The hardest part of trading is how to time correctly the market and, although there isn’t a sure way, you can use two methods.
The first one is by using technical analysis in line with the fundamental direction. Let’s say you’re bearish EUR/USD because you expect the Fed to be faster in its tightening cycle than the ECB and you want to find a good level to short the pair while limiting your risk.
So, you proceed to make some technical analysis on the EUR/USD chart marking your swing levels, trendlines and so on. You find good spots where you can execute your trades limiting your risk by placing the SL some distance away from your entries where you think that your ideas would be invalidated if the price gets there.
The biggest problem with a technical entry is that you don’t know what level may actually hold and therefore you may get stopped out more times before getting it right or you may not even get the chance of an entry because the market just proceeds in its direction. That’s where the second method comes handy.
The second way is by using catalysts in line with your fundamental idea. A catalyst can be anything from a breaking news to an economic report and it’s basically something that the market is focused on and makes it move immediately and in a more sustained way in your direction.
Let’s say, as per previous example, you are bearish EUR/USD because of the divergence between the Fed and the ECB and you want a reason to short the pair without risking a technical entry. Therefore, you wait for a catalyst, something that the market is focused on and can reinforce your fundamental idea. The market meanwhile moves in your direction and you get some type of FOMO seeing the price going your way, then it ranges and so on. That’s when you should be disciplined and wait.
Then the catalyst comes. You immediately strike and jump in shorting the pair and placing your SL above a good technical level you marked up previously and wait for the market doing its thing.
- Now three scenarios may play out. The price goes your way and from that moment on you just manage your position by reducing risk, taking some profits off the table if you want and so on.
- The price just stays there and even goes in the opposite direction in which case you just should cut your trade and wait for the next opportunity.
- The price goes immediately in the opposite direction BUT you think that it’s wrong and you “fade the reaction” shorting at better levels. This last scenario requires some experience and independent thinking, you may get it right or wrong, but if you have a high conviction in your analysis then it’s worth the risk.
You can also use the two methods in conjunction. For example, you can use the technical levels as kind of risk barometer and manage your trades accordingly. So, if the price after a catalyst instead of going in your direction breaks a strong level in the opposite direction and just runs, then you can just cut the trade.
If we take as an example the first arrow in the previous picture, that was a US NFP day.
That technical swing level is really good, but the price reached that level only after the reaction to a bad headline number. At that time though the market was focused on wage inflation and average hourly earnings surprised to the upside. That’s when you “fade the reaction” going in the opposite direction and can use the technical level as your risk limit.
This way of trading can help you to avoid unnecessary losses caused by the urge of being in the market everyday and getting caught in the day to day noise. Remember that your job is not to trade but to make money.
This article was written by Giuseppe Dellamotta.