Do you have the killer instinct? Can you press the trade? Then the following trade-management technique may be for you. If you ever want to hit home runs, if you ever want to make a huge score in trading, then this is the only way for you to trade and FX is the single best market to effect this strategy.
Let’s review the EUR/USD trade discussed in last month’s article. Again, assume you get short at 1.2500 but this time your strategy is different. If the pair trades up to 1.2550, you cut your loss quickly and await the next opportunity. If, however, the trade moves your way, you do not automatically take half the position out of the market. Rather, you wait patiently and watch the price action. Imagine the price has now moved to 1.2200, fully 300 points in the money. Instead of taking profits, you add another unit to the trade. If the price begins to retrace all the way back to 1.2350, you cover the whole position for a scratch. You haven’t lost anything on the trade, but you haven’t made a profit, either.
However, if the price retraces only slightly but then resumes direction, you stay in the position and again monitor price action carefully. The price has now reached 1.2000 and you sell another unit at that price. You now have sold a total of three units at an average price of 1.2230. As long as the price remains below this level, you stay in the trade.
Your patience pays off and the price collapses to 1.1700, at which point you finally cover the whole position. Let’s review the total profits from the trade:
•1 unit at 1.2500 covered at 1.1700 results in a profit of +800 points.
•1 unit at 1.2200 covered at 1.1700: +500 points.
•1 unit at 1.2000 covered at 1.1700: +300 points.
•Total profit: 1,600 points.
•Total risk: 50 points.
For those traders who can implement this strategy, this is clearly the best way to trade. Dennis Gartman (the famous investment newsletter writer), an old pit trader himself, calls this method “doing more of what is working and less of what is not.” It is no doubt deceptively simple and seductive.
In fact, here is a description (taken from the Elite Trader bulletin board) of another famous pit trader, Richard Dennis, employing just such a strategy in the bonds.
As someone who has seen the likes of Rich Dennis and Tudor Jones operate, those “5 percent” winning trades involve add-on after add-on. Case in point is Dennis in the 1985-86 bull market in bond futures. He would start with his normal unit of 500 contracts and get chopped for days.
Buy the day’s high, put ’em back out on a new swing low, etc. Every once in awhile he’d wind up with 500 that worked. Then he’d start the process higher, all over again. Work ’em in, work ’em out.
After maybe a couple of months the market has rallied 10 points from where he started and he has 2,000 on (meaning 2 million a point). Now the market is short and ready to pop on any size buying and he’s there supplying the noose. Bidding for 500 on every uptick, he finally gets to a point where for the last month of the move he has 5,000 on. Tbonds rally 20 points in just over a month and he’s up $100,000,000 on a trade that started out with him just testing the waters, losing $100,000 a few times before he could establish a position worth doubling up on.
Wouldn’t we all want to own that trade? One trade, $100 million in profit. But let’s remember what’s required to get there:
• Accurate directional entry into trend.
• An intense, multi-hundred-point trend with little or virtually no retracement along the way.
What are the chances this type of strategy succeeds? Minimal at best. Note that the writer described these as “5 percent” trades, meaning they occurred only 5 percent of the time. In fact, the perfect confluence of events to generate such profits probably happens less than that.
Far more than the fortuitous market conditions necessary to produce such windfall profits is the unbelievable psychological pressure such trading will generate. The term “pressing the trade” is most apropos to describe this dynamic. Not only is the trader pressing the market by adding more and more units as they go deep into the money, but he is also pressed by the market as his profits pile up.
Put yourself in Richard Dennis’ place. Would you be able to stay in the trade once it hit $1 million? How about $10 million? $50 million? At each level the intensity is enormous, and for most people the pressure of winning can be far worse than the fear of losing.
Forget Richard Dennis and just think how you would have felt if after selling the third unit at 1.2000 you had to cover at 1.2233 as prices retraced, and you had to watch a certain profit of 700 points evaporate.
For those unconcerned with such issues, for traders who are more than willing to suffer a long series of losses and empty trades for a chance to score big, FX offers the best opportunity to do so of any financial market in the world. Why? Leverage and liquidity.
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