Quelling two of the five most common fears in trading: event risk, and trade expectancy, will go a long way in quieting the other three: fear of failure, fear of being wrong, and fear of no control. This is because event risk and trade expectancy are directly related to trading, while the other three are personal foibles. Event risk is not so hard to deal with using sound money management and stops, but fear of trade expectancy… well that is what proves the end of the road for most speculators.
Trade Expectancy is your anticipated win/loss ratio plus your risk to reward ratio. Without having a good idea what those numbers are, you will not be able to stomach the risk of executing a trading system through even reasonable draw-downs. It is essential that you understand how your method or system will perform overtime in all trading environments. The biggest road blocks to a high expectancy rate, i.e. success, is that markets have 2 different tendencies, which categories the speed and distance with which they move through time: the first is trending, and the 2nd counter-trending. It can be difficult to make money consistently with one method in both environments, particularly if you are on a higher time frame chart; difficult in a demo account, dangerous in a live account. Experienced traders understand that markets spent more time moving in counter-trending patterns than trending. This is because of #1: professional market makers – whose job it is to supply a constant bid, and a constant offer in a market, i.e.: buy and sell all day long as many times as they can which creates a sideways pattern– and #2: low event risk, a.k.a. lack of new news (significant incoming information) to move the markets from one level to another.
But just when the market appears to be giving a reliable sideways pattern, the rate of change suddenly increases and the price snaps higher, or lower, with little or no warning and we go from a listless sideways environment, to a violent, trending environment. You need to be able to trade in both climates, which is more difficult to do on higher time frame chart using just one methodology. This is because the longer you are in the market, the greater your risk. If you are trading a daily chart your risk/reward is in proportion to the size of a daily candle. So to trade a higher time frame chart means excepting a higher risk on the trade, and that higher risk is what is going to sink your expectancy. There are also less trend shifts on a higher time frame chart than on a lower time frame chart, which means less buying and selling, and more waiting for price direction to develop. On the lower time frames however there is a whole other world of activity, albeit at a much quicker pace, yet with proportionately less risk, and higher expectancy.
Markets are very physical and their movement is measured in momentum, distance and time. When you take a closer look at price, and roll down to a shorter-time frame, the movement typifies fractal geometry, where the pattern on the higher time frame is replicated on the lower time frame, albeit with a degree of complexity. This means there will be more price shifts, and more price patterns, on a 15-minute chart, than on a daily chart. The higher time frame direction – slope and momentum—on that daily chart is still very important to the direction and pattern on the lower time frame 15-minute chart, but does not impede price from moving more freely both up and down over the course of a day or week on the 15 minute chart. This constant back and forth price movement on the micro level can provide many more trading opportunities than are available on the higher time frame, and with a less risk. Let’s look at an example of a simple trading method on both the daily chart and the 15 minute chart for EURJPY. The method is buying following a bear trendline break inline w/ price pattern, or selling following a bull trendline break inline with price pattern.
The method worked out ok on the daily EURJPY chart above. That collapse in mid-March following the Japanese tsunami and nuclear crisis obviously created much risk, and points on the validity of using stop loss orders. From there though the method starts to get on track, but it’s hard to get a read on it giving how it gives so few signals.
Now we look to the same method on a 15-minute chart.
On the lower time frame EURJPY chart we see a lot more signals, and they look to have more continuity, i.e.: a more attractive expectancy. This is because by nature you will have many more reversals and pattern shifts on a lower time frame chart than a higher time frame chart, which are going to mean more opportunities to buy and sell. Not to diminish the importance of higher time frame patterns and direction, but an understanding of the fractal nature of markets, from the standpoint of consistency, can be an eye opener for even experienced traders.
Jay Norris hosts Live Market Exercise where he spends 12 hours per week pointing out trade set-ups and signals on intraday charts in live markets. He the author of Mastering Trade Selection & Management, McGraw-Hill, 2011, and Mastering the Currency Market, McGraw-Hill, 2009.
Trading futures or Forex is a risky endeavor and not suitable for all investors!
