The Benefits of Using a Lagging Indicator
Many traders bemoan the fact that the indicator they are using does not signal an entry on the first few pips of a move. They condemn the indicator for “lagging behind the market”…that is, signaling an entry after the initial move has begun.
Keep in mind that it is the very nature of indicators to lag the market.
All indicators, RSI, MACD, Stochastics, Moving Averages, etc., are going to be lagging to a greater or lesser degree since they are based on an average of price action that has already taken place. The result is that pips can be left behind since the initial part of the move has taken place before the entry signal is generated.
The longer the time frame of the chart and the greater the amount of periods comprising the indicator, the more reliable it will be since the signal is derived from a greater amount of data. While shorter time frames and fewer periods will generate more entry signals, because they are based on a lesser amount of data, more “false entry” signals will likely result.
Even though every trader would like to be in on the very first pip of a move, in my opinion, it is fine to miss the initial move that a pair makes in favor of entering a trade that has a greater level of confirmation behind it.
And therein lies the benefit of the lagging nature of indicators.
If we are looking to enter a trade at the very first sign that a move may be taking place, we are going to find ourselves entering many trades based on very short term signals and a low amount of data.
While we will give up some pips at the beginning of the move, this lagging aspect of indicators will get us into trades that have a bit more confirmation behind them based on the greater amount of data.
In other words, the indicator will force us to wait a bit before entering.
Let’s take a look at the historical 4 hour chart of the CADJPY with the MACD in place below…
If a trader had based their short entry on the MACD crossover, when the MACD line (red) crossed over the Signal Line (blue) to the downside, they would have given up the pips between point A and point B on the chart…about 26 pips.
However, inasmuch as the downward momentum signaled by the MACD cross was in place, there was the greater likelihood that the bearish move might follow through. As it turns out, it did; posting a gain of 220 pips between points B and C.
While this type of confirmation will not translate into a winning trade each and every time, waiting for the move to “mature” a bit before entering will result in taking higher probability trades.
Bottom Line: I would rather enter later and be right than enter earlier and be wrong.
If you lived in the United States before the year 2000, the thought of yellow and orange-jacketed traders screaming at the top of their lungs across a rainbow of other-colored jackets, slips of paper flying everywhere, is probably something you associate with markets and exchanges. These stressful environments were synonymous with the notion of markets. Emotions ran high, and depending on the exchange – one may even be risking their own personal safety by entering ‘the floor.’Times have changed quite a bit; many exchanges exist only in cyberspace, no longer seeing the need for physical manifestations of their trading activity. Even the New York Stock Exchange; have you seen it lately? If not, just turn on CNBC, it's not like it used to be (quite a bit more quiet these days).But one thing that hasn’t changed is the fact that people love fast markets. Only now they mostly exist through the Internet, and now they are available to anyone willing to risk their money – not only the select few that could afford or draw on family connections for a ‘seat on the floor.’ When a big news event happens; or even perhaps a news event driven by an economic catalyst, like the 2008 Financial Collapse, markets can attempt to price in the newest data so fast that prices move at breakneck speeds. For the poor investors that are in long positions in mutual funds, the hope of stemming the bleeding before market close doesn't exist. They have to wait and watch the devastation until the end of the trading day so that they redeem out of their mutual funds.But to the trader that can take a short position just as quickly as ‘hitting the bid,’ these ‘panic’ periods present quite a bit of opportunity. Prices are moving fast and pips can stack up quickly – if you are on the right side of the trade. The big question is if this is something that fits in your trading plan?What type of trader are you?By many accounts – fundamentals and news events create price changes, thereby – fundamentals dictate what prices will do. Technical analysis on the other hand, analyzes past price movements, showing us what prices have done. And sometimes, what price has done in the past can help us build a game plan for the future; looking to those fundamental catalysts to create big price movements (the hybrid fundamental-technical trader).The alternative approach is the trader that analyzes those same past events, looking to avoid those fundamental catalysts, hoping that the technical levels from the past hold true (the technical-range trader).That’s really all there is. A pure fundamentals trader wouldn’t be looking at charts at all, and a ‘technical-breakout/trend’ trader would really be, in many ways, looking to fundamentals to continue substantiation of those trending/breakout conditions, so they wouldn’t really be a ‘pure technical’ trader.Considering the fact that ‘panic’ markets can create rapid price movements in a short period of time, which can just as easily work against the trader as it can for them, it behooves one to know as much about their risk profile before wagering their hard-earned capital.So, if you consider yourself a ‘pure technical’ trader, and have no interest whatsoever in following or keeping up with the news – I advise you to attempt to avoid panic markets. This can often be done by setting stops at major levels of support (or resistance in the case of short positions) so that when we do get those big breakouts – they don’t work against you too heavily.For all those that dare to tread in fast markets – read on; and we will share with you some ways that experienced traders approach these volatile scenarios.How to Trade Fast MarketsThe same question was broached in the article ‘How to Trade Forex Majors Like the Euro during Active Hours,’ and the recommendation to trade breakout strategies could not be more on point.As David shows in the article, increased activity often means larger and potentially more erratic price movements. And because these movements can be more erratic, it can greatly affect the trader’s ability to forecast price changes. The chart below, taken from the aforementioned article, shows how widely price swings can magnify on EURUSD during the London and the London/US overlap session (often considered the most ‘active’ period in the FX market). Prepared by David Rodriguez, from Here is How to Trade Forex Majors Like Euro During Active HoursNow if we consider that panic markets often have an external stimuli; whether it be a natural disaster like what was seen in Japan in 2011, or a man-made disaster like what was seen at Bear Sterns and Lehman Brothers in 2008 – we have to know the market movements can be even more exaggerated, meaning price movements can become even more magnified, and forecasting can become even more difficult.Why trade breakouts to address panic?Because price movements can become greatly magnified while also becoming more erratic is the reason why trading breakouts is the best prescription for handling volatility. If we happen to be on the right side of the movement, price can trend for a continued period of time, giving us far greater potential profit targets if we are right. If we’re on the wrong side of the movement (which will probably happen more than half of the time), then we can cut our losses early before the pair continues against us in a move that could potentially drain our accounts.A critical aspect of trading breakouts is the necessity of strong risk-reward ratios, such as the trader risking 20 pips, but looking for 100 pips if correct. This could be expressed as a 1-to-5 risk-to-reward ratio (20 pips to the stop-loss order – 100 pips to the profit target = 1:5 risk-to-reward).This is what can allow rampant volatility to actually work in your favor.With a risk-reward ratio so aggressively on the trader’s side, one would need to be right only 2 out of 5 times to gleam a net profit. If a trader was right 40% of the time with a 1-to-5 risk-to-reward ratio, they could be looking at a handsome profit (2 winning trades at 100 pips each = 200 pips won, 3 losing trades at 20 pips each = 60 pips lost, net profit of 140 pips (200-60) not including commissions, slippage, etc).But what if the trader above was only right on one out of five trades? Well, they are still looking at a net profit (once again, not including spreads, slippage, etc). One winning trade at 100 pips only gives up 80 to 4 losers at 20 pips each, leaving a net profit of 20 pips; and that is with a winning ratio of 20%.How to Trade BreakoutsAn easy way of looking at breakout strategies is to simply think of ranges – and then reverse it.While range-traders look to buy support and sell resistance, breakout traders await breaks of resistance to buy (in anticipation of price continuing to rise now that resistance is broken) and looking to sell when support is breached (once again, looking for price to continue heading lower).There are numerous ways of identifying support and resistance levels to be used for breakout strategies. Some traders don’t even use indicators, electing, instead, to simply analyze and build their strategies off of price, and price action. Some traders rather use strategies based on indicators like Price Channels to point out these support and resistance levels. Many of the various Pivot Point offerings or Fibonacci studies can help in this same regard as well.Whatever the mechanism, it is important to realize that complete elimination of false breakouts is totally impossible. What often makes or breaks a breakout strategy is money, risk, and trade management.This is a hazard sport, as it can be a regular occurrence for price to break support (or resistance) briefly enough to trigger our, only to pop back into its prior range. This can be frustrating for breakout traders, and has even earned the title of the ‘false breakout.’This topic was explored in greater detail by Walker England in the article ‘Can False Breakouts be Prevented?’Not to spoil the article, which you should absolutely read, but the answer to the question is ‘No.’ False breakouts, unfortunately, cannot be prevented.To the trader looking to be more conservative, additional ‘wiggle room’ can be given to the entry in an effort to attempt to decrease the chances of caught by a false breakout.But preventing false breakouts is impossible due to the simple fact that no trader in the world knows what will happen next. So when trading panic markets, protect your trade, protect your account, and trade your plan.
Even the best forex traders in the world have losing trades - losing is a part of trading - but how do you react when you lose? How do you feel? If you're angry or sad; chances are you were risking too much, or taking a trade you knew you shouldn't - or both. Whether looking at a successful breakout trader, trend follower or scalper; there is always a common theme: they all have a trading system and they stick to it. These traders don't get emotional when they take a loss; they were trading according to their rules and the trade didn't work out. They lost a pre-determined amount they were comfortable with and accept it as an unavoidable part of trading. They move on to the next trade, knowing their system is profitable over the long term.tradAn inexperienced forex trader might open a long position in an uptrend thinking the market is continuing to move up. They didn't put a stop loss on the trade, as they were confident about the overall direction and worried about getting needlessly stopped out. They think "I'll exit if it moves against me" … Bearish news breaks and the market quickly move 100 pips against them. They are now looking at a 100 pip loss when it could have been limited to a fraction of that.Now what? The market snaps back 50 pips. The inexperienced trader is relieved "maybe it's going back up?!". BAM! classic 50% retrace before continuation: the market falls another 100 pips. This is too much for our trader; he finally cuts the trade at the lows, losing 150 pips. Over the next few sessions the pair recovers to his original entry and beyond, in line with the trend. Did they do the right thing, cutting at -150? Maybe - it well could have continued to fall.The fact is, our trader should have never been in this position in the first place and was forced to make a less than optimal decision. If they'd had a clear exit strategy in place, there would have been no question about what to do. Their stop loss would have been hit or they would have exited manually, (yet systematically) for a much smaller loss.Whether your entries are discretionary or systematic, you should always have a clear exit plan for each and every trade. Don't be left saying "What do I do?"Plan your exit and react accordingly.
Let’s take a look at the currency pair nicknamed The Bird or the NZD (or New Zealand Dollar) and USD (or US Dollar).As of late 2015, the exchange rate for the (indirectly quoted) pair is around 1 NZD / 0.67 USD. It follows that NZD is referred to as the base currency (or the currency that is intended to be bought or sold); USD is referred to as the quote or counter currency (or the unit of currency required for payment).Here’s a compilation of other facts about currency quotes:1. Currency pairs can be quoted in 2 ways: they can be presented as either direct quotes (also known as priced quotes) or indirect quotes (also known as quantity quotes). Direct currency quotes state the foreign currency price in relation to domestic currency price. Indirect currency quotes, on the other hand, state the domestic currency price in relation to foreign currency price.In an example similar to the one above, let’s say that the domestic currency is the NZD and the foreign currency is the USD. A direct currency quote, in such a case, is USD/NZD. If this were quoted indirectly, it’s NZD/USD; furthermore, it means that with 1 NZD, you can purchase 0.67 USD.2. Upon encounter with a currency pair that does not have the USD as either its base or its counter, the currencies are referred to as cross currencies. The list of examples of such currencies are EUR (or Euro) /GBP (or Great Britain Pound) and CHF (or Swiss Franc) / JPY (or Japanese Yen).3. Quoted currencies are known to come with bid prices and ask prices. In a currency quote, the first figure is the bid price; the second figure is the ask price. Here is an example involving the NZD/USD pair:NZD/USD = 0.6700/10Bid price = 0.6700Ask price = 0.6710When setting a short position, the bid price is involved; it is the price that a dealer is required to pay When establishing a long position, the ask price is the price required by a dealer. It’s important to note that the figures will always be expressed in terms of the base currency.In this regard, the knowledge of spreads is important in currency exchange; it is important when learning about the correct way to go on with your forex transactions. Particularly, the spread is the difference between a currency pair’s bid price and ask price; in the example above, the spread is 10 pips.