From day-trading stocks to swing trading forex
With intraday moves in the stock market turning sour, this long time stock trader turned to what once was an unlikely target for retail traders; foreign exchange. Here’s how he did it.
For the last 10 years, the stock market has been a fertile ground for active day traders. The late 1990s provided a market environment in which anyone who could fog a mirror could make money trading. Early 2000-01 left only the more seasoned traders standing. Then 2002 and 2003 had everyone scratching their heads. The volatility had ground to a halt.
What was once a game that you could win just buy getting to know an individual stock well and trading accordingly became a market that was suddenly very stingy with its rewards. What caused the lack of volatility? While we’ll never know what exactly caused the intraday tendencies of the market to change so abruptly, the market is what it is. “Where’s the range?” (right) illustrates the equity day-trader’s dilemma clearly.
Of course, each day does have its pockets of volatility in certain stocks and sectors. However, focus and concentration is the hallmark of a consistently profitable day trader. Scanning for stocks degrades that focus and intuitive edge. There are traders who can play that game, but most flourish with just a handful of securities to examine every day.
With opportunities for day-trading the stock market evaporating, many traders would do well to turn to other markets. After all, a trader with a solid set of skills should be able to trade any market provided some time is spent getting to know that market’s particular nuances.
Given today’s landscape, one market is offering particularly strong prospects for the beleaguered stock market – foreign exchange.
THIS ISN’T IBM
Until a year or so ago, online forex trading, or e-forex, wasn’t even a topic among active equity traders. Today, it is becoming far more common. The reasons are clear. Forex is the most liquid market in the world, provides 24-hour access, offers reasonable spreads, allows no-commission trading and permits low account minimums.
Based solely on these reasons, retail traders owe it to themselves to at least look at foreign exchange. Consider, the intraday and multi-day ranges for some of the most active forex pairs (see “That’s more like it,” right).
While it is easy to show charts and draw what seem to be obvious conclusions, let’s look a bit deeper. The moves up or down appear orderly, but the range traveled on a per-bar or multi-bar basis is extensive. Using the euro as an example 80-120 pips over a few hours is a common range. That equates to $800-$ 1,200 if you are trading a minimum lot size for most e-forex brokers. So, while the technical patterns appear orderly, there is a fair amount of movement occurring. This is the first challenge to stock traders turned forex traders, dealing with sizable equity swings.
First of all, experience demonstrates that trading forex off a chart on less than a 60-minute time frame is quite difficult. Given that stock traders are used to one, five and 15-minute charts, this introduces a new twist. Gone are the days of immediate gratification, but if you have patience, and are proficient at technical analysis, your skills should be rewarded.
Rather than re-inventing the wheel, most stock traders should be able to transfer their basic premise of trading stocks to foreign exchange. For this stock trader, this cross-market relevance of strategies made the adjustment far easier; the major change was letting the patterns and the patience level play out.
TIPS FOR TRADiNG FX
Trading in the direction of the trend is a common idea that gets a lot of lip service, but rarely is put into practice. Forex is no different, but reversal trades are possible and very effective at select times. Let’s explore a few techniques that are common to short-term stock trading but apply well to forex too. Most readers will find this analysis simple, but overly complicated analysis dilutes most traders’ abilities to use their intuition and experience to further refine an idea.
Here are some basic techniques and strategies for swing forex trades:
* Continuation trades
* Reversal trades
* Fibonacci levels for support and resistance
* Using a stochastic to isolate entries and exits
* Fundamental/macro analysis
While these techniques are common, it is how we will integrate them that provides an edge. In addition, there is no substitute for repetition and viewing tens of thousands of charts to pick up on the nuances that every skilled trader relies on. In terms of the last technique, fundamental/macro analysis, unlike equity markets, there is a definite transferability of this type of analysis to tangible trades. Here’s a recent case in point.
The Group of Seven (G7) meeting in Boca Raton, Fia., from Feb. 6-7 had the potential to change the overall perception of the value of the dollar. Until then, it had been accepted that the declining dollar was the best way to adjust the imbalances in the American financial system. However, Europe was growing concerned that the appreciating euro, as a result of this weak dollar, was hurting its export sector.
Going into the G 7 meeting, there were signs that a statement regarding this scenario was in the cards. As a result, it seemed reasonable to position for a weaker euro. In addition, the trade also had the characteristics of a good reversal trade based on solid resistance and an overbought oscillator. When there is a confluence of three indicators, and considering that a stop loss can be locked in regardless of the price that the euro opened, taking the trade made sense (see “Preparing for a fall,” left).
As it turns out, the comments from other G7 ministers were rather harsh regarding a weak dollar. The trade turned out to be a fantastic short-term opportunity with lopsided reward relative to the risk taken. This type of trade simply does not exist in the equity markets. Regardless, however, we can’t forget two key technical components that alerted us to the trade in the beginning: the Fibonacci extension and an overbought stochastic. The G7 meeting was merely the catalyst.
Again, your analysis does not have to be terribly complex, at least from a technical standpoint. The path of least resistance is to go with the flow. About 80% to 90% of this trader’s forex trades are continuation trades with the remaining ones being a combination of reversal and “special situation” trades. Special situation trades are ones that occur due to economic numbers being released or Federal Open Market Committee and G7 meetings.
“Keep it moving” (left) illustrates some basic parameters for establishing a continuation trade. In this case the trend is up in the British pound, as defined by the positive slope of the 20-period exponential moving average (EMA); there has been a pull-back and consolidation at the EMA; the stochastics oscillator is on the verge of crossing back up, indicating more upside momentum.
In addition, this trade also took place after the G7 meeting. The major currencies were roughed up pretty good in the wake of the dollar’s rally. However, two currencies stood out, the pound and Australian dollar. Both of these currencies never broke their uptrend or even retraced 37.5% off the swing low/swing high. These were obvious choices when reconsidering long positions.
The exits were determined by two factors: price projections (potential resistance) and slowing momentum (an overbought stochastic reading).
The potential resistance was indicated by the Fibonnaci extension derived from the daily pound chart and simply transferred over to the 60-minute chart that was being traded off of for easy reference. This level served as a great exit. It also provided a catalyst for another long in the pound a couple days later, a trade also exited on slowing momentum arid an overbought stochastic.
Reversal trades, as most traders know, tend to be low probability trades. However, when they pan out, they usually pay-off well. The G7 trade in the euro was such an example. While Fibonnaci extensions are no mystery to traders, the speed at which the euro had shot up and then consolidated in that exact area was what was interesting. In such situations, consider the market like a rubber band; it can only stretch so far before it snaps back to some degree.
Today’s retail-oriented forex markets allow for a set of skills originally designed for short-term trading of stocks to be transferred into a completely new market. The great thing is that because forex seems better suited to swing and position trading, it still allows for a trader to pursue an existing approach in another market, or perhaps forex just offers you more than you need. Either way, forex deserves a look from all traders.
Dave Floyd is the president of Aspen Trading Group (www.aspentrading.com) and a columnist with TradingMarkets.com. he has been trading professionally for more than 10 years in the forex and equity markets. He resides in La Jolla, Calif.
Copyright Futures Magazine Group Apr 2004
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