Hello traders! This week’s newsletter will discuss how to increase the reward to risk ratio on your forex trades while decreasing your total number of trades by only trading near the edges on the chart!
What Does it Mean to Trade on the Edges of a Chart?
Now, first of all we must define what I mean by the edges. Every time frame, and therefore every trading style, can be broken down into three trends: up, down and sideways. When a market is consolidating, or basing, the edges are very obvious. In this chart, I’ve marked 3 obvious sideways trends (each area can be called a base) with short blue lines where price paused for a few candles before beginning a new trend. In all 3 cases, the trend was to the downside, coincidentally. I’ve also marked a much larger and longer base with the two pink lines. For clarity’s sake, all zones are roughly marked instead of using our more specific supply and demand zones.
Depending on your trading style, meaning, how long you plan on spending in a trade, you could have played the smaller zones (marked in blue) back and forth, long and short, until price broke out of the zone. These smaller forex trades aren’t displayed on the chart, but they could have earned you in the neighborhood of 20-40 pips per side.
For the larger pink zone, trading on the long side at the 2 lower arrows should have earned you about 60 pips. On the short side, at the top downward pointing pink arrow, the short should have earned around 2-300 hundred pips.
So now the question is, where are the edges in a trending market?
Using the same EURUSD pair but going out to a larger, weekly timeframe shows a pretty clear downtrend for the past several months. In a downtrend, we prefer to stick with the dominant direction, so short forex trades for our conservative traders! The four blue arrows show where the trader should be looking for short trades in supply zones. Again, each trade would be worth anywhere from 100-300 pips. The more conservative trader will be able to use the bottom edge in a downtrend for profit targets, then patiently wait to re-enter on the short side.
Our more aggressive traders may look to go long, against the trend by playing retracements. Going against the trend is harder, and generally means going for smaller profit targets.
In an uptrend, to trade the edges the conservative trader will look to go long in that uptrend, near the lower edge in a demand zone. On this 60-minute EURGBP chart, this trader had at least 3 possible long entries, worth anywhere from 50-100 pips.
So how do we define the edges? Personally, I’m just using the obvious swing lows and swing highs. Because of our decentralized market when trading spot forex, I don’t need to be as specific as trading a centralized market like futures or stocks. This is why my trendlines, as they are called, don’t line up perfectly as some others would have you draw.
Another important thing to remember is that our task as traders is to keep our losses small and let our winners run! When trading the edges, your losses should remain very small in relation to the winning trades. In addition, you should be taking fewer trades, because you won’t be forcing trades in the middle, away from the edges. Our recommended reward to risk ratio is 3:1, meaning I’ll risk $1 for every $3 of potential reward. However, when adopting this technique, I believe your reward to risk ratio should rise dramatically, to 5:1 or even 10:1 ratios.
Until next time,