Trading 101 says "ALWAYS place a stop". So you follow that rule and three trades later you have been stopped out on every position losing a total of 30 pips.

Well, silly trader. Your stops were too tight. I can guarantee that a 10 pip stop will be hit in close to 100% of your trades. So what is the right level?

A simple answer is: A stop should be 10-20 pips beyond the level that determined why you entered the trade. For example, if you entered a long trade because price exceeded yesterday's high, then set your stop at 10-20 pips below yesterdays high.

There is a problem with the whipsaw effect though. To illustrate lets take a look at the following GBP/USD hourly chart. I want to take the short trade at the closing price of 1.4878. There are a host of good reasons for this trade but the primary trigger is that price closed below the 62 EMA (Blue colored line). I want a target of 100 pips and I would place a stop at 1.4935 which is 23 pips beyond my trigger, the 62 EMA. This follows the simple stop rule. [side note: This setup is for illustration purposes only. Don't use a similar setup for an actual trade. Play along with me though and you will see the point!]

The next chart shows the whipsaw that stops the trade out. At that first stop it is easy to believe that the previous uptrend is going to be continued. This would mean that price would continue to rise after hitting the stop.But in fact, price returns downward with a candle closing again below the 62 EMA. So I enter a short trade again at 1.4894. I set the stop at 1.4935 (same as last time) and my target is now 116 pips.

Oops! I get stopped again. Two trades, two stops, and I am down 96 pips. I must be an idiot to have believed that price was going down. Obviously price is going to return to the uptrend as it won't break through some support level around 1.4865. So I should reverse and ride the trend up and up!

That would be a silly move as the next chart shows. Price in fact makes my initial target and with 20 or so pips beyond before encountering any support. So where was the error? Did I just enter too soon? Were my stops too close? And if that's the case how big should my stops be?

The answer is that the stop was at the wrong level. The right level is illustrated in the third chart. It is above the Pivot point. The Pivot point (shown as a dashed magenta line) works as a protective barrier far better than the 62 EMA. But if you regard the 62 EMA as the first barrier, then the stop is placed two barriers beyond entry price. Under this scenario, the first trade could be held to completion. If a 83 pip stop is too steep, then entering the trade at either circled point would yield a more modest stop and a very profitable target.

The new stop rule: Set your stop 10-20 pips behind a protective barrier a level deeper than your entry trigger.

The next question that should jump out is "What are protective barriers?" Any price level that acts as support or resistance is a protective barrier. I don't want to over use the term "barrier" but it is an illustrative term. But to get back to standard terminology, we are talking about support and resistance. The support and resistance levels (SR levels) I use are the 62 EMA, the 248 EMA, the 800 MA, the Pivot points (Pivot, S1, S2, R1, R2), Fibonacci levels from the most recent trend of at least one day, and the previous day's high or low. For stops and targets, the ones I use the most and in order of significance are Pivot Points, 62 EMA, and Fibonacci levels. Any time two or more SR levels are close together or equivalent, I regard that level to be especially strong.

There is much more to be said about stops, but we will have Part 2 in a later post.

Published in 1866, Robert Louis Stevenson's novella The Strange Case of Dr. Jekyll and Mr. Hyde was a masterpiece that dealt with the duality of our natural selves being both good and evil. For millennia philosophers, religious leaders, and thinkers of all political, national, educational and theological stripes have debated whether man is inherently good or evil or, as Mr. Stevenson put forth, both. I would contend that we are both, and it is the struggle to overcome the evil that defines our existence. It is the hope, indeed the promise that we can overcome evil, that makes life worthwhile. Indeed, it is the love reflected in a child's face and the bright faith in a better future for that child that define the pinnacle of joy for most of humanity.

But I digress.

This is a blog about trading good and trading evil. I confess to succumbing to trading evil. The trading week ended May 1 (2 weeks past) was entirely dominated by my Mr. Hyde trading persona.

My children call this persona Chuck. Chuck is the person that yells at them to do unreasonable things. Chuck is the person that is irrational, angry, rude, and otherwise evil. Daddy, however is loving, cheerful, generous, and a joy to be around.

In trading, Chuck is brash, self-conceited, over-confident, fixated on a particular outcome despite all evidence to the contrary, and completely beyond reason. Once Chuck is in control of trading, no amount of risk is too great. He becomes certain that price is going to a certain level and any opposing movement is just an unexpected pull back that will come around to his determination of the future. At a point Chuck will become desperate and compound his investment by doubling down. He will move from a reasoned position to a maniacal losing position and short of outside intervention, nothing can prevent him from a disastrous result.

In my case, there are warning signs of the emergence of Chuck. I am of the firm hope that Chuck can be contained, controlled, and even banished by several key steps.

First, recognize that Chuck exists and will always be lurking in the shadows. Such an acknowledgment keeps one humble and in the proper defensive frame of mind.

Second, allow someone close to you to monitor your trades and trading progress. This person can step in and cut Chuck off at the knees before too much damage is done.

Third, never enter a trade unless you know these three things:

1. Why you are entering the trade
2. What is the profit target
3. What is the stop price

Fourth, request (or insist) that the person close to you ask you for those three things. That person can intervene if the answers are not certain.

I will elaborate on stops and how to use them in a subsequent post.

+210 Pips +21.1% growth 10 Trades 80.0% Wins

+250 Pips +12.4% growth 10 Trades 80.0% Wins
Click here for explanation and commentary.

Are you a Geek?

If you have the smallest amount of geek in you, you will find the following information fascinating. If you are the Anti-Geek and could care less about why things are and how they came to be and other such stuff.... if that describes you, may God have mercy on your soul.

However, if you, like me, find background information, the hows and whys, and math, and geometry, and slightly famous Italian Mathemeticians spectacularly interesting; then you will love this post. As an added bonus, I am going to tell you some things you probably have never heard if you have only read about Fibonacci ratios from Forex sites or other such sources.

Who is Fibonacci and why do we Care?

Leonardo Bonacci, aka Leonardo of Pisa, was a 13th century mathematician who introduced the Arabic Numeral system to Europe. His father ran, or more accurately managed, a Pisan trading post in Algiers where the bright young Leo was introduced to the superior arithmetic used in the Arab world. At age 35 he published a book Liber Abaci (Book of Abacus or Book of Calculation) which described counting in Arabic numerals, processes of multiplication, conversions including currency and profit (hence he was involved in Forex!), formulas for arithmetic and geometric series, and other such subjects. Surprisingly, the book was a great hit among the 13th century elite and he won a salaried (sort of a tenure) position with the Roman Emperor Frederick II. He was given the name Fibonacci posthumously which means "little one of Bonacci"

In one chapter of the book, he addressed the very pressing problem of rabbit farmers in medieval Europe expressed as, "How many rabbits can be bred in one year?". The resulting answer was the following series of numbers:

1,1,2,3,5,8,13,21,34,55,..... where each subsequent number F is represented by the formula F_n = F_(n-1) + F_(n-2).

So why is this sequence important? The sequence grows at a rate 0f 61.8% which is the Golden Ratio and designated by the ancient Greeks as 'φ'. (Actually, the growth of the sequences approaches φ and it is only approximate with the early numbers of the sequence.)

It appears that this sequence and the Golden Ratio appear a lot in nature and in the heavens. It also is found in architecture both ancient and modern. It is used in Computer Science theory. More than a few doctoral dissertations have centered on it. And some very successful stock, commodity, and Forex traders have used it to amass fortunes.

Forget Rabbits, what about Honey Bees?

Not everyone believes in the magic of Fibonacci numbers in Forex or market trading in general. Some people even scoff at the notion and say that these ratios only work because everyone is using them. I think such naysayers are nincompoops. But before we discuss the use of the Fibonacci sequence and the Golden Ratio in Forex, I want to share some fun information.

Everyone has heard the story about the rabbits. Fibonacci skeptics will tell you how rabbits don't really reproduce the way Leo described it. Well, then let me introduce you to honey bees. I ripped the following snippet from a Dr. Ron Knott who has a bunch of accreditations following his name: Ph.D, M.Sc, B.Sc (Pure Maths), C.Math, FIMA, C.Eng, MBCS, CITP. I'm sure he's a lot smarter than me.

Honeybees and Family Trees

There are over 30,000 species of bees and in most of them the bees live solitary lives. The one most of us know best is the honeybee and it, unusually, lives in a colony called a hive and they have an unusual Family Tree. In fact, there are many unusual features of honeybees and in this section we will show how the Fibonacci numbers count a honeybee's ancestors (in this section a "bee" will mean a "honeybee").

First, some unusual facts about honeybees such as: not all of them have two parents!
In a colony of honeybees there is one special female called the queen.

There are many worker bees who are female too but unlike the queen bee, they produce no eggs.

There are some drone bees who are male and do no work.

Males are produced by the queen's unfertilised eggs, so male bees only have a mother but no father!

All the females are produced when the queen has mated with a male and so have two parents. Females usually end up as worker bees but some are fed with a special substance called royal jelly which makes them grow into queens ready to go off to start a new colony when the bees form a swarm and leave their home (a hive) in search of a place to build a new nest.

So female bees have 2 parents, a male and a female whereas male bees have just one parent, a female.

Here we follow the convention of Family Trees that parents appear above their children, so the latest generations are at the bottom and the higher up we go, the older people are. Such trees show all the ancestors (predecessors, forebears, antecedents) of the person at the bottom of the diagram. ....

Let's look at the family tree of a male drone bee.

1. He had 1 parent, a female.
2. He has 2 grand-parents, since his mother had two parents, a male and a female.
3. He has 3 great-grand-parents: his grand-mother had two parents but his grand-father had only one.
4. He has 5 great-great-grand parents [--edited by me]
5. He has 8 great-great-great grand parents. [--edited by me]
6. He has 13 fourth-generation grand parents. [--edited by me]
7. He has 21 fifth-generation grand parents. [--edited by me]
8. and so on ...

... [thus we see the Fibonacci sequence in the number of grand parents in each increasing generational level --edited by me]

Source: The Fibonacci Sequence as it appears in Nature by S.L.Basin in Fibonacci Quarterly, vol 1 (1963), pages 53 - 57.

Even the bee does Fibonacci!!

Its Easy to Draw Fibonacci

An old trading adage says "Buy on the dip. Sell on the high." Here I will introduce a practical application of that adage using Fibonacci ratios known as extension levels.

If you were to buy on the 'dip', extension levels would define the 'high' where you would sell. Graphically, we can illustrate by using the points A, B, and C.



Price has trended up from point A to point B. The total increase in price is represented as 'B-A'. Price then dips to point C. This is where we would buy. Point C (the Buy point) can be taken from Fibonacci Retracement levels. (ie. 23.6%, 38.2%, 61.8%, or 78.6% retracement.)

Once a buy order is taken, a profit target needs to be determined. This is where extension levels come in. The following chart illustrates various extension levels. I use terminology taught by Joe DiNapoli for the levels. The first is "COP" which stands for Contracted Objective Point. The second is "OP" which stands for "Objective Point". And the third is the "XOP" which stands for "Extended Objective Point".

It is based on the math shown below using the Golden Ratio of 0.681. There are four different columns showing extension levels that depend on the level of retracement.

ABC Extensions	C = 0.618	C = 0.382	C = 0.236	C = 0.786
(B-A) X 0.618 + C = COP	1.236	1.000	0.854	1.404
(B-A) x 1.00 + C = OP	1.618	1.382	1.236	1.786
(B-A) X 2.00 + C = XOP	2.618	2.382	2.236	2.786

Generally, I only use the extension levels based upon a retracement of 61.8%. And my target will always be the COP point (1.236). That is more than enough profit for a single trade.