Nerves of Steel: Forex Markets

A reflection about trading the news and the following wild volatility requiring "Nerves of Steel" when trading the forex markets

Posted in Forex Trading | Traders' Delusions, Submitted by Trading Critic on Wed, 2006-08-02 13:33.
A Chart of the Australian Dollar (AUD/USD) reaction to the 0.25 percent interest rate to 6 percent announced by the RBA 2-8-06

This morning I was looking at the reaction of the Aussie dollar as a result of the Reserve Bank of Australia (RBA) released the outcome of their deliberations yesterday. The interest rate was scheduled to be announced at 0930 Sydney time so I was in front of my laptop by 0920 watching the screen (And putting on a trade). As you can see from the minute chart above leading up to the announcement, trading was thin in the minutes leading up to the announcement. The gold star marks 0930 hours. Everyone was 99 percent sure that the Australian interest rates will rise by 0.25 percent to 6 percent. And the interest rate did rise. So what does a forex traders' mind run through in a trade like this one?

A Quick Forex Overview

If you aren't aware of foreign currency movements and the reasons why they move here is a quick overview. I was looking at the Australian (Aussie) dollar price with respect to the US dollar price: i.e. the AUD/USD currency pair. Now, last week, the RBA announced 4 percent inflation, which is way above the Bank's target rate. The market saw this a sure bet that the interest rate would rise the following week (the event today). So the market priced in the interest rate move and the dollar spiked from around the 0.7500 level all the way to just above 0.7670. Some 170 pips. Which is a huge spike in the dollar if you look at the weekly charts. Anyway, fast forward to today. Yesterday during American trade, the dollar actually hit 0.7600, but by the time the Aussie market opened this morning the dollar recovered from the "profit taking" (the reason the media always gives when the market spikes and then falls the following day/week) to open at around 0.7650. When I previously stated "thin trade" this is shown by the sideways movement of the dollar together with the lack of coloured candles. Finally, a country's currency usually reacts positively to any prospect or actual interest rate increase. And that's what some traders call "trading the news."

The Truth

To tell you the truth, I broke a few trading rules in this trade. Well one, specifically. And that was to set in stone, your stop loss by actually placing the order at the time you open the position. So what do I do? I actually had a mental stop loss - and I broke that too! So now the question follows: why did I break my own trading rules?

That gold star marks the minute following the decision release. I don't own a Bloomberg box, or subscribe to Bloomberg TV or any other live news services. So I was there frantically refreshing my browser trying to get the www.rba.gov.au website to show the updated figure. Those guys need to upgrade their system. I only had their webpage up at 0932 hours. Two full minutes too late. Those guys need to upgrade their web servers. I don't usually trade the news, but I wanted in on this piece of news. The last time the RBA raised rates, I was just sitting on the sidelines watching the dollar jump as a result of the trade. But this time, it was different. And that's because the market was already sure about the decision because of the inflation rate that was announced last week.

Trading Rule Broken

So I was in the trade. I had a plan. A "mental" stop loss (risky), a profit target and a time horizon of less than an hour. But the question remains: why did I break my own trading rules of only having a mental stop loss?

Call it confidence and uncertainty. Whenever an economic announcement comes along, the market acts wildly: highly reactive and volatile. My heart wasn't pounding, although its pace was slightly faster than normal. On 0930 on the dot, the dollar started to fluctuate up by 8 pips to 0.7558 in the first few seconds, then it quickly dived to 0.7542 then down to 0.7532. My mental stop loss was 0.7540. Only 10 pips away from my entry price.

So why did I break my own rule? You may answer rules are made to be broken. But that's not a valid reason for this case. Call it experience. I was reading somewhere about trading the news - they discussed subscribing to a news service, setting close stop losses, putting in trades seconds before the news release. But I haven't experienced that yet: or tried it. So I relied on my past experiences to guide me through this short term trade.

Experience Pays

In my mind, a stop loss of 10 pips was too close, and from my own experience from trading the AUD/USD: on average a stop loss of around 30 pips away will allow most of the volatility through while preserving the number one tenet of trading: let the profits run. So, while I had my trading platform to sell at the ready at 0.7540, in my mind I could tolerate a loss of up to 0.7520. All this occurred in seconds... the price movements, the decisions... any hesitation or brash decisions can prove fatal. What is required is courage, confidence and nerves of steel.

What If...

I've fallen into the trap before: Just look at the chart again and listen closely to this hypothetical: What if you were not really thinking clearly... had a long run of losses... overtrading... Then you are definitely in the loser's mindset. Now think about this: what about if instead of holding on, you exited your long trade and short sold the currency when you saw the dollar fall drastically down to 0.7632? Then see it bounce back? Mind you - in this fast moving and volatile market, you didn't look at even setting a stop loss... ARGH! That situation happens to every trader at least once or twice if not more… A situation always brought about by fear.

Exit the Trade Gracefully

In my own experience there are two ways to exit such a position. There is the instant solution or the "see what happens" solution. There are advantages and disadvantages to both routes in your trading. The instant solution may realise your losses instantly (however large) by exiting your losing position on the spot but on the bright side you won't go through the day with a knot in your stomach benefiting your health. The "wait and see solution" allows for the volatility of the forex markets to give you the trader the opportunity to sit and wait to find an exit point that will minimise your losses. While your monetary loss is minimised, the disadvantage to this solution is that you will be putting your health on the line. If you don't know what I'm talking about (I'm talking about the additional stresss, pain in the chest, migraines etc), then you're probably one of the fortunate traders!

In the end, it was a profitable trade and a good day in the markets. Good Luck!

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