Sunday, September 16, 2007

Your Forex Trading Style - The Spider Or The Cat Approach?

Forex trading is a very individual activity and each trader has a particular Forex trading style depending on their personality type.

Being able to objectively analyze our own trading style is a great asset. We can then develop our style into a more consistent trading method by identifying positive and negative characteristics. The following analogy from the natural world is a tool we can use for self-analysis.

The Cat Versus the Spider

What's the difference?

Cat's Chase Their Prey

Cats by instinct chase their prey. They may stalk for a while and then pounce and chase, following their prey.

Applied to the foreign exchange markets, this type of Forex trading style involves watching for a price breakout or a substantial move in one direction and then joining it, effectively chasing the market.

Some traders like to have this confirmation that price is definitely moving in a particular direction before joining the momentum.

Spider's Net Their Prey

A spider on the other hand spins a web and patiently waits for the prey to come to them. The unsuspecting fly gets caught in the net and the spider gets a meal.

This analogy, as applied to a Forex trading style, exemplifies the trader who carefully examines price action in relation to previous support and resistance levels and anticipates where price is going to stall.

This trader now places an entry order at the strategic level and waits for price to come to them. When it does and fails to break through, instead retracing or bouncing, the trader gets paid!

Advantages Of The Spider Forex Trading Style

While many traders are successful in going with the momentum there are decided advantages to the spider method.

Entering a trade once price has already moved in a certain direction by 20 or 30 pips exposes one to the risk of a retracement. A bigger stop is necessary to cover the possibility that price may go back 20 or 30 pips to retest a previous line of support or resistance.

Also, price may abruptly stop just after we enter a trade moving rapidly in one direction and then retrace taking out the stop for a loss.

On the other hand, after carefully assessing major lines of support and resistance by looking at the higher time frames and seeing where price highs and lows have been over the last few days, we can predict where price is likely to stall or retrace.

Using Fibonacci calculations along with pivot points we can sometimes see 2 or 3 layers of support and resistance. If price has already moved a substantial number of pips during the trading session, it is likely to stall at a key support resistance level. Entering a trade at this point means we can set a smaller stop and we are nearer to getting our profit.

On the other hand, price may have moved a substantial number of pips, perhaps 30 or 40 in one direction, and is now retracing. By looking at the previous high or low, and by using Fibonacci, especially the 50% retracement level, we can predict how far price is likely to retrace before continuing in the direction of the trend.

Submitting an entry order to get into the market at that key retracement level often means we can set the stop just 20 to 25 pips away, beyond the price swing or high for safety, and collect a good profit of 25-40 pips at the Fibonacci 127% extension level.

The One That Gets Away

Of course, the spider will sometimes see a powerful fly go straight through the web and knock a hole in it! That's the one that got away.

The spider Forex trading style will sometimes see price go straight through a strong support or resistance level and not hesitate at all. Again, that's the one that got away!

However, more often than not, price will react at key support and resistance levels. By adopting a patient waiting attitude, allowing price to come to you rather than chasing it, a safer trading approach can be developed, one that can contribute to consistent substantial profits in the long run.

Once you have identified your personal Forex trading style, see if there are lessons you can learn and adjustments you can make using the cat and spider analogy. Try to develop the habit of netting your profits as opposed to chasing them!

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