Monday, July 25, 2011

Advanced Technical Analysis: Finding the Gold In Your Losing Trades

Below a guest post provided by Forex Traders.  I typically focus on equities (stocks), but trading strategies in Forex applies equally well.  If you would like to write a guest post, please contact me.  Click on the About Me link for my contact info.

In life, most of the real lessons we learn are borne in the fires of adversity.  In trading, things are the same.  As humans, we tend to avoid pain at all costs.  Therefore, when we experience pain, our immediate reaction is to do whatever is necessary to stop feeling that pain.  When we have a losing trade, it hurts.  It doesn’t hurt physically, of course, but it hurts emotionally and mentally.  Thus, most traders react to a losing trade by trying to put it out of mind as quick as possible,  and they move on to look for the next trading opportunity. This is a huge mistake.
In life, there are typically deep lessons hidden inside of our failures.  If a person doesn’t look at their failures and extract all that can be learned, then trials are wasted.  In trading, the same principle exists.  We must learn to not run away from losing trades and losing streaks.  They are a natural part of the trading process.  Instead, it is absolutely imperative to objectively review every losing trade in order to find the gold hidden in your losing trades.  In this article, we are going to discuss how to find the gold in your losing trades.

The Plan
Keeping a trade log is essential in relation to developing a high level skill set.  Now, very few traders actually keep a trade log because it can be very tedious, and it is definitely not exciting!  Trading is exciting.  Buying and selling a financial instrument is exciting.  Planning out your trades and recording them in a detailed trade journal is not exciting.  However, if you want to really find the gold that is hidden in your losing trades, it is only possible if you are journaling your trading activity.

The Action
Keeping your trade journal is basically like gather evidence.  If you simply gather evidence, but never analyze it to come to a conclusion, then it’s worthless.  As we stated earlier, very few traders actually keep a detailed, consistent trading journal, and of those who do keep them, even fewer actually analyze their entries in order to find patterns of behavior!
The way to find the gold that is hidden in your losing trades is to sit down at the end of each trading week and intensely analyze every single trading decision and outcome from the week, especially your losing trades.

Why Winners Don’t Teach Us Much
If you follow your stock or currency trading plan perfectly and you close out a position at your profit target, what have you really learned?  Not much, really.  You put your plan together, you followed it, and you were rewarded.  The only thing you will learn in this process is that your plan works.  It will act as further confirmation and help continue to build your confidence, which is very important.
When you have a losing trade, however, something else is happening.  If you follow your plan, and a trade does not work out, why does it not work out?  Something happened that you were not expecting.  And this is where, with a little persistence, you can find gold.  Throughout your trading journey, you will most likely go through stretches where your trading approach will have to be modified.  By analyzing your losing trades, you will find common patterns of behavior around losing trades, and this can be invaluable information.

An Example
I love to use Average Daily Range in my currency trading.  Assuming the 20 Day ADR on EUR/USD is 120 pips, I love to fade EUR/USD back into the trading range once it reaches that 120 pip area and hits major support/resistance.  During the late spring of 2010, when Greece was facing certain default and EUR/USD was falling sharply every day due to forex news, I suffered a major losing streak.  As a result of logging my losing trades and analyzing them, I noticed that if EUR/USD reached its 20 Day ADR too early in the trading day, then the chances were better that it was going to continue in that same direction and not revert back into the day’s range.  This literally transformed my approach and utilization of ADR.
Now, I have a strict rule that if a currency pair reaches its ADR before 8:00 am EST, then I will never fade that momentum.  Instead, I will look for an entry in the direction of the day’s movement, in expectation that we are going to see a large range expansion day.
There is gold hidden in your losing trades.  By closely analyzing them, you will discover how to tweak and refine your trading approach.
Risk Disclaimer: Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite.