The Way of the Dollar

sideways before the full moon take no action, but watch the direction of the next two days for guidance.

The influence of the full moon may only be felt for about 3 days beforehand and 5 days after; and it has been most visible in the D-Mark and SF dollar parities. But as you can see from the chart, there has often been a two week cycle running from full moon through new moon and back –a cycle which has sometimes been uncannily reliable for months on end. Rationalise it as you please: the impression is that market action tends to be primitive, dim and emotional before full moons, and more collected and rational after them; and that there is sometimes a periodicity in currency fluctuations which can be almost as reliable as the tide! If this continues to be so, we will have an edge if we exploit the phenomenon. And successful trading is not about being a genius, but about constantly exploiting ‘the little edge’ .As the legendary futures trader Richard Dennis* put it: “If you take something which has a 53% chance of working each time, over the long term there is a 100% chance of it working.”

Using ‘stops’*

One of the surest ways of losing the edge is to allow your own calculated time frame to be swallowed up in the “instantism” and emotionalism of the market’s daily fluctuations. They have nothing to do with us. Let them be someone else’s problem.

Once we hold a position, we have only one problem, which is deciding when our reason for holding it no longer applies. The danger to our rational judgement in this matter is that an adverse price movement will panic us out. What will happen is that we will use our potential loss as an excuse to justify abandoning the position, when the real reason is fear. The conventional solution to this problem is the “stop-loss” limit. It’s useful but it’s not a panacea.

What we have to watch out for is that we don’t use stops as a crutch – to absolve us from the responsibility of making a wrong trade. Peter Steidlmayer* has put it at its most forcible: “if you ask me, people who are using stops are using a crutch or buying insurance, like in blackjack. If you don’t have the confidence that you’re right, don’t make the trade. What happens is that people who use stops end up making more trades because they feel they have this crutch that they are leaning against. ‘Well, it’s only going to cost me five cents’. Those attitudes are copouts” (The Big Hitters). Even if we don’t go all the way with Peter Steidlmayer, we must be clear in our minds that if a stop is hit, it has to be because we have made a wrong trade.

Steidlmayer’s position is that “using stops is absolutely ridiculous”. But you need a crutch if you’re lame; and some of the most successful traders have got on best with this crutch.

We win some and we lose some, let’s always remember. The conventional idea of the stop-loss is to provide an automatic way of ejecting ourselves from the losers – one that eliminates the danger that we shall be wrong-footed by fear… or hope. It follows that the stop must be placed at the point where price action will have apparently proved us wrong –i.e. other forces than the ones we diagnosed are dominating the market. So our stop will be set far enough away not to be hit by random fluctuations. It must not be hit if our script is right, only if it is wrong.

The stop will be set in the light of the volatility of the currency we are dealing in, and will be dictated by our time horizon. We can use mental stops: we don’t have to put the stop with ‘the market’. But we must decide our stop level before we put on the position –not least because the stop defines the size of our position: if your stop is 5% away from your entry point, and you do not wish to risk more than 2% of funds on this particular trade, then you can only put 40% of funds on that position.

The stop would stand (normally) unless the price moves in the right direction. In that event it is appropriate to move the stop along in line with the price movement –a “crawling stop”* some people call this or “trailing stop”. Again, you try to place the stop where it won’t be hit.

Should we use target stops for profit-taking, as well as limit stops to limit losses? Answer, sometimes. CB’s sentiment gauges are designed to pinpoint extremes, so it makes no sense to set targets at the outset when a position is initiated: such targets are guesswork, or worse. By contrast, when a turning point has been located by means of our sentiment gauges, a target stop can make a lot of sense. Markets have a way of getting especially volatile at turning points. We sometimes see ‘trampolining’* (page 64), and –very often see double tops and double bottoms. So, in the event that a price has reacted sharply from an extreme, you can set a target stop near that extreme – and this one you should leave with the market (instruct your broker or bank), specifying “good till cancelled” (GTC*), and “market if touched” (MIT*), if you like.

Market Lore

If you had to choose just one piece of market lore that has survived the ages it might be the adage “cut your losses and let your profits run”. Like all such adages, it is not a panacea for beginners. It only works once you understand it deep down, from experience. And experience can’t be taught.

This adage comprises two concepts. One is that we must have a system for distinguishing good trades from bad ones. It may be rough and ready, but concluding that trades that show you a loss are bad trades and those that show you a profit are good ones has the benefit of simplicity and common sense. The other concept is that we must get full value out of our good trades. We cannot afford to fritter them away.

There is an overwhelming weight of evidence in the handed-down wisdom of the markets that the big money successful operators have ended up taking out of the markets over time has almost all been made in trades that were held over the long haul. The long haul means different things to different people. But no matter what our time frames may be, the long haul is those trades we held through the corrections.

You only know this is true when you have done it a few times. It’s a matter of understanding what is driving the price; understanding that a move is in its early stages and why; and understanding that the time frame of those who are responsible for the correction is shorter than the duration of the move, and that your time frame is longer than theirs. You know you mustn’t lose your position.

Losing your position is the occupational hazard of active traders. Listen to old Mr Partridge, a hero of the legendary trader Jesse Livermore*, in the story told in Reminiscences of a Stock Operator. Old Partridge was being hectored by a young tyro to sell a stock they both held on the grounds it was due for a reaction. The old hand said he was much obliged, but he couldn’t possibly do that. Why on earth not? Because this was abull market… “if I sold the stock now, I’ d lose my position “ , he added, in some distress –explaining that he had gained this insight through many years of experience. “I paid a high price for it and I don’t feel like throwing away a second tuition fee… It’s a bull market you know.” And with that he strutted off, no doubt leaving the youngster none the wiser.

Old Partridge knew that if he was fortunate enough to be holding a

good stock in a bull market, he was in a good trade. He might or might not be lucky enough to call a reaction. But even if he were lucky, he would have to be lucky a second time to get back in at a good price. From bitter experience he knew that his odds were much better holding on to his position. That left him with only one decision – which was to get out of the stock when it was no longer a bull market.

Catching Watersheds

The starting point for the big swing must, by definition, be the point at which the previous big swing ended. At that point, you invariably have a big consensus which has finally aligned itself in the direction of the