
The number-one trading skillyou need to succeed as atrader is theabilitytoprotectyour tradingaccount.This isparamount to all other goals,protecting your accountmeans survival. Traders whoare unable tomake the jump
from novice trader toprofessional trader fail torecognize the importance ofplaying defense. Professionaltraders are very good atplaying defense. Watch the“TaleofThreeTrades”videoat www.fxjake.com/book forarealmarketexampleofhowthis concept may be appliedto live trades. If you can getinto the habit of playingdefense, you can become a
successfulprofessionaltrader.Learn to recognize theimportance of playingdefence. Without this youhavenochance.Traders who are unable to
protect their money havedifficulties with beliefs.These traders may believethey are unworthy of largeamountsofmoney.Theymayalsoconfuse theirbeliefwiththefacts.Beliefsmaybecome
facts, but traders deal withoddswhenitmattersmost.I may believe the
USD/CAD is headed downbecause the market prints abearish kangaroo tail on thedaily chart. I may decide torisk money based on mybeliefthattheUSD/CADwillstart trading lower soon.However, thisdoesnotmakemybelieffact.Imustwaitforthemarkettotellmewhether
mybelief isgoing tobecomemarketfact.Ifthemarketinsteadbegins
totradehigherandhigherandhigher, I come to acrossroads. Perhaps I decideononeof thefollowingthreecourses of action: (1) I maydecide to dump the tradebecausemybeliefseemstobeincorrect.(2)Imaydecidetomovemystop losshigher, togive the trade a little more
breathing room because Iknow the market willeventually fall. (3) I mayeven decide to walk awayfrommycomputer, to let themarket decide whether mybeliefiscorrect,knowingthateither my stop loss or myprofit targetwill be hit. Twoof these reactions (1 and 3)are acceptable means ofdealingwithmybelief,basedonthecurrentmarketactivity.
The other reaction, 2, isdetrimental to my tradingaccount. I have decided torewrite my trading plan(initial stop loss moved, thetradenowhasmorerisk thanoriginally planned for), and Ihavedecidedthatmybeliefismarket fact, even when themarket provides informationtothecontrary.Think about that. The
markethastoldmethatafair
price is higher, not lower. Ithink the market is headedlower.Thisismybeliefbasedonthedailybearishkangarootail. However, the markettrades higher. I ignore themarket information, themarket freely provides mewith information about theUSD/CAD (the fair marketprice is higher), and I decidetoassumetheoppositeisfact.The market goes up and I
decidethemarketiswrong.Whodoyouthinkwillwin
thisbattleofwits?WillIwinorwillthemarketwin?Remember to keep your
beliefs in perspective. Thereare no beliefs worth morethan your entire tradingaccount. You work hard foryour money, so defend it.Throw away your beliefswhen the market tells youtheyare incorrect.Keepyour
moneyinstead.There are many other
beliefs that stand in the wayof trading success. Perhapsyou are familiar with theseriskyideas,suchastheI-will-make-it-big-once-I-get-a-big-accountidea.
YouNeedMoreScreenTime
At times it may seem as
though you do not have thetime to trade. Among thedaily commitments of work,family,andhobbies,itcanbedifficulttofindtimetotrade.Those missed opportunitiescan be awful. Simplywatching the market marchon without you can be moredifficult todealwiththanthestandard-issuelosingtrade.Maybe more time in front
of the computer will mean
more profits? Maybe youthink that trading shorter-timeframe charts mightmultiply your tradingopportunities and accelerateyour equity curve? Perhapsthisistrue;ifyouareabletotrade the shorter timeframesyou may find moreopportunities, if you are abletoschedulemorescreentime,more time in front of yourcharts.
Please beware that “I needmorescreen time to trade” isnot an excuse for avoidingback-testing. All of yoursystemsshouldbevettedwithback-testing results, forward-testing results, and thesmallerlive-tradingaccount.Most traders will use this
excuse to create a case forleaving a job, and thisthinking isadangerousplaceto be. Many traders are not
quite ready to start tradingfull-time, but they think thatby leaving their full-timepermanent jobs, the addedscreen time will push themover the top and make iteasier for them to achievetradingsuccess.Sadly, thisisoftennottrue.
YourJobIsHoldingYouBack
Related to the I-need-more-screen-timetrapistheI-gotta-dump-my-job trap. Tradersfantasize that more time,specificallymorescreentime,will help them to achieveconsistent profits. A littlemore focus will bring theresultstheyarelookingforintheirtrading.This seems logical, but it
rarelyworks.Puttingyourselfin a situation in which you
need to make moneyconsistently from yourtrading account, before youhave learned how toconsistently make moneyfrom your trading, is a badidea.Youwouldnotexpectastuttering game showcontestant tobeable to rattleoff quiz answers with thepressure of the clock tickingdown, would you? This iswhyitmakessenseforyouto
takethepropersteps,startingwith back testing, moving toforward testing, then on tosmall account trading, beforeyou ever begin trading for aliving, trading your largetradingaccount.Unrealistic expectations
may also affect your trading.It may be tempting tobackward engineer yourtrading profits. Perhaps youdecide to trade the daily
charts,andyouwouldliketomake $15,000 per monthfrom your trading. Youdecidethatyouneedtomake500 pips each month andtradefor$30perpip.$30perpip × 500 pips = $15,000;simple math provides youwithyourtradinggoal.What if your trading
account contains only$35,000?Youmayhavetobevery careful. If you are
trading at $30 per pip andyour stop loss is 100 pipsaway from your entry price(certainly possible with adaily chart trade), you arerisking$3,000onyour trade,that is 8.5 percent of yourtradingaccountatrisk.Threelosingtradessuchasthisoneandyouwouldbedownover30 percent on your tradingaccount. This is why manytraders have a difficult time
making the jump from part-time to full-time trader, yournice-to-have-profits turn intomust-haveprofits;thefocusison the money and not thetradingresults.Thinking about trading in
terms of money is preciselywhy many part-time traderswant to leave their full-timejobs. It is also the reasonmany part-time traders findconsistentlyprofitabletrading
so elusive once they leavetheir jobs. Remember toconcentrate on your trading,executeeachtradeasbestyoucan.Themoneywill come ifyouconcentrateonbecomingabettertrader.
YouNeedaBiggerAccount
Some traders insist onholding to the idea that only
larger trading accounts willallowforsuccess.Theideaisthat thegiant tradingaccountin the sky will bring somesort of nirvana.Unfortunately, for many ofthe reasons listed earlier inthischapter(namely,attitudestoward money and wealthypeople), the opposite isactuallytrue.The great majority of
traders around the world do
much better trading whenplacing trades in very smallaccounts. Once traders moveuptolargeraccounts,inmostcircumstances these tradersend up thinking too muchaboutthemoneyandtoolittleabout managing tradesaccording to their systemrules.It is possible to do
exceptionally well, even ifyoustartoffwithaverysmall
trading account. The focusshould be on trading yoursystem.Youreffortshouldbeplaced on executing andmanaging your trades asclosely as possible to therules of your system. If youmoveawayfromtradingyoursystem and instead focus onthe dollar amounts, you willlikely see your performancesuffer.Ifyouhaveissueswithmoney and wealthy people,
you are sure to see yourperformancesuffer.Theideathatalargetrading
accountwillhelpyouachieveyour financial goals may becomforting, but until youhave been able tosuccessfully manage yoursmaller trading account, anduntil you deal with yourbeliefs about wealthy peopleand money, trading a largetradingaccountwillprobably
belittlemorethanfrustrating.Large is, of course, a
relative word. For sometradersalargeaccountwouldbeanaccountof$10,000,andfor other traders an accountsize of $150,000 is small.Thinkaboutthis:theideathata few traders may see anaccount and think that it isvery small and other tradersmayseethesameaccountandthink that it is a very large
account.The fact that traderscan view the same accountvery differently is moreevidence for the idea thattraders’ attitudes and beliefstowardmoneywilldrasticallyeffecthowwell tradersmakemoney and sound tradingdecisions.So if you find yourself
thinking, “I need a biggertrading account so I willreally be able to make some
serious money,” make surethat you are making seriousmoney with your smalleraccounts first. A largeraccount may simply maketrading more difficult if youare not prepared for thechallenge.
ThinkingThatTradingIsEasy
Maybe you think that
consistentlyprofitabletradingis easy. Perhaps you havescrolled back on some chartsand identified the wonderfulopportunities staring back atyou.Theseopportunitiesmaycomeintheformofkangarootails and big shadows atmarket turning points, thoseplaces where the marketoffers a clue aboutwhatwillhappen next. You maybecome confident that
successful trading can beyours. Maybe you begin tothink that profitable tradingcanbeeasy.Be careful of this
overconfidence that oftenappears as the successful-trading-is-easy idea. Tradingsuccessfully can be simple,but that does not make iteasy. Trading successfullywillmeanputting in the timeback testing your system,
developing a trading plan tocover all of the what-ifscenarios you can come upwith, and creating a methodfor overcoming the doldrumsof the inevitable drawdowns.Planningiscriticalforyoutosucceed in the long term,butit is not the only ingredientforsuccess.Tosucceedyouwillneeda
healthy dose ofdetermination. History is
litteredwithstoriesoffamouspeople who overcameadversity, people whoaccepted success becausefailure was not an option.Determinationisthecommonthread among these stories.WaltDisney took threeyears(double the anticipated 18months) to produce a moviethatwentoverbudgetby400percent.Allthewhile,peoplesurrounding him questioned
whether his full-lengthcartoon movie would haveany mass appeal. The moviewasanoverwhelmingsuccess—you may have heard ofSnow White. Another manhad an altogether differentlife experience. His motherdied when he was nine. Hisfriend lenthimmoney to runabusiness,andayearlaterhelost the business and wentbankrupt. He ran for public
office on five occasions andlosteachtime.Theloveofhislife died before he couldmarry her. He suffered anervous breakdown. Hissecond son died at a youngage. You may know him asAbraham Lincoln, thesixteenth president of theUnited States. Anotherfamouspersonbeganlifeasachild in a poor household.She was the result of a one-
night stand. Her motherworkedasamaid.Herfatherwas in themilitarywhen shewas born. As a young child,she lived with hergrandmotherinpoverty,oftenwearing dresses made ofpotato sacks. She wassexually abused by hercousin, her uncle, and afamilyfriendfromtheageofnine. She ran away fromhome, became pregnant, and
her child died soon after hisbirth. Despite this dubiousstart in life, Oprah Winfreybecame a millionaire at age32 and is considered therichest woman inentertainment. She has actedin movies, co-authored fivebooks, and inspires millionswho watch her televisionshows and read hermagazines.Each of these people share
one thing in common:determination. You simplymust have determination tosucceed in trading (or anyother endeavor). Allsuccessful people sharedetermination. Yourdetermination will guide youto trading expertise in theformofallthehoursspentinfront of charts, back-testing.Yourdeterminationwillyieldresourcefulness when it is
needed most, duringdrawdowns and when yourconfidence is shaken. Yourdetermination will help aidyou to see your successbefore it appears.Determination isyour ride tosuccess. Let it carry you towhereyouwanttobe.Youknowwhattodonow.
The question remains: Areyoudeterminedtosucceedasanakedtrader?
AbouttheTradingSoftware
andVideoTutorial
In order to improve yourtrading, a special members’area is available on the webto supplement the concepts
laid out in this book.At thisspecial link you'll findinteractive tutorials and aFREE software tool,including:
Support andResistanceInteractive VideoTutorial: Gainconfidence whentrading withSupport/Resistancebyimplementingmy
proprietary rules aslaid out in thistutorial.Big ShadowInteractiveTutorial: Masterthe step-by-steprules to trading myfavorite andsimplest yet mostsuccessful strategyby watching thisinteractivetutorial.
Support andResistanceSoftware: Tradeside by side withme, using thiscutting-edgesoftware that sendsmy S&R lines rightto your tradingcharts,inrealtime.
Go towww.fxjake.com/book tocreate an account and access
the FREE Naked Tradingmembers’areatoday!
AbouttheAuthors
AlexNekritinAlex Nekritin has been aprofessional trader for morethan 10 years and is thefounder and president ofTradersChoiceFX.com.TradersChoiceFX is a forex-
introducing brokerage firmthat is able to enhance itsclients' forex trading successbymatchingthemupwiththebestfitforexdealerforthem.Alex's specialties include
riskmanagement and systemdevelopment.Hehasadegreewith a concentration ininvestment banking andderivative instruments fromBabson College inMassachusetts.
WalterPeters,PhDBefore becoming aprofessional trader, WalterPeters worked as a clown,magician, online marketresearcher, and juryconsultant. Dr. Peters has aPhD in experimentalpsychology and an extensivebackgroundinstatistics.Asanakedforextrader,Dr.
Peters enjoys trading simple
trading systems. He has akeen interest in tradingpsychology and how tradingbeliefs yield trading results.He trades with forex tradersaround the world on hiswebsite www.fxjake.com aplacefornakedtraders.Whenhe is not trading, Dr. Petersenjoys spending time in theocean and talking abouttrading.
Index
Action(cycleofdoomphase)AustralianDollar(AUD)four-hour wammie trade,triggeringline chart, price actionclarityone-hourtrendykangaroo
stoplosstrade,survival
reversalsRSIbuysignalRSIsellsignaltrade,stoplossplacementtrendykangarootradeweekly chart, kangaroo tail(printing)zones, pip distancedifference
Australian Dollar (AUD)dailychartbearishbigbelt
bearishbigshadowstoplossplacementthree-barexittrade, stop lossplacement
bearish big shadow, stoplossplacementbearishcandlestickbearish kangaroo tail,printingbearishtrendykangarootail,characteristics
candlestickfake-outkangarootailtrendykangaroo
appearancecandlestick,consolidationrange
uptrend,marketpausewammietrade
Australian Dollar (AUD)four-hourchartbearishkangarootail
bullishkangarootailprofittargetplacement
kangarootail,lengthwammie,printing
AustralianDollar(AUD)one-hourchartbearishkangarootail
printingcandlestickthree-barexit,applicationtrades, three-bar exit stoploss
trendy kangaroo trade,three-barexit(application)
Automatedback-testingadvantagedisadvantagesdiscretionary traderavoidanceForextraderavoidancepostdictiveerror
Back-testing, See alsoAutomated back-testing;Manualback-testing
advicedata,usefulnessdefinitionForextestergoalsmistakes,acceptancesoftware,usagestyle,considerationtime,usageusage
BadmarkettheoryBad-markettraders
fundamentalanalysis,usageterrible-system traders,contrast
Bad-markettraders,approachBankofJapan,interventionBank traders, risk manager(presence)BarchartBearishbigbeltcandlestickprintingcharacteristicsoccurrence
openingpriceprofittargetsellstop,placementstoploss
placementtradeset-up
Bearishbigshadowexamplesroomtotheleftset-ups, bearish big shadowcandlestick(importance)stoplossplacement
BearishbreakoutsBearishcandlestickBearishkangarootailscandlestickrangeclose,rangefailureopen/closeprinting
Bearishlast-kisstradesBearishtrendykangaroocharacteristicstail,characteristics
tradesBigbeltbearishbigbeltdefinitiontrading,advicezoneprinting
Bigshadowsappearancebearishbigshadowbullishbigshadowcandlestick,successprofit
rangerulestrade,entry
Blame(cycleofdoomphase)Bolour,AshkanBreakoutsfailurestrategytrading
Breakouttradeconceptexample
fake-out,relationshipBullishbelt,stoplosspositionBullishbigbeltadvantagecandlestick,printingcharacteristicsentrypriceopeningpricerewardtoriskratio
Bullishbigshadowscandlestickclosingprices
trade,buystopentryBullishcandlestickBullishkangarootailslengthopen/close, candlestickpositionproblemtail,shortnesstrade
entrytriggering
Bullish last-kiss trades, buy
stopplacementBullish trendy kangaroocharacteristicsBullish trendy kangaroocandlestickBullishtrendykangarootailsBuystopentryBuystopplacement
CanadianDollar(CAD)one-hour chart, bullish bigshadowresistance
presencesupport,presence
CanadianDollar(CAD)dailychartbearishbigshadowbearish last-kiss trades, sellstopplacementbullishbigbelt
entrypricebullishkangarootailbullish trendy kangaroo,stoplossplacement
double-bottom formation,creationdowntrendsupport/resistancezonetrendy kangaroo,appearance
CanadianDollar(CAD)four-hourchartdouble-top formation,printinglast-kiss trade, emergencystoploss
calculationCandlestick. See Kangarootailbearishkangarootailchartclosuredefinitiongiant candlesticks,avoidanceone-hour candlestick,supportprinting
stoplossplacementrestrictionstoplossplacementsuccessiontrades,stoploss(usage)
Catalystsdecisionkangarootail,relationship
CHF.SeeSwissFrancChoppy market, tradingsystemexploitationClosingprices
connection, line chart(usage)Europeantraders,reactionimportance
Cofnas,AbeCognitivepsychologyConfidence. See Self-confidencegainingissues,originmeaningpractice,comparison
regainingrelaxation,impact
Consolidationphasezone
exampleidentification
Countries, Forex traderpurchases/salesCurrenciescodelesson
listCurrentmarketpriceCycleofdoomactionphaseblamephasedefeatfamiliarityphasesrelationshipsearchphase
Decision-making process,verbalization(difficulty)
Demonstration account(demoaccount),definitionDiscipline,problemsDiscretionary traders,automated back-testingdiscouragementDiscretionary tradingsystems,traderusageDouble-bottomformationscreationdefinitionexample
indicationproblemreversalformationswammie formation,relationship
Double-topformationscreationmoolah,relationshiptrading
Downtrend, trendy kangarooappearanceDrawdowns
extensionDriftingmarketphase, price actioncontainment
Emergency stop loss,calculationEmotionaltradingEntryprice,markettradesEntrysignals,mistimingEURchartminorzone,clarityzones, pip distance
differenceEUR currency, purchasedecisionEURdailychartbearishbigshadowbearish kangaroo tail,printingbullishbigbelt
entrypricedeclinedouble-bottomformationfake-outs
kangarootail,uptrendlastkiss
trade,signaltrending
MACDbuysignalsupport/resistance zone,exampleszone,importance
EURfour-hourchartbearish big shadow, profittargetconsolidationphase
minorzone,presencetransitiontrendingphase,increasezone,identification
EURone-hourchartbearishbigshadowbuysignalnakedbuysignal,stochasticbuysignal(contrast)
EURresistancepresence
EURsupport
presenceEUR trades, MACD buysignalEURweeklychartbearishbigshadowbullishbigbeltbullishkangarootailkangarootail,printing
EURzone,clarityExit. See Ladder exit; Splitexit;Three-barexit;Zonesmanagement
signal,triggerstrategies
Expertise,acquisition/statusExpertsback-testingbecoming,stepscatalysts,decisioncomfortzoneforwardtestliveaccounts,tradingsecretsmallaccounts,trading
statustricks
Experttrading
Fake-outbreakouttrade,relationshipfour-hourchartexamplekiss,relationship
First touch, low (wammietradeplacement)Foreignexchange(Forex)back-testingcycle
machinemarket
interbank market,contrasttraders/players
trades,toolstrading
fundamentalsplatforms,usageprofit
Foreign exchange (Forex)traders
automated back-testingavoidanceeffort,expertstatusindicator-basedapproachpurchase/salerole
Forex Tester, manual back-testingsoftwareForwardtestFundamentalanalysis,usageFundamental indicators,technicalindicators(contrast)
Giantcandlesticks,avoidance
GreatBritainPound(GBP)one-hourtrendykangaroo
stoplosstrade,survival
trendy kangaroo trade, stoploss
Great Britain Pound (GBP)dailychartbearishbigbelt
sellstop,placementbearishbigshadowbullishbigshadow
double-bottomformationindication
last-kisstradewammietradeset-upzoneidentification
Great Britain Pound (GBP)four-hourchartbearishbigbeltbigshadowbullishkangarootailbullish trendy kangaroocandlestick
downtrendmarketrecovery
Great Britain Pound (GBP)one-hourchartcandlestickkangarootail,printingthree-barexittrades, three-bar exit stoplosstrendy kangaroo trade,three-barexitapplicationzoneassumption
Great Britain Pound (GBP)weeklychartbearishbigshadow,roomtotheleftbullishkangarootaillast-kisstrade
Gunnersexits
HighwinrateHindsightbiasdefinitionimpact
Indicator-based trader,advantagesIndicator-based tradingsystemsIndicatorscreation,pricedata(usage)definitionimprovementlag,definitionpricedatabasisslowness
Information, interpretation
processInterbank market, Forexmarket(contrast)
JapaneseYen(JPY)chart,minorzone(clarity)line chart, price actionclarityone-hourchart
bearishbigshadowbearishkangarootailbullishbigshadow
reversals
trade,stoplossplacementweekly chart, bearish bigshadow(roomtotheleft)
Japanese Yen (JPY) dailychartbearishbigshadow
stoplossplacementthree-barexittrade, stop lossplacement
bearish last-kiss trades, sellstopplacement
bearishtrendykangarootail,characteristicsbullishcandlestickcandlestickmoolahtradetrendy kangaroos,candlestick (consolidationrange)wammietrade
Japanese Yen (JPY) four-hourchartbullishkangarootail
consolidationzonedriftingmarket phase, priceactioncontainmentlast-kiss trade, emergencystoploss
calculationminorzone,presencezone,identification
Kangarootailadvicebearishkangarootails
open/close
printingbullishkangarootails
candlestickpositionlengthproblemtail,shortness
candlestickcatalystclosedefinitionexampleexitstrategy
failureformationlength
importancemarketbehavioropenplacementprinting,examplesprofittargetsretailForextradingshortness,problemsingle candlestick
formationsstoploss
placementtradinguptrendzonepenetration
Ladderexitfunctionstoploss,placementusage,patience
Lastkissconcept
markettrendingtrading
Last-kisstradesbearishlast-kisstradesbullish last-kiss trades, buystopplacementemergencystoploss
calculationplacement
profit,findingsignaltriggering,absence
Learningcurve(acceleration),back-testing(usage)Lien,KathyLinechartclosingprices,connectionusage,SeealsoZones.usefulness
Liveaccounts,tradingLong-tailed kangaroo tail,marketprintingLosing,reasonsLosingtrades,impact
Lotterywinnings,auctioning
MACD.SeeMovingAverageConvergenceDivergenceManualback-testingavoidanceexperience,accumulationlabor/timesoftware
problemsusage
Marketbuying/sellingexperience
consolidation,anticipationhistory,involvementinformation,usagemoodsscars,zones(comparison)specialist,definingtheory,badmarkettheorytrading,level(increase)turnaround
assumptiondoublebottom,initiation
turningpoint,capture
Marketbiofeedbackdefinitiondomainslearningoccurrencerecordation,issues
Maximumdrawdownexperience
Meta Trader™, F12 keyusageMillionaire Traders(Lien/Schlossberg)
Minorzonesavoidanceclaritydefinitionpresence
Moneytraps,risk
Money,attitudesMoolahsadvicecharacteristicsdoubletop,relationship
identificationtrade
characteristicstradingprocess
Moving AverageConvergence Divergence(MACD)appearancebuysignals,exampleslagmovingaverages,increasesignals
trader,profit
Naked buy signal, stochasticbuysignal(contrast)NakedForex,definitionNakedtradersadvantageexpertiseprofittrades,marketmovementszones,importance
Nakedtradingmarkethistoryinvolvement
set-upssignal,processstrategies
adoptionimpact
NewZealandDollar(NZD)chart,zonecontactdailychart
bearishcandlestickbearish kangaroo tail,printing
New Zealand Dollar (NZD)
four-hourchartbearishkangarootailcandlestick, bearishkangarootailprices,choppinesszone,clarity
One-hourcandlestick,supportOversold stochastic, buysignal
Personalbeliefs,tradinggoals(alignment)
Pipsdefinitiondistance,difference
Playingdefense,importancePostdictiveerrorPractice, confidence(comparison)Priceimpactimportance
PriceactionsignalPricedata
change,indicators(impact)metric
ProfitmanagementProfittargetsplacement
Range,definitionRelativeStrengthIndex(RSI)buysignal,exampleindicator
lagusage
sellsignal,example
Resistanceline,conceptResistancezonesEUR/CAD daily chart,examplesidentificationmarket,relationshipprice,relationship
RestingspotsRetail Forex traders, riskmanager(absence)Retouchdefinition
principle,basistrading
Retracements,tradeentryRetrading,problemReversalsexampleset-ups,tradingsignal,printing
Riskappetitemanagers
absence
presenceprofilerules
Riskmanagementcontrolsissuesproblems
Roomtotheleftexamples
RSI. See Relative StrengthIndexRunners
exits
Schlossberg,BorisSearch(cycleofdoomphase)Secondary thinking,encouragementSelf-confidenceSellstopplacementSingle candlestick formation,definitionSleepingpoint,definitionSmallaccounts,tradingSmall-tailed kangaroo tail,
downtrendSpecialty,back-testingSplitexitexecutionpatienceprofitusage
Spreadsheets,usefulnessStochastic buy signal, nakedbuysignal(contrast)StochasticmovementStoploss
highlevelmanagementplacement
AUD/JPYtradecandlestick,printingthree-barexit,usage
positiontriggering, candlestick(usage)wammietrade
Success,reasonsSupportline,concept
SupportzonesEUR/CAD daily chart,examplesidentificationmarket,relationshippips,additionprice,relationship
SwissFranc(CHF)monthly chart, bullishkangarootailone-hour chart, trendykangaroo tail (market
decline)supportweekly chart, bullish belt(stoplossposition)zonecontact
Swiss Franc (CHF) dailychartbullishbigshadow
trade,buystopentrydoublebottom,indicationzoneidentificationzonepresence
SwissFranc(CHF)four-hourchartbearishkangarootail,failurebreakouttradebullish trendy kangaroocandlestickdouble-top formation,creationdowntrendfake-outtouches
Technical Forex traders,
technicalindicatorusageTechnicalindicatorsdefinitionfundamental indicators,contrast
Terrible-systemtradersbad-markettrader,contrastblame
Three-barexitapplicationcandlesticks,printingstop loss (triggering),
candlestick(usage)successusage
Timeframecharts,usage
adjustmentinitiation
selectiontrading
TouchesTradersapproaches
back-testingblameexpectationsexpertiseexpertstatus,effortForexbrokerdivisionsjob,impositionlosingstreaks
reasonslossesmarketbiofeedback,usageroutine,rewards
screentime,increasesuccess,reasonswinning/losing,reasons
Tradescorrelationdecisions,basisentryexecutionexit
profitgunnersinitiation
loss,responsibilitymanagementmarketmovementbasisrunnerssignal
drawdown, naked traderavoidance
specialist,definingstagestools
Trading. See Emotionaltrading
accountlevelprotection,absencesize,increase
beliefscomputers,usageconsistencyeaseexpertisegoals, personal beliefs(alignment)habits
journal,creationlifestylepatterns (determination),back-testingdata(usage)personality,knowledgeplayingfield,selectionpractice,importanceproblems,avoidancepsychologyreasonsresponsibilitiesroutine,rewards
screentime,increasestatement,evaluationstyle,considerationsubjectivitytolerance
definitionencouragement
tricksvideojournal,setupwinning/losing,reasons
Tradingsystemapplication,traderapproach
back-testingchangeconfidencecreationdefiningdiscipline,problemsduplicationfitnesslifestyle,impactmakeup,impactquestionrules
suitabilitytestingtrustwinrate
TrailingexitsTransitionexampleidentification
TrendindicatorsTrendingmarkettradingsystemexploitation
Trendingphase,increase
Trendykangaroocandlestick,appearancecharacteristicsconsolidationrangedailychartappearancemanagementone-hour trendy kangaroo,stoplosspriceactionset-uptail,printingtrade,stoploss
tradingset-up,characteristic
traps,avoidanceTurningpointsTwo-candlestick big-shadowformationTwo-candlestickformationdefinition
Two-candlestick reversalformation
Uptrends,marketpauseU.S.Dollar(USD)
currency,purchasedecisionfour-hour wammie trade,triggeringmonthly chart, bullishkangarootailRSIbuysignalRSIsellsignalsupport
declinetrades,MACDbuysignalzone,clarity
U.S.Dollar(USD)dailychart
bearishbigbeltprofittargetsellstop,placement
bearish kangaroo tail,printingbullish big-shadow trade,buystopentrybullishcandlestickbullishkangarootailbullish trendy kangaroo,stoplossplacementdecline
double-bottom formation,creationdowntrendfake-outkangarootail
uptrendlastkiss,markettrendingMACDbuysignalmoolahtradetrendykangaroo
appearancecandlestick,appearance
uptrend,marketpausewammietradeset-upzone
importancepresence
U.S. Dollar (USD) four-hourchartbearishbigbeltbearish big shadow, profittargetbearishkangarootail,failurebigshadow
breakouttradebullish kangaroo tail, profittargetplacementcandlestick, bearishkangarootailconsolidationphaseconsolidationzonedouble-topformation
creationprinting
driftingmarket phase, priceactioncontainment
fake-outkangarootailmarketrecoveryprice,choppinesstouchestransitiontrendingphase,increasewammie,printingzone,clarity
U.S. Dollar (USD) one-hourchartbearishkangarootail
buysignalkangarootail,printingnakedbuysignal,stochasticbuysignal(contrast)trendykangarootail,marketdeclinezoneassumption
U.S. Dollar (USD) weeklychartbearishbigshadowbullish belt, stop lossposition
bullishbigbeltkangarootail,printinglast-kisstrade
Videojournal,setup
Wammiesadvicecharacteristicsentrystrategyformation, double bottom(relationship)identification
printingtradingprocess
Wammietradecharacteristicsprofitset-upstoplosstriggeringzone,touching
Winning,reasonsWorldcurrencies,listWorst-caseplanning
Zones. See Minor zones;Resistance zones; Supportzonesagecharacteristicsclaritydiscoveryadvicediscoveryprocess
linechart,usageshortcut
exitpatience
identificationdifficultylinechart,usage
importancemarket
approachscars,comparison
misconceptionsobviousness,absenceprice
impactrespect,absence
scattering
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