Wayne McDonell shows you how to get into and out of a trade
Speed of the Market
How to use medium-term moving averages to measure the rate at which the market is moving and thereby the energy behind its moves.
Momentum of Price
How to use short-term moving averages to measure price momentum—ideally to trade when price and the market are aligned.
Announcements
How to use the calendar to ensure news or other new information being released will not change speed or momentum.
Range
How to trap price using support and resistance of recent price action.
Trend
How to interpret a currency pair’s fair market value compared with current price.
That is a lot of information. Some of it may seem obvious, but there are many subtleties that are not always apparent until you start trading. I encourage you to read or even re-read that article. There is no magic system, secret formula, crystal ball or green/red arrows to help you trade. However, you will learn how to read the market.
‘Smart planning’ will help you understand how the market is behaving so you can adjust your trading to suit current conditions and plan your trades in advance. No guessing. No reacting. Just gathering intelligence and formulating a strategy.
Part I, ‘FOREX Entries’ focused on developing a strategy. This article, ‘FOREX Exits’, will focus on the tactics of implementing that strategy.
At this point, let us assume you have analysed the speed of the market, the momentum of price and aligned both with trend. Are you ready to pull the trigger? No, not yet. Almost. We now have to set up the trade PLAN: Pivots, Limits, Alarms, or Nothing.
Pivot points
Pivot points are a form of support and resistance (S&R). S&R lines can measure price and market in the same way as moving averages do.
In Part 1 we discussed how to trap price in a range by using S&R lines. These lines are very useful, but like most technical analysis they lag behind price action. Pivot points are another form of S&R, but they are a leading indicator.
Pivot points can tell you the possible top or bottom of the trading day many hours in advance. They do not offer support and resistance of price, but of the market. Once again, there is a difference between price action and market activity.
Pit traders, who had to make trading decisions amidst the chaos of trading on an exchange floor, created pivots. They would sit down before the market opened, look at what happened during the last trading day and do some basic calculations. They would look at the high, low and close of yesterday’s trading to predict today’s top or bottom.
These levels became reversal areas, or pivotal zones to keep an eye on. You certainly didn’t want to buy near the top or sell near the bottom. Therefore, traders would write these prices on the back of their order cards. Just before the traders placed their orders, they would check the back of their card to see if now was a logical time to get in or out—not because of emotion, but from doing calculations before the heat of battle.
PP = (High + Low + Close)/3
S1 = (2 x PP) – High
S2 = PP – Range
S3 = S2 – Range
R1 = (2 x PP) – Low
R2 = PP + Range
R3 = R2 + Range
Many professional forex traders are from the commodities, indexes and equities trading world. They were already familiar with trading with pivot points and they brought pivot analysis with them. As a retail forex trader, you may find pivot points extremely useful simply because so many of the big traders, such as bankers and hedge fund managers, use them. Remember, they control the market. Try to do what they do. Let them lead.
Figure 1: Pivot points
The basic pivot points we use (figure 1) are Resistance 1 & 2 and Support 1 & 2. The S and R pivots are separated by the Central Pivot Point. For more accurate entries and exits, we insert Median Pivots between the S, R and Central Pivots.
R2 > M4 > R1 > M3 > CP > M2 > S1 > M1 > S2
Keep it simple. R means resistance and R pivots may hold price down. S means support and S pivots may hold price up. The key ‘Pivot Profit Zones’ are R2 to M4 on up-trending days and S2 to M1 on down-trending days. These zones are areas in which to consider taking profit as well as to stay alert to the possibility of price reversals.
Limits
Every trade needs two limits, one for profit and one for loss. Limits should have nothing to do with greed or fear. Novice traders fear losing money. Professional traders fear losing profits. Either way, fear can be detrimental to our trading. Experienced or not, you will always be working on controlling your emotions. Setting limits with a clear-cut trading plan will help you manage your emotions, just as you control any other risk.
Defensive exits
You never want to hit this limit, but it does happen from time to time. I like to think of it as my ‘fall back position’ when things go wrong. When I am spot trading, my stop loss is always set for 50 pips away. However, as I will show you, I never intend to have my limit triggered.
My stop loss limit exits are an insurance policy. They protect me from catastrophic events, such as an earthquake that knocks out all power and telecommunication lines. If that happens, and I know I cannot contact my broker to manage my open positions, the worst thing that can possibly happen is that I take a 50 pip loss. If you manage your money properly, that should be no big deal at all.
Offensive exits
These can be for profit or for loss. It really doesn’t matter to me. It is simply when I exit my trade. I have no control over the outcome of the trade. But I can control when I come out of the trade. This can happen when moving averages cross or when pivots are hit.
Moving averages exits
I can plan to exit a trade when momentum has changed direction, or, if not, certainly when the market has changed direction. These changes are extremely easy to see. They occur when the short-term or medium-term moving averages cross. They are a signal that the market is not what it used to be and I need to plan on trading in the other direction, or to stay out of trading for a while as the market adjusts.
Figure 2: Euro/US dollar spot
Pivot point exits
Forex is all about the law of averages. If you trade forex long enough, you know that your success never comes down to one trade. You are interested only in trading repeatable patterns than you can anticipate. Sometimes they produce more pips than you expected. Sometimes not. You just split the difference and call it a day.
Pivot points are probably the best example of this. Often you exit your trade in the Pivot Profit Zone and price reverses. Other times it just keeps on going and you have some pips left on the table. A professional trader doesn’t care about that. They take the most pips with the least amount of risk.
Does a Las Vegas casino care if you win a big hand in Black Jack? Not if you keep playing. To the casino, and to a professional trader, success is in the long-term numbers. Profits come from within the law of averages. Any one trade is just not very important, as long as you are doing what you are supposed to be doing—conservatively trading repeatable trades.
Alarms
Paint a mental picture of your trade before you ever trade it. At FX Bootcamp we often wait twenty to sixty minutes for a trade to set up. I do the analysis ahead of time and we discuss it as a group, as it may or may not come to fruition. We rarely have to respond to what the market is doing, because we are not reacting to price action, but planning our trades in advance.
You should be able to visualise your trades. Will price be rejected at resistance? Why is this resistance expected to resist? Is it a reversal pivot point? If so, what would happen next? What would Stochastics do? What would MACD do? Or momentum, or speed?
What will your charts look like when all this comes together? What will make you pull the trigger? If it is a momentum change seen at the cross of the short-term moving averages, then that is your alarm. When you see it, you will recognise it, because you have already visualised it. Pull the trigger! Set your stop loss limit, just in case the worst happens. Then stay in your trade until something changes, like speed or momentum.
Nothing
If you go through all of this planning and you end not trading, have you lost? No, you’ve won! You just avoided a losing trade. If you recognised your trade setup because you took the time to gather intelligence first and then formulate a strategy, then your tactics are quite simple. When price action falls into your little trap, such as the momentum cross after the rejection at resistance, then you execute your plan. You’ll exit your trade for profit or for loss. Either way it was a well-constructed plan.
If price does not fall into your trap and it does break resistance… do nothing. Don’t trade. You clearly have missed something in your analysis. Walk away. Live to trade another day. Just redo your analysis, gather intelligence and formulate a new strategy. Then wait for your new trade plan to give you another opportunity to profit.
Remember, you are not a forex trader. You are a forex profiteer. Focus less on making trades. Focus more on understanding the market’s behaviour so you can find opportunities to profit from its predictability. This means planning your trades in advance, not reacting to price. Stay in control of your trading. Don’t let price action control it.
This article was originally published in the Mar/Apr 08 issue of YourTradingEdge magazine (www.YTEmagazine.com). All rights reserved. © Copyright 2009, MarketSource International Pty Ltd.
Posted: March 11th, 2010
at 10:37pm by admin
Tagged with Momentum, momentum range, pivot points, Range, support, wayne mcdonell
Categories: trading articles
Comments: 4 comments
4 Responses to 'Wayne McDonell shows you how to get into and out of a trade'
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Great Blog! Very informative, I appreciate all the information that you just shared with me very much and I also bookmarked this on dig too. Take care and I’ll be back to read more in the future.
27 Jul 10 at 7:14 am
There have been quite a few earthquakes in Cali as of recent. What I don’t really understand is how they are saying that this is typical behavior for Cali and earthquakes. We should be honest with ourselves, when have we felt this many eartquakes in a row? Ya maybe, but they sure as heck haven’t been as big and as regular as the ones we have experienced now. I’m wondering if 2012 isn’t exactly a myth? What do you guys think?
29 Jul 10 at 7:26 pm
I usually don’t normally post on many another Blogs, still I just has to say thank you… keep up the amazing work. Ok unfortunately its time to get to school.
14 Aug 10 at 4:30 am
I like what you all have to say. Very straight to the point. All in all great blog
14 Aug 10 at 8:47 am