Although I do not encourage day trading in the forex markets as can be seen from the recent 2 days volatility with the SNB abandoning its CHF cap, there are those amongst us who can really discipline themselves and make a success out of day trading. But it takes a lot of discipline, carefully watching the day volatility and determining quick entry and exit points. Just imagine if you went long for a short hour on the EUR prior to the SNB making its announcement? All the more reason I continuosly and strenuously advocate trading with a hedge. Stop losses are largely ineffective in rapid moving markets and when they get overrun you could be in for a horrific shock as to where your stop actually fell when your provider fills your order.
So for those who do have the mental toughness and discipline to handle this arena then let us examine how a day trader can handle the whipsaws and reversals that frequently occur when sudden news events sends the volatility shooting for the stars! because everything that goes down goes back up and vice versa; it is the nature of the universe; the Yin and Yang and to and fro of price action.
Usually day traders wait for news events like economic data releases and they perfect their entry points on the sudden releases of data and manage risk through the application of a stop-loss. However, surprises to come, as with last this Thursday's shock SNB announcement that caught many big traders wrong footed. Losses frequently compound with further entries. It would take a revolution in human nature were we to confess that the whole human ego could be contained from the slightest impulse to re-enter a position having had the original stop-loss over-run. Thereafter, swift moving markets can lead traders into false traps as a second trade gets wiped out and the human ego gets hurt and foolhardy enough to enter a third trade with a stop-loss fooling his own self that the market will turn and that his analysis should stand without correction. Nothing can be further from the truth. It takes utter humility to learn this painful lesson that once over-run; walk away from the screen, temper your flaring ego, and come back a little later on to see how the dust has settled.
But any how, let us try now explore how we could manage risk in the face of adversity. Let us now attempt observe a market reversal in the following 5 minute chart of the to illustrate how a trader can manage to contain reverse and risk effectively and ride the negative pullback even in spite of closing the stop loss marker and minimize losses to potentially earn a modest profit.
Let us assume that on January 13th 2015, 6am GMT, that is 2 whole days prior to the market chaos on the EUR, we entered a long FX cash position in the following EUR/ USD chart coupled together with a put option on the March 2015 Future, together with a Stop Loss. In the chart below see the first blue star to represent our long entry.
Thus our entry would be -
Cash FX - 1 Long - 1.1785
Stop Loss - 1.1775
Put Option Mar 15 - Strike 1180 at 0.01900s = $2375.00
Using an option as a safety valve in the short term can be expensive, however, 1. losses can be mitigated if the long position is stopped out (( as can be amply illustrated with the SNB causing chaos with the CHF and the EUR)), and 2. the use of the option can be retained for further successful longer term forays to trade on the dips for short periods of time. of course the option will only retain a net value so long as time decay does not begin to decrease at a greater rate than the previous day. That is why if you purchase an option then make sure you have decent time value for your purchase, like taking an option on the 2nd contract forward. The premium maybe expensive but the outlay worth its weight in gold in adverse market movements like what happened the last 2 days with the EUR. So a successful day swing trader may be able to get some good mileage out of an option for as long as perhaps 5 trading sessions, bearing in mind Exchange fees can run high for the entry and close of the option position.
Now after the first long trade has been entered we are adopting the outlook assuming that the market will bounce upward after several negative sessions but with an extra option insurance to protect the downside. Then from there we will take a look at how we can react when things hypothetically go wrong.
Now here is the 5 minute chart for the EUR/USD on that day 13th Jan -
Now during the course of the day at 9am our cash position had got stopped out with a loss of 10 pips because the cash price declined through 1.1775 and in fact reached 1.1760 by 10am. Our original swing trading idea of taking a long to take advantage in the easing of selling pressure has backfired.
Our new net position would be -
Cash FX - 1 Long - - 1.1785 stopped 1.1775 - 10 pips
Put Option Mar 15 - Strike 1180 = $2400 (+25)
Thus although we got our trade wrong, the put option has indeed protected and minimized our losses to some extent subject to deduction of Exchange fee. Of course the option requires a premium down-payment particularly if your strike price is near the market price and represents a bigger cash outlay than the cash FX. But in the long run, with good time value, the option insurance value can be retained for good purpose so long as time decay doesn't rapidly begin to grow. A mere 30 days can be a lifetime in the forex markets. Indeed if we decided to let the put option run without further cash long entries then the put option could potentially accumulate value where the price of the cash FX to sink further to 1.700 and beyond due to long term weakness in the market. However if we had day traded without the option we would be 10 pips loss. Thus trading with options add to a degree of safety in that losses can be minimized. Furthermore, in view of the last 2 days, should our put option trade still have been in place on thursday morning, then put option would have rapidly increased in value as EUR sank to the 1.16 and further.
But coming back to our angle of Day Trading, let us now assume that on an 13th we decided to enter another long cash FX represented in the chart above as a 2nd blue star entry.
Our new position at 10am would be thus -
Cash FX - 1 Long - 1.1760
Stop Loss - 1.1750
Put Option Mar 15 - Strike 1180 = $2400 (+25)
Now on this day the market bounced from 10am to 12 noon to 1.1795
Thus our new net position would be -
Cash FX - 1 Long - 1.760 - + 35 pips (closed 1.1795)
Put Option Mar 15 - Strike 1180 = $2350 ( -$25)
Options prices do not exactly move with cash FX and may present arbitrage opportunities.However exchange fees can vary.
From here on the market hit a sideways trading channel for the next 10hrs before further decline, which became the lull before the SNB storm 2 days later on Thursday.
In this manner the successful day trader first of all suffered a setback with the first long fx position losing 10 pips, albeit with protection of the put option, and then in a second fx position entry a plus of 35 pips was made taking advantage of short term swings in the market and to net 25 pips overall in total for the 2 trades.
The professional swing trader would then let the put option hold since there are another 60 days to expiry and significant time value in the option and accumulate in value until the point of deciding to make the next long entry in another swing trading entry to take advantage of respite when pressure eases off the Euro. At the 1600's within a few days of retention the put option may have gained $250-300 dollars before exchange fee as it still has significant time value inherent.
Prices do not go down hill all the way if you could pull up a 6 month chart of the EUR/USD. prices may have fallen but they zig and they zag.
Successful day traders take advantage of this zig and zag like learning to harness the Yin and Yang opposing forces. They would swing trade with long entries and maintain put option position in the direction of the trend being short. Up or down, high volatility or love volatility, taking a short or long cash fx position can sustain any damages should adequate option protection be maintained as in the example of the EUR crash on Thursday this week. Furthermore should the trader decide to switch strategies from the short term swing trade to a longer trade, then the put option could be rolled over, should the trader deem it necessary to trade all the way down the price action should the EUr naturally gravitate to the 1.00 parity as is forecast.
The key is flexibility. the necessity is to know when to switch from a short term trading strategy to a longer term position. markets are constantly in flux. and as the SNB showed us on Thursday, sudden surprises can stretch known volatiles to the limits. Price movement means price discovery and opportunity. in an adverse scenario should the long fx cash position be stop lost even 200 pips away from it's original entry, the put option increment in value would negate the loss incurred through an over-run of the stop loss. I cannot underscore the value of options hedging and the market action on Thursday demonstrates the reasons why options hedging should be advocated.
Conversely, with an upward trend a swing trader may look to short every respite in buying pressure and maintain a call option position in the direction of the trend being long.
In this manner a trader may not get his results right every single day, but in the long run with options trading he has mitigated his chances of losses on bad days and has increased his chances of gain on good days subject to Exchange fees for trades.
Pieter Bergli - DeLoren Trust Holdings
Forex education technical training for currency traders
Disclaimer - U.S. Government Required Disclaimer - Commodity Futures Trading Commission
Futures and Options trading involves risks of losses. No representation is being made that any reader and account will or is likely to achieve profits or losses similar to those that are being discussed on this blog http://forexeducationperspective.blogspot.com/. The past performance of any trading system or methodology discussed is not necessarily indicative of future results.
CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
All trades, patterns, charts, systems, etc., discussed in this blog http://forexeducationperspective.blogspot.com/ are for educative and illustrative purposes only and not to be construed as specific advisory recommendations for actual trades. Disclaimer - http://forexeducationperspective.blogspot.com/ bears no responsibility for the trading actions of its readers.
