A Lesson in Avoiding Poor Trades

There are very few strategies out there that work well in all market conditions. Some work well in ranging markets, some work well in trending markets for example. But when we’re assessing the type of activity a market is currently exhibiting, there’s also the question of how it’s moving. Is it volatile or is it calm? Is it rotational with many pullbacks or is it unidirectional where it has no counter directional pullbacks to speak of? If you know where your strategy is likely to be more or less effective, you can increase your overall success rate. A great place to find a lesson in avoiding poor trades is an ECB Thursday.

I want to run through the example in this post, but if you’re interested in taking a look, I’ve produced a YouTube video on the example too.

Strategy Vulnerability

In the EU Session Trade Room, the primary focus is on trading using Netpicks Trend Jumper system. Trend Jumper is great for directional movement. Even when there’s no clear direction for a session, it often does well too. But there’s one achilles heel it has. When a market is moving directionally in a trend channel, experience (and common sense) shows that there’s a big danger of taking consecutive losses.

Part of how setups are formed with this strategy is that they occur when there’s a push in a direction. The problem is that when the market is moving directionally within a channel, these pushes often take place towards the containing channel line and this inevitably leads to any setups which are generated as a consequence, stopping out as the market pulls back within the channel.

Trade Setup

In the above example, the channel is drawn from the first setup. It should be pointed out that although there were suspicions of the possibility of a trend channel forming, really it wouldn’t have been until the fourth setup that you’d have added it to your chart. The first and second trades were avoided for reasons other than the channel itself.

Trades 4-7 are the setups that would have been legitimate if it hadn’t been for the trend channel and you can see that all were losing trades. Each trade occurred towards the high or low of the channel or with their money management level which is designed to make a trade relatively safe (the first of three target dots on each setups) outside of the channel. To take a trade close to a key level, trendline, moving average or whatever else is specifically important to your trade plan, it’s always sensible if the entry hasn’t already broken the level, to only take trades where the money management level is ahead of the key level – i.e. if doesn’t need to break it in order for the trade to trigger risk being reduced.

Work With What You’ve Got

If you do find that the market you’re trading is moving in a less than ideal way, it’s important to work with what you’ve got.

In this example that means: –

  1. Quickly accepting that the market is in a trend channel and therefore you shouldn’t be taking trades that need to break the channel to be winners.
  2. Recognizing what needs to happen in order for the market to possibly change it’s current behavioral pattern.
  3. Identifying any trades that could give you a good chance of success without anything changing.

We’ve already covered point 1. Point 2 sounds obvious. There needs to be a break outside the channel. But there’s one aspect that needs to be cleared up here.

The breakout from the channel can occur in or against the direction of the move. The issue with a break with the direction is that the market has already expended a lot of energy in moving in that direction. So sustaining such a breakout is going to require a great deal more energy than one against the direction of the channel where existing short term positions are more likely to need to exit. It can happen of course and occasionally these are very strong moves. However, in practice it’s probably more sensible to wait for a break against the direction of a trend channel.

The last point is about finding possible trades that fit with the activity. In the first chart, the channel is up. So if there’s a setup where the entry is a long off the channel support line, it would have a better chance to succeed without needing to change its current channel behavior. I’ve denoted the first such setup in green on the chart.

A Lesson in Avoiding Poor Trades

Knowing under which types of conditions your strategy is particularly vulnerable to generating a greater number of losing setups and planning appropriate steps to avoid poor trades is an important factor in being successful. Of course there’s a trade off to make in avoiding these trades – when the market does break out, you’ll be far more likely to miss a good trade. But accepting that there’s a strong chance that you’ll miss a good trade as the market transitions between one type of activity and the other pales into insignificance when you see how many losing trades you avoid.

Learn when your strategy performs at its best and worse and plan for how to adapt your approach dynamically.

Trade well.

For more updates from Mark and the team at NetPicks, be sure to visit their trading tips blog at NetPicks.com.