and unscrupulous broker/dealers look torun through these areas, then take a position in the opposite direction.
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The FXCodex Entry TechniqueAfter I have a fully selected candidate to trade, I use one of two entry methods.The dagger method is the simplest, but you may not always get the opportunityto use it because it requires the market to meet certain conditions. The breakaway method can be used if the dagger isn’t a possibility.You may use the same methods to exit a trade, assuming you have notbeen stopped out or your price objective reached. See Figures 11.1 and 11.2.Use the mapping possibilities you’ve visualized to help determine entry.
The Initial Stop-LossWhat is true for entry also goes for stops. There are a variety of methods. SeeFigure 11.3.Stops are often a mirror image of entry, although the trader has less flexibility because he already has a commitment to the market. Again, the stop-losscan be based on one these factors:VolatilitySystemRatioSupport/resistance
FIGURE 11.1 The Breakaway Entry Method.Once you are certain you wish to enter a market, look for a small breakawaymovement on the smallest chart scale you are using. Entries and exitsshould always be found on the smallest chart scale for your trader proﬁle.The horizontal line represents where the wave has broken out by exceedingthe measured move for that wave. This method requires speciﬁc pricemeasurements to occur; thus it is called a cardinal technique.
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FIGURE 11.2 The Dagger Entry Method.(1) Wait for the major trend to be deﬁned. (2) Wait for a reaction to themajor trend. (3) Enter on the ﬁrst signiﬁcant price movement back in thedirection of the major trend. Close stops may be placed below thebeginning point of the secondary reaction wave. This method does notrely on speciﬁc price measurements and is an ordinal technique.
System BasedSupport / ResistanceVolatility BasedFixed Ratio
FIGURE 11.3
Stop Loss Techniques.
For a volatility stop simply calculate the average volatility of the market over20 or 30 time units and place the stop slightly more than that distance from thelowest price bar. A system stop is determined by one’s trading system. A ratio stopis determined by your profit objective and trader profile. A day trader might havean objective of 100 pips and place a ratio stop at 25 pips. Support and resistancestops are placed below support or above resistance. I do not recommend them.
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FIGURE 11.4 Stops and Waves.Place a stop at a point where the GSCS wave is not forming according toyour prediction. In this example, you expected wave 3 to carry past thehigh point of wave 1. It has also exceeded the 50 percent return of wave3, giving indications that the primary wave may be wave 2 and not wave1. GSCS stops will also help you avoid the support and resistance areaswhere many traders place their stops.
Ratio and volatility stops are the most manageable for the new trader.The FxCodex method places an initial stop at the point where the GSCS formation we are hoping to ride would be broken. For your first trades, I recommend a fixed value stop as described in Chapter 3.The mapping possibilities can also help you locate an initial stop position. The point at which a wave is no longer behaving as predicted is a naturalstop point. See Figure 11.4.
SummarySomething to keep in mind at this stage in the process is that when a trade isactive, the only process action you can be actively involved with is monitoringthe trade and waiting to see if your judgment proves to have been correct.
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Monitoring a TradeWatch your trades as you would watch your little children.—Charles B. Goodman
t is not difficult to monitor a trade. You’ve already done all the hard work ofmonitoring candidates, selecting and qualifying the candidate, and enteringthe trade.The job of monitoring involves two duties:
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1. Watching for unexpected news events or price action (they often gotogether) that might necessitate bailing out of the trade.2. Moving your stop-loss as the trade works in your favor to first guarantee and then maximize the profit from the trade.Use both your mapping possibilities and eyeballing for early indicationsthat a trade may be going sour. Don’t be afraid to exit a trade if it starts to becomeunpredictable or out of character. However, don’t close out a trade just becauseyou are nervous, if it still meets most of your criteria. It’s a thin line between staying and leaving; only experience will help you develop the appropriate skills. Remember Charlie’s old adage: “I made most of my money sitting on my hands!”
What If the Music Stops?It often seems that as soon as we enter a market, it goes quiet. This happensbecause it is generally only active markets that attract our attention, and evenactive markets can go quiet for a time.
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FIGURE 12.1 Quiet Markets.This GBP/USD was a quiet trade that suddenly exploded. In FOREX, quietmarkets seldom last for long periods of time!Source: FXtrek IntelliChartTM. Copyright 2001–2007 FXtrek.com, Inc.
It is true: You will make most of your money sitting on your hands—eithermonitoring a market, waiting patiently for your profit objective, or passing onmarkets that don’t exactly meet your criteria. If you have to trade something inthe absence of the perfect opportunity, trade quiet markets. See Figure 12.1.Here is where you must sit on your hands and wait for the trade’soutcome—the market’s verdict.
Intersession or Fresh Start?If you are either a guerilla or a scalper, you will never stay over a single session.Certainly, never stay over if you can’t watch the markets full-time. It is better toclose out your active trades and begin anew later.Day traders will occasionally stay over between trading sessions—sometimes two, three, or more. It is impossible to stay awake that long, so stopsin the market are required when you are away. Position traders may stay a weekor longer, but in FOREX that is very, very rare.
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The length of time you stay in the market can cut both ways. On the positive side, prices can move further over time and you can make more moneywith a trade. On the negative side, the longer you are in the market, the higherthe probability is that a disconcerting news event will strike or the overallmakeup of the market will shift dramatically. Volatility, directional movement,and/or thickness will morph. These factors may or may not impact your tradenegatively or positively, but they all spell R-I-S-K.For the new trader, I do not recommend keeping any active position inthe market when you are not online and watching it full-time.
Monitoring CriteriaWatch for unusually swift changes in a market’s makeup. Changes in volatility,directional movement, and/or thickness can indicate that something is afoot inthat market. You don’t necessarily have to bail out (or you may want to do soand just watch the action), but you should be prepared for unexpected price activity and have your stops well placed.
Trailing StopsTrailing stops always sound like a great idea—until you trail the stop just a little too close, get stopped out, and leave a big part of your profitable trade onthe table.Be conservative in how far you trail stops away from the market and howoften you move them. When you look at your trading activity over a year, you’llsee that the outstanding trades are what carried you, and you can’t get those bybeing prematurely stopped out of the market.It sounds like a good idea to use trailing stops to protect your profit as itbuilds. But don’t move your stops too often. Remember that each order youplace in the market is a decision—and each decision has the potential of beinga good one or being a bad one. The markets are a process, and the less you interfere with the process, the better off you will be in the long run. Use trailingstops gingerly, and raise or lower them according to all the criteria you usedfor selecting the initial stop, not just because you’re bored and looking forsomething to do. Before moving a trailing stop up or down, wait for unusuallyhigh volatility and then move your stop just below or above that point. SeeFigure 12.2.Don’t let a decent profit get away. If the market is close to your objectiveand begins to vacillate, or if some of the four eyeballing characteristicschange—bail!
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FIGURE 12.2 Trailing Stops—Good and Bad.A trader long this USD/CAD market would need patience. Stops could beraised after the downward thrusts occur and the market begins to moveback up.
Market environment characteristics—directional movement, volatility,thickness, and rhythm—usually change gradually, but not always. Be aware ofthe ME profile of the market you are trading and watch for ME changes as aclue to consider exiting soon. See Figure 12.3.The greater the time scale unit of a chart, the more slowly market environment characteristics will change. On very long-term charts (daily, weekly)they seem extraordinarily consistent, partially because few traders are watchingthem or trading off them. Even to the guerilla trader, long-term charts offervaluable perspective.
SummaryThe critical issue in monitoring a trade is to keep an objective attitude. You willfeel a sense of ownership with an open position, and that isn’t a particularlywise emotion. Try to stay objective and detached. Other than moving yourstops, there is not a great deal you can do after a trade has been executed. Eitheryou take your profit or your stop-loss gets elected.
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FIGURE 12.3 A Changing Market Environment.In this example of the EUR/JPY, directional movement changed quicklyalthough thickness stayed somewhat constant.
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Exiting a TradeJacks or better open, but they rarely win the hand.—Charles B. Goodman
f you are superstitious, Chapter 13 may not be a happy choice for a chapteron exiting the market!We want to exit from our profit objective, not from a stop-loss. This is athree-step process.
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Steps to Exiting a TradeFirst, set a rational profit objective, then monitor the profit objective to see if itchanges. It should only change slightly, if at all, if you’ve done your work correctly. When your profit objective is met, exit the trade; don’t let greed alteryour decision. Let’s look at the former possibility first.Setting a Proﬁt ObjectiveIf you are using GSCS as your primary tool, set profit objectives according toyour swing measurements. It is better to lower your profit objective than tomake it too high. If the market runs, a trailing stop can be used to capturemore profit than you expected. But never overstay your welcome!Monitoring a Proﬁt ObjectiveThis is the time to sit on your hands. If you did your work, let the trade playout. Exit the trade from your profit objective or stop whenever possible. Watch
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for changes in the market environment and your wave failing to perform asexpected.The market neither knows nor cares if you are in or out, if you get stoppedout or meet your profit objective. Don’t anthropomorphize the market.Meeting a Proﬁt ObjectiveThere is no better feeling than a trade completed with a profit. Don’t secondguess your objective on any specific trade. But if your periodic trade reviewshows your objectives to be too high or too low, make minor—not major—adjustments to your process.But sometimes you get stopped out of a trade. If you’re a guerilla orscalper, it will happen very often, so you need to learn to deal with these eventseffectively and unemotionally.No one enjoys being stopped out, but good traders learn to live with losses.If your stops are hit too regularly, you may be placing them too close. Are they realistic with respect to the volatility of a market? Does the stop point actually represent the failure of a wave? Analyze your losses regularly and objectively. (See Figure13.1.) New traders should use fixed ratio stops initially. Move on to adjusting forvolatility, and later, only after some experience trading, use system stops.During the course of a trade there is often enormous pressure to eithertake profits ahead of an objective or move a stop-loss order. These sort of ad hocdecisions normally turn out badly, and they also violate the concept of trading asa process. Unless new information has entered the market that would have altered your earlier stop-loss or price objective, don’t do it. News events can impact prices dramatically; let your profit objective and stop orders do their workfor you; don’t second-guess either the market or your own trading decisions.Remember, this is only one trade; you intend to be in the market for along time and make many, many trades. It is the after-trade postmortem whereyou should decide if your selection of price objectives or stop-loss was improper. Make your adjustments going forward, not going backward.If you find you often have the temptation to alter price objectives or stopsduring a trade, you may wish to examine both your decision-making processand your emotional attachment to a trade. Watch the market for a short timeafter you exit. Don’t draw conclusions on the basis of a single trade, but after10 or more trades perhaps you can see a pattern such as placing stops too closeor too far away. The trading process is continuous and doesn’t start and stopwith the beginning or end of each specific trade.Keeping TabsKeep a record of all your trade statistics: number of winners and losers per every10 trades, average winning trade dollar value, and average losing trade dollar value.
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FIGURE 13.1 Stopped Out!This EUR/USD had a near perfect 1-2-3 wave and return early. But therapidly changing thickness and directional movement would have madestops difﬁcult to place anytime later.
SummaryTraders tend to release their pent-up emotions when a trade is completed. Ifthey made a profit, elation is natural. If they lost money by being stopped out,discouragement and even depression may well come to the surface.Elation has a tendency to make us want to trade more and make moremoney, because after a winning trade it all seems so easy! Avoid the King Kong“I can do no wrong” syndrome.Conversely, when we are discouraged, we tend to hang back, afraid. Bothemotional responses are very natural, but the winning trader recognizes thesetendencies and consciously works to pull his emotions back into a narrowband.The markets neither like you nor hate you; they are not out to get you, either. Try not to develop the common habit of giving anthropomorphic tendencies to an inanimate process that has no interest in your activities, one way orthe other.
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The Complete FOREXTrader
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14Chapter
Postmortem andRecord KeepingAfter a trade, grieve or celebrate—then move on to the next opportunity.—Charles B. Goodman
Why Keep Tracking Records?You should do a postmortem of every completed trade and keep records andsummaries of your trading activity, for several reasons. Perhaps the most important relates to the codex concept of process. All processes have feedback loops. Ifsomething goes wrong in the process—in this case, a losing trade—it is caughtand analyzed in the feedback loop.The famous ISO 9000 standard is an excellent example of a processwith feedback evaluation. When something goes wrong, a corrective actionticket is written and the process is adjusted accordingly. Your notebook reports should include at least similar diagnostic information. Format is notcritical but having a record of your conclusions is very useful. Over a numberof trades, you will see patterns in your trading and analysis that improve yourperformance.The constant feedback loop also prevents errors from welling up andnecessitating a major overhaul of the process instead of simply an adjustment.
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Feedback LoopIn the codex process each element talks to the other elements. Forexample, your trading tools must match both your trading style andmoney management approach.Trading Tools fi Money Management fi Style
Another good reason to keep consistent records is to be able to take thepulse of your emotional state, thereby obligating yourself to stay with theprocess itself. Record keeping will assist you to not stray from the straight andnarrow path of your codex.
Codex RecordsFollowing are the reports you should be using, along with an explanation ofhow to organize and maintain them.The Trade LogThis is the report you’ll maintain on each trade, beginning with monitoring.Because many trades you begin monitoring won’t become actual trades, someof the logs will be incomplete. But keep them anyway, as a way of reviewingyour thinking and progress as well as your actual trades.Alternatively, you may want to keep the trade log as a function of thesteps in your codex. This method is a little less time consuming, but more difficult to keep track of over a long period of time.Begin to devise a classification method for keeping track of your logs,whichever approach you decide to use. Define some consistent terms and symbols to use.Elements of the Trade Log Keep an accurate record of all your trades. Breakthem into (1) a single ledger, (2) weekly, and (3) monthly. If you use the trading campaign method outlined in Part One, also keep them grouped by eachcampaign. Most broker/dealer trading platforms allow you to customize therecord of your trades but you will still want to at least export that informationto your codex notebook.Record at least the following information:• Pair or cross traded.• Entry and exit dates.
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• Profit or loss in dollars.• Profit or loss in pips.The Trade SummaryFor each trade completed, you will want to add a short summary. This doesn’tneed to be long or involved. One or two paragraphs summarizing the trade isenough. If the summary entails some research—a new idea, a correctiveaction—attach that to the summary when it is complete. Do your daily reportthe same day that the trade is closed, while it is still fresh in your mind.Elements of the Trade Summary Here you will want to be able to get a quicksnapshot of how you are doing. For each week, month, and campaign traded,record:• Largest win/largest loss.• Average win/average loss.• Aggregate win/aggregate loss.I like to record values in both pips and dollars.If you use market environments, note the values (directional movementand volatility) for each trade.
The Daily and Weekly Trade PlanOne of the factors separating the winners from the losers in trading is that thewinners conceptualize the future. That means they plan for contingencies, bothgood and bad. The markets move quickly, and in FOREX the leverage magnifies mistakes, making them costly. It’s important to have contingency plans forall possible outcomes.Much depends on your specific codex. In the most general terms, the prepared trader has plans for how the market evolves over any given trading session. See Figure 14.1.A prime example of conceptualizing the future is anticipating the different forms a wave may propagate. The trader always wants to be prepared for allcontingencies, not just the one he hopes will occur.Your daily and weekly plans should also note which markets you arewatching and which stage of the codex process each is in at the beginning andend of the session. The watchword is: Be prepared.Design your plan according to the requirements of your own codex.Don’t make it too long or involved. Its purpose is to keep you focused and on
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PRICE
???TIME
FIGURE 14.1 Conceptualizing the Future.At minimum, go into each trading session with plans for what to do if themarket moves sideways, up, or down.
track. I like to do my daily plan right after a session closes, and then review itbefore the next session begins.Elements of the Trade Plan The daily trade plan should be a short paragraphincluding the salient points you intend to observe. For example, does the 50percent return price point constitute a continuation or reversal point? It shouldalso include the times of any news or reports that will impact your trade. (Howdoes the market react?) Any important contingencies should also be in the dailytrade plan.The trade plan serves to keep you focused, remind you of the critical factors in a trade, and allow you to make quick but intelligent decisions.DiaryI also keep a short diary, separate from other reports, in a spiral binder. I makea short note before the session begins and a short note after it closes. This iswhere I try to keep track of my emotional state of being.A diary entry need only be one or two sentences, before and after a trading session and after a trade has been exited. Its purpose is mostly to help yourecall the trade later when you are reviewing your performance. For example, “Itraded this EUR/USD off a 50 percent return. My profit objective was tooclose as the trade ran 40 pips past it.”
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If you use the Rogers Method (see the next section), you will need tostore your diary on a CD or in a computer file.The critical issue of a diary and summary is whether you can look atthem a week or a month or even a year later and accurately take yourself backto that moment in time. Develop and use a consistent set of symbols and/orkeyword terms.The Rogers MethodTrader Joe Rogers, my friend, takes reports and feedback to the next level. Ithink it is an excellent idea, especially for the beginner and intermediate trader.Joe uses a product called Camtasia (www.techsmith.com) to fully record histrading sessions. The Rogers Method really doesn’t take that much more time,but it does require an investment in time to set it up and learn it. It allows youto record all of your trading session, including the trading screen and even awebcam video of you. The product has a number of other useful features, aswell, for archiving and annotating your session.Techsmith also makes a nice utility called SnagIt that is great for annotating your charts.Thanks to Joe Rogers for sharing the Camtasia method with me!
SummaryIt takes time to do even modest reports, and it takes effort to do them consistently. No one likes to think about a trade gone bad, but those are the most important ones to track. You learn more from your losses than from your wins.A single report may not provide you with much feedback or useful information. It is in the longer-term log of many trades that you will see patterns ofbehavior useful to honing your process and your trading skills.
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Options and OptionsGentlemen don’t trade oats—or options.—Charles B. Goodman
lthough the money management and style concepts in this book shouldbe adequate for all traders, you may want to explore other ideas for yourtoolbox of trading techniques.As I mentioned early in the book, the sheer number of technical tradingideas is enormous; it is not uncommon for a trader to quite literally get lost inthe process of exploration. Be careful. You can prune the materials to some extent simply by eliminating those that do not appeal to you or that do not fityour trading style or codex.My advice is, as always, keep it simple!
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Trading ToolsFollowing is a brief discussion of some popular trading tools and where to lookfor more information.Candlestick charts. These have proven very popular with FOREX traders.There are any number of identified short-term patterns, and with furtherstudy you may find others applicable to currency trading. A serious statistical study of these patterns and their reliability would be useful. Pendingthat, I recommend the bathtub analysis approach mentioned in Chapter 6.Almost all FOREX trading stations offer candlestick charts. The guruof candlestick charting is Steve Nison. His Japanese Candlestick Charting,published by the New York Institute of Finance (1991), is the basic primer.
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Joe Ross. Joe Ross has written three books on commodity futures trading,primarily using short-term bar chart techniques: Trading by the Minute,Trading the Ross Hook, and Trading by the Book, all published by the author (http://.tradingeducators.com).DiNapoli Levels. Some traders swear by DiNapoli Levels. I find the entireconcept a bit subjective, as I do Elliott Wave and Gann theory, but youmight find the concept a potential addition to your toolbox. I recommend Trading with DiNapoli Levels, published by Coast Investment Software (1997).Classic bar charts. The classic bar chart patterns have been around fordecades and many traders still rely on them. Again, I find them too subjective. It is easy to see the patterns such as head-and-shoulders and pennants after the fact. Two books with information on these are RobertEdwards and John McKee’s Technical Analysis of Stock Trends (1948) andThomas Bulkowski’s Encyclopedia of Chart Patterns (New York: WileyTrading, 2000). Another resource is Trading Commodity Futures withClassical Chart Patterns, by Peter Brandt (1990).Charts are charts. A book emphasizing stock charts or commodityfutures charts is perfectly fine for the FOREX trader as a study guide tothe technique in question.Point and figure charting. Although P&F charts have fallen in popularity, they are still an excellent way to record and analyze prices. My favorite books on point and figure charting are The Point and FigureMethod of Anticipating Stock Price Movements, by Victor De Villiers andOwen Taylor; The Three-Point Reversal Method of Point and Figure, byA. W. Cohen; and Point and Figure Charting: The Complete Guide, byCarroll Aby.Taylor and the old school. Before the advent of computer analysis—mostlyin the 1940s, 1950s, and 1960s—a great number of books were printedon charting techniques. Many of these were privately printed in smallquantities and are almost impossible to obtain today, such as BurtonPugh’s The Great Wheat Secret. Fortunately, Ed Dobson’s Traders Press(www.traderspress.com) has seen fit to reprint some of them. They arecertainly worth exploring. One I have found useful is The Taylor TradingTechnique, by George Taylor.Indicators. If you want to study or use indicators despite my caveats andreservations, the seminal work is Welles Wilder’s New Concepts in Technical Trading Techniques.Volume and open interest. Because there is no central clearinghouse or reporting agency, there are no volume or open interest figures for currency
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trading. This is a shame, because they are very useful to the commodityfutures trader. There are a number of excellent works about volume andopen interest, including Charting Commodity Market Price Behavior, byLee Belveal; Volume Cycles in the Stock Market, by Richard Arms; and Volume and Open Interest, by Kenneth Shaleen.I am currently working on formulas for deriving synthetic FOREXvolume and open interest. I will publish my findings on my web site,www.fxpraxis.com. Once established, they will allow the FOREX traderto use the same tools as does the commodity futures trader.The Companion volumes. These books, eight in number and directedto the FOREX trader, were privately published by this author andJames Bickford. They offer a plethora of new ideas and statisticalanalysis for the currency trader. The FOREX Chartist Companion volume, with substantial updating, has been republished by John Wiley &Sons.The Internet. If you Google “technical analysis” and related keywordsand terms such as “FOREX trading techniques” or “market trading systems,” you will find hundreds of web sites with many interesting tradingtechniques, methods, and systems. Other popular ideas you can explorewith an Internet search: Bollinger Bands, Gann theory, and Elliott Wavetheory.
OptionsOptions for stocks have been around for more than 100 years.