Over-trading is one of the biggest mistakes you can make in financial markets. Having a great idea and acting upon it before the time is right can lead to losses, even if the idea behind the trade is truly fantastic.
Take EURUSD. Ever since the European Central Bank’s January meeting ECB President Trichet has been labelled hawkish. Anyone who watches the interest rate markets would have seen the spread between German (proxy for Eurozone) and US government bond yields start to widen in Europe’s favour. Eventually, this spread equated to EURUSD reaching 1.4000.
This sounds like a good trade since FX markets are sensitive to interest rates, but as of the start of February this level has been elusive. For those traders who put the position on at the January low prior to the ECB meeting when EURUSD traded below 1.3000, they have made a cool 7 figures. However, for those who got in later – between 1.3550 and 1.3700 – it has been a tough range to trade. The pair has oscillated wildly between these two levels, so far failing to break the 1.3750 level that would need to happen for 1.4000 to be a realistic target.
So what can we learn from this? The best lesson is to take your time. Don’t just jump on the back of an idea since ideas don’t move markets – prices do. This advice comes from Jesse Livermore, the famous Massachusetts-born trader who was so good at picking trades at the right price that he was run out of nearly every Bucket Shop in the US during his early trading days. He was famous for calling the 1907 stock market crash, where he sold the market short and made a fortune. He studied markets and would only make a trade when the time was right. He would look for levels and prices, and only when these milestones were reached would he phone his broker. Livermore’s market discipline is the equivalent to financial folklore.
Although Livermore was trading stocks, the same principles can be applied to currencies and other asset classes. The logic is fairly simple. In the example above, if EURUSD has climbed 7 big figures already and seems to be getting stuck at 1.3750 but you still believe it has legs to move higher then you may want to wait until it has closed above 1.3750, say at 1.3760/70 before putting on your position. That way you aren’t tied into a losing trade. If the price doesn’t close above 1.3750 and starts moving down then perhaps your original view that EURUSD would reach 1.4000 wasn’t quite right, and instead the pair may be heading back below 1.3000.
By analysing what the market is doing – this requires looking at a live price chart – you can let the price action make your trading decisions for you. Since it is price that determines whether your trade makes or loses money, surely it makes sense to base your trading position on where the prices are going.
Analysing price is the basis of technical analysis, so where does this approach leave fundamental analysis? In my personal view traders worth their salt use both fundamental and technical analysis when calling their trades. The main ingredients of fundamental analysis: economic data, central bank speakers, geo-political events and even politics all have an impact on financial markets since they drive asset prices. For example, US employment data, which is released the first Friday of every month causes a flurry of excitement in the financial markets and price volatility across asset classes as investors get another piece of the US economic puzzle, which helps them gauge the strength of the world’s largest economy.
To achieve the sort of discipline that led to Jess Livermore’s success there are four steps: firstly, choose your currency pairs. This can be a difficult step for the novice trader, there are more than 28 main currency pairs and that doesn’t include the emerging markets. However, I find the best way is to pick a currency that seems to be dominating market action. For this you need to keep your eyes and ears open. If there are a number of press reports about the US dollar or say government officials in Japan are talking about the level of the yen then you may want to choose these currencies. Likewise, if the US economy looks like it is growing, while the UK looks like it might underperform then the selection is easy: you would want to short sterling versus the US dollar, otherwise known as a short cable trade.
The next step is to analyse your chosen pair– find out what levels look like significant resistance and support. Look at the charts and try to find trading patterns (you might need a technical analysis 101 to do this, but you can find lots of helpful notes and guides on the internet). These may include head and shoulders patterns, Fibonacci levels or Ichimoku cloud patterns to name just a few.
Thirdly, note those levels down and set up alerts or watch the prices until they close above your chosen level. And last but not least, don’t forget to check the economics calendar to see if there is any data or speakers that could propel the asset price to your target level faster than would otherwise be the case. Once you are at this stage you can pounce and hopefully the profits will follow.
Nothing in trading is easy, which is why it appeals to people who like success. If you find the above steps hard to achieve at first then keep reminding yourself that patience is a key quality possessed by all good traders.
Kathleen Brooks can be contacted at Forex.com