Trade Forex Fundamentally

Use the right forex trading strategy for the right environment or you lose…

The last few posts covered how to guage sentiment and imbalances in the market to select the right direction and currency pairs to make money trading forex. In this forex trading tutorial we cover how to actually enter the trades in a specific market environment using the so called, “short gamma” forex trading strategy. 

Once you’ve gotten the hard part done (analysis and selecting a direction to trade in), all you have to focus on is selecting the right forex trading strategy and looking for a trigger that signals when to enter. Let’s cover two simple forex trading strategies for entering the market, which should be selected carefully depending on the current market environment to maximize your chances of making money trading forex.

“Short Gamma” trades (low volatility forex trading strategy)

What you are basically doing with the short gamma trading system is taking advantage of the choppy up and down price action during ranging periods and relying on the fact that prices tend to “revert-to-mean” when there is not a strong enough driving force to push price in one direction or another. If you bring up a daily price chart of your favorite currency pair, notice how high volatility price bars caused by the release of important economic news will push price directionally for a few days until it hits the uppper end of the range and then returns back to the middle of the range it’s been in, after the excitement wears out. This happens several times until a catalyst, or “Gestalt Shift” gives the market enough conviction to move price out of the range and transition into a trending environment.

Warning! To make money trading forex involves thinking differently from commonly accepted beliefs

Warning! Some of the things I’m about to show you go against common thinking and may shock a few people. But don’t worry, the ones who do something different from the crowd and “think outside the box” are the ones who win in this market. If you are not prepared to do this, I suggest you not try to make money trading forex. If you’re with me, then read on…

Attention signal (Is there an opportunity?)

With short gamma trades we want to first identify an opportunity. The indication of an opportunity is that we are in a ranging environment. Remember when we talked about market cycles? We want to make sure conditions are right for entry. Market cycles tell us that whenever there is a big, sustained directional move, price eventually slows down and enters a range to buy time for the market to absorb the implications of the latest move. That means when you see a big move followed by the formation of a recent high and low within 400-700 pips of each other, it is likely that the market is taking a rest and entering a sideways-ranging period. When this attention signal shows itself, we start looking for triggers to enter.

Remember, just because price has been ranging for several months and isn’t making a sustained move in any direction doesn’t mean that you want to sell the tops and buy the bottoms in that range: this is VERY DANGEROUS. If you don’t know what you’re doing and don’t select a direction ahead of time, price could spike out of the range in either direction and cause a big loss. Part of our edge is aligning ourselves with the direction of the fundamental trend of the market so that we’re prepared if the market breaks out. Use sentiment from forex indicators such as COT, currency strength, and price action to news events to select the correct direction.

The trigger for entry

Contrary to popular belief, in these types of environments, it doesn’t matter precisely what price level you enter at because things are so random. Most traders focus on using a dozen indicators and patterns to try to time the exact moment and price level of entry to maximize their chances of success, but take it from my experience that this is a fool’s game. As long as you’re aligned with the right direction then you will make money trading forex due to both the intraday gyrations of the market and the underlying fundamental driving force moving the currency pair. Your trigger is to enter after a range has formed. Here’s how:

1. Enter the first position in the direction of sentiment at a consistent time of the day of your choosing, preferably after price has pulled back a bit.
2. Set your stop loss at 2 * the 14 day average true range (ATR) value to allow plenty of room for randomness- (i.e. for price to “breathe”) so you don’t get stopped out easily by the randomness of the market. If the ATR is 100 pips for today, then your stop should be set at 200 pips.
3. Risk no more than 5% of your account equity. If you have a $20,000 account and your stop loss is 200 pips, you would buy with a position size of 50,000 or 5 mini lots.
4. Enter a second position after at least 2 days have passed and price has moved a bit away from your first entry (this is to allow the market time and space to move around so that you don’t overleverage yourself)
5. Hold no more than 2 positions at a time
6. Take profits at 1/3 the size of your stop loss (e.g. if your stop loss is 200 pips, then you take profits after 0.33*200 = 67 pips have been reached). I know this sounds like heresy to those who have heard, “run your profits and cut your losses short,” but does that adage really make sense when the market is not making any sustained moves?
7. Do not enter if price moves against your direction violently. This means that something is surprising the market and volatility is increasing (which doesn’t suit this strategy). Objectively this means if you see a big downward candle on the chart when you’re going long that is at least 1.5-2*ATR. When this happens, wait for price to stabilize and start moving back toward the middle of the range while going in your direction. Patience pays off here.

There you have it- how to make money trading forex in low volatility environments. The next post will be about how to trade in high volatility markets.