Finding value in fear

It is not every day that markets get caught out by overwhelming fear

Fear
ForexLive

The new coronavirus outbreak brings back many lessons in markets and one of them is to not be too blinded by the fear.

There is no doubt that things may still get worse before they get better, especially with the fact that the hectic travel period during the Chinese New Year holidays is yet to come.

But ultimately, it is all about trying to identify how bad things will really be. We’re already seeing markets start to be a little more greedy over the past few hours – as compared to the pessimistic behaviour seen in trading yesterday.

US futures are up by ~0.5% while the Shanghai Composite index has erased gains of over 1% earlier to hit session highs now, keeping near flat levels on the day.

As with all such related fears and geopolitics, they will eventually pass at some point in time.

Instead, the real fear in all of this is whether or not the new coronavirus outbreak is going to have a more profound impact (longer-term) on markets. In this case, perhaps it may chip a little away at the Chinese economy this year.

However, unless this threatens to be develop into something like the SARS virus outbreak back in 2002-03 and plague markets with some element of uncertainty for a few months, expect markets to quickly move on from the pessimism here.

Sure, there may still be some days in the near-term that fear may creep back in.

But don’t squint your eyes and cower in terror. Instead, open your eyes and look for value. Eventually, there will be a turning point and that’s when fading the fear pays off.

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The jump from trend to bubble is faster than ever

What’s the rush?

What's the rush?

I love this quote from George Soros because it is more true every day. He said it in his book on the crash of 2008 but he might be talking about fake meat, marijuana or electric cars today.

We can all see trends towards environmentalism, renewables, e-commerce, the internet, eating out and TV streaming along with a dozen other things. The reaction function of the market is to identify a trend and throw money at it in a virtual gold rush, hoping that one day the claims will pay.

Last year we saw it in WeWork. Co-working was undoubtedly a trend and WeWork was the biggest and best-known name in the space. SoftBank and others drove the company valuation into the stratosphere but it all came crashing down when the collective conscience of the world realized the business model could easily be replicated.

The big macro trend of the generation is low and falling inflation. We’re at the point now where every bond investor — voluntarily or not — is betting on low inflation. The perception (or perhaps misconception) is that inflation will stay low forever. If the market is wrong, it would be the mother of all financial busts. The bond market is worth more than $ 100 trillion with a myriad of derivatives layered on combined with endless knock-on effects, like mortgage rates.

Other trends are less controversial but misconceptions abound. Renewable energy is coming and the age of fossil fuels will one day end. Yet just in the past few years we’ve seen a dramatic drop in investment in fossil fuels. While a 50-year investment in a oil field is a bad idea, there is unceasing demand for the next 15 years. If no one is bringing on new production in the meantime, what happens to the price?

I often think about the paradox of a remote mining town. With mines, you usually know the lifespan so you know when it will close, everyone will be out of a job and the local economy will collapse. That leaves the housing market in a precarious spot. At the end of the line, you want to be a renter but somewhere before that, it makes more sense to buy. When exactly is the crossover? As the time winds down, you would assume there is massive demand for rentals and that market could become completely disconnected. Any way you look at it, the volatility would skyrocket.

That’s how I see the fossil fuel era ending. It’s like a mine right now that has a short life. It’s past the point where people are investing in projects that have a payback period of more than 30 years. Yet it’s still highly uncertain when oil won’t be needed anymore. One belief was that shale was a perfect bridge because it could be ramped up quickly and operations have short shelf lives. However that turned out to be a misconception itself and wells are costing much more.

The final piece of the puzzle is price. I think it’s inevitable that we get a spike in oil prices but even at $ 80, $ 90 or $ 100 we may find that companies are loath to invest because the market won’t reward it and won’t believe high prices will last.

Markets are the best way to price anything but in a changing world, be wary of identifying any ‘trend’ and assuming it will lead to profits.

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The Trump impeachment legal team and your trading. How are they related?

It’s all about building your case

In an economic week in the US where the existing home sales, the weekly unemployment claims and the flash manufacturing PMI are the only events on the docket, it is hard to get too excited about the prospects for trading. At least from the economic release angle.

However, the US impeachment trial of President will begin this week with enough uncertainty and drama for viewers to be mesmerized – and potentially ruin any hope of movements in the forex markets as a result of the made for TV drama.  

At the end of the day, however,it will take a “2/3 supermajority of those present in the Senate” to impeach the President. With 53 Republicans, 45 Democrats and 2 Independents, the odds are in the President’s favor that he will NOT be impeached.  

Nevertheless, the show must go on and there are other battles to be won through the process. It is after all, an election year.  If impeachment is not possible, voting out the President or shifting the power in the House and Senate is at stake.  It IS a high stakes game.

To defend himself, President Trump announced his team of lawyers who will defend him yesterday.  Included in the list is Alan Dershowitz.  

Dershowitz is a retired Harvard Law Professor and famed criminal defense attorney.  He  became the youngest full professor of law at Harvard in its history at the age of 28.  

Dershowitz is a Democrat who endorsed Hillary Clinton, calling her a “progressive on social issues, a realist on foreign policy, a pragmatist on the economy”.  He also supported Barack Obama for re-election on the basis of his “excellent judicial appointments, his consensus-building foreign policy, and the improvements he has brought about in the disastrous economy he inherited”.  

He campaigned against Trump during the 2016 election, and has been a critic of some of his actions including his travel ban, and the rescission of protections for “dreamers”. 

Sounds like a Trump type of guy right?  I would have expected that Trump would steer clear of that resume and might have taken a shot or two at him on Twitter at some point as well. 

However, Dershowitz has also be supportive at times of the President calling the Trump’s alleged disclosure of classified information to Russia as the “most serious charge ever made against a sitting president”, and called the Democrats attacking Trump’s mental fitness as a “very dangerous” line of attack.

Alan Dershowitz and Jeffrry Toobin

Last night after seeing a movie and winding down afterwards before calling it a day, I flipped on CNN.  Dershowitz was on with CNN legal analyst Jeffrey Toobin and host Anderson Cooper.   It was an interesting discussion and explained why Trump choose Dershowitz to be part of his defense team.  

Dershowitz is a staunch supporter of the Constitution and in particular section 4 of Article 2 of the Constitution which says, 

“The President, Vice President and all civil Officers of the United States, shall be removed from Office on Impeachment for, and Conviction of, Treason, Bribery, or other high Crimes and Misdemeanors.”

Dershowitz’s argument in favor of the President is that what the President did with regard to the Ukraine (the “other high Crimes and Misdemeanors”) was not on par with the stated crimes of Bribery and Treason as so stated in the Constitution.  

He argues that the framers could have explicitly used the term “abuse of power” but they chose not too.  He describes himself as an “advocate against impeachment”.   He said, “I am not part of the strategic legal team. I am a constitutional analyst. I want the impeachment to fail. I hope it will fail.”  

He added “I am working for the Constitution.  At this time the beneficiary happens to be the president. Last time it was President Clinton , the time before it was Pres. Nixon.”. He says “I am making a constitutional argument on behalf of Pres. Trump’s team against impeachment. I am against impeachment. I think would be a very bad thing to happen”

Clearly, Dershowitz has a role in the defense team.  He provides a specific point of view on the Constitution. He will not defend the nuances of what took place between the Pres and Ukraine.   That defense will be made and defended by the other six members of the Trump legal team.  Dershowitz is only one of the seven. Each of the others will have their own specific role.

So what does this have to do about trading?

While watching the drama of the interview play out (it was good TV -you can see it here), I was thinking of a question from a Forexlive follower yesterday, who asked the following:

“….please talking about the weekly range and the mid point of the range in the GBPUSD …. this is so important…. is it possible to explain technically how can I benefit from it …. because once I saw a trader talking about that but to be honest, I did not understand what he was talking about”

My response started with:

“The midpoint is just a piece of the technical story. I would not say it is “so important” but it is a piece. I like to think of the 50% midpoint as a tilt area. Also, it is important to think about how the buyers were in control above the midpoint, but how the bias shifts below 50% level.  What does that do to the tone of the market? “

The Trump defense team of seven different people are each likely to have a role in the impeachment trial. Dershowitz will only speak to the Constitution. The others will add their expertise to the defense of the President.   The hope is that they not only AVOID impeachment (which already is likely), but also convince the American people, that the grounds for impeachment were unwarranted. 

On the other side, the House managers team will argue the opposite side of the argument. That is, there is likely to be someone who will argue the Constitution DOES allow for the impeachment for the abuse of power. There will be others on the team who will be more suited for the other pieces of the trial (much like the Trump team).  

There will be a battle.  

Paralleling to trading, for me the 50% retracement is part of my “team” when analyzing the market.  It can be an influence to the “tone of the market”.  It helps to tilt (in my view), the bias to the “other side”.  If the price moves below the 50%, it tilts the bias to the downside. If the price moves above the 50% it tilts the bias to the upside.  That is by itself. However, their are other members of the technical team.  

Dershowitz is the 50% retracement.  His stated goal is to tilt “3 to 4” Democrats to the “this is unconstitutional” side.  In the debate on CNN,, he stated just that.  Remember, we live in a political world where getting 3-4-5  members on one side to tilt to other is nearly impossible.  Putting it another way, a 57 to 43 vote is a lot more convincing to the American people vs a 53 to 47 one.  However, Dershowitz is just one piece of that team. The other members will be fighting as well with their expertise, to add even more to the Presidents side.  

Going back to trading, if the 50% is Dershowitz, the 100 and 200 hour MAs can be thought of other members of the team.   

The GBPUSD on the hourly chart

Looking at it in the GBPUSD chart above from yesterday, the 50% was at 1.30361.  The price on the way down yesterday, cracked below the 200 hour MA (green line currently at 1.30512), the 50% and stalled at the 100 hour MA (the blue line)  The move back higher stalled near the 200 hour MA again before moving back below the 50% and ultimately the 100 hour MA. The pair closed at the session low.    

The sellers on my team had the 200 hour MA, the 50% and the 100 hour MA as technical hurdles. Each of them is a “piece of the technical story” (or defense).  If the sellers can win their arguments, the price goes lower. 

On the other side are the buyers (think of them as the House managers).  They may argue the bullish side and help swing the price off the 100 hour MA (blue line) by “stating their case” to buy against that level. However, when the 200 hour MA (green line) held on the correction, and the price moved back below the 50% and then the 100 hour MA, the bias shifted in the favor of the sellers.   The vote for NOT impeaching went to 57-43 (or better and outside the yellow area).

The point is, the impeachment process will be a battle that will pit Trumps team vs the House managers team.  In trading the price action process is a battle that pits sellers vs buyers.

As the trial goes on, there will be ebbs and flows, but there should be a winner that emerges. 

In trading there are ebbs and flows as well, but the technicals will often show the way. Often times it takes clues from more than one technical  tool to influence the trading bias.  

The best places to trade (win the battles) are at the places where you are stating your case. The sellers in the GBPUSD stated their case when the 200 hour MA was retested and held near that resistance level. The rest of the team then did their job and the price moved lower and to new lows for the day.  

Although the week may be more focused on the trial vs the economic data, think about the ebbs and flows in the trial and how the same process happens in trading.  It can make for a clearer vision of the outcome.

Good fortune with your trading. 

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JP Morgan on the yen – narrow ranges to persist

JPM client note on the Japanese yen, say its losing its attraction as a safe haven play

USD/JPY annual range of less than 10% for three consecutive years

  • 2019 range less than 8% (smallest since 1980)

Yen:

  • “when a risk-on mood was strong, market participants would normally actively engage” in the yen-carry trade
  • but when risk-off hit “investors would be pressed to close their positions”  – to sell the higher-yield currency & buy back yen they had sold, which is why the yen would strengthen in risk-off environments 
  • “But because in recent years the yen is no longer being sold off in the first place, it is not acting as much like a safe-haven currency as in the past”

JPM on what will prompt wider ranger:

  • if interest rates increase in other countries (opening a wider gap with rates in Japan)
  • would encourage yen-carry trades

Yeah 1980 might have been a narrow range but as the 80s went on things did hot up (check your historical charts …. google the Plaza Accord)

Probably not about the yen range but its from the 80s (ok, 1979)

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What were the financial lessons of the 2010s?

The next decade is often different from the prior one

The next decade is often different from the prior one

“Financial markets tend to base their expectations of the future on the experiences of the recent past”

That’s a part of human nature that has repeatedly led to folly. Nowhere moreso than in financial markets.

We’ve started a new decade with the same enthusiasm that ended one of the greatest decades in stock markets. Yet few people are out there to remind market participants that the S&P 500 had an average annual total return of negative 0.95% from 2000 through 2009.

One is the WSJ’s Jason Zweig who wrote the Heard on the Street column edited the latest edition of Benjamin Graham’s classic the Intelligent Investor.

In a recent article he highlighted how investors (and traders) tend to pile into trades that have worked recently. A parallel from the 2000s decade as the carry trade. Buying NZD/JPY was a spectacular trade, until it wasn’t. In the most-recent decade the market fell in love with the US dollar.

Market patterns don’t reverse in 10-year cycles like clockwork; there’s no guarantee that the coming decade will be the opposite of the one that just ended. But before you bet that the future will be like the past, it’s worth remembering that this decade hasn’t turned out the way investors predicted it would 10 years ago.

Here is how FX returns looked in the past 10 years:

FX returns from the past decade

What that doesn’t include is emerging markets. The South African rand lost 48%, the Russian ruble 52%, the Brazilian real 56.5% and the Turkish lira 75%.

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Guest trader: Martin’s 8 principles to trade by

Martin Nikolov is our guest trader this week

In a series of articles this week, Martin Nikolov will share his trading philosophy and then guide us how he sees markets unfolding with real-world examples. Martin is a long-term professional senior trader at Varchev Finance a firm in Bulgaria with a trading office in the City of London. He trades indexes, commodities and stocks on the basis of technical analysis, but does not ignore the fundamentals.

Martin Nikolov is our guest trader this week

My trading philosophy

As each art, trading is also a craft that requires knowledge, skills and discipline. All of these three aspects of every craft form a philosophy that is individual for everyone. You actions, decisions, thinking and idea – birth process will revolve around that philosophy. As practise comes it forms principles and a routine. Being a professional trader, you will be required to form and exceptional routine and principles. That will get you to the long – term path of being profitable and successful.

I will share with you my eight trading principles that I believe in and why.

Let my profits grow

 I don’t use take profit. Simple as that. My trading technique as a short to long – term trader doesn’t need from me to limit my profits. I am a trend follower as well so I open positions only in the direction of the trend. I am backed by the motto: “Trend is your friend”. I let go of my profits to grow, building on the initial entries. I exit when I am psychologically satisfied with the results or when the trend starts to get exhausted. I don’t use limits, because they are putting stress on me and who ever wants to limit their potential of profit?

Cut my losses fast

 As letting go of my profits to grow, also I have learned to let go of the positions that are not doing well. Fast. Without hesitation and never putting the trade to stay on hopes and wishes. If for some reason – mostly unpredicted fundamentals are set in to place and the trade stalls, can’t execute my technical analysis as well, and I am in to a loss I just close the position. This is healthy for your mental state and for your balance. The market will always present to you the next opportunity to recover and to grow. I also answered your question “Why?”. Because I do not hope for a miracle.

If a trade doesn’t go well, close without hesitation

 A repetition to the upper paragraph, but this is very important. Forging a strong mental state requires for you to take fast decisions to protect your money. Like in life, saying “No”, letting go of toxic people or sacrificing something that brought you comfort for years, so in trading you need to CUT AND LET GO of negativity, losses and always confronting your comfort and safe zones. This will fine your character, mental state you will feel more confident. Forging a “Warrior – fighter” attitude towards trading will reflect in your personal and professional life as well. So that’s why I let go of emotions and bad trades.

Trade with the trend

 “Trend is your friend” is a sentence that has turned as a cliche but for me it my axiom in trading. I don’t go below 4H chats – I precise the entry there. I chart and stare the daily and weekly charts. Noise is limited and pretty much you don’t care about news and fundamentals. The TREND is THE most powerful indicator. Finding it, charting it and discovering the support and resistance levels is enough. If the trend is just forming – that’s the perfect entry. If there is a correction, enter on the end of the correction. Never enter in a trend that’s too steep and the price is no where or at the consolidation phase, signaling that the trend potentially ends. Some trends continue with months or even years and building positions in the direction of the movement can lead to some very outstanding profits. Some may say “Yeah , too long for me to get my profits”. Trust me, if you want to distinguish yourself from the gamblers, take it as a real business and to achieve something, you need patience. Don’t rush it. Why? No one became rich in a night or couple of days – in the retail branch.

Follow a strict, company money and risk management

Even though I work as a professional trader and I follow strict company and risk rules, same applies to the retail traders and everyone else. Proper money and risk management go side – by – side with your discipline and trading routines. There are standard risk rules: Follow 1:2 at least risk – reward ratio, don’t risk more than 1% and so on. Understand that trading in the markets exposes your capital to 100% risk if not managed correctly. You are managing your own money. MANAGING. Let that sink in. You on you own are a fund manager. So not following risk discipline is a true disrespect towards your money, the art and to the markets. It may be as much just to go tot he casino. You don’t deserve your money and to have the opportunity to trade. You need to be grateful that first you’ve saved money to enter the markets and secondly – that you CAN actually have access to the markets. From there on you are obliged to respect that opportunity, the spirit of money and trading business. That’s why you need to follow a strict risk and money management, even as a retail.

Buy low, sell high, look for a correction

The tricky part. As mentioned – look for a correction. Observing correction is the way for you to discover the cheapest price to buy and the highest one to sell. For corrections I apply Fibonacci levels on the main trend and on the retracements. In addition I chart the trend lines on the spikes and on the bodies on the candles and I chart the insider (fractal) diagonals as well. Doing that gives you a roadmap of the potential movement of the price.

Never trade news

Simple as that. Never. It’s a complete gamble and I’ve heard a lot of people saying to place limits and stops for both of the direction to catch the move…

Never. Trade. News.

Why? Spread can go super wide, lack of liquidity, slippage, platform stall, extreme volatility. You can’t use proper management. Anxiety will kick in, stress, 100% risk for your money and mistakes that can lead to a complete wipe out.

Never trade before earnings

This is mostly for the traders that trade stocks like me. As with the news, earnings can be a true gamble as well. Even though they can be more predictive because they rely on actual and real accounting and numbers, and real fundamental facts, for example a trade war, they can lead to surprises as well. The negative surprises can be a lot more volatile and crushing the price of a stock and the positive. Also earnings are publishes before the opening of the stock market or after the close. In these cases you can’t react at all to your opened orders. If you have stop loss on a certain level and price before the opening or after the closes reaches it and passes trough, it will be executed on the next opening and on the first AVAILABLE PRICE! Which can a lot below your initial stop loss. Have that in mind.

Conclusion

Trading is not simple. But it can be easy and comfortable if you follow strict rules and be disciplined. Do not listen to others, do not follow other analysis and do not follow signals. I don’t need to explain why…

Trading requires an individual approach, emanating from your character. Trading is a lone profession even working in the proper office or floor environment. Only YOU are responsible for your actions and do not blame other people, persons or events for your mistakes and losses. 

Check back tomorrow where Martin will write about what he’s trading right now. If you’re interested in participating in our guest trader series, email me at adam(dot)button(at)forexlive(dot)com.

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Gold gives back gains as the fear trade fades

Gold gives back $ 25 in gains

Gold remains in positive territory but has given back the bulk of its gains. It’s up $ 10 to $ 1562 from a high of $ 1588.

The move is part of a broader fade in the fear trade that started in European trading and has picked up in the past hour. 

 
This chart is beginning to look ominous.

Gold gives back $  25 in gains

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Expect gold buyers on any further US/Iran military strikes

Trading 101

Trading 101

In this instance when the US President Trump directed the killing of top Iranian general Qasem Soleimani in a drone attack at Baghdad airpot during last week escalation of the situation seems inevitable now. I can’t see a situation where there is not a response. The only question is, ‘to what degree is that response and what will the knock on impact be?’

Look our for a reaction from the following markets on any further escalation or retaliation of the present situation 

Yen

The Japanese Yen is a safe haven currency which investors rotate into during times of uncertainty. The Yen is most probably the largest risk sentiment mover and is the go to currency of choice for risk on and risk off moves.

Risk off= YEN strength

Gold

Adam has continually reminded us of the strong bids in gold during January over the last few years and any risk off flows only add extra fuel to that fire. Expect bids at market for gold on any further military reaction from either the US or Iran

Oil

Oil is bid on supply issues with a middle eastern crisis liable to spill over to Iraq and Saudi Arabia. so again look for bids here. 

In terms of risk off moves, these are some of the key markets to focus on should the situation deteriorate further.  Also, look for reverse moves should the situation surprisingly de-escalate.  A simple playbook. 

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The positive power of doing nothing

We find doing nothing very hard 

We find doing nothing very hard 

It seems that we find doing nothing incredibly hard. In fact a paper in the journal Science found that people found being alone with their own thoughts extremely hard. The surprising conclusion of the study was that many people would rather give themselves an electric shock than be left alone with their own thoughts and nothing to do. One man in the study even gave himself 190 shocks during his brief time of being forced to do nothing. Ok, he was clearly a bizarre individual or just having a funny half hour, but the conclusion of the study was that, ‘most people seem to prefer to be doing something rather than nothing, even if that something is negative’. This study would show that we are psychologically hard wired for action, even when that harms us. That makes sense because generally speaking action in life is helpful. However in trading it isn’t always the case. In fact, nothing can pay. 

 Why nothing can pay

We find doing nothing very hard, FX

Jack Schwager wrote the famous trading book Market Wizards in which he tries to answer the question about what it is that, ‘separates the world’s top traders from the vast majority of unsuccessful investors?’ Jack Schwager interviews some fantastic traders in a bid to answer that question. One of the key principles that emerges from that book is the ability to have patience to wait for the right trading opportunity. The flip side, of course,  of waiting for the ‘right opportunity’ is avoiding the wrong ones. So, there are times when we literally need to be doing nothing. In an interview for the Street, Jack Schwager was asked about this principle of doing nothing and in particular why investors found it so hard to do? The first part of Jack’s answer to that question was:

Because doing nothing requires the patience of a saint. It is common for traders who develop good methodologies that signal trades infrequently to take other trades that lack the appropriate criteria because of a need “to do something.” 

The need to do something…Is that a problem that you have with your trading? I have got better at this over the years simply because I have learnt the hard way that I can easily give away the money I made on one no-brainer trade with three or four bad trades taken on impulse. Below are some tips that I have to to help you do nothing. 

Expose yourself to multiple markets

over trading

One aspect that can help you do nothing is by exposing yourself to multiple markets. If you are primarily a currency trader and wake up to a sleepy Thursday with no data, no driving news and narrow ranges you can easily start putting on silly trades. However, if you trade multiple markets you might notice that a particular commodity has some strong fundamental news or an individual share has outperformed some fundamental data point. You can chase other rabbits for the day. The more markets you have access to, the wider pool you have to chase that high probability trade. 

Find another project

This is where being a currency analyst helps me which I really enjoy as I get a boost out of guiding people in navigating the markets.  There is always plenty for me to do in writing an article, meeting a client, teaching a core concept or conducting research. However, there are many different things that you could do, so having another hobby or project can distract you by doing something else.

Reward yourself for doing nothing

When you manage to not take a trade all week because there was nothing to trade give yourself a reward. You have saved your powder for when you need it. Reward yourself.

Imagine that something big is just around the next corner 

Preserve trading capital

This thought helps me. When nothing is happening I think, ‘there could be some really big market moving news just around the corner’. The uncertainty of the market is really an asset to me in this respect. One of the market maxims that I teach in an event I run in Dubai 5 times a year is that , ‘unexpected events can and do occur in the market’. My go to illustration of this is the removal of the 2015 EURCHF 1.2000 peg. However, as well as a cautionary tale, the uncertainty of the market can also provide opportunities. Just because the day is scheduled to be quiet it doesn’t mean an unscheduled surprise event won’t provide a great trade. As long as President Trump and Twitter co-exist, then there is one permanent source of potential rapid market change.  Of course this is also a cause of sadness. It always feels odd to me that ‘bad news’ for the world  can be ‘good news’ for a trade. This conflicted feeling recently occurred with the latest tensions in the middle east causing an extra bid into some gold longs I have. 

In FX markets we only risk our capital when we take action. Taking no action at all means that we risk none of our capital in direct market exposure. Doing nothing may be your most powerful weapon. Now over to the great and good of Forexlive readers. What have you found helpful to keep you out of silly trades and harness the positive power of ‘doing nothing’?

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Recognise the trigger for a sentiment shift trade

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When do you pull the trigger? This takes time to know when to pull a trigger on a sentiment shift trade. It is the combination of experience, planning, knowledge and good old fashioned bottle (or confidence for non-native speakers) to recognise and act upon a trigger for a sentiment shift trade. Trades that have an obvious
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