Basic Rules For Swing Traders

Because of the time frame involving several days in swing trading, the nature
of this style of trading is slightly more advantageous in forex, mainly
due to the fact that you have 24-hour access to monitor and to trade a forex
position. Because of this constant market action, there are very few times
that gaps occur. Therefore, I do not trade or use the gap-“fade” techniques.

However, here are some basic rules that apply to swing trading and to
which forex traders should adhere.

• If a day trade moves sharply in your favor, carry it through the
overnight session, except for Fridays. Do not hold positions over the
weekend unless you have a very well funded trading account or can
manage a position that has a big profit built into the trade. When a mar-

ket closes strong near the highs in the U.S. session (5 P.M. EST), odds
favor the likelihood that there will be more upside potential in the European
session. Tighten stops and look to exit the next day near a pivot
point target resistance level.

• If your trade starts making money from the get-go, your entry was correct.
Good trades generally start to move in your favor almost immediately.
Prices may come back to test your entry level a little, but they
certainly should not test your risk level. It’s perfectly acceptable for the
market to hover at your entry level for a bit before performing in your
favor.

• Do not carry a losing position from one session to another. Exit the
trade and look for a better signal.

• When you enter on a bona fide trading signal, don’t get fancy and try to
get a better fill by placing limit orders; go to the market. Other traders
or systems (competitors) may also pick up on the signals, and you
could miss out on a great trade.

• Never anticipate that a signal will happen. Wait until the close of the period
for which you are trading to confirm the signal. If the market is
going to move, it is best to go with the trade momentum as confirmed
by the closing time period rather than guess and be too early on a long
entry, only to watch the market crash and burn.


When you are looking for a short-term day trade, focus on the 5- and 15-
minute time periods for which a signal was generated. If you have time
constraints that limit you to following the markets, such as work or
bedtime, then scaling out of positions and trailing stops are great features.
If you capture a strong-trending market condition and turn a day trade to
a swing trade, then follow the 60-minute chart at the close of each 60-
minute time period to see what the relationship of the close is to past highs
and lows.

In addition, focus on the higher-degree time frame pivot points, such as
the monthly and weekly support and resistance levels, as well as on the
moving average values, to see where prices are in relation to both averages.
If there is a crossover and prices close above a prior high and if the 60-
minute chart closes above all of these variables, then you want to go long
and/or look for buy signals on the shorter-term time frames, such as the 15-
and 5-minute periods. For swing traders, watch the daily charts and the 240-
minute time period in conjunction with the 60-minute period.
Source: Forex Conquered: High Probability Systems and Strategies for Active Traders

DO and DON'T in trading

I list here ten rules that I think are important for trading forex. I have split the list
into five Dos and five Don’ts.
Dos
1. When trying out a new trading strategy, always test it in a demo account, or with
a small amount of money, before you commit more money to it.
2. Always keep a record of each of your trades, with details of: why you got in,
how you got out and why it turned out the way it did.
3. Have a personalised trading plan and update it as you learn from the market.
4. If you are unsure of a trade, stay out. It is better to miss an opportunity than to
have a loss.
5. When trading, keep up-to-date with both the fundamentals and technicals
affecting the market. A trader in the dark is a trader in the red.

Don’ts
1. Don’t trade with money you can’t afford to lose! It will affect you emotionally,
and you will most likely lose it to irrational trading.
2. Don’t follow someone else’s trading advice blindly. Always know why you are
getting into a trade, and how you are going to get out of it.
3. Don’t be concerned about being right. Just be concerned about being profitable.
4. Don’t over-leverage. Chances are that your account will be decimated before
you can recoup your losses and go into profit.
5. Don’t revenge-trade the market. Vent your frustrations elsewhere after a loss.
Source: 7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets

Follow The Rules In Your Trading System

 The first step to successful trading is to analyze your character to ensure
you are not bringing your bad habits to the trading table. Your moral
constitution, work ethic, and personal beliefs will mirror your trading
habits. If you are a rule breaker, then there is no point in trying to learn a
new successful skill that requires rules to be followed. If it is in your
character to break rules, then learning a new successful skill that can
change your financial future is useless. You will simply break the rules and
self-destruct.

I know a person who is habitually late to work. Despite the fact that his
employer requires him to arrive on time, he doesn’t seem to believe that
showing up on time is that important, which is why he has had to change
jobs four times in the past year.

As a result of his tardiness, he is repeatedly terminated. Yet he refuses
to change his behavior. He is more willing to go through the trouble of
searching for a new job than he is to change a simple, yet critical, destructive
personal habit. What I find with most unsuccessful people is that they
fail to see the importance of following rules that will lead to their success,
such as showing up on time. The truth is, changing little unproductive
habits makes a huge difference to one’s success.

People underestimate how important preparation is for success.
However, the reason they get locked into poverty and mediocrity—only
getting by—is that they show up to the battlefield totally unprepared and
unprotected. Their focus quickly turns from the cause they were fighting
for to survival and self-preservation. “I didn’t bring the proper armor to
fight this war, I didn’t think I’d be here this long, I don’t have enough food
to survive, I don’t have enough ammunition,” and so forth. With that
survival mentality, one’s attitude turns from that of a conquerer to that of a
crumbler.

To survive the coming learning curve and successfully transition to a
productive career trading on Forex, you will need to properly arm yourself.
Creating your personal constitution is like acquiring the best helmet possible
to protect your most important asset—your mind. Your mind is the
epicenter of your body and the control tower of your destiny.

You first need to identify, and perhaps define, who you truly are. The
following exercise will help you discover your personal constitution. Once
you have completed this exercise, you will be able to see what you
need to change in your personal life to become a successful trader. This
exercise is what I call a litmus test. (A Litmus test commonly refers to a

test done to determine substance.) Taking this personal litmus test
forces you to face the brutal reality of whether you are made of “gold” or
“fools’ gold.”
Read More : Follow The Rules In Your Trading System

Six Cardinal Rules

Once you identify your strongly held trading beliefs, you can switch to the task of building a trading system around those beliefs. The six rules listed below are important considerations in trading system design. You should consider this list a starting point for your own trading system design. You may add other rules based on your experiences and prefer-ences.
1. The trading system must have a positive expectation, so that it is "likely to be profitable."
2. The trading system must use a small number of rules, perhaps ten rules or less.
3. The trading system must have robust parameter values, usable ^ over many different time periods and markets.
4. The trading system must permit trading multiple contracts, if possible.
5. The trading system must use risk control, money management, and portfolio design.
6. The trading system must be fully mechanical.

There is a seventh, unwritten rule: you must believe in the trading principles governing the trading system. Even as the system reflects your trading beliefs, it must satisfy other rules to be workable. For example, if you want to day-trade, then your short-term, day-trading system must also follow the six rules.

You can easily modify this list. For example, rule 3 suggests that the system must be valid on many markets. You may modify this rule to say the system must work on related markets. For example, you may have a system that trades the currency markets. This system should "work" on all currency markets, such as the Japanese yen, deutsche mark, British pound, and Swiss franc. However, you will not mandate that the system must also work on the grain markets, such as wheat and soybeans. In general, such market-specific systems are more vulnerable to design failures. Hence, you should be careful when you relax the scope of any of the six cardinal rules.

Another way to modify the rules is to look at rule 6, which says that the system must be fully mechanical. For example, you may wish to put in a volatility-based rule that allows you to override the signals. Be as specific as possible in defining the conditions that will permit you to deviate from the system. You can likely test these exceptional situations on past market data, and then directly include the exception rules in your mechanical system design.
Read More : Six Cardinal Rules

Rule 1: Positive Expectation - 7 Cardinal Rules

A trading system that has a positive expectation is likely to be profitable in the future. The expectation here refers to the dollar profit of the average trade, including all available winning and losing trades. The data may be derived from actual trading or system testing. Some analysts call this your mathematical edge, or simply your "edge" in the markets.

The terms "average trade" and "expectation" represent the same object, so they are freely interchanged in the following discussion. Ex-pectation can be written in many different ways. The following formu-lations are identical:
Expectation($) = Average Trade($), Expectation($) = Net profit($)/(Tbtal number of trades),
Expectation($) = [(Pwin) x (Average win($))] - (1 - Pwin) x (Average loss($))].

The expectation, measured in dollars, is the profit of the average trade. The net profit, measured in dollars, is the gross profit minus the gross loss over the entire test period. Pwin is the fraction of winning trades, or the probability of winning. The probability of losing trades is given by (1-Pwin). The average win is the average dollar profit of all win-ning trades. Similarly, the average loss is the average dollar loss of all losing trades.

The expectation must be positive because, on balance, we want the trading system to be profitable. If the expectation is negative, this is a losing system, and money management or risk control cannot overcome its inherent limitations.

Assume that you are using system test results to estimate your av-erage trade. Note that your estimate of the expectation is limited by the available data. If you test your system on another data set, you will get a different estimate of the average trade. If you test your system on different subsets of the same data set, you will find that each subset gives a different result for the average trade. Thus, the expectation of a trading system is not a "hard and fixed" constant. Rather, the expectation changes over time, markets, and data sets. Hence, you should use as long a time period as possible to calculate your expectation.

Since the expectation is not constant, you should stipulate a mini-mum acceptable value for the average trade. For example, the minimum value should cover your trading costs and provide a "risk premium" to make it attractive. Hence, a value such as $250 for the expectation could be used as a threshold for accepting a system. In general, the larger the value of the average trade, the easier it is to tolerate its fluctuations.

Note that the expectation does not provide any measure of the variability of returns. The standard deviation of the profits of all trades is a good measure of system variability, system volatility, or system risk. Thus, the expectation does not fully quantify the amount of risk (read volatility) that must be absorbed to benefit from its profitability.

The expectation is also related to your risk of ruin. You can use statistical theory to calculate the probability that your starting capital will diminish to some small value. These calculations require assumptions about the probability of winning, the payoff ratio, and the bet size. The payoff ratio can be defined as the ratio of the average winning trades to the average losing trades. As your payoff ratio increases, and your Pwin increases, your risk of ruin decreases. The risk of ruin is also governed by bet size, that is, percentage of capital risked on every trade. The smaller your bet size, the lower the risk of ruin.

In summary, it is essential that your system have a positive expectation, that is, a profitable average trade. The value of the average trade is not fixed, but changes over time. Hence, you can specify a threshold value, such as $250, before you will accept a trading system. The expectation is also important because it affects your risk of ruin. Avoid trading systems that have a negative expectation when tested over a long time.
Read More : Rule 1: Positive Expectation - 7 Cardinal Rules

The Role of the Clearinghouse

Associated with every futures exchange is a clearinghouse, which performs
several functions. One of these functions is to guarantee that the
two parties to the transaction will perform. To see the importance of
this function, consider potential problems in the futures trade described
earlier from the perspective of the two parties—Chuck the buyer and
Donna the seller. Each must be concerned with the other’s ability to fulfill
the obligation at the settlement date. Suppose that at the settlement
date the cash price of the stock of Company X is $70. Donna can buy
the stock of Company X for $70 and deliver it to Chuck, who in turn
must pay her $100. If Chuck does not have the capacity to pay $100 or
refuses to pay, however, Donna has lost the opportunity to realize a
profit of $30. Suppose, instead, that the cash price of the stock of Company
X is $150 at the settlement date. In this case, Chuck is ready and
willing to accept delivery of the stock of Company X and pay the
agreed-upon price (i.e., futures price) of $100. If Donna cannot deliver
or refuses to deliver the stock of Company X, Chuck has lost the opportunity
to realize a profit of $50.

The clearinghouse exists to meet this problem. When someone takes
a position in the futures market, the clearinghouse takes the opposite
position and agrees to satisfy the terms set forth in the contract. Because
of the clearinghouse, the two parties need not worry about the financial
strength and integrity of the party taking the opposite side of the trade.

After initial execution of an order, the relationship between the two parties
is severed. The clearinghouse interposes itself as the buyer for every
sale and the seller for every purchase. Thus, the two initial parties are

free to liquidate their position without involving the other party in the
original trade, and without worry that the other party may default.

Besides its guarantee function, the clearinghouse makes it simple for
parties to a futures trade to unwind their positions prior to the settlement
date. Suppose that Chuck wants to get out of his futures position.

He will not have to seek out Donna and work out an agreement with her
to terminate the original agreement. Instead, Chuck can unwind his position
by selling an identical futures contract. As far as the clearinghouse is
concerned, its records will show that Chuck has bought and sold an
identical futures contract. At the settlement date, Donna will not deliver
the stock of Company X to Chuck but will be instructed by the clearinghouse
to deliver to someone who bought and still has an open futures
position. In the same way, if Donna wants to unwind her position prior
to the settlement date, she can buy an identical futures contract.

Margin Requirements
When a position is first taken in a futures contract, the investor must deposit
a minimum dollar amount per contract as specified by the exchange. This
amount, called initial margin, is required as a deposit for the contract. Individual
brokerage firms are free to set margin requirements above the minimum
established by the exchange. The initial margin may be in the form of
an interest-bearing security such as a Treasury bill. As the price of the
futures contract fluctuates each trading day, the value of the investor’s equity
in the position changes. The equity in a futures account is the sum of all
margins posted and all daily gains less all daily losses to the account.

At the end of each trading day, the exchange determines the settlement
price for the futures contract. The settlement price is different from
the closing price, which many people know from the stock market and
which is the price of the stock in the final trade of the day (whenever that
trade occurred during the day). The settlement price by contrast is the
value the exchange considers to be representative of trading at the end of
the day. The representative price may in fact be the price in the day’s last
trade. But, if there is a flurry of trading at the end of the day, the exchange
looks at all trades in the last few minutes and identifies a median or average
price among those trades. The exchange uses the settlement price to
mark to market the investor’s position, so that any gain or loss from the
position is quickly reflected in the investor’s equity account.

Maintenance margin is the minimum level (specified by the exchange)
to which an investor’s equity position may fall as a result of an unfavorable
price movement before the investor is required to deposit additional
margin. The additional margin deposited is called variation margin, and
it is an amount necessary to bring the equity in the account back to its

initial margin level. Unlike initial margin, the variation margin must be in
cash rather than an interest-bearing instrument. Any excess margin in the
account may be withdrawn by the investor. If a party to a futures contract
who is required to deposit variation margin fails to do so within a
specified period, the exchange closes the futures position out.

Although there are initial and maintenance margin requirements for
buying stock on margin, the concept of margin differs for stock and
futures. When stocks are acquired on margin, the difference between the
stock price and the initial margin is borrowed from the broker. The
stock purchased serves as collateral for the loan, and the investor pays
interest. For futures contracts, the initial margin, in effect, serves as
good faith money, an indication that the investor will satisfy the obligation
of the contract. Normally, no money is borrowed by the investor
who takes a futures position.
Read More : The Role of the Clearinghouse