When To Defend Forex Trades

When to defend Forex trades (See diagram and video below)

When to defend Forex trades is one question, just as how to defend them is another! The received wisdom for defending Forex trades is to use stop loss orders. These simply close trades when a pre-defined maximum level of loss is attained. As discussed in my article; “The top 5 reasons why forex traders lose money and why they don’t need to do so!” – I don’t do stop loss orders – under almost any circumstances. My defence mechanisms, as taught in the Making Money With forex Course, mainly consist of hedging.

See video below and email jeff@ravenglen.com or follow this blog to get the risk management tool free of charge.

However, in this article I am going to put the question of how to defend trades to one side and will concentrate on when to defend them. I am also going to look at the scope for increasing trade sizes (volumes) as a result of having a defensive strategy in place.

Don’t worry if this all seems a bit technical, that is for the benefit of people who demand a full understanding. For the rest of the world I will provide a free tool that takes the hard work out of this and a video explanation of how to use it.

Some underlying assumptions

First, I want to buy at the bottom of the price range, sell at the top of the price range and do both in the middle of the price range as discussed in my article: “Rule of thirds trading”.

Second, I don’t like to place trades in the “wrong” thirds per se and doing so leads to defensive trades being placed a long way from the trades that they are defending. This in turn brings a danger of having a very wide gap between buy and sell trades to have to manage our way out of, as well as a large, at least temporary, loss of equity.

One approach could be to ONLY trade in the middle third area of the trading range so that all defensive orders can also be within the middle range and then no trade need ever be in the “wrong third”. This is a legitimate strategy; however, it is one which would miss out on a lot of the major moves, at extreme highs and lows that give very large profits.

Therefore, it seems logical to start defending trades when borders between thirds are being approached or have just been crossed. That said we don’t want defensive trades to be too close to the trades that are being defended – that would be safe but pointless! In addition, I like the idea of splitting the defence into more than one defensive trade and, usually split it into three trades.

Anchor point

All of the calculations used to determine where to place defensive trades relate to an “anchor” point. This is simply the average price at which the open trades have been entered or an alternative level of the traders choice. The calculation or selection of an anchor point needs to take into account the total volume of the open trades being protected.

Example calculation – if 3 buy trades had been entered at 1.55047 (volume 2) 1.54461 (volume 2) and 1.53045 (volume 1) the average would be [(1.55047 x 2) + (1.54461 x 2) + (1.53045)] ÷ (2 + 2 + 1). This is effectively 7.72573 ÷ 5 or 1.54515 so in this example 1.54515 would be the anchor point.

Accordingly, all positions for the placement of defensive sell trades will be at given numbers of Pips below 1.54515 (sells and below because we are defending buy trades it would be buys and above if we were defending sell trades). Defending a mixture of buy and sell trades is more complicated and outside of the scope of this article but the same principles would apply.

Forex trade defence guidelines

Taking the above assumptions, calculation and considerations into account, I have developed some new guidelines on placing defensive trades in Forex trading.

  1. Buy trades, which should only be within the lower third or middle third areas, should start to be defended with a sell trade at or around 6 Pips below the nearest pivot line (whole number or Jeff’s line) below the middle / lower third area border or around 6 Pips below the nearest pivot line below between 200 and 325 Pips away from the average trade entry price – whichever is lower. The initial defence should cover 25% – 50% of the total volume of the open trades
  2. Sell trades, which should only be within the higher or middle third areas, should be defended with a buy trade at or around 6 Pips above the nearest pivot line (whole number or Jeff’s line) above the middle / higher area border or around 6 Pips above the nearest pivot line above between 200 and 325 Pips away from the average trade entry price. The initial defence should cover 25% – 50% of the total volume of the open trades
  3. Further defensive trades should be placed against 25% – 50% of the volume of open trades at between 50 and 100 Pips further from the average trade entry price (anchor price). This will then mean that eventually 100% of the open trades are defended and buy and sell trades will be of equal volume.
  4. Each defence trade may be taken off, for a small profit, and replaced a couple of times close to its original point if it looks like being a major pivot point for the price action. Therefore, defensive trades should not be at the limit of our preparedness to not defend, there should be some “wiggle” room.
  5. These guidelines do not remove the necessity to have a back-stop defensive order in place to cover any exposed trades that are undefended and that are not covered by pending defensive trade orders. For example, with an initial defensive pending order set close to a border it may be better to protect more of / the rest of the orders being defended with a back stop instead of having more defensive trades open on the “wrong” side of the border. However, the defensive trades described above can be put in place as pending orders thereby removing the need for back stop defensive orders.
  6. Remember that when “gaps” occur the price can “jump” pending orders causing them not to trigger as the price passes them. This is another reason to set several pending orders up and for having a back-stop pending order when needed.

Trade volume size

To date I have always recommended that the total volume of buy or sell trades should be equal to no more than 0.0006 x equity. This means that an account with £1,000 of equity should have a maximum value of open buy or sell trades of £0.60p – assuming that only buy or only sell trades are held.

This very small value of open trades to equity allows for trades to go against the average trade entry point by up to 1,667 Pips before all of the equity has been lost. In practice the account may be closed, at the brokers discretion, before this degree of loss is reached so do not rely on this figure, defend well before you get to it. In the past we simply relied on a relatively large pool of free equity to save us from oblivion before the price moved back in our favour to put the account back in profit. In fairness, this has worked well for most of the time though there are some rare but notable exceptions! That said, it takes a very brave soul to trade like this and a very disciplined one to keep the trade size down to 0.0006% of equity.

The new guidelines above allow traders to decide how much, that is what percentage, of their equity they are prepared to risk and how far away, in Pips, they want to start defending trades that go against them. The trading tool gives a choice of 3 “standard” defence schemes with an open choice of the percentage of equity reduction accepted by the trader before and between the lines of defence. Alternatively, the trader can have a complete free choice in setting all of the parameters. The free choice option can also be used to pose “what if” questions and to compare different defence regimes.

Risk management

The choice of defensive positions, anchor point and percentage of temporary equity reduction level combine to give a value per £1,000 to be used for trades and a combined value relative to the equity in the account.

The table below summarises the positions for the three standard defence regimes:

Scheme                Defence points (Pips)             % Equity used for defence   £ Trade Volume per £1,000 equity

A                            200   250  300                                   31%                                     £1.31

B                            225   275  325                                   31%                                     £1.24

C                            250   300  350                                   31%                                     £1.08

I have chosen to use the £ trade volume per £1,000 of equity as my “valve” to adjust the level of risk to my chosen 31% of equity. I could equally have used the number and placement of the defence points to do this.

Example of setting defensive pending orders

Example of anchor point average calculation

Trade 1                Buy volume 2 @ 1.55030               x 2 =       3.10006

Trade 2                Buy volume 2 @ 1.54461               x 2 =       3.08922

Trade 3                Buy volume 1 @ 1.53045               x 1 =       1.53045

Total                                                                                         7.71973

Total volume                                                                                       5

 

Anchor point average = 7.72573 / 5                              =        1.54394

Anchor point – 200 Pips = 1.54515 – 0.200                  =        1.52394

Current lower / middle border position                           =        1.51853

Position of border relative to anchor point = 0.02662     =        266.2 Pips

Initial defence position is therefore (H) = 1.52394 because the border (I) 1.51853 is more than 200 Pips away from anchor point.

Defence schemes for forex trades

Example of a defence scheme in use

 

About The Author

Jeff Fitzpatrick

Probably the UK's most successful home Forex trader