EUR/USD hasn’t closed at 1.3350 or lower for almost a year. That is a fact. And based on this fact, I am planning on going long. Continue reading for the most simple, almost naive approach to forex trading.
I am not an active forex trader. As a matter of fact, I do not trade regularly any more, due to lack of time. Yet, from time to time I scan the forex charts, looking for a promising setup. This one on EUR/USD chart I’d say is safe that promising. For one good reason:
Yes, I like repeating myself, because you are likely reading this post in fast-forward and I need you to, at least read the line above. After all, it’s the article’s main point.
Today, Euro is trading for 1.3380 US dollars.
Going long on support. Have you heard it before?
Of course you have. Buy at support levels, sell at resistance levels. If only trading was that easy. Still, some traders (majority?) will be going long at 1.3350.
For a bunch of reasons, like “1.3350 is cheap for Euro” or “US economy is about to crash” or “what goes down must go up”. At the same time, other traders will find bearish signs on the forex chart and will probably bet on a break down. I don’t care about them. I care about my trade. This particular trade on EUR/USD.
Sure, a break down is possible, that is support to fail. It has happened before. It will happen again. That is what stop loss orders are for. Preventing from losing too much money on a single trade. So, instead of watching my trade eating up my funds, I will place a stop loss. A loose stop loss, way below my entry point (1.3380). How about a stop loss at 1.3280?
A 100-pips stop loss! I need it to be that loose, since I am trading on the daily chart in this case. Like yourself, I have traded on the 5-minute chart and have used tight, 5-pips stop loss orders before. I am not afraid to tighten my stop loss up. It’s just that it doesn’t work that way.
True, I could load the hourly chart and use that for setting a tighter stop loss. But I won’t. I’m staying faithful to the daily chart.
Others will join me and buy EUR/USD today, tomorrow or during the week. If we, buyers are more than sellers, EUR/USD eventually will rise. If we kneel due to selling power, Euro will fall. Yet, in that scenario I stand to lose no more than 100 pips according to my trading plan.
Thus, I risk 100 pips on this trade. I’m going to trade a mini-lot and risk a hundred dollars. Less than 1% of my trading capital. Surely my bankroll can afford this trade. Can yours?
But, what is my reward?
Setting a 3-to-1 reward. Or not?
Have you heard of risk/reward ratio? I bet you have. Since I risk 100 pips, my RR ratio would be:
- 1-to-1 if my profit target is 100 pips as well.
- 2-to-1 if my profit target is 200 pips.
- 3-to-1 if my profit target is 300 pips.
You get the idea.
Experts will advise me to aim for the ultimate risk/reward ratio; the 3-to-1. They’ll do so, because beginners fail when predicting the market. Thus, if they are lucky enough to make correct predictions 25% of the time, they’ll break even. That’s fair.
Only, I am not a beginner. Setting different profit targets is managing a different trade each time. Why?
- If I believe EUR/USD’s chance to gain 300 pips before losing 100 is 26%, I’d pick that trade for its miniscule value (4%).
- If gaining 200 pips is 35% likely though, I’d rather set a 2-to-1 risk/reward ratio because my edge or long-term net profit is bigger (5%).
- Finally, if the 1-to-1 RR ratio is 55% likely, that trade’s value is now 10%!
See? By just changing the profit target and keeping the entry and stop loss levels constant, I’m able to compare 3 different trades. Only I am able to trade only one! And I’d pick the one with the most value.
Is 1.3480 a good profit target for my 1-1 RR ratio trade? It certainly is. 1.35 has been a key support level till now and I highly expect the awaited EUR/USD reversal to meet substantial resistance.
How about 1.3580 or 1.3680 for the other trades? Maybe there are good too, but I can’t give an estimate of how likely Euro is to climb that far. So, I’m sticking with my 100 pips profit target and hope I’m correct 55% of the time. The only way I’m losing money is if I’m wrong more than half of the time.
Do you want to complicate this trade a bit? How about scaling out 80% at 1.3480 and moving the stop loss up to the break even point? You could do just that, but remember: I’m keeping this trade as simple as possible. And for one good reason.
EUR/USD hasn’t closed at 1.3350 or lower for almost a year.