Hello traders! This week’s newsletter comes to you from snowy and chilly Colorado. As I sit here looking at the snow-covered mountains, I am reminded of a question that comes up pretty frequently in class – “Is it too late to get in?”
This topic almost goes hand in hand with my article from December 6, 2016 “Why You Should Stay Patient When Considering Trade Entries.”
What happens in your trade plan if you wait too long, have perhaps been too patient? Very often our charts have already gone without us-but can we still enter trades after the train has left the station? Many traders will take the point of view that if they don’t get the absolute perfect entry, they will take no trade. Personally, I disagree with this viewpoint. I don’t mind “paying up” a few pips when the charts say there is still a large potential profit in the trade. As you may have heard by now, our recommended reward to risk ratio in our trades is at least a 3:1 (meaning I will risk $100 to possibly make a $300 reward, for example.)
On the following AUDUSD 60 minute chart, I’ve drawn in a simple demand zone that is 12 pips wide, and a supply zone that is 10 pips wide. For discussions’ sake, let’s say we were considering going long at .7295 with our stop loss three pips below the bottom of our demand zone at .7280, risking a total of 15 pips. With our reward to risk ratio rule of 3:1, we need at least 45 pips of potential profit in this trade.
If we use the bottom of our supply zone as our profit target, this would give us 51 pips of potential profit. So the question is, if I missed the perfect trade entry can I still get into the trade? The answer is yes, provided the remaining reward is still three times the increased risk. Let’s do some simple math. If the chart has moved all the way up to .7320, could we still take the trade? If you were using the same stop loss price of .7280 and the same profit target of .7346, absolutely not! That would be a reward of 26 while risking 40 pips! Certainly not what we recommend. In this example, because we would only be able to accept a couple pips higher in price, we would not have a trade.
In the following USDJPY 30 minute chart, again I’ve marked in a couple of zones for a potential long trade. With these zones marked there could be a trade entry at 115.80 and a stop loss at 115.60 for twenty pips. Using a profit target of 117.50, our reward would be 170 pips and a stop of 20 for a reward to risk ratio of over 8:1. Not bad!
Time for some more math. How far can we “miss” the perfect entry before no longer considering the trade low risk? The answer is approximately 116.42. About the easiest way to figure out the worst price you could still consider the trade is as follows:
Take the distance from your profit target to your stop loss and multiply that times .33. Add that number of pips to your trade entry (on the long side) and you have your maximum allowable entry price for this trade. (117.50 – 115.60 = 190…. 190 x .33 = 62.7… entry price of 115.80 + 62 pips is 116.42, your maximum price.)
Many of the more experienced traders reading this would think more along the lines of using different zones on the way up to the profit target for entry, which is yet another technique.
So, there you have it! The perfect entry is not always able to be taken; so now you have a potential new rule for your trading plan that will allow you to still join a potential move.
Until next time,
Rick Wright – firstname.lastname@example.org