Trading strategies

Many traders utilise shares or options amongst their investment strategies either for income or capital growth. One key factor that such traders may consider in their choice of specific markets to trade is liquidity, with a higher trading volume impacting positively on the ability to get in and out of trades at a fair price. Others may find the choice to trade specific companies or sectors not as well represented in their local market.

For many therefore, the breadth of choice and liquidity may make this market the preferred market to trade. Like any type of trading, sustainable results require a depth of knowledge and commitment to trading an individual tried and tested system. This system should include in depth reference to risk management throughout.

However, due to the choice of market, a trader can make regular profit and yet lose this (and potentially more) through the currency risks associated with trading in US dollars rather than, for example, their base currency of Australian dollars or GB pounds. Holding a significant position in US shares or options means that many traders have exposure to positions in tens of thousands in USD. So what is the currency risk?

The reality is that profits can be ‘used up’, or losses can be compounded, by adverse currency movements. The reason for this is simple. Let’s assume that your currency is AUD and it is transferred into USD for trading purposes.

The exchange value when converted back to the original currency at some time in the future will be dependent not only on trading results but on the movement of AUD versus USD. While your money is in your account in USD, weakness in AUD will mean a greater worth in AUD when converted back, whereas a lesser conversion worth will result if there is AUD strength while your money is sitting is USD. Let’s give an example...

See below a daily chart of AUD/USD for the last 3 years. Note the price from the end of January 2018 at a level of 0.8134. The price at Nov 2019 was at 0.6776 so a difference of 0.1358 So, an investment to fund a trading account of AUD$30,000 would have equalled an original USD value of $24,402.

With the movement in the currency alone over this period (assuming no movement in share price) the value of the account when transferred back into AUD would have risen to $36,007.59 or in other words a 20.03% increase. So, in this case the underlying currency movement was of benefit. However, if this positive currency outcome is the case when there is USD strength (when your trading capital is in USD), with the same AUDUSD currency movement in the other direction, the loss could be 20.03%.

This would mean that you would have had to profit by this 20.03% in your trades simply to breakeven. This WAS the case if you look at a chart from the beginning of Jan 2016 to Aug 2017. More than this of course, if you have lost $6007.59 on a similar price move in the other direction, broke even on your trades during that period, so your equivalent AUD value is $23,992.41, your trading return would have to be now 25% profit to recover the original capital level simple because of currency movement.

Bear in mind, of course we have chosen only a $30,000 example, some of you may have considerably more than this in the market (and so considerably more currency risk) than the example we have given. Risk management of your hedge Although you are entering a low margin requirement Forex position due to the leverage associated with Forex, we cannot understate the importance of a full understanding of the implications of this. Should the AUD move lower still (as we explained above in looking at what has happened since January 2018), the value of your hedge may move significantly.

If we look at using the analogy of an insurance policy in trying to explain the concept, the maximum risk is the initial “premium” paid in this case. However, with any Forex position there is obviously the risk of losing more than your original investment. Additionally, you are trading your shares/options in a different account and hence there must be the ability to money manage between the two accounts.

Our team can guide you further on these important issues. One last thing… Although we cannot advise when it is right for you, if at all, to put in a currency hedge, it is worthwhile raising the question about what the current AUDUSD chart is telling you now technically. Additionally, with the potential for further US rate cuts, and if you believe there will be some resolution to trade tariff wars between the US and China, both events have the potential to strengthen AUD (and so weaken your USD capital).

If invested in USD based trading for some time you have benefitted, logically, it is not unreasonable to consider whether it is worth ‘locking’ some of this in. So, what can you do? Your choices are twofold. 1.

Allow your invested trading capital to be subjected to the risks associated with underlying currency movements or, 2. Hedge the currency risks with a non-expiring Forex position. If option “2” looks attractive, the reality is you can: • Mitigate the risk through consideration of a Forex hedge. • Attempt to optimise your hedge by timing its placement and exit i.e. use technical landmarks, to decide when to get in and out of a hedge. (Please note: a hedge is for insurance purpose and so although there may be merit in timing entry and exit, we are not suggesting you trade in and out of a hedge on a regular basis).

Learn how to reduce the risk We are happy not only to show you how but guide you step by step in how to set this up. There are a couple of practical issues you would need to have in place to manage this well but again we can go through these to enable you to make the right decision for you. If you think this might be for you, then simply connect with us at [email protected] and we will arrange for one of our account team to discuss a currency hedge that may be a fit for you.

Irrespective of what vehicle you are choosing to trade (Forex, CFDs, share CFDs ), position sizing is a crucial part of your trading risk management. It is position sizing, along with effective exit strategies, that have an undoubted major impact on your trading results both now and going forward. At a basic level, the following are part of a position sizing system: a.

Identify a tolerable risk level per trade based on your account size (often 1-3%) meaning you aim to keep any loss sustained within this tolerable limit. b. Using any stop level for specific trades and your tolerable limit to work out how many lots/contacts you can enter to achieve this goal. c. Ensuring you are not inadvertently over-positioning in one market idea (e.g. broad-based USD strength or weakness, by entering multiple trades across currency pairs/ commodity CFDs that will multiply the impact of USD movement).

But what then? How do we explore refining our position sizing to potential optimise results? Here are two initial ideas for potential testing… Idea 1 – Position sizing according to volatility When exploring using volatility for any trading decision it is not just the level but potentially, more importantly, the direction of the volatility i.e. increasing/decreasing.

Volatility is often seen as a reflection of market certainty but perhaps consider volatility as a measure of the likelihood that an asset e.g. Fx pair, is more likely to move away from its current position (and that can be either positively or negatively of course). Logically, therefore, increasing volatility in either direction could represent an increase in risk (and of course visa versa).

Consequently, it is not unreasonable to consider altering your tolerable risk level according to this. So, for example, if your standard is 2% of account capital on any one trade, if you were to implement this as an idea, increasing volatility could mean a decrease in risk level to 1% and decrease to 3%. The challenge, of course, is to determine a method through which you can determine this change.

The ATR is a volatility measure commonly used and would be a potential tool that can assist. Of course, the other aspect is to choose the timeframe to measure this variable. Logically, the shortest timeframe should be the timeframe you are trading but there may be wisdom in looking at longer-term timeframes also.

Idea 2 – Ensure that trail stops account for your tolerable risk level. Arguably a common mistake made by many traders is to view trades on their P/L and make decisions on the fact they are “up” on the deal and as long as the trade is closed before getting back to breakeven then they have a win. An alternative and logically an advanced approach is your net worth in the market is where it is right NOW and hence any pullback in any position is a “loss” from your current place.

This is the rationale behind trailing a stop in an attempt to still have access to the further upside (“letting your profits run”) whilst capping any pullback to a new an improved level to that of your initial stop. There are many ways of trailing a stop e.g. retracement, price/MA cross but again would it not make sense to use your tolerable risk level as part of your trail stop equation. So lets see, for example, use an account size of $10,000 and you are trading a 2% maximum risk level to set your initial stop.

This means that your contract/lot size is based on your technical stop and $200. You have a position that is now up to $350 if you were to adopt this approach when you trail your stop you should ensure that it is placed at a level that would mean that the worst scenario would be that you would close the position at $150 profit. There are of course other advanced position sizing techniques you could test which will be the topic of an upcoming Inner Circle session.

Make sure that you are part of this through registering for these sessions so you can jump on board with this advanced trading education group to access the topics applicable to your trading development. In the meantime, we would be delighted, as always, to hear from you, so if you are using an advanced position sizing technique it would be great to hear from you at [email protected]

Trading Volume: General principles Many experienced traders (even those using a simple system will incorporate volume as part of their entry (common) and/or exit (less common) system. It is essential (as with any indicator) that you understand the role volume can and cannot play with suggestions of what is happening to market sentiment. So generally speaking, trading volume may offer some guidance as to whether market participants are changing sentiment towards the pricing of an asset, and if there is a price move, whether it may have a higher probability in continuing in that trend direction.

Many would consider it more “leading” than the majority of other indicators. Indeed, VSA (volume Spread Analysis) which is based on this principle is an approach used by many. In simple terms, a price move (either way) with higher traded volume is thought to be more robust in terms of trend continuation.

Whereas Lower volume with a price suggests market uncertainty or no interest. Trend reversal and retracement A trend reversal is, as the name suggests, sentiment moving from an established upwards trend to, a new trend forming in the opposite direction e.g. upwards to downwards trend (or visa versa). The risk of remaining in a trade that is reversing is loss of potential profit in that position if one delays exit.

A trend retracement, is a temporary pull back in price prior to continuation of that change in the same direction, often termed a trend pause). The risk of exiting a trade on a retracement is that you are missing out of the additional profit from a subsequent trend continuation move. This differentiation is important when the trader is considering an exit from a specific position.

For example, recognition a reversal from a uptrend to downtrend early would be beneficial when in a long trade. Whereas should the price move be a retracement then to continue to hold that position may prove to have a better outcome as the price subsequently moves higher. The challenge, of course, Is that ability to differentiate and identify through the use of technical “clues” what may be happening to market sentiment.

Is volume the “clue”? If one accepts the premise that level of volume is an indicator in terms of the potential strength of a price move, then can this be a “clue” as to whether the more likely outcome is reversal or retracement? See below for an hourly chart of USDJPY.

We have labelled the confirmed start of trend after a double top type of chart pattern through to the end of the trend and subsequent reversal. Note the lower volume of the two retracements (shown in blue highlight) and the subsequent higher volume as the trend ultimately reversed. In terms of trading actions logically one could consider the following: • Retracements may be a signal to trail a stop loss to the base of the retracement. • Increasing volume may be a signal to exit directly in anticipation of a confirmed reversal.

The Forex Volume Challenge? As many readers will be trading Forex it would remiss of us not to discuss the specific issue briefly with the volume seen on an MT4 platform. With shares (and the volume shown on Share CFD charts for example), the number of traded positions is managed and reported by the central exchanges (e.g.

ASX, NYSE). However, with FX there is no central exchange so the volume you see reflects the trades going through relevant liquidity providers. Additionally, Forex volume on MT4 measures a record of ticks rather than the number of lots traded.

One tick measures a single price change. As a price moves up and down this “tick volume” alters within the specific chart period. On the MT5 platform there is a option to choose so called “real volume” and yet it should still be borne in mind that compared to a stock exchange which theoretically shows all trades from the whole exchange this is not the case with Forex.

Hence, some may question as to whether the measured chart volume with Forex is sufficiently valid on which to make decisions (although theoretically the principle remains the same). The reality… Whatever your thoughts on this, arguably you could question the validity of any indicator. So, ultimately you use the same process for testing and subsequently potentially adding any indicator you may be considering the use of in your individual decision making i.e. back-test to justify a forward test and on evidence decide whether, and how to add volume to your trading decisions.

You challenge is to do the testing, and plant your flag as to whether you are to utilise this in your trading.

A written trading plan, usually comprising of several guiding action statements, serves the following two invaluable purposes: Facilitates consistency in trading action e.g. in the entry and exit of trades, allowing the trader AND Measures the strategy used specified within each statement to make an evidence-based judgement on how well these are serving you and test and amend these statements so you can develop an individual trading plan that may work better for you. Let’s move past the fact that many traders choose not to have a plan at all, an approach that goes against what is one of the key components of giving yourself the chance to become a successful trader, to those who have a plan in place already. This article is targeted a those who have made the logical choice to have some sort of written plan in place.

Great though having a plan is, many traders still have issues with the two purposes outlined above. They still fail to some degree to develop the consistency described and are not really able to measure effectively. A common problem, if we look closely at some of the plan statements used, is that such statement may not be specific enough, have some ambiguity, that means that those purposes may be difficult to achieve.

Let’s provide and work through an example for clarity (we have used something generic that applies to all trading vehicles). Consider the following statement… “I will tighten my stop/trailing stop prior to significant, imminent economic data releases” Firstly, on the positive side again, this does demonstrate an awareness of potential risk and a desire to have something within your plan to manage this risk. However, in terms of being a measurable statement that you can make a judgement as to how well this approach is serving you, there are the following issues: What does ‘tightening’ mean in practical terms in relation to current price point of the chart you are trading?

How close to a data release is ‘imminent’? What constitutes a significant data release (amongst the many that are released daily)? So, to take the previous example consider the following as an alternative: “Prior to imminent economic data releases, I will tighten of a trail stop loss for any open trades, 15 minutes prior to the release and to within 10 Pips of the current price (or course this can be adjusted to points or cents dependent on what you are trading).

This will be actioned for the following data points: Interest rate, CPI, industrial production and jobs data from the country of either currency pair (or Germany, France of across the Eurozone if one of the currency pair is the EURO). US and Chinese PMI manufacturing data, GDP, industrial jobs and interest rate decisions as these may impact all currency majors." So, with THIS amended plan statement the following elements could be measured (if journaled appropriately of course): What would the difference be in your trading outcomes if: No tightening had been actioned. If a different proximity to current price is used e.g. 15 rather than 10 Pips.

If other data releases are added/removed. With this level of measurement, possible with the revised statement, one would now be able to make any changes, backed up with evidence, to your trading plan. Alternatively, of course, you could make the choice to do nothing, retain statements such as the original, and not have the ability to create the richness of evidence to make considered amendments to your plan.

Logically ask yourself the question, "which choice is more likely to serve my trading going forward?"

We have discussed many times the importance of unambiguous, and sufficiently specific statements within your trading plan in previous articles and at the weekly “Inner Circle” webinars (for more information see the Inner Circle in the navigation bar). The benefits of this are twofold: 1. Assist in developing consistency in execution when trading when attempting to follow a trading plan in the “heat of the market” & 2.

Facilitate measurement of aspects of your trading plan to review and refine on evidence. This article aims to give you an example in the context of trailing a stop, one of the key exit strategies employed by traders. Below are some commonly used trading scenarios for trailing a stop, relevant challenges faced when attempting to be appropriately specific within your plan are below.

So, for example, using the first example, we could articulate the statement as follows: "I will check the current 15EMA at the end of every chosen candle chart period for any open position, and trail my stop to this level until the price has crossed below (if long), or above (if short), at which point I will exit the trade". Your challenge is simple. Once you have chosen your trail stop method, review your existing statement and make a judgement and take action if you think you could tighten it up to mean that statement potentially better meets those two aims highlighted at the beginning of this article.

The MACD (or the ‘Moving Average Convergence/Divergence oscillator’ to give its full name) is one of the popular extra pieces of information we often see added to charts. The purpose of this article is to clarify what it may be telling you about market sentiment and offer a description as to how traders commonly apply this in their decision making. This is a slightly lengthier article; brief explanation may not be clear, and we want you to really get to grips with this so you can make the right decisions for you.

Taking a step back. The purpose of technical indicators is to provide the trader with information to assist in entry, or exit, decision making. We have discussed the choice of adding indicators previously and suggested the following: a.

You should not add an indicator unless you understand what it is telling you about market sentiment. b. You should only use any indicator if it provides additional information to that which you have already. To do so may create a more colourful and impressive looking chart but little else. c.

You should always articulate how you are going to use an indicator for entry and/or exit in your trading plan in a specific unambiguous statement to facilitate consistency and measurement. d. There is no point on adding extra indicators if you are not sufficiently disciplined to use the existing plan you have. There is a different priority here you may need to work on if this resonates with you!

In this article we are hoping to add some value in addressing “a” through to “c”. What could the MACD be telling you? The MACD was developed in the 1970’s with the aim of offering information about changes in trend and momentum of a price move.

Additionally, there is a signal line that could assist in pressing the entry/exit button. Despite the somewhat complicated and jargon -filled full version of its title (hence the abbreviation), which unfortunately may put off some inexperienced traders from finding out more before they jump in and blindly use it, when you pick it apart, it is not perhaps as complicated as it may first seem. The indictor is based as the name suggests on using the commonly used and more easily understood moving averages and the principle that if you plot two of these on a chart of different periods e.g. 10 and 20, a cross of these may indicate a change in trend.

Before we move on to looking at the MACD on the MetaTrader platform, it is worth noting that those traders with experience of other software will notice a difference in how the MACD is shown. We will be discussing the MT4/5 version of this indicator as that is the platform that most of you will be using. Before we look at the indicator itself let’s look at a simple chart with two moving averages plotted and explain some of the terms to help explain some of the terminology once we move to the indicator itself.

Here we see a GBPUSD 15-minute chart. There are two exponential moving averages (EMA) namely a 12 and 26 (the reason for this will become obvious in a moment. We see a moving average cross marked; in this case the 26 EMA has moved above the shorter 12 EMA often perceived as indicating a change in trend to the downside.

We also see highlighted in yellow, firstly an example where the moving averages are moving further apart (termed divergence), this is often seen as a signal of increasing momentum as a trend develops. Subsequently, we see highlighted the space between the moving averages narrows (termed convergence). This is often seen as a signal of decreasing momentum and often ultimately results in reversal.

So, back to our MACD, in simple terms, a MACD will give you the same information as above, though admittedly in a different form. Here is the same chart as above but with the MACD added. We have illustrated with the green arrows how the information on the top of the chart relates to the MACD at the bottom.

Now, just to swing back to a point made earlier. The reason we chose the 12 and 26 EMAs on the chart above to help understanding that these are the default settings on a traditional MACD (these are of course adjustable, though most traders wouldn’t choose to do this, nor should without testing). EMA cross and trend direction There is a ‘centreline’ at a zero point on the MACD you can see if there is a cross of the moving averages; the graph also crosses over this line.

If the histogram (the vertical bars) are above the line what this means is that the shorter term (12) EMA is above the longer term (26)EMA. This is indicative of an uptrend. If the vertical bars are below the line, then the longer EMA is on top (see chart above).

Momentum (convergence versus divergence) As referenced earlier in simple terms if the distance between the moving averages is increasing (divergence), this indicates increasing momentum in the trend (and so is thought to be a sign of potential continuation). If you look on the top chart, you will see how this increasing gap is illustrated on the MACD by increasing height of the bars. Conversely, when the moving averages begin to converge (get closer) then length of the bars decreases, this is suggestive of decreasing momentum in the trend which if continues may ultimately result in trend reversal (and a cross of the two EMAs).

On the Metatrader platform the length of the bars in the histogram is a numeric representation of this gap between the two EMAs (12 and 26). It is not unreasonable to question (and many do) that if all this information is on the top chart anyway and easily visible what justification is there to add the MACD box? The signal lines The answer lies in the only new piece of information, that is termed “signal line” as seen on the MACD example above.

The calculation of how this line is plotted is based on taking a simple moving average (SMA) of the difference between the two EMAs. It is seen as potentially important when there is a cross of this line above or below the histogram bar height. The purpose of this line is to potentially give additional information relating to the likelihood of that change in trend momentum and to create a readiness to take action.

To help explain the potential use of this “signal line” let’s use the diagram below which is a “snip” taken from part of the chart as it moves into uptrend. At the start of the uptrend, we see the histogram bar tops over the signal line. As the signal line is a SMA of the height of the bars you note it tracks upwards along with the increased momentum.

Ultimately, as momentum (divergence) begins to “top out”, the height of the bar moves below the signal line. Subsequently, we see a drop-in momentum as the EMAs converge and ultimately the trend ends. Hence, theoretically this could signal a potential reason to exit a trade.

Bringing it all together… Despite the additional “signal” line many questions the usefulness of adding this to decision making processes. However, it remains a popular indicator and as such our advice is, as always, not whether to use or not use it in your system, but rather emphasise the importance of testing your trading system. As with any indicator, general trader consensus is that NO indictor should be used in isolation.

Certainly, there is no information within the MACD that shows whether an asset is overbought or oversold, whether there is associated volume, and of course no accounting for the proximity of key price points (support and resistance), nor the potential impact of economic data. Logic would suggest that all of these are worth consideration alongside the MACD if you are choosing to integrate it within your system. There is some practical use of this that seem odd.

For example, if your “favoured” moving averages on a chart are let’s say 5 and 15 and yet you are using the default 12 and 26 EMAs as part of your MACD set up, this is worth exploring. The fact that much of the MACD information is easily seen on a standard chart is a compelling reason perhaps to test a system with and without MACD and simply look at results. Ultimately, and to finish, it is of course your choice as to which criteria you use.

Remember, whatever these are for you, the key lessons of specifically identifying how you are to use the criteria within your plan, the importance of forward testing (as well as back-testing) of any system change, and of course the discipline of following through are critical whether you use the MACD or don’t.