Price action does not need to be significant, but it helps

In our chart below, price action suggests probability but is context more important?

Trading Range

The hourly bar chart below shows a trading range (TR) and a possible breakout.

Bar 2 was a consideration for an entry short. If we look to the bars to the left, we see that the close of bar 2 was at or above the TR base (shown by a yellow arrow). Therefore, although bar 2 was prominent, engulfing the prior three bull bars, it did not, to our mind, qualify as an entry bar.

If we had taken the entry short at bar 2 our stop would have been twice the width of the TR, putting it marginally above the spike of bar 3. Weak traders had their stops taken by the peak of bar 3.

Price action, bar 3

Bar 3 provided a reasonable price action. The close of bar 3 was below the TR (the yellow arrow). However, most breakouts from a TR fail. Moreover, bar 3 was possibly the final push of a wedge, in this instance three drives short.

That provides us with a dilemma. We have a wedge and a prominent trend long. However, the price action (that is the shape of bar 3) provided an acceptable probability of a measured short against the trend.

How to measure our target. Unusually we measured the whole of bar 3, wick included and got a measured target some 92 pips below. The trade was exited with 36 pips of profit and at the 21st bar since entry. We try not to let a deal go beyond 21 bars.

Traders equation

Context overrides price action, nearly every time. In this instance, a 30 pip measured move for a scalp of the body of bar 3 may have been the more intelligent trade. The issue with that is the stop would have been three times further away than the target, therefore not a traders equation.

On that point, at least we took a planned 1R trade (that is reward/risk were equal). Our actual trader’s equation, the pullback against bar 3 and our entry, was 11R. In other words, our gain was eleven times more than our ‘actual’ risk.

Price action against the trend, scalp only.
Price action against the trend, scalp only

Control the losses

To lose only as much as we win is a good thing.

Not being able to control losses is one of the reasons many traders have a reducing account; it’s all about managing losses.

We’ve day traded a single currency pair (GBP USD) this week. We traded well all week but took a loss yesterday afternoon. We allowed emotion rather than a strategy to influence us. There are lessons and reasons why we let the feeling happen, but the important thing is that the loss was measured. That is, it was in proportion to our gains.

All too often with inexperienced traders losses are disproportionate to the benefits. Constant awareness of probability, risk, reward and therefore the trader’s equation is the most vital skill in the trader’s tool bag.

Why just trade the one market? It is possible to day-trade multiple markets, but by doing so, the trader can only employ a limited number of trading strategies. We are not computers, and therefore we need to compromise.

Personally, we prefer to day-trade a single market with multiple strategies. This, on average provides us with 4 or 5 trades per day. Within those trades, we will take a swing or scalp trade depending on market cycle and context. (A swing is a trade on our chosen chart that allows for a pull-back. A scalp, once the trade has taken, will not allow a pullback).

(I have left the commodities for the time being to work on day-trading GBP USD. As an aside: gold and silver have done what we said. I would not trade the interim climb in gold and silver as it goes against the principal direction of the COT report.)

Our issue with day trading the fund is “spread” relative to the size of the trade. The spread, the difference between the ‘buy’ and the ‘sell’ price, becomes an issue with day traded larger accounts. Let me explain from a trade we took yesterday morning.


Above is a 2-minute chart for clarity. We entered the trade (long) at the green arrow. We exited the trade a few minutes later on a scalp at the red arrow. Okay, here’s the issue. We mentioned last week about spreads. When we bought at the green arrow, the spread was one pip. And our green arrow 0.5 pips higher than our ‘buy’ position. When we sold, at the red arrow, the spread was two pips, so we got an exit price that was one pip below our actual exit. The real trade was 21.5 pips to us. The spread accounted for 1.5 pips leaving us with 20 pips of profit.

At £6 a pip the trade gave us £120 worth of profit. Our broker took the 1.5 pips difference (or £9 in this instance) for themselves. Coincidently, this trade provided a one to one reward. Our risk was £120 or 20 pips; this is the minimum scalp that we can take to make the trader’s equation work about the broker’s spread size.

Only taking swings, and therefore aiming for a higher number of pips, proportionally helps the spread dilemma. However, with our fund size we need to build our risk and to do so makes the spread even more so of a consideration. Let’s take a full trading risk per trade of say £480. In this instance, with the same trade above, the broker’s spread fee would have reduced our profit by £36. And that is expensive.

For the more significant account, financial spread betting is not ideal. However, balanced against the leverage, flexibility and the tax (being free) benefits it is still the best trading vehicle for us.

How to improve our lot? As our risk size increases (and probably not until after the Brexit vote) we will change brokers to a pro account; this involves moving to a different chart set-up which will need time for familiarisation. However, the spread benefits are worth it. In the £480 risk example above. In the pro account that we are considering the trade could have cost us £16 for the spread, plus £4.50 for each trade, making a total cost of £20.5. Still not cheap, but better than we presently have.

The pro account only benefits the higher volume trades.


The most important thing is…

60% probability of success is the best we can expect from a trade.

If we look at a trade and say, ‘yeah, I think that will work,’ then the probability is still, at best, 60% that it will happen as we want it to happen.

On the other hand, if we look at a trade and say, ‘yeah, I think there is a chance of that working,’ then it’s a 40% probability.

In other words, the best we can expect is between 60% to 40% of being right in any one trade.

Therefore, our reward needs to be at least twice our risk in a 40% probability trade and at least equal to our risk for a 60% probability trade. Each of these makes a positive traders equation.

Striving for trades that give a positive traders equation is the way to make money over a series of trades.

Achieving a positive traders equation is the most important thing to grasp, and do, as a trader.