Early bird does not get the worm in forex trading

[This post was updated on January 13, see addendum below.]

I have discussed my enthusiasm in shorting the Aussie a few times this week. First trade was shorting AUD/JPY at 84.53. After that got stopped out, I re-tried at the same level the next day. My trade history in this currency pair is shown in Figure 1 below. Evidently, I am early in my trades as the recent upward momentum is still going. But that’s just speaking from hindsight advantage. What is actually wrong with this play is that I was too eager at the first entry when the price was just at a minor resistance (short-term trendline of Fig 1). In turn, that caused me to lose my confidence and not be as aggressive as I should be when the price reached a major resistance at 85.50.

Referring to Fig. 1, I made 5 attempts on the minor resistance below 84.60 in the first round. What’s worse is that I didn’t have enough patience to wait after these shorts failed and I tried again at 84.52. Even though that resistance level is voided already.

But here comes the kicker. I actually noted the important 85.50 level before my first attempt. It was clearly on the chart and I even mentioned about its significance. I just figured that it wouldn’t be touched. How wrong I was.

As I said, another problem with being early in a trade is that it stripe you of your confidence prematurely in a good setup. My setup to short AUD/JPY is as good as ever now. I am drooling over that negative RSI divergence shown in Fig. 1… But since I’ve already taken a beating in this pair this week, my account drawdown dictates that I limit my risk. As such, I can’t back up the truck to pile in on this trade at this point. But why not?

I won’t break one rule to compensate for another. Although I am light in this trade now, I will not compromise my risk management rules to compensate for my own mistakes. That would just open a whole new can of worm. Besides, I can’t say this often enough — risk management is always the top priority in trading.

In any case, there will always be other opportunities.

The moral of the story is this. Do not be too eager to get into a trade. Secondly, adjust your position size accordingly to the significance of the setup in play.

AUD/JPY, 3-hour

Update January 13:

Figure 2 below shows an updated view of AUD/JPY a week later. The red dot on the 9th was my last stopped out entry. As you can see, I missed the smooth 200 pips ride down. This experience is proving to be better than I expected to illustrate how being early in a trade can really hurt your account.

A week later in AUD/JPY, 3-hour chart

An example of how trading in fear is bad for your account

Having had a hard time day trading the EUR/USD last week, things haven’t been well for me this week either with the market in a gridlock. My one and only viable setup so far is built for a trending market. So this range-bound market is new territory for me as I experiment (in hindsight, haphazardly) to come up with more profitable forex trading setups. As you can imagine, trading without discipline is a recipe for diaster.

I have given back all the paper gain from this month by the start of this week and is treading on thin ice with my demo account dipping dangerously close to the November opening balance. Needless to say, I do not want to see my account in the red for this month.

But that is what happened after today’s string of failed trades. I am officially in the red for this month, for now. While there are several mistakes I made resulting in this mess, I think it all boils down to one flaw in my trading this week. Yes, those day trading stints I did surely have put a dent in my demo account, but what’s worse is that I’ve unconsciously have let those losses affect my trading mentality.

These losses were stuck in my mind and my mental “goal” for this week was recovering from them. However, I have approached the problem in the wrong way by not wanting to lose anymore in my account. In other words, I was afraid of losing.

So how did that materially affect my trading? Here is a simple example as illustrated in my order history on the GBP/JPY chart attached at the bottom of this post. The 3 yellow triangles are my short entries and the 3 red dots marks the stopped exits.

According to my setup, my original entry at 149.50 had a stop at 150.50. But I moved my stop closer to 149.80 in the morning because I didn’t want to risk more. That got taken out easily as 149.80 is within the congestion zone. Then I tried to short it a couple more times with tight stops because I see the downside potential to be still intact. Those were eaten up alive too and now I don’t have a position because it would have been more foolish to keep trying in vain.

While just 3 trades wouldn’t have done much damage, I was doing the same thing across the board in shorting CAD/JPY and EUR/CAD. A few here and a few there. They add up to a bad day.

As of this writing, it looks like these pairs are finally moving in my direction. But instead of being patient with reasonable stops, I thought I could do better and micro-managed my positions to end up taking multiple small losses and with nothing left on the table to ride the move.

So what is the correct way of following up on a dent in the account? I should have done the following instead:

1. Reduce risk exposure by limiting trade size or overall opened positions until I am back up.
2. Focus on what I did wrong last week and stop doing that, i.e. no more day trading.
3. Recall my best trades and do more of that, i.e. my one and only finalized setup, FTC.

Not so coincidentally, now that I’m in the deepest drawdown ever, this is as good as ever to put this emergency recovery procedure into practice.

GBP/JPY, 1-hour

My bad EUR/USD day trading and what to do about it

I’ve stayed home from work this week because of the flu. So with spare time on my hands, I had the urge to experiment with day trading the forex market. Bad decision. After a good 3-4 days of day trading EUR/USD with my demo account, here is what I have to show as illustrated in my account balance graph for the past 4 trading sessions below.

Account balance Nov 10-14, 2009

Yes, you can push back up your dropped jaw now.

I considered not accounting for these losses in my paper trading account because these trades were meant to be experimental only. However, as the whole point of me paper trading the forex is to learn and improve, I decided to keep these losses and suffer the consequences of my own doing. Heck, I wouldn’t have had the choice if this were real money (which is the way that I should treat this demo account anyway).

I stepped out of my circle of strength (swing trading) into something that has burned me many times before. Well guess what, history does repeat itself.

Enough with lambasting myself. The real focus of this post is to point out what I did wrong and what can I do to improve in day trading the forex. Not that I’m intent on day trading though. This is merely to increase my arsenal in forex trading.

Figuring out what I did wrong is actually obvious in hindsight. Figure 2 below depicts the trades I made on Nov 13, which led to most of that steady decline in my account balance as shown in Fig. 1. See the bounce from about 1.4820? I kept shorting it and shorting it all the way up to 1.4880. What was I thinking?

The main reason for this epic failure is that I broke a fundamental rule in trading. Trade what you see and what you thought (Techniques of Tape Reading by V. Graifer). Based on the previous day’s market sell-off from 1.5000 and the Asian markets failing to break 1.4900, I thought the market would follow through on Friday and break through this 1.4820 support. In particular, just before NY open before 9:30am, EUR/USD had a couple of big drops, as shown in Fig. 2. All these circumstances led to my believe that we’ll see a weak day like yesterday.

EUR/USD, 5m

However, a support is still a support until it’s broken. I shouldn’t keep shorting it even though it has obviously bounced.

While identifying the trend is trivial in hindsight, what evidence did I have at the time to tell me that? The evidence was in fact staring me in the face that morning. Figure 3 shows part of the screen that I usually use for intra-day observation. As you can see, S&P500 rejected the previous day’s close with a strong negative TICK reading and then broke above the morning range. The TICK also remained strong with many +800 readings in the morning. All the classic signs that point to a strong positive trend.

intraday sentiment

Furthermore, if only I had stepped back and observed the bigger picture, as shown in Fig. 4 with a 30-minute chart, I would have seen that we have a great positive divergence swing setup (and which I normally would have exploited if I weren’t so focused on trading the 5m that day).

EUR/USD, 30-minute

What is my goal in future day trading? Instead of a declining equity curve as in Figure 1, just flip it up-side-down and that’s what would be perfect. All I needed to change is being able to spot the right trend and ride it. Easier said than done. So what is the moral of this story? I have once again proven that I am still no good at day trading. Stick with swing trades.

An undisciplined trade: Shorted EUR/USD @ 1.499, stopped 1.505 (-62 pips)

I started to doubt this move mere minutes after placing it, which rarely happens. And not because of the price action. It was solely for my reasoning for this trade. On a quick mental review of this entry, I noticed that they sounded more like excuses than reasons. First sign of it was that I laid in a 100% position to fade a strong trend on the daily on the basis of my 3-hour chart. My strategy is to not risk more than 50% (preferably 25% – 33%) to fade a trend on the daily. Lack of discipline #1.

Next, I already had six 50% positions open at the time. That would roughly translate to 3% of my account, without even taking into account the high correlations (working on a spreadsheet for this). By adding this 7th position, I’ve broken my fundamental rule of risk management to not risk more than 3% of the totals funds at any single moment.

Lastly, it was the end of the trading day on Friday. Carrying trades over the weekend is well known be even more risky than usual because so much could happen over the two days. To add a low probability trade on a loaded to the neck account into the weekend is practically suicidal. I’m just glad that I had a hard stop to limit my risk. At least I did something right here.

In terms of the dollar amount lost, the loss for this trade is $44.17 on paper. And after this stupid move, I have given up all my +500 pips gain (also on paper) from the week before. Much work remains to be done to improve my trading performance.

A last note to self from this what-not-to-do lesson. All trades should be taken with logic and reasons. I failed to do that in this trade by convincing myself that USD should reverse over the weekend. On top of it, I took as big of a position as my system allows to gamble on this intuition. These are two breaches of trading rules that could ruin an account. It’s good that I’m stopped out with a loss in this trade because if this became profitable, it could boost my ego and this problem would only get worse.

Another silver lining in this is that I am beginning to trade forex with paper trading instead of diving in with real money first. In addition to testing my forex strategies (which I haven’t followed as diligently as I should), I’m learning much about my weaknesses in trading in general by keeping a detailed journal and statistics of my trades.

Update: EUR/USD cratered to 1.4844 today. Another shortcoming with an undisciplined trade is the opportunity cost. If I weren’t so preoccupied with the stop loss from this morning, I would have followed my setup and shorted EUR/USD today as it went spiraling down.

EUR/USD

EUR/USD, 3-hour