Two Interesting Questions

 BarroMetrics Vieews: Two Interesting Questions

An interesting question came in from ‘John’ and Paul raised a great question in comments. I’d like to share my answers.

John is a subscriber to our weekly, free video-newsletter. In the most recent video, I said I’d only short the AUDUSD if it moved above the high at 0.7875 before generating a sell signal (See Figure 1).  In part, John wrote:

“By insisting on a…(break above) 0.7875, aren’t you behaving like the spoilt kid who won’t play unless you get your way?…Aren’t you risking missing out on good trades?”

Well, you could frame it that way.

I prefer to see it this way……….We are trading the right-hand side of the chart; hence, have no idea what the future will bring. We can only assess the subjective probabilities and choose to take the trades that we assess:

  • to provide a high probability of success and
  • an adequate reward to risk.

Without a doubt, I will miss some very profitable trades. Those who turn out to be very profitable, but I have not taken because

  1. I assessed them as being too high risk, and/or
  2. I assessed them as having an inadequate reward to risk .

The fact is I will always miss some trades that, with hindsight, I ‘ought to have taken’.  That is the nature of the game we are playing. It’s the same as choosing to exit a trade only to have it subsequently move in my favour. If we trade long enough, this will happen.

It’s important to remember that as traders, our job is not to be on every winning trade – our job is simply to make money. We make money by having a positive expectancy return. This means keeping our losses small enough so that our profits, given our win rate, will be in excess of our losses.  There are times when this is more difficult than others – what I have called an Ebb State.

In the past few blogs I have shared that when in Ebb, I am better off using structural stops rather than price stops. This strategy has allowed me to turn, in Feb 2015, a negative return to a small positive one. And, this brings me to Paul’s question: what allows us to be wrong about a trade and not lose is time i.e. we can be wrong about the market is likely to do if have time to exit before price proves the trade wrong.

For example, let’s say in Figure 1, I had gone short at .7887 and let’s say that my stop is .8037. After the price action on Mar 3, I decide that the AUDUSD is likely to accept above .7846, and if this happens, it will invalidate my sell setup and trigger. So, I decide to exit the trade.

This trade has given me time to exit. By exiting early, I have missed being stopped out for a loss when being stopped out at .8037. If the AUDUSD had moved directly to .8037 after my entry, I would have less (or no) time to make an early exit and thus less (or no) time to avoid the loss.

Of course, at time of exit, we have no idea if the AUDUSD will break .7846, and even if it does, whether the AUDUD would then move to .8037. We can only be certain of this when it happens.

What prevents me from executing this preemptive exit is fear – the fear that “I’ll exit a great position, only to have the market move ‘humongously’ in my favour BUT I won’t be aboard!” This is the same fear that keeps traders in losing trades. And, it’s the fear we need to manage if we are to become better traders.