STOP LOSS

Let’s examine stop losses. First, there is really no such order as a “stop loss.” We’ve called it that because stop orders are most commonly used in this protective manner, but they are still simply “stop” orders. There are three types of stop losses we will want to use at different stages of a trade. They are all going to be stop orders, but the thinking behind each stop (stop loss) order placement will be different. The initial stop we place when entering a trade is known most often as the protective stop loss. This stop loss represents the potential for loss. It’s a risk-based stop, and it’s placed where the trade would no longer be valid. The risk-based stop is the opposite of the entry. If an entry is the reason to get in, then the point of validity/risk-based stop is the reason to get out.

The risk-based stop is the one we all hope we will have the discipline to place and not have to use. Transitioning from a risk-based stop to a breakeven stop is done only when the trade moves in our favor and to the first stop loss. It should become clear right about now that using support and resistance to place stop loss and profit targets is important because a market moves from level to level seeking support and resistance. The way you place your profit target, the thinking behind their location, is what will set your risk management in motion. This is lost on far too many traders. This is how far too many traders let a winner turn into a loser. How do we define a winner? It’s a trade that has reached the first of hopefully two to four more profit targets. How do you manage two to four profit targets? That is done with multiple lots.

Once prices reach the first profit target, the trade is officially a “winner” and should be protected from a reversal that could happen when prices reach the support or resistance that was the profit target. This is a possible scenario when prices reach any kind of support or resistance, and since just about any order you place will be because of the support or resistance it has, then there is the possibility of either a continuation through this level or a reversal.

The psychological trade many traders fall into here is trailing their stop too aggressively. This is usually because they have experienced so many losers during the early part of their trading and learning curve that the slightest profit triggers a fear reaction: I have to take this profit now! Many times the traps that most of us have to navigate through can be avoided with order entry that lets us observe the market rather than being involved with it too hands on once the trade goes live. There is too much temptation, fear, and greed, and the only way we can avoid and manage these emotions is with order entry.

First of all, the only way a trade should and can be extended past the first profit target is to have multiple lots. One lot equals one profit target. A breakeven stop allows for enough wiggles (the typical amount of volatility) that a position must be given in order to compensate for corrections along the way to the next profit target. Trailing stops are most often and incorrectly done by using some sort of fixed pip or percentage. I’ve already explained why stop losses should not be placed with this type of thinking, and the same thing applies to every kind of stop. Trailing a stop is done as a trade moves in the direction we expected it to and reaches profit targets, which then in turn trigger the transition from risk-based to breakeven to finally trailing stop.

A breakeven stop, as the name implies, is where the trade would be stopped out and yield no loss or gain. It’s placed either just below the entry price if the entry is a buy or just above the entry price in a short. The breakeven should be just beyond the entry as to be able to get maximum use out of the support or resistance that triggered the entry. As a trade progresses, if it progresses, the trailing stop is next.

Trailing stops are what we all love because they mean that no matter what, the exit is still a profitable one. But they should not be placed with fixed levels that trail current prices. The same levels that were once profit targets are now going to be valuable levels of support and resistance that the trailing stops will be placed at. Here’s how it works. On the chart there are multiple levels that the trade could travel to as it moves in the profitable direction and these levels are resistance in a buy and support in a short. Remember that what was once support becomes resistance and vice versa, so that now we are looking at a set of levels that can support prices in an uptrend and be a ceiling in a downtrend. This is exactly what we need for trailing stops.

The stop order itself should not be placed at the profit target level exactly but just beyond. So that means that in a buy, the resistance levels that were once profit targets are now support and trailing stop levels. Place the stop order just below the support level. In a short it’s the support of profit targets that have become resistance so the stop order will be placed just above that level. How much above? Three to five pips to account for the spread will do.

ORDER ENTRY

I think there is too much and not enough discussion of order entry. I can and have talked about the mechanics of entering a buy or sell order with limits, stops, or at the market. Mechanics and definitions don’t do the art of order entry enough justice because they make it seem flat and lifeless. In reality order entry is dynamic.

I have seen over the years that most traders use market orders. This is the “get me in” or “get me out” now order. A market order in the wrong hands and if overused is not unlike the lever on the slot machine in Las Vegas. It’s the impulse buy while checking out at the grocery store. The psychology behind the most common use of market orders is little planning and even less trade and risk management. Now I am not saying that all market orders are somehow misguided, but it’s usually only very skilled and disciplined traders that should use this order type with any frequency.

If a trade is planned ahead of time, before price triggers an entry, then it should be logical that if the trade is preconfirmed a few orders can be “parked” in the market. When I say “parked,” I am referring to pending orders such as limits and stops. These orders can be placed well ahead of time and handle the trade entry, risk-based stop loss, and initial profit target.

I don’t think at this point we need another discussion of what stop, limit, and market orders are. I think the main issue is why and how we place these orders. In fact, it’s really more about the job each one of these orders has. We only have three order types, but which we use has more to do with how we want to communicate our wishes to the market.

INDICATORS

How about indicators? I remember a trader long ago trying to explain his stochastic entry methodology to me. First it was based primarily on the indicator itself and not price (first warning!), and it was reliant upon my learning to recognize this squiggle of a move on the indicators lines (second warning!). Okay, I thought, he’s well intentioned, and this shouldn’t take too long. He showed me a few examples, told me it was really easy (third warning!), and off I went to try and put this to work.

I thought I had found a few good instances where the stochastic squiggled in the right way. So I clicked off a few demo trades. It didn’t work, which is to say the trade was a loser. But I know that a losing trade is not indicative of a methodology not working. Nothing wins all of the time. So I did it again, and again, and again. It still couldn’t seem to generate the entries as he had described, so consequently I would wander back over to his station only to see that he was up! All the “wrong” triggers I took were none of the ones that he took.

“What gives?” I asked. “I did it just like you told me to with this little squiggle here.”
“Oh well, you see your trigger didn’t squiggle like this . . . ,” and he proceeded to show me his squiggle triggers.
“They look the same to me,” I replied.
“No, no, no, yours crossed like this but mine crossed like this.”

This is subjectivity. I’m not saying his stochastic squiggle trigger did not work (but I will add that after the stock market boom of the late 1990s and early 2000s ended, so did his run as a daytrader), but I could not replicate it. I couldn’t see it the way he did. Darn subjectivity.

What good would it be if I showed you a bunch of strategies, and you couldn’t recognize them for yourself, by yourself? I’d be wasting both our time. Since I am both a trader and a teacher, objective tools are a must because that’s the only way I can be sure that there is a high likelihood that you will see what I am seeing! The reason so many traders lose more than they win is that most tools set them up for failure due to the fact that there are too many nuances in interpretation and the market just does not set-up the exact same way time after time.

TRADE WITH PRICE

If it isn’t already obvious, I want you to rely on price and price action to make your trading decisions. This isn’t because I don’t respect fundamentals or data—in fact I do—but they are not reliable when it comes to market timing (your entry) and market direction. This is due primarily to the way news filters through the market and is discounted. Discounting is the process by which news and data is factored into the market, often well ahead of the actual information or data that is released or confirmed. The markets are always forward looking. This means that what traders think may happen is what moves the market.

One simple way of seeing this at work is looking at data releases and the way market participants factor in the forecast or consensus of a report and the way they react to the actual data. So it’s not enough to simply see that a news event has beat or missed expectations (the consensus). You must also factor in to what degree the number beat or missed its mark and also know beforehand how much the consensus was discounted into the

market. The very act of trading news requires that you understand price action. You will notice with frequency that “good data” can make a market sell-off and “bad data” can make a market rally. Again, the data is not compared month to month, or whether the number was positive or negative, but rather it’s compared to what traders expected the number would be. So is trading news and fundamentals a level playing field? Heck, I forget if it is level or not . . . it’s hard enough to even find the field itself! Another factor that makes fundamental analysis unrealistic for not just Forex in Five trading but for most traders is that it is time consuming to gather and analyze the data, all the while knowing that you may not even have the complete picture, or all the data, or even the correct data. Then you must take the last step and determine how much of what data is already factored into price. And I’m not overcomplicating this. This is the process. Instead do what I do, focus on two numbers, the consensus, which is what is most widely baked into the cake (discounted), and the actual, which you’ll find out when everyone else does. This brings up another issue with trading news, the order entry. I will go into detail about order entry in the next chapter, but I want to mention here a few salient facts.

Let’s be realistic. I am not some hotshot trader at a bank or a pit trader with instant access to the market. I am a home office–based, private trader. I can’t trade as anything but that. Nor should I try. I am not privy to all the latest market intelligence, and I can’t delude myself into thinking that I know something that the market doesn’t. Order entry during economic news releases is insane at best and stupid at worst. Order entry platforms have a terribly inconvenient tendency to freeze during these volatile times. Spreads widen, the market jumps. I don’t want to be in the mix during these times but I can still take advantage of trading the moves that are generated during releases. You see the follow-through may come from the release itself, but more often than not, you will have an opportunity to setup and enter a market in advance of the release—if you watch price action, that is. It’s not that common really for prices to make sharp reversals from economic releases. More often the data simply hits the accelerator in the current direction. Weak gets weaker, strong gets stronger.

Are there advantages to being a small trader? Sure. I am nimble, and the market won’t see my trade size coming. Frankly, it doesn’t care. I can watch the big boys make the moves, and I can react to them knowing that the moves they make are large. I can move under the radar, in and out, and do it all over again. Why have I relied on trading price? It’s the only level playing field, and there’s just too much news and fundamentals out there to paint a complete picture and act on it with confidence. I’m never going to know everything, although I try to convince my husband that I do.

MARKET MEMORY

This is a simple concept and one rooted firmly in trader psychology. It is also vitally important that you use this concept when setting up your trades, finding support and resistance, significant highs and lows, and last but definitely not least, getting a correct and consistent reading of the Wave clock angle on each time frame. Let’s discuss the importance of how you determine what you look at on your chart. Now this is the first time we’re actually discussing charting. Before now it’s been mainly trends and relationships, but here we are going to start getting very detailed about chart set-up because, after all, this is how you are going to interpret price action and understand the market’s movement.

One of the reasons you and I have spent so much time discussing concepts is because without this foundation there will come a time that you may abandon these methods because you quite simply don’t understand why you were doing it this way in the first place. I think the only way I can prepare you for the rigors of the market is to teach you the why and the how. All instruction without concept is simply going through the motions. I need you to understand why you are doing your analysis in a particular way so that when things get tough you can stand firm knowing that there is a reason for the approach, and moreover you will have more confidence. Most traders simply adopt a methodology because they learned it somewhere and likely from a source they had some trust in. But it’s not enough for you to have trust in what I am teaching or that I know what I am doing. If you cannot do this on your own, what’s the point? You need to have trust in the instruction as much as the instructor.

Market memory is related in many ways to my not using multiple time frame confirmation. Most traders rely upon looking at many time frames so that they can identify key support and resistance levels. If I were to ask you right now to look at a chart, any time frame you wish, how would you determine how much data you would include in the chart? For most traders, this is completely random or determined by what is comfortable to look at, which again is completely random. The problem with this is that without an understanding of how much price action to view on a specific time frame, you are likely to miss relevant levels and move and totally misread the market’s current cycle.

So you might ask, What’s the problem with looking at multiple time frames? Well, first of all you should know by now that each time frame could and probably is moving at a different market cycle. Second, what is support on the 30 minute chart may not even register as support on a 180 or 240 minute chart. Third, and this is the main reason, it opens up a Pandora’s Box of allowing you to begin looking for reasons to stay in a losing trade. If a 30 minute chart moves against you, it’s just too easy to jump to the 60 or the 240 or even the daily time frame to justify your position. I’ve seen it far too often. If you set-up a chart on the 60 minute time frame, you manage it from the 60 minute time frame. The only way you can do that is to make sure you are looking at and making your analysis from a complete market memory.

Each time frame has a specific market memory. The reason is that short-term time literally have short term memories, while longer time frames, like the 240 minute or the daily (also known as the end-of-day chart), require more data to make a decision because monthly and yearly high and lows matter. This is partly due to the number of candles you get per day on different time frames. We already discussed the brick-by-brick approach to time frames so you already understand the number of candles we get per day. To make a decision on a longer-term time frame, I am simply going to need more calendar days to generate a sufficient number of candles on the chart in order to see significant highs, lows, rallies, sell-offs, support, and resistance. But what is sufficient?

I began asking myself the same question years ago and started seeing some obvious clues in the way specific time frames respected certain price levels, depending upon how long ago the level was established. I was mainly interested in how far back I could go and whether or not traders reacted to older highs or lows. I began to see that each time frame had a general “memory,” which is basically a limit to how far back support and resistance would be respected. The easiest to figure out was the daily.

Traders are very aware of 52-week highs and lows, and this not only allowed me to determine that the market memory for a daily chart was one year, it also made it very clear that these 52-week highs and lows were psychological levels. So for a daily chart, you need one year of price action on your chart. It is also in this view, the complete market memory, that you will take your clock angle reading of the Wave.

Reading the Wave can be subjective if you do not look at the clock angle within a specific amount of data. The X axis (horizontal) and the Y axis (vertical) are affected by your charting platform. Most charting platforms will try to automatically squeeze in the closest recent high and low from the current price. This “auto scaling” means that you will not have complete control of how much data is on your chart, but we’re not looking for nor do we need that much accuracy. In fact, market memory is really designed to be more of a guideline to keep a trader from putting “too much” or “too little” price action on a chart.

If you were to expand the horizontal or X axis of your chart you would also be flattening out the angle of the Wave. Squeeze in too much on the X axis and you could and will most likely artificially steepen the Wave. So, yes, market memory as applied to the clock angle of the Wave is very important.

For the 30 and 60 minute charts, the market memory is two weeks. This two-week view will represent the significant highs and lows as they pertain to the 30 and 60 minute chart. By the way, even though we haven’t yet discussed it, there are other very easily identified levels called “psychological levels” that are observed beyond that of what is included in the market memory, and we’ll talk about those shortly. And I know I mentioned this already, but if you cannot fit two weeks exactly into your chart view, you can simply err on the side of slightly more rather than slightly less.

Since I trade the 30 minute, 60, 180, 240, and daily charts, those are the market memory settings I will get into detail here. But you can apply this psychology to any time frame so I will also include a few other settings on some popular requests that I get. The 180 and 240 minute charts should include a look back of no less than one month. With these two time frames I have no problem with going out as far as 8 to 10 weeks although one month/four weeks will be absolutely fine and effective. Personally, due to the way my charts typically compress on my charting platform, I am usually looking at four to six weeks.

The most popular requests I get for alternate time frames are the 5 and 10 minute, 120 minute, and weekly. For the 5 and 10 minute time frames, work with a 3 to 5-day market memory. For the 120, use the same settings as the 180 and 240 minute charts. Finally, for the weekly, which actually I do refer to for big picture trades and significant longer-term highs and lows, it’s a five-year market memory.

So let’s review because I’ve thrown a lot at you here. The main reasons for using market memory is to make sure you are looking at the most relevant price action and reading the Wave for the most accurate clock angle reading. When it comes to Forex in Five trading, the chart set-up, making sure you are looking at price action in its proper perspective, will add up to quicker and more importantly, more accurate analysis.

A WISH

If there is only one thing you get (I do sincerely hope you get more than that) out of this book, it’s the concept of market cycles. It’s my wish that when you think of me, you think, “Yeah, that’s The Wave girl and her market cycles.” I hope you get so sick of me talking about them that you are bludgeoned into using them! I hope that you see that unless you know what cycle your strategy was designed for, your success will be hit or miss.

I hope that you take the time to understand what cycles your strategies are designed to take advantage of and also your indicators. There is not a more important concept than this, and the great part is that it will work and improve anyone’s trading because it applies to every type of entry there is. Most of the time when I see traders struggling, it’s because they don’t know when to apply a particular strategy. They continually feel like they are buying when they should be selling and selling when they should be buying! And that’s because oftentimes they are!

Market cycles let you know the difference between a correction and a reversal. They let you know whether a support or resistance level should be bought or sold. They let you know when the market is range bounce waiting for a breakout and when you should trend follow. I am standing on the shoulders of giants whose words seem to have been lost or forgotten by too many traders. I hope that you will see that the single best thing you can do right now, at this exact moment, is understand that without first identifying the cycle of the market, you are at best simply guessing at how you should trade the market.

EUR/USD.USD/JPY.

EUR/USD. The euro is the base currency here, and the U.S. dollar is the second currency. When looking at quotes of the EUR/USD, also called the “fiber,” you are seeing how many U.S. dollars you will need for each euro or conversely how many euro you will get per U.S. dollar. So if the quote is 1.2600 that means you need 1.26USD for each euro. An uptrend in this market reflects a strengthening euro and/or a weakening U.S. dollar. A downtrend reflects a strengthening U.S. dollar and/or weakening euro.

USD/JPY. The U.S. dollar is the base currency in this pair and the Japanese yen is the second currency. This pair is most often called the “dollar-yen.” When this pair is trending up, it is reflective of a stronger U.S. dollar and/or a weakening Japanese yen as higher prices reflect that the U.S. dollar gets you more yen. Lower prices indicate that the yen is stronger against the U.S. dollar or that the dollar is weaker against the yen.

Realize that one side of the pair can be enough to move prices higher or lower. The Japanese yen does not necessarily need to strengthen for the U.S. dollar to be weak against it . . . a simple move lower on the U.S. dollar would be enough. This is why data from each country involved in the pair is important and impactful. Additionally, because all the pairs have one thing in common—the U.S. dollar—the U.S. market and data coming from the United States is going to affect market psychology for these pairs.

GBP/USD. The British pound/U.S. dollar is called the “cable.” Traders seem to have a habit of giving everything a nickname. By now hopefully you are starting to see that the first currency in the pair is the base currency and when paired with the U.S. dollar, higher prices indicate base currency strength and/or U.S. dollar weakness.

USD/CHF. The U.S. dollar/Swiss franc is another pair where the U.S. dollar is the first or base currency. When the U.S. dollar is the base, then higher prices equate the U.S. dollar strength and/or second currency weakness, in this case the Swiss franc. When the “swissy” is trending higher, that means that each U.S. dollar is worth more and more Swiss francs. A lower trending swissy indicates Swiss franc strength and/or U.S. dollar weakness.

So as we round out the final two pairs, both of which are comm dolls, we can see that the USD/CAD (also known as the “Canada”) has the U.S. dollar as the base currency, and the AUD/USD has the U.S. dollar as the second currency. Since these currencies have a relationship with both the U.S. dollar and also a commodity, I refer to these as “split personality” pairs. There will be a triangular relationship. For example, the AUD/USD (Australian dollar/U.S. dollar) has of course a relationship to the U.S. dollar, but it also has a relationship to precious metals, namely gold.

We can add a seventh pair to this list with the NZD/USD (New Zealand dollar/U.S. dollar) pair as it moves very similarly to the “aussie” and has a comm doll relationship to the same commodities as the aussie. Additionally you will see a relationship to the Continuous Commodity Index. Frankly, it is almost impossible to look at the forex market without considering secondary cues and confirmation from the commodity futures market. I certainly use these to my advantage, and I will teach you to do the same a little bit later. I consider myself lucky to have started my trading career in the futures market, and I encourage all forex traders to use this connection, since it is one that when correctly applied will give you more understanding of price action in the most widely traded forex pairs.