Forex Investment and Currency Trading

It’s one thing to speculate in the market and get the direction wrong. That’s good old-fashioned risk-taking, and it’s just part of the business of trading. But it’s another result entirely to get the direction right and still lose money, or not make as much as you could have, or not keep as much as you’d already made.

Most traders can readily accept the idea of getting the direction wrong. They shrug it off and get back to work in short order. But take a trader with a winning position in the morning that goes south in the afternoon, and you’re suddenly looking at a case study of negative trader emotions. With a wrong-way trade, it’s a simple case of not missing what you never had. Whit a good trade gone bad, it’s hard not to feel regret or think the market is out to get you.

Experience traders know that keeping what you’ve made is often as hard as making it in the first place, so they guard their profits aggressively. The best way to do that is by adjusting your stop loss in the direction of the trade once it’s in the money. You can do this by using either a trailing stop loss or manually changing your original stop loss based on specific price levels being surpassed.

A trailing stop loss is a stop-loss order that automatically trails the market at a user-defined distance (say, 40 pips). For example, if you’re short at 55, and you have a 40-pip trailing stop loss, the stop starts at 95. As the market moves lower, the trailing stop will adjust so that it is always 40 pips from the low. If the market trades down to 10, your trailing stop is now at 50, guaranteeing you at least a 5-pip profit. Trailing stops are great for catching longer-term movements, because they rely on a market reversal of x pips before being triggered.

If you’re more inclined to trade according to technical levels, you may want to consider manually adjusting your stop loss after specific levels are broken. For example, if you’re long, you may raise your stop loss from its original level after technical resistance has been broken.

Above all, if the market reverses and your profit starts to decline, don’t worry about getting back what you’ve just lost – worry about keeping what you’ve still got.

Placing your orders effectively

Currency traders rely on orders to take advantage of price movements when they’re not able to personally monitor the market and also to protect themselves from adverse price movements. If you’re going to be trading currencies, odds are that you’ll be relying on order as part of your overall trading tactics.

The two main types of orders are limit orders, used to buy or sell at rates more favorable than current market prices, and stop-loss orders, which are used to buy or sell at worse rates than prevailing levels. The key difference between the two types is that you generally want your limit orders to get filled, but you don’t want your stop-loss orders to be triggered. That’s because limit orders are used to take profit and enter positions (which you want), and stop-loss orders are used mainly to exit losing positions (which nobody likes). (The exception is stop-loss orders, in which you use a stop-loss order to enter a position – on breakout, for example).

The risk with using orders is that you miss having your take-profit limit or entry orders filled or that your stop-loss orders are triggered at extreme price points. The catch here is that markets have a penchant for going after stop-loss orders and shying away from limit orders in the routine noise of daily fluctuations.

That makes where you place your orders critical factor in your overall trading strategy. Deciding where to place orders is definitely more art than science, and even the most experienced currency traders continually grapple with the question of where to place their orders.

Factoring in the dealing spread with orders

Online currency traders face two other complicating factors: the dealing spread of the currency pairs and the order execution policies of online currency trading platforms.

Most online platforms operate on the basis that a limit order to sell is filled when the bid price reaches the order rate and a limit order to buy is filled when the offer price reaches the order rate. In the case of stop losses, a stop-loss order to sell is triggered if the bid price reaches the order rate, and a stop order to buy is executed if the offer price reaches the order rate. In both cases, the dealing spread works against the order, and traders need to take that into account.

For example, you may be long USD/CHF at 1.2250 with a take-profit order to sell at 1.2330 and a stop-loss order to sell at 1.2200. For your take profit to be executed, the dealing price must print 1.2330/35. If the highest price quoted is 1.2329/34, no cigar. Your stop loss would be triggered if the dealing price ever trades at 1.2200/05; if the lowest quoted price is 1.2201/06, your order is still alive. As you can see, it’s frequently a game of inches played out in milliseconds.

Factoring in technical levels when placing orders

Many traders focus on technical levels to decide where to place their orders, which can make for challenging decision-making. Continuing the order example from the last section, if there is resistance from a trend line or hourly highs at the 1.2330 level, many other sell orders could be grouped there. If the selling interest is strong enough, the market may never get that high, because sellers step in front of the resistance level, start selling, and stop prices from rising.

In the case of the stop-loss level, it may be placed on Fibonacci retracement support or recent daily lows, which may also attract other technically minded traders to place their stops at the same level. If the market start to move lower, sellers will frequently try to test key technical-support levels to see if they hold, in the process triggering stop-loss orders left at those levels. The stops may be triggered and the level exceeded briefly, only to see prices rebound and the support ultimately hold.

Getting stopped out at a market top or bottom is a very frustrating experience, but it’s happened to everyone at one point or another. Remember: Someone has to sell at the low and buy at the high.

Placing stop-loss orders based on technical or financial levels

There are generally two schools of thought when it comes to the basis for deciding where to place stop-loss orders:

• Technical stops: Placing a stop-loss order according to price levels identified through technical analysis. Whatever technical approach you choose to follow, you’ll be looking to identify key technical points that, if exceeded, will invalidate the trade setup and signal that it’s time to get out of the trade.
• Financial stops: Based on the amount of money you’re prepared to risk on a given trade. You may base the trade on a fundamental view of future developments, but you’re willing or able to risk only a certain amount of money on the trade.

Our own preference is to base orders on technical levels rather than financial considerations, but the ultimate limiting factor is the amount of money at risk. That may sound like we’re trying to have it both ways.

Financial stops may be appealing to highly conservative traders who don’t want to risk more than a fixed amount on any single trade. If that’s your way of maintaining trading discipline, by all means go with it. But we think it’s important to point out that financial stops are essentially arbitrary and have no relation to the market. They’re much more a function of position size and entry price – elements you control – than any objective measurement of market prices.

Technical stops, on the other hand, are based on analysis of past price action, which is about the only concrete way traders have of gauging future price movements. If GBP/USD has repeated failed to trade above 1.5515 in the past, to pick a random price as an example, a move above that level suggests that something has changed. And the market, in its infinite wisdom, has decided that GBP/USD should move higher. We have no way of knowing for sure whether the break will be sustained; we can only go with our best analysis.