Forex Trading Tips: Can The Dollar Rally More?

FX Market Outlook

Faced with rapidly deteriorating economic conditions in the Euroland. the ECB finally blinked and lowered rates by full 50bp taking the yield on the euro down to 2%. In his post announcement press conference Jean Claude Trichet was uncharacteristically dovish admitting that the situation on the ground was dour, that price pressures have disappeared completely and that more easing was in store.

Ironically enough, the euro which slid all week long on anticipation of rate cuts, actually staged a mild rebound a day after the news. There were two key take away points from ECBs press conference that provided some support for the single currency. First Mr. Trichet noted that any future rate cuts will be postponed until March at the earliest, thus removing the threat of perhaps another 25bp cut at the February meeting three weeks away. Secondly, he dismissed the idea of pushing rates to zero, in effect providing a possible floor for EZ rates at 1% or a bit higher – a policy that would leave the euro with a slight interest rate advantage over the dollar and the yen.

Next week US capital markets are closed on Monday for Martin Luther King Day and Tuesday brings Inauguration of President-elect Barak Obama, so the currency market price action may be muted. The calendar carries only a smattering of second tier data with most of the interesting news coming from UK. While the euro saw small reprieve on Friday the bounce is likely to run into some strong resistance at 1.3500-1.3600 range as threat of further rate cuts is sure to make some traders pause.

As we noted on Friday, “With ECB event risk out of the way the likely near term fate of the EUR/USD lies in the slew of micro economic data due to be released over the next few weeks. For EUR/USD to hold its ground, traders will need to see some signs of stabilization in EZ economic downturn. As we’ve noted earlier the pair has carved out a broad 1.30-1.40 range but if the economic news form Euroland continues to disappoint the pair could easily drop into the 1.20’s in the foreseeable future.”

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—————--Risk and Reward—————

How do you determine proper risk and reward in trading? I don’t think anyone can ever provide a definitive answer to that question because its is akin to asking how many layers do you need to walk outside of my apartment in New York City in the winter. Right now as the thermometer reads a balmy 8 degrees Fahrenheit as I type this at 3 in the morning, you need about four layers just to make it to the coffee shop across the street. But just last week you could have made the same journey in a T shirt without feeling a chill.

Trading, like the addled, globally warmed weather of my great metropolis is an imprecise and a highly volatile proposition. Therefore the question of risk and reward always changes with the circumstances of the moment. The traditional view on risk and reward is to set the ration to at least 2:1 -- risking half the amount of pips as you are trying to make, so that if your profit target was 100 then your stop would be 50.

In theory this sounds like a terrific plan. You only need to be correct 4 out of 10 times to make money. However, I’ve never met a real life trader who actually put this principle into practice. I’ve received plenty of such advice on this matter from analysts, strategists, trading coaches and a whole host of others who have never wagered so much as their breakfast money on a trade, but I have never seen the 2:1 ratio employed by anyone who actually makes their living from the market.


The primary reason is that most people who never trade, do not realize that there is no such thing as reward in the market. There is only risk. Markets are not like factories that manufacture profits to your order. In fact, markets do everything possible to frustrate your goals. Imagine a trade where you risk 100 points with a profit target of 200. Initially the trade goes your way and the floating p/l quickly rises until it reaches +199. Disciplined in your 2:1 strategy you wait for the profit target to hit so you can book another good trade. But guess what? The market suddenly stalls and then reverses. You watch in horror as the positive trade quickly turns negative and then drops through your stop. What was you loss? On paper you lost 100 points, but in actuality you lost -299 points ( 100 points on your stop and -199 you did not book). Welcome to real life trading where the “theoretical” 2:1 risk reward is far more elusive than you think.

The fact of the matter is that profits cannot be forecast in the market. The only thing you can control is risk. That’s why we always trade with two units. That’s why we always take short first targets and that’s why we assiduously control risk by trailing our stops. It may not be glamorous, but its the only way we know how deal with risk and reward at BKT.

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