Forex Stops, Exhaustion and Big Figures

Sorry I had to miss yesterday's post, but works of charity are always important. At any rate, the repairs went well, and my friends are all sound and termite damage free once again. Unfortunately, I can't say as much for their neighbors...

In this post we are going to talk about setting stops (again), market exhaustion signs and big figures. Some of this may be a repeat, or just a re-statement of things you've read elswhere, but they are all pretty salient points when it comes to managing risk while letting your trade "breathe".

After all, that's the real trick to setting good stops right? You don't want to get knocked out of an extended move too early, but you don't want to give up too much profit, if your move is finally over. What is a trader to do? Ahhh...decisions, decisions...

Hopefully this post will help you along in that regard.

Let's begin with yesterday's break even Canada trade. We entered about midway through the Tokyo session which is typified by slow action and lower volatility. Oftentimes, currencies will just drift in a certain direction. As the Candollar was making a triple high at the same figure around 1.0440, and since that resistance had seen price failures on 2 previous occasions, it looked as though a break lower may be tipping the market's hand---that it had run out of steam once again.

So we entered around 1.0420 or so. We set our stop at 1.0465, which was well above the triple high resistance area. We could have set it closer, perhaps down around 1.0455, and saved ourselves 10 pips. So how did I chose our stop? In this case, I based it on our previous win in the Candollar earlier in the day. We had successfully scored 45 pips on a small trade, and I didn't want to risk more than that, turning our week negative before we really got started. Plus 45 pips gave us a lot of room for wiggle, to let it breathe. So that was really the basis for that stop. It was above significant market resistance, and it would not turn us negative for the week.

Of course, we were eventually stopped because of the breakdown in the commodity currencies "down under" (Australia and New Zealand). But I knew this was important resistance, and so let me here repeat an important principal, "Old resistance becomes new support". Once an old resistance is broken and prices move to the upside, that old resistance is like a magnet, trying to pull the price back. Almost always it does so successfully. And when the price retreats to that old level, it will frequently stop there and that becomes new support. But remember, it may not stop there "on a dime". Frequently, the price will exceed that support on a sharp break downward, but then rebound right back up to close at or just above the support. When the price does that, we count the support to have held. And if the next candle trades above the previous one, it is a good place to go long. But I'm getting ahead of myself.

After we broke through that triple top, I began looking for the market to retrace to that level. I wasn't disappointed. As the market moved higher, it looked to me as though the price was clear all the way to 1.0500, in other words, there was no serious resistance. I took a position just below 1.0500, because sometimes the market just turns right before it gets to a big figure, sometimes right after. But I only held a draw down for about 25 pips. Then the market began selling off. It seemed the market was getting tired in this push up, so I was happy to keep holding short.

How did I know that exhaustion was setting in? First, let me say, that no one ever really knows. We can't predict the future, but we can look to the past to repeat itself. In the seven 15 minute candles leading up to the break of 1.0500, 4 of them were either bearish candles or very weak, indicating less buying pressure When the last candle pushed up, it closed within 1 pip of its high. A close there or at the high is often a sign of exhaustion. Especially when the next candle cannot exceed the previous high, (which in this case it didn't), and when that secondary candle exceeds the low of the one that pushed high (which it did). So now, all I had to do was sit tight and wait for the weakness to filter through.

So remember, big figures often have a serious effect on prices, but don't try to trade them to the "T". Often, an upmove will blow past a big figure by 20 pips before it reverses down ward. The opposite is true of a downmove, it will exceed the big figure by 20 pips, then reverse upward.

I often visualize prices as a man in a speeding car who turns the wrong way up a one way street. Two blocks away he sees a tractor trailer barreling down on top of him. He slams on his brakes, but he can't stop on a dime...so he slides a few hundred feet. However, getting his car to stop is not the only goal. He has to get it in reverse also. So seeing a big figure ahead of the price action, is like that. The market may actually put the breaks on at the figure, but it still "slides" a bit past it. Then it hurries to get into reverse. Sometimes even that takes a little time.

Hope that helps!

Drop me a line with any comments or questions!

bill@thefxtradingmasters.com

Happy Trading!

Bill