Weekly Trading Lesson: Discretionary Trading vs. System Trading

Written by Thomas Long, FX Power Course Instructor

In our quest to develop a trading approach, a couple of weeks ago we decided that these were the keys points to include in our strategy:

1. Determine whether you are looking for a buy or a sell.
2. Find your entry.
3. Identify your initial risk.
4. Find your exit.

Last week we looked at how to satisfy the first rule in that we would look at the daily chart with one year of activity to find the strongest trends to trade. After having worked through a couple of dozen daily charts, I see the AUD/NZD to be in a strong uptrend. The chart posted first is the daily chart of the AUD/NZD and you can see that this market is moving straight up and has been for all of 2008. This is our first step in identifying the pair to trade and since it is in an uptrend, we will only look for buys and ignore all sell setups. Entries should be one of two situations for trend traders, we should look to buy a pullback down to support when the market is in an uptrend or look to sell a rally up to resistance when the market is in a downtrend. You could just look for these setups on the daily chart, but if we move down to a 4-hour chart, we can find more trading opportunities with lower risk. The key is going to be to only look for buys because the daily chart shows a strong uptrend. This increases our chance of success and puts us in a position to be in on some of the big moves that the FX markets are known for. So we are looking to buy on a pullback down to support. But what really does that mean if you don’t know how to identify support? This is where the use of technical indicators can come into play.

On the 4-hour chart below the daily chart, I have plotted a Slow Stochastics indicator with values of 15,5,5. The idea here is that you buy when the Slow Stochastics moves below 20 and then crosses over and moves up above 20. If we were looking for a sell, we would look for a move and a crossover above 80. I have circled those moves from below 20 to above 20 on the chart and you can see where they can help traders better time their entry. Technical indicators do not predict the future and can only show us changing momentum. But when that momentum changes at support when the market is in an uptrend, we have a classic buying opportunity. There are many other examples of how to use technical indicators to time your entry in earlier lessons posted in this forum, to include MACD and RSI. It really doesn’t matter which indicator you use as they are all just really fancy moving averages. I always recommend that traders use one or two that they find easy to use as that is what will make them effective. But once again the key is to try to quantify your entry so you are being consistent in the trades you choose. That is how you can see consistent results in your trading. Next week we will start on the subject of money management and how we can fine tune our approach to help us increase our chance of being consistently profitable.