Contents

Cover

Series

TitlePage

Copyright

Dedication

Foreword

Preface

Acknowledgments

PartOne:NakedForexTrading

Revealed

Chapter1:TheFundamentalsofForexTrading

AQUICKLESSONINCURRENCIESPLAYERSOFTHEFOREX

MARKETTOOLSOFTHETRADE:FUNDAMENTALVERSUSTECHNICALINDICATORSWHATISNAKEDFOREX?

Chapter2:AvoidingaTradingTragedy

ISTHEREA“BETTER”INDICATOR?TAKINGRESPONSIBILITYFORLOSINGTRADESLEARNING

FROMMARKETBIOFEEDBACK™

Chapter3:Back-TestingYourSystem

THREEGOALSOFBACK-TESTINGMANUALBACK-TESTING

USINGBACK-TESTINGSOFTWAREAUTOMATEDBACK-TESTINGTOPTHREEBACK-TESTINGTIPS

Chapter4:Identifying

SupportandResistanceZones

ZONESAREBIGFATBEERBELLIESOLDZONES,NEWZONESHOWTOFINDZONESFIVETIPSFOR

FINDINGZONES

PartTwo:Naked-TradingMethodology

Chapter5:TheLastKiss

WHATISABREAKOUTTRADE?WHATISALASTKISS?TRADINGTHELASTKISS

Chapter6:TheBigShadow

WHATDOESITLOOKLIKE?DOESBIGGEREQUALBETTER?THESTOPLOSSENTERINGTHETRADEIMPORTANCE

OFTHECLOSINGPRICEROOMTOTHELEFTPROFITINGFROMBIGSHADOWSTHERULES

Chapter7:WammiesandMoolahs

THEDOUBLEBOTTOMTHEDOUBLETOPIDENTIFYINGWAMMIESANDMOOLAHSHOWTO

TRADEWAMMIESHOWTOTRADEMOOLAHSTIPSFORWAMMIESANDMOOLAHS

Chapter8:Kangaroo

TailsWHATISAKANGAROOTAIL?THEOPENANDCLOSEKANGAROOTAILSARELONGKANGAROO

TAILPLACEMENTENTERINGTHETRADETHESTOPLOSSPROFITTARGETSKANGAROO-TAILTIPS

Chapter9:TheBigBelt

WHATISABIGBELT?THEBEARISHBIGBELTTHEBULLISHBIGBELTTIPSTOTRADINGTHE

BIGBELT

Chapter10:TheTrendyKangaroo

WHATISATRENDYKANGAROO?TRENDINDICATORSTRADING

TRENDYKANGAROOS:RESTINGSPOTSTRENDYKANGAROOCHARACTERISTICSBEWARETHETRENDYKANGAROO

TRAPS

Chapter11:ExitingtheTrade

EXITINGWITHMONEYEXITSTRATEGIESMANAGINGEXITS

PartThree:Trading

Psychology

Chapter12:TheForexCycle

WHATISTHECYCLEOFDOOM?

LIVINGINTHECYCLEDEFEATINGTHECYCLE

Chapter13:CreatingYourTradingSystem

WHATDOYOUBELIEVE?RISKRULES

MANAGINGYOURTRADESKNOWINGYOURTRADINGPERSONALITYDEFININGYOURTRADINGSYSTEM

Chapter14:BecominganExpert

WHYDOYOUWANTTOTRADE?THESECRETOFTHEEXPERTSSIXSTEPSTOBECOMINGAN

EXPERTDOINGITAGAINBORINGTRADINGISEXPERTTRADINGASIMPLETRICK

Chapter15:GainingConfidence

THEORIGINOFCONFIDENCEISSUESCONFIDENCEINYOUREASONSFORLOSING

STREAKSTHEBADMARKETTHEORY

Chapter16:ManagingRisk

YOURRISKPROFILETRADING

PSYCHOLOGYANDRISKMANAGEMENTRISKYMONEYTRAPS

AbouttheTradingSoftwareandVideoTutorial

AbouttheAuthors

Index

Foundedin1807,JohnWiley& Sons is the oldestindependent publishingcompanyintheUnitedStates.With offices in NorthAmerica, Europe, Australiaand Asia, Wiley is globallycommitted to developing andmarketingprintandelectronicproductsand services forourcustomers’ professional andpersonal knowledge andunderstanding.

The Wiley Trading seriesfeaturesbooksbytraderswhohave survived the market’sever changing temperamentand have prospered–some byreinventing systems, othersby getting back to basics.Whether a novice trader,professional or somewherein-between, these books willprovide the advice andstrategies needed to prospertodayandwellintothefuture.

Foralistofavailabletitles,please visit our Web site atwww.WileyFinance.com.

Copyright©2012byAlexNekritinandWalterPeters.

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products,visitourwebsiteatwww.wiley.com.

LibraryofCongressCataloging-in-Publication

Data:

Nekritin,Alex,1980-NakedForex:high-

probabilitytechniquesfortradingwithoutindicators/AlexNekritin,WalterPeters.p.cm.–(Wileytrading;534)

Includesindex.ISBN978-1-118-11401-8(cloth);ISBN978-1-118-

22435-9(ebk);ISBN978-1-118-26244-3(ebk);ISBN978-1-118-

23749-6(ebk)

1.Foreignexchangemarket.2.Foreignexchangefutures.

3.Speculation.I.Peters,Walter,1973-II.

Title.HG3821.N452012332.4′5–dc232011043306

Forallguntradersaswellasthoserudeandcutepossums

oftheworld.

ForewordThe Internet engendered theonline trading phenomenon.Onecantradeanywherethereis a connection to theWorldWide Web. The result hasalso been the creation ofinstant experts, trading guruswhooffermodernversionsofsnake-oil cures for traders.

The web is flooded withtrading alerts, systems, andblogs that promise returnsthat will lead to instantwealth.Most of the books inthe field fail to provideactionableknowledge. In thisenvironment, Alex Nekritinand Walter Peters in NakedForex: High-ProbabilityTechniques for TradingwithoutIndicatorsprovideanhonest and effective

presentation about forextrading that certainlybeginnersneed,andthatmoreexperienced traders forgettheyneed.Naked Forex makes some

powerfulpointsabouttradingforex that really apply toother markets as well. Firstand foremost, price is themost important indicator ofall.All indicatorsarederivedfrom price. Many traders

have forgotten this factbecause computerization hasmade iteasy togeneratenewindicators. Indicators workmore like trainingwheels forlearning to ride a bicycle.They are temporary in theircapacity tohelp tradersbuildtheir skills. They actuallylimit the evolution of atrader’s performance becausetheyprovideadisincentiveto“listen” to themarket.Naked

Forexgoesintodetailonhowa trading signal that isindicator-based is inferior towhatNekritinandPeterscalla“naked”signal.Anotherkeyinsightthatthe

book provides is theimportanceofknowingone’spersonality in trading.Trading systems that arebased on untested algorithmsthat are purely technical willsurely fail. Nekritin and

Peters argue that tradingsystems should reflectdecisions that traders wouldmake that are based onlooking at charts. Manualbacktesting, they suggest, isaneffectivewaytoidentifyatrading system’s strengthsandweaknesses.A third major focus of

NakedForexistheconceptofidentifying support andresistance zones. The fact is

that with the trillions ofdollars that float each hourthroughthecurrencymarkets,pricesreachcertainlevelsandstop.Onecantrytofigureoutwhy they stop rising or stopfalling. But the job of thetraderistoobserveaccuratelywhere theprice is andwhereit came from. Price zonesprovidethenakedtruthaboutmarket sentiment. If a pricebreaks through a zone, no

matterwhatthereason,itisasignal–and a more powerfulsignal than any indicator.NekritinandPeterscall thesepoints of price actionmarketscars. It is a good metaphorbecause markets havememory and so do traders.The authors introduce the“last-kisstrade”asapowerfultool in identifying whenbreakoutshaveoccurred.Thebook is filledwith gems that

provide visualizations ofprice action, such as the bigshadow, kangaroo tails, andthebigbelt.As someonewho has been

training people on how totrade forex for nearly 13years,Iwelcomethisbookasonethatstandsoutasabasicmanual on how to evaluateand trade the increasinglychaotic forex markets. I willuseitformystudents.

AbeCofnasauthorofTradingBinaryOptions(Bloomberg)and

editorofTheFearandGreedTraderNewsletter,

AgoraFinancial,Inc.

Preface

Unfortunately, most forextraders lose out. Profitabletrading is reserved for theselectfew.Expectationsdriverealityformanythingsinlife,and successful trading is nodifferent. Most forex tradershave three preconceptionsabout successful trading.

These are the threemyths ofsuccessful trading, and thestructureofthisbookisbasedoneachofthesemyths.Myth 1: Successful trading

must be indicator based. Thefirst part of thisbookdispelsthis myth. There are manyways toprofit in forex, someofthemdoinvolveindicators,but indicators are notnecessary for successfultrading. There are

professional traders aroundtheglobe,manyofthemgoodfriends of mine, who use“naked” charts to maketrading decisions. In someways, indicators delay theprogression of the traderbecause the focus is on theindicator, rather than priceaction. Indicatorsbecomethescapegoat for losing streaksand often keep losing tradersin a holding pattern. It is

much easier for the novicetrader to begin tradingwithout indicators from thebeginning.Myth 2: Successful trading

mustbecomplex.Thesecondpart of this book is aboutnaked tradingsystems.Thesesystems are incrediblysimple. Do not confusesimplicity with ineptitude.Although these systems aresimple when applied

correctly,theymayalsoyieldbig profits and buildconfidence in your trading.You may view this as themeat of the book, the mostimportant section, but Idisagree. I think the thirdsection is themost critical toyourtradingsuccess.Myth 3: Successful trading

is dependent on the tradingsystem. This is probably themost widely held belief

among traders. This isprecisely why there arethousands of trading systemson the market, all promisinggreat riches to the bravetraders who pony up themoney for the next HolyGrail. Many veteran tradersunderstand the importance oftrading psychology. Personalbeliefs and attitudes towardriskarethegreatestpredictorsof trading success, and the

trading system is not nearlyas important asmany tradersassume. For most traders,afteryearsoftrading,thisfactbecomes apparent. The thirdsection of the book concernstrading psychology and howyou may both identify andchange your thinking,because this is the realdrivingfactor inyour tradingsuccess.Manyreaderswillcontinue

to hold onto these myths. Infact,somereaders(thosewhobelieve trading successdepends on the tradingsystem) will simply read thesecond section and begintrading the naked tradingsystems. This is unfortunate.The first section is criticalbecause it offers reasons forprice action trading (a newbeliefsystem)andacourseofactionforbecominganexpert

atnakedtrading(newtradinghabits). The third section iswherebreakevenand slightlyprofitabletraderswilllearntomove into the realm of thetrue professional trader. Allsections of the book areimportant, and it ismy hopethat by reading it you willfind simple methods forextracting profits from themarket.You can trade successfully

without indicators. Formanytraders,naked trading isbothrefreshing and easy to apply.You can trade successfullywith simple trading systems.Simple systems are robustand powerful. However,ultimately, your success as atraderwilldepend,notonthetrading system, but on howyou incorporate your beliefsand attitudes about risk intoyour trading routine. I hope

thisbookwillaidyouinyourjourneytotradingsuccess.Ialsohopethatyoukeepin

touch by stopping by thecompanion web site for thisbook, complete with livemarket trades, additionaltools, and new naked tradingsystems.Youwillfindthisonthe Web atwww.fxjake.com/book.

WalterPeters,PhD

Sydney,AustraliaOctober2011

Acknowledgments

There are many people whodeserve acknowledgment forthis book. The list includesbut is not limited to thefollowing: Meg Freeborn forpatienceanduniqueabilitytoturn rough stones intopolished gems (I knowbecauseIhaveseenherdoit).

EddieKwongdeservescreditfor putting this book idea infrontoftherightpeople.SeanLydiard is living proof thatsix degrees of separation isfact.ArshiaBolour,who isatruebrotherineverysenseoftheword.AbeCofnas,forhispatience and kindness inhelping me with theconversion from trader totrading author. Evan Burtonforbelievinginthebookidea

and making it happen. ColinJessup for his uniqueperspectiveonnaked trading.My brother Ashkan Bolour,who introduced me to theworldofforexsomanyyearsago. My parents forunconditionally supportingme in every endeavor. Mydissertation committee (andDr.DavidEstesinparticular)whotaughtmeyearsagohowto write so that others could

understandme.My sister foralways being there for me.And to the first-line editorMelissa McConaghy—without your help, I amcertain this book would nothavehappened.

—W.P.

PARTONE

NakedForexTradingRevealed

CHAPTER1

TheFundamentalsofForexTrading

Gregory: “Draw thy tool…”

Sampson: “My nakedweaponisout.”—Shakespeare,Romeoand

JulietWelcome to the world offorex trading. Forex is thelargest market in the world.Forex traders exchange $4trillioneachday,but is forexthebestmarket foryou?Theanswerdependsonwhat youarelookingfor.Ifyouwantamarket that never sleeps, if

you want the opportunity totradeatanytimeoftheday,ifyou would like to make aboatloadofmoney in a shortamountoftime,forexmaybefor you (it should be notedthat you may also lose anincredible amount of moneyin a short amount of time).Traders with very littlemoney can begin tradingforex.Inforex,youmaytakerelatively large trades with

small amounts of moneybecause of the favorableleverage requirements. Therearemanyreasonstobecomeaforex trader, but beforejumping into the reasons,perhaps we should take acloser look at thecharacteristics of a forextrade.

AQUICK

LESSONINCURRENCIES

“Forex” is simply anabbreviation for “foreignexchange.” All foreignexchangetransactionsinvolvetwo currencies. If anindividual trader, a bank, agovernment,acorporation,ora tourist in a Hawaiian printshirt on a tropical islanddecides to exchange one

currency for another, a forextrade takes place. In everyinstance, one currency isbeing bought and,simultaneously, anothercurrency is being sold.Currenciesmustbecomparedto something else in order toestablish value; this is whyforex trading involves twocurrencies.IfyouandIgotothebeach

and I tell you the tide is low

rightnow,howdoyouknowthis is true?Youmaydecideto compare the currentwaterlevel to the pier. If there arestarfish andmussels exposedon the pier, youmay believemebecauseyoucancomparethe currentwater level to thepreviouswaterlevel.Inforex,we compare currencies inmuch the same way,currencies are traded in pairsand, thus, one currency is

always compared to anothercurrency.Anexamplemaybehelpful

to illustrate how currenciesare traded. If you are ahotshot forex trader, andyoubelieve that theEUR/USD isgoing to go up, you maydecide tobuy theEUR/USD.Thus,youthinkthattheEurocurrency will get stronger,and the U.S. dollar willweaken. You are buying the

EUR/USD currency pair,anotherwayto lookat this isto say you are buying Eurosand simultaneously sellingU.S.dollars.Theunique(andoften difficult to understand)aspect of forex trading tokeep in mind is this: Eachforextransactioninvolvesthebuying of one currency pairand simultaneously theselling of another currencypair.

If you have experiencebuying or selling in anymarket—the stock market, afutures market, an optionsmarket, the baseball cardmarket, or the used carmarket—thenyouunderstandmarkets. For any markettransaction a buyer wants tobuy something and a sellerwantstogetridofsomething.The forexmarket is simplyamoney market, the place

where speculators exchangeone currency for another. Inmanyways, the forexmarketisnodifferentfromthestockmarket.Themajordifferencesbetween forex and the stockmarket are as follows: Aforex transaction involvesbuyingonecurrencypairandselling another, also, thesymbols to identify forexpairs are consistent andsystematic, unlike the

symbols used to identifycompanies listed on a stockexchange.Forex traders buy and sell

countries. It is true: Forextraders are basically buying“shares” in a country, just asastocktraderbuyssharesinacompany. For example, ifforextraderEmmadecidestosell the EUR/USD, she isessentially selling theEuropeanUnion (and buying

the United States). To beevenmorespecific,wemightsuggest Emma is buying theeconomyoftheUnitedStates,and selling the economy ofthe European Union. Doesthis mean that Emma mustkeeptabsonalltheeconomicdata for all the countries thatshe is trading? The shortanswerisno,butwewilltalkmoreaboutnewsand tradingbasedoneconomicnewsand

data a bit further on in thisbook.Just as a stock has a

symbol, so do currencies.Table1.1 illustrates themostpopular currencies and theirsymbols. Do you notice apattern? There is a secretcode for currencies. Thethree-letter code for eachcurrencypair is composedofthe country (first two letters)andthenameof thecurrency

(last letter). So, for example,the Japanese yen is JPY, the“JP”standsforJapan,andthe“Y” stands for Yen. Thecurrencies listed inTable 1.1are the major currencies;these are the most widelytradedcurrencies.

Table1.1MajorCurrenciesoftheWorld

PLAYERSOFTHEFOREXMARKET

The forex market is anenormous, growing market.Forex trading doubled from

2004 to 2010, and today theamount of money traded inforex each day is staggering.The New York StockExchange, theworld's largeststock market, turns overabout $75 billion each day.Forex traders trade five timesthatamounteachday.You often hear people

claim that because the forexmarket is so large, it isrelatively easy for forex

traderstojumpinandridethetrendsinthisgiganticmarket,the world's largest market.However, most forex traderstradewhat iscalled the retailforex market; this is adifferent market (akin to aparalleluniverse)tothe“real”forex market in which $4trillion is exchanged eachday.Inessence,therearetwomarketsinforex.Thereistheinterbank market, where

banks, hedge funds,governments, andcorporations exchangecurrencies, and there is theretail market. Most forextraders trade in the retailforex market, an entirelydifferentmarket to the “real”interbankmarket.In the retail forex market,

your competition is the otherforextraderstradingtheretailforex market, and, believe it

or not, your broker. Whenyou make money tradingforex, these other traders inthe retailmarket lose, and sodoesyourbroker.Most retailforex traders do not makemoney. In fact, your forexbroker will assume that youare going to lose money inthe long run. This is aperfectly reasonableassumption, since the largemajorityof forex traders lose

money.Would you like to know

about the secret that forexbrokers don't want you toknow? Here it is: Forexbrokersdividealltradersintotwo groups. There are thewinners—these are the forextraders who make money—and then there are the losers—these are the forex traderswho lose money. Guesswhich group all new forex

traders get put into? Retailforex brokers believe that allnewcustomersareunlikelytomake money, so all newaccounts are placed into theloser group. After severalmonths of consistentlyprofitable Forex trading atradermaybeplacedintothewinnergroup.Itmaysoundsurprising,but

it is true. Ifyoustartmakingmoney trading forex over

severalmonths,youwill jointhewinners.Yourretailforexbroker will begin to hedgeyourtrades.Inotherwords,ifyou are in thewinner group,your retail forex broker willtake trades in the real forexmarket, the interbankmarket,to offset the profitsaccumulated by the winnergroup. For example, if mostof the traders in the winnergrouphavedecidedtobuythe

EUR/USD, then the brokerwillput ina trade tobuy theEUR/USD in the interbankmarket in the hopes that, ifthe winners are correct, theforex broker can use theprofits in the interbankmarket to pay the winningtraders. This is how yourretail forexbrokerdealswithwinningtraders.What about losing traders?

Since most forex traders are

losing traders, your forexbroker assumes that youwillnot make money when youopen up an account. Onlyafter you have consistentlymade money trading forexwill your broker becomeconcerned with your trading.Guesswhathappens toallofthose losing trades? Thoselosing trades fatten yourbroker's pocket. All losingtrades are “business profits”

for your broker. This isbecauseyourbrokertakestheothersideofyourforextrade.Although it is true that someretail forexbrokersmatchuptrade orders so that a traderwith a buy trade order ispairedupwithatraderwithasell trade. However, theoverwhelming majority ofretailforexbrokersdonotdothis. Unless you are aconsistently winning trader,

yourbrokerwill taketheriskon your trades, and assumethat your trades will losemoneyinthelongrun.Thisisnot something that is widelydiscussed,butitistrue.Yourforex broker wants you tolose, because your losses areyourbroker'sprofits.How would you like to

make the jump from thegroupof losing traders to thegroup of winning traders?

Would you like to join the 5percent ofwinning traders? Iknow you can join the 5percent, and Iwill show youprecisely how you can leapinto the group of winners inlaterchapters.

TOOLSOFTHETRADE:

FUNDAMENTAL

VERSUSTECHNICALINDICATORS

So, how do forex tradersdecide when to buy or sell?There are basically twoschools of traders, and youmustdecidewhichschoolfitsyour trading personality.Thefirst school is the school offundamental analysis.

Fundamental traders useeconomic reports and newsreports as the basis for theirtrading decisions. Forextraders who have afundamental approach willclosely examine worldevents,interest-ratedecisions,and political news.Fundamental traders areconcerned with properlyinterpreting news, whereasthe focus for the technical

forextraderisquitedifferent.The technical forex trader

uses technical indicators (or“indicators”) to properlyinterpretpricemovementonachart. The forex trader whoadopts a technical, indicator-based approachwill examinethepricecharts.So,whilethefundamental forex trader isconcerned with interpretingnews and world events, thetechnical trader is concerned

with interpreting price on achart.What are technical

indicators? Indicators aresimply another way oflooking at amarket price. Inmuch the sameway that it ispossibletoexaminethespeedof a car in many differentways, it is possible toexaminepricechartsinmanydifferent ways, withindicators.Justforamoment,

consider how many differentways you may measure thespeedofacar:

Measured inkilometersperhour.Measured in milesperhour.Measured in thetime it takes totravelonemile.Measured by thetime it takes toaccelerate to 60

mph.Measured by howquickly the car canstop.

Likewise, there are manyways to look at price on achart. There are moretechnical indicators thantelephone call centers inIndia.

WHATIS

NAKEDFOREX?

It can be very confusing forthe novice trader, and this isone reason why nakedtrading, trading withoutindicators, can be liberating.When starting out, manytradersfocusontheindicator.This is completelyunderstandable since nearly90 percent of the forex

trading books, the vastmajorityof forexsiteson theInternet, and forex tradingseminars focus on indicatorsandindicator-basedtrading.Indicators encourage

“secondary thinking,” whichis a real handicap for traderslooking to acquire expertise.Secondary thinking involvesanalyzing the indicator,spending time consideringwhere the indicator may go,

rather than focusing on themarket. Naked traders, bydefinition, focus on themarket, which is verydifferent.Focusingonindicatorsmay

beoneoftheprimaryreasonsthatsomeforextradersdonotmake money. Indicators canbe confusing, unhelpful, andjust plain wrong. In the nextchapter we take a look attechnicaltrading,andsomeof

the tragic trading mistakesforex tradersmake, and howtoavoidthembyadoptingthenaked-tradingapproach.

CHAPTER2

AvoidingaTradingTragedy

Out of intensecomplexities intensesimplicitiesemerge.

—WinstonChurchill

If you are reading this book,you are probably a technicaltrader. You may have spenttime, money, and effortlearning about indicators.You may have learnedthrough experience thattradingwithindicatorscanbevery difficult. In someways,tradingwithindicatorsmakesit difficult to find profits.Perhaps a close look at whyindicator-based trading

systems have difficultyfinding profits in forex is inorder.All indicators are created

frompricedata.This iswhatallindicatorsdotopricedata:Price data enters into anequation and is spit out assomething else. Sometimestheendproduct isa squigglyline, sometimes a straightline, sometimes a color or anumber; it depends on the

indicator. The end result isalways the same: Theindicator changes price datavia a formula. The form ofthis end result (the indicator)may vary, but the process isalwaysthesame.Theseverysameindicators,

based on price data, aremeant to hint at futuremovements in the market.Stated another way, anindicator will suck in price

data, massage and processthesedata,andthenspitoutagraphical representation ofthese data. Indicators offerprice data in another form.Perhaps this new form ofprice data is easier tointerpret; perhaps this newform of the price data willhint at what the market maydo in the near future. Allindicator-based tradingsystems are founded on the

idea that price data is in abetterformwhenpresentedasan indicator. Trade decisionsbased on indicators assumethatthedatainindicatorformis more valuable than rawpricedata.

INDICATORAmetricderivedfrompricedata.Historicalpricedata—such as the open, close,high,and low—areentered

into a formula to calculatethe metric. This metric isthen representedgraphically to anticipateand interpret marketmovements.

Traders want to knowwhere price will go in thefuture. Traders pay millionsupon millions of dollars foreducational seminars, DVDs,website lessons and, yes,even books such as this one.

The great hope for mosttraders is that there is avaluable indicator (or recipeofindicators)thatwillhintatwherethemarketisheadedinthe future. Millions uponmillions of dollars are spenteachyearbytraders(andalsoinvestment companies, hedgefunds, banks, etc.) because aslight edge may providemillions of dollars in profits.In forex a slight edge may

mean billions of dollars inprofits.

ISTHEREA“BETTER”

INDICATOR?Which indicator is best?Which suite of indicatorsoffers a clear edge in themarkets?Perhapsit isbest to

find out who is makingmoney in forex, and then dowhat they do. Which is themagic formula?Unfortunately, the answer tothisquestionis“Itdependsonwhoyouask.”Thismayverywell be the correct answer.As we will see later in thebook,tradingisoftenrelativeandrarely,ifever,aone-size-fits-all endeavor. Someindicators are considered

shams, others aremisinterpretedbythemasses,and still others are best usedcontrary to their originaldesign intent. Indicatorsmaybe incorrect. What if theindicator is correct, but a bitslow to hint at the directionthe market will take? Theindicator might providevaluable information, butmight also be slow to theparty, and thus not of much

value. Perhaps a slightchange to the indicatorformulawillspeeditupabit.Perhaps indicators are

similar to a wristwatch,constantly improving, morefeatures available as needed,but would it be possible totake a wristwatch, andmanipulatetimebyrunningaformula through the hours,theminutes, and the secondsdisplayed on thewristwatch?

Would the wristwatch keepbetter time once the formulamanipulated the actual timeoftheday?Usingaformulatocreatea

better time on a wristwatchmay seem weird andcounterproductive, but this ispreciselywhatindicatorsmayaccomplish by changing andmassaging price data.Indicator-based trading istaking a wristwatch and

changing the time with acomplexformulainthehopesthat the wristwatch willsomehow tell time better.Whowantsawristwatchwithsomethingother than therealtimedisplayed?Doindicators(all of which are calculatedusing price data) allow us tounderstandpricebetter?Perhaps it is best to put

aside any philosophicaldifferences with technical

indicators.Letusassumethatour indicator isbaseduponamagical formula and thisformula allows us to get aglimpse of the future. Ourindicator magicallytransforms price data intosomeothernumber, color,orline,andsuggestswherepriceis headed in the near future.Unfortunately, even if ourindicator is able toaccomplish this, difficulties

may endure with indicator-basedtrading.Indicators are inherently

slow. The market will bemoving up long before anindicatorsuggestsitistimetobuy. Likewise, an indicatorwill suggest it is time to selllong after the market hasstarted falling.This is oneofthe main complaints withindicators: they lag behindprice. This is a fair concern.

Figure 2.1 contains anAUD/USD four-hour chartwith the Relative StrengthIndex (RSI) indicator.Traditionally, there are twoRSI signals. If the RSI isabovethe70level,themarketis overbought, and once theRSI falls back down below70,aselltradeisinitiated.

Figure2.1TraditionalRSISellSignalonAUD/USD4-HourChart.

©2000–2011,MetaQuotesSoftwareCorp.

Likewise, if the RSI fallsbelow 30, the market is said

to be oversold, and,traditionally, a buy trade issignaledonce theRSImovesback above 30 (see arrow inFigure2.2).

Figure2.2TraditionalRSIBuySignalonAUD/USD4-HourChart.©2000–2011,MetaQuotesSoftwareCorp.

In these examples we seethat the RSI indicatorsuggests a trade at about the

righttime.ThemarketturnedaroundneartheRSIsignalinboth examples.However, theRSI did not signal a trade atthe precise turning point inthe market. To find theseturningpoints,anindicatorofa different type is required.One of the primary reasonswhy naked trading is soattractive to forex traders isbecausenaked tradingallowsfor early entries into trades.

Indicatorsmayalerttraderstothe fact that the market hasturned around after themarket has turned around,but naked traders may findturning points in the marketas theyoccur. Naked tradingstrategies are based on thecurrent price of the market,and, therefore, theyallowforan earlier entry. Indicator-based trade signals will lagbecause it takes time for the

price data to be processedthrough the formulas thatmakeuptheindicator.

INDICATORLAG

Significant moves in theforexmarketoccurbeforeatechnicalindicatorprovidesasignal.

Naked traders have anincredible advantage.

Entering a trade early oftenmeans the entry price isclosertothestoplossprice.Atighter stop loss may meanmore profits, the precisereason for this is examinedlater in the book. Aftermastering a few simplestrategies, naked traders finditverydifficulttomovebackto indicator-based strategiessimplybecausenaked-tradingstrategiesremovethelagtime

that is inherent withindicator-basedtrading.Here is another example,

this timewith the EUR/USDdaily chart (Figure 2.3). Inthis example the indicator atthebottomof thechart is theMoving AverageConvergence Divergence(MACD). The constructionandtheorybehindtheMACDis not important, the MACDconsists of a few moving

averages. The critical signalfor the MACD is when thetwo moving averages cross(see thedark circle inFigure2.3).A traditional buy signaloccurs when the MACD hasbeentravelinglowerforsometime and then turns around,and the faster-movingaverage crosses the slower-movingaverage.

Figure2.3TraditionalMACDBuySignalon

EUR/USDDailyChartmarkedwithacircle.©2000–2011,MetaQuotesSoftwareCorp.

InFigure2.3theEUR/USDdaily chart has been fallingfor some time.Price starts toturnaroundand tradehigher,and consequently theMACDmoving averages start tocreepupward.Finally,weseethe faster-moving average ontheMACDhascrossedabovethe slower-moving average.This signals a buy trade forthe MACD trader. Aftercrossing upward on the

MACD, the market doesindeed move higher (seeFigure2.4).

Figure2.4TheEUR/USDtradeshigherafterthetraditionalMACDBuySignalonEUR/USDDailyChart.©2000–2011,MetaQuotesSoftwareCorp.

Although this trade lookslike a nice trade, the nakedtrader would have entered

this trade earlier than thetrader using the traditionalMACD trading strategy. Thenaked trader and theMACDtrader both profit, but thenaked trader is able to enterthe trade sooner and use atighterstoploss.Tighterstopsmean more money. Thenaked trader and theMACDtradercouldhavebothexitedat the same price, but thenaked trader captures more

profits because the stop lossis placed closer to the entryprice. The money-management section of thisbook will have moreinformation on how nakedtrading strategies enabletraders tomakemoremoneysimplybecausenakedsignalsappear earlier than indicator-basedtradingsignals.TheMACDandtheRSIare

not the only indicators that

lag. All indicators lag. Thestochastic is a popularindicator used to time tradesaccording to the naturalrhythms of the market. Onetraditional stochastic tradingmethod is similar to the RSIstrategy. A sell signal isindicatedwhen the stochasticfalls below the 30 level andthen crosses higher (seeFigure2.5).

Figure2.5EUR/USD1-Hour

Chart—TraditionalBuySignalontheOversoldStochastic.©2000–2011,MetaQuotesSoftwareCorp.

PIPSA “pip” is a percentage inpoint. One pip is equal to

1/100thof1percent. Ithastraditionally marked thesmallest move a forex paircan make. Forex traderstrack trades in terms ofpips. However, manybrokers are now using“pipettes”—these are1/1000thof1percentunits.

TheEUR/USD1-hourchartshows the stochastic fallingbelow30onthestochastic.Afewhourslater,thestochasticcrosses upward and rises

above 30, a clear buy signal.The stochastic ismoving up,so price should follow.However, the market thenfalls a further 90 pips. Formost traders this tradewouldbeabigloser.Whataboutthenakedtrader?Inthisinstance,the naked trader gets a veryclear buy signal after thestochastic buy signal (seeFigure2.6).

Figure2.6EUR/USD1-Hour

Chart—NakedBuySignalversusStochasticBuySignal.Thetraditionalstochasticbuysignaloccursimmediatelybeforethemarketfalls.Thenakedtraderhasabuysignalatthemarketturningpoint.©2000–2011,MetaQuotesSoftwareCorp.

What happens after thenaked trading signal? Themarket jumps more than 40

pips immediately. The nakedtrader avoids many losingtrades bywaiting for a priceaction signal and quicklyfinds profits. Not all nakedtradesarewinners,ofcourse,butthistradeisanexampleofhow the naked trader is ableto avoid some of the verycommon indicator-basedmistakes because the nakedtraderusesthepriceactionofthemarkettodetermineentry

signals.Notice how the naked

trader avoids the drawdownwith this trade signal. Themarketimmediatelymovesinthe expected direction,upward, after the signal.Contrast this entry to thestochastic entry signal. Thecharacteristic indicator lagassociatedwith thestochasticmeans that the stochastictradernotonlyentersalosing

trade, but immediately afterthe stochastic signal themarket trades in the wrongdirection,andthetradeentersinto a protracted drawdown.In fact, it is unlikely that thestochastic trader ever hadprofit on this trade. Naked-trading strategies enable thetrader to enter a trade basedon current market priceaction, and often avoid thesevere drawdowns associated

withindicator-basedtrading.Most tradersbelievesevere

drawdowns are a part oftrading. This is simply nottrue. Severe drawdowns arecharacteristic of mistimedentry signals, and mosttraders use indicators to findentry signals, somost tradersmistimeentries.

TAKING

RESPONSIBILITYFORLOSINGTRADES

All traders experiencedrawdowns. All tradersexperience losing trades.However, naked traders takeresponsibility for losingtrades.Indicator-basedtradersoften blame their indicatorsfor unsuccessful trades (e.g.,

“the MACD looked like itwasgoingtocrosshere,”“myindicator did not loadcorrectly,” “maybe I shouldchange the settings on myindicator because the markethasbeenchoppylately,”“thatmoving average crossoverwas a fake out—whipsawedon that one,” etc.), but thenaked trader does not havethis excuse. There is noscapegoatwhenyouareusing

market data (price action) totake trades. Trading withpriceaction,thatis,theactualpriceonthechartasthebasisfor all trading decisions,means that the naked traderhas no excuse for losingtrades. This is extremelyliberatingformanytraders.The indicator-based trader

alsohas theaddedadvantageofanindicatortoblamewhenthings go awry; the naked

trader can blame no one butthe market for losing trades.This is a subtle but veryimportant difference point ofreferenceforthenakedtrader.Alltradinginvolvesanaspectof luck. All tradersexperience a lucky streak ofwinning trades and anunlucky streak of losingtrades.Without the crutch ofindicators, naked traders aremore likely to take

responsibilityfortheirtradingresults.Perhaps we should take a

close look at this idea oftrading responsibility. If youdecide to tradeanewtradingsystem,youmayhaveputthesystem through a screeningprocess. After spending timetesting the system, you haveconvinced yourself that thetrading system is worthwhileandwill indeedmakemoney

over the long run (at thisstage your research may farexceed the effort that 90percent of forex traders putintotheirtradingresearch).If,after all of your research,when you start trading liveyousee the first seven tradesturn out to be losing trades,you may be discouraged.Whatwouldyoudo?Perhapsyou decide to maintaintrading the system, and you

suffer through an additionalthree more losing trades.After 10 consecutive losingtrades what would you do?Would you stop trading thesystem? Would you create anewruletofilteroutsomeoflosing trades that you haveexperienced? Would youdecide the trading system isnolongerprofitable,andgiveup on trading the system?There are many possible

explanations for the reasonwhythetradingsystemfailedafteryoulauncheditintoliveaction.Maybethemarkethaschanged. Maybe the systemno longerworks.Perhaps the10 losing tradeswere just anunluckystreak.Your decision, after faced

withthe10losingtrades,willplace you into one of twogroups: the terrible-systemgroup or the bad-market

group(onlynakedtraderscanavoid these groups). If youare unsure about your group,pay attention to what youthinkaboutthenexttimeyouhaveastringoflosingtrades,youwill quickly learnwhichgroupisyours.Terrible-system traders,

after a string of 10 losingtrades, blame the tradingsystem. Terrible-systemtraders will say “the trading

system is not workinganymore” or “this tradingsystem must be modified toget it back on track.”Terrible-system tradersdecide to modify or give upon the trading system after alosing streak. Often, terrible-system traders will suggestadding another indicator orotherwise slightly modifingthe trading system to helpfilter out some of the losing

trades recently triggered.Theother strategy employed bythese traders is togiveuponthe trading system. “Thesystem is broken,” they say,or “This trading systemworkedwell before, but nowit is breaking down, allsystemshaveashelflife,andthis trading system hasexpired,”or“thesystemmayhavemadegoodprofitsinthepast, but it simply doesn't

workanymore.”If you find yourself saying

something similar, you areprobably a terrible-systemtrader. If you are constantlychanging trading systems,particularly after a losingstreak, you are a terrible-system trader. All terrible-system traders blame thesystem when finding profitsbecomesdifficult.Bad-market traders take a

different approach. Bad-market traders analyze thelosing trades after adrawdown and insteadconclude that themarket haschanged. Bad-market traderscan come up with manyreasons that this market isstructurally very differentfrom before, and may beheard muttering things like“the Bank of Japan'sintervention has changed the

market,” or “things havechanged with the Euro sinceSpain went bankrupt.” Theprecisereasonsmayvary,butthe essence of the argumentremainsthesame.Sometimesthebad-markettraderwillusesubtle arguments such “themarketistoovolatile,”“thereisnotenoughvolumetoday,”“my broker is unable toexecute my trades fastenough.”The latterargument

hints at a common scapegoatfor the bad-market trader—thebroker.Bad-market traders are

often identified by theirwillingness to engage inbroker conspiracy theories.The fact is that dishonestbrokers are found out, andforex traders will eventuallyabandon the dishonestbrokers. Word spreadsquickly, particularly among

intelligent, Internet-savvytraders with high-speedInternet connections. But forthe bad-market trader, thebroker offers the perfectexcuse for a failing tradingsystem. Bad-market tradersplaceblameon thebrokerorthe market, and thus have areason for abandoning alosingtradingsystem.Many bad-market traders

engage in fundamental

analysis, but not allfundamentaltradersbelongtothe bad-market camp. Theinterpretation of economicdata and engaging infundamental analysis is oftenanopportunityforbad-markettraders to further theirargument. These traders willdecidetogiveuponatradingsystemafteraseriesoflosingtrades, just as the terrible-system traders decide to

abandonalosingsystem;itisonlythereasonforgivinguponthesystemthatvaries.Theterrible-system trader placesblameonthesystem,andthebad-market trader isconvinced the market hasfundamentally changed. Bothbad-market traders andterrible-system traders willend up searching for anentirely different tradingsystem.

Interestingly, thedifferencebetween a terrible-systemtraderandabad-markettraderis often conscientiousness.The conscientious trader isusuallythebad-markettrader.This is because theconscientious trader willspend time testing andensuring that any tradingsystem employed is viablebefore risking money in themarket.Theend resultof the

system testing is confidencein the system for the bad-market trader. For the bad-market trader, the experienceof a drawdown is quiteharrowing and unexpected,because the trading systemhas been tested and seemsviable; if the system cannotbewrong,themarketmustbe“wrong.”Ourterrible-systemtraderis

unlikely to have spent the

sameefforttestingthetradingsystem. The terrible-systemtrader probably found thesystem on a forex Internetforum, purchased it from anInternet marketer, learned itfrom a friend, or perhapsheardacircleofforextradersdiscussing the system inhushed tones at a party. Theterrible-system tradermaybetrading a profitable system,butwithoutspendingthetime

testing the system, theterrible-system trader isunlikelytoholdthesysteminhighregard.So how might you avoid

fallingintotheterriblesystemor bad-market groups? Whatmightyoudo tochangeyourfate? You may want tocarefully consider adoptingnaked trading.Tradingnakedmeans trading withoutindicators, and removing

indicators from your chartwillmakeitdifficulttoadoptthe attitude of the terrible-system trader. Also, if youdecidetotradenakedyouwillbe trading on price action orthe market movements. Youcouldblame themarket forastring of losing trades as anaked trader, but that wouldbeabitlikeblamingtheriverforbeingwet.Naked traders find trades

based onmarketmovements,so, unless the market ismoving“incorrectly,”thereisnosuchthingasabadmarketfor the naked trader. Nakedtraders may only blamelosing trades on poorexecution (the trader's fault)or poor luck (sometimes youflipacoinseven timesand itlands on tails every time).Naked traders may find thattrading without indicators is

extremelyliberating.Traders around the world

have found that adoptingnaked-trading strategiesmeans letting go of a trade.There are no indicators togive false signals, there areno settings to tweak; there issimply the market price andthe trading decision. Nakedtradershavea trueadvantagebecausethefocusofthetradeis the current market price.

Thereisnobetterindicatorofthe sentiment, attitude, orexuberance of the marketthanthecurrentmarketprice.Naked traders make thecurrent market price theirindicator. In fact, for manynaked traders, the currentmarket price is a bit like abiofeedback machine. Icertainly look at the marketprice as biofeedback. Abiofeedback machine will

allow you to tune into thephysiologicalchangesinyourbody, in the hopes that youcan better control yourphysiology.Forexample, if Iam an anxious person, and Iam always suffering fromstress, I can hook myself upto a biofeedback machine.ThemachinewillalertmeifIbecome anxious (bloodpressure increases, heart rateincreases, etc. would cause

the machine to produce thesound) by sounding off analert.Icanthenpayattentionto the soundsof themachineanduserelaxation techniquesto decrease my anxiety. Themachine simply alerts mewhenIneedtorecalibratemyphysiology. Over time, Ishould be able to weanmyselfoffofthebiofeedbackmachine and reduce myanxiety on my own, without

the aid of the biofeedbackalerts.

LEARNINGFROM

MARKETBIOFEEDBACK™Itmayseemstrange,butyouwill eventually be able to dothe same thing with your

trades if you decide to adoptnaked-trading strategies. Inthe beginning, the marketprice is your biofeedbackmachine. If the market isgoing in thewrongdirection,you have valuable feedbackon your trade. Learn fromthis.Wastheentrytooearly?(Most traders I know aremuch more likely to jumpinto a trade too early than towait too late.)Was the entry

too late?Themarketwill tellyou how your trade rates.Why is it important to payattention to the marketbiofeedback? Because youwill learnmore fromMarketBiofeedback than you willlearn from any guru, anytrading book, or any onlinecourse. Another way to statethis is as follows: Payingclose attention to how themarket behaves after you

enteratradeisoneofthebestlearning tools available toyou.

MARKETBIOFEEDBACKA psychological,behavioral, and tradingresponsetothemarketpriceafter a trade has beenentered.

Market Biofeedback

involves two distinctdomains,Thefirstishowthemarket reacts (price action)after you enter your trade,and the second is how youreacttothepriceactioninthemarket after you enter yourtrade. Both parts of theMarketBiofeedbackequationare needed for you to get aclearpictureofwhatyouarelearning, and moreimportantly,whatyoushould

learn, from your tradingexperiences. You shouldlearnfromthepriceactionthemarket offers after you enteratrade.Youshouldalsolearnfrom your reaction to themarketafteryouenteratrade.Even if you do notconsciously intend to learnfrom Market Biofeedback, itis important for you torecognize that MarketBiofeedback will yield all

your important tradingdecisions.Howyouapproachyour trading, which tradingsystemsyouemploy,whetheryou give up on your tradingor go on to a long andsuccessful trading career, allthese things are determinedbyMarketBiofeedback.Most traders allow Market

Biofeedback to completelydictatetheirtradingapproach,evenwithout realizing this is

happening. For example,some tradersstartout tradingthe five-minute charts andthen slowly gravitate towardlonger timeframes, such asthe four-hour or daily charts.Whydothesetradersdothis?The answer is MarketBiofeedback. Other traders,after several losing trades,will give up on a tradingsystem and search for a newone. This change in trading

strategyis,onceagain,duetoMarket Biofeedback. Othertraders may trade the exactsame tradingsystemandwillexperience seven losingtrades insuccessionandholdsteady, knowing that thecurrent drawdown is simplyan aberration. MarketBiofeedback is thedifferencebetweenthetraderswhogiveup on a trading system andlook for a new strategy and

those traders who maintainconfidence despite the losingstreak.Howyoureactandrespond

to adrawdown, to awindfallof pips, or something inbetween is exceptionallyvaluable information. Theeasiest way to see MarketBiofeedbackistorecordyourthoughts as you trade. Youcanrecordyourvoicebefore,during,andafteratrade.You

can take screenshots of thetrade before, during, andafter. You may also recordvideo of the trade before,during, and after with adesktop-computer recordingsoftware.Here are the important

questions to answer as yourecordMarketBiofeedback:

Where has themarketmoved sinceIenteredmytrade?

If I looked at themarketnow,wouldItakethesametrade?HowdoIfeelaboutmytrade?WhatdoIlikeaboutthistradenow?What do I dislikeabout this tradenow?On a scale of 1(poor decision) to10 (great decision),

where would I rankthistradenow?If I were not in atrade now, would Itake the oppositetrade?

If you ask yourself thesequestions and record youranswers before, during, andafter the trade,youwill havebuilt up a database of yourpersonalMarketBiofeedback—an invaluable tool. More

importantly, you will bringintoconsciousawarenesshowyoureacttothemarket.Mosttraderswill trade theirwholeliveswithoutrecognizingthatMarket Biofeedback dictateshowtheyadaptandchangeasa trader. By simplyacknowledging MarketBiofeedback, you canunderstand how you react tothe market in general, andhowyourtrades,inparticular,

mold your approach totrading. Market Biofeedbackis the one area that mosttraders neglect, most tradersare not quite aware of thisprocess. By paying attentionto Market Biofeedback overtime, you will be able tobecome aware of, andeventually control yourtrading behaviors. This willallow you to take a big steptowardsconsistentprofits.

If you would like to learnmore about MarketBiofeedback, please go towww.marketbiofeedback.com.

CHAPTER3

Back-TestingYourSystem

You need to continue togain expertise, but avoidthinkinglikeanexpert.

—DenisWaitley

The consistently profitableforextrader isanexpert.Justas an expert farmerunderstands seeds and soil,and the expert mechanic canhearthedifferencebetweenablown gasket and loosemuffler, the expert forextraderknowsmarkets.Wheredoes this expertise comefrom? How does the noviceforex trader become anexpert? This is the million-

dollarquestion.Make no mistake about it,

when you step into anymarket, including the forexmarket, and decide that youwant to make money, youhavedecidedyouwilloutwitand outperform some of themost determined, intelligent,and well-resourced people inthe world. All theseimpressive people have onegoal: to take your money.

Howcanyoumakemoneyinthe markets, knowing whomyou are up against? Theanswerissimple.Perhapstheanswer is much simpler thatyouwouldbelieve.Youmustpractice.Practiceyourcraft.Practice

your trading. This is thesimple way to become anexpert.Simpledoesnotmeaneasy, because many tradersexpect to become experts

without practice, and sadlythey never achieve expertise.Consistently profitabletrading is yours if youpractice trading and becomeanexpert.You now have the secret

formula to achieveconsistently profitabletrading. Will you use thissecret? The best estimatessuggest as many as 74.8percent of traders do not use

the secret. This is because74.8 percent of forex tradersdo not consistently makemoney trading (ForexMagnatesU.S.ForexBrokersProfitability Report forQuarter 2, 2011). The 25.2percent of consistentlyprofitable traders practicetradingtogetbetteratit.Only 25.2 percent of all of

the traders reading this willdecide to practice trading to

become an expert. It is nocoincidence that about 25.2percent of all traders areconsistently profitable.Practice helps achieveexpertise in nearly everysport and vocation. It isinterestingtoseehowthevastmajority of aspiring tradersexpect to immediatelybecome successful withoutputting the effort intobecominganexpert.

Experttradersputtheeffortintobecominganexpert.Itisironic that many traders areattracted to the tradinglifestyle,thinkingthattradingwill allow passive income toaccumulate. This is certainlytrue, any trader can makemoney while sleeping, butexpert tradersaremuchmorelikely to achieve consistent,passive income from trading.Tradingis likeanyother job:

Practice and effort must bewell-placed in order to reaptherewards.Theexperttradermaybeable toquicklymaketrading decisions and placetrades,butthesedecisionsarethe fruits of many hours ofpractice, in nearly everyinstance. Traders must earntheirpipsthroughpractice.Practice means confidence.

Practicing your tradingsystem will enable you to

keeptradingyoursystem,andavoid all distractions andexcuses (e.g., terrible-systemtraders and bad-markettraders) along the way.Practicing your tradingsystem will allow you toenjoy the confidence ofknowing when you place atradehowlikelyyouaretobesuccessfulwiththatparticulartrade.Would you enjoy trading

more if you had a quiet,unshakable confidence inyour trading system? Wouldyou find it easier to walkaway from your computer ifyou knew the preciselikelihood that your tradewouldbeawinner?Woulditbenicetoknowthatyouwillavoidtheexcusesbad-markettraders and terrible-systemtraders make? What wouldhappen if, from today

onward, you maintainedconfidence in your ability toextract profits from themarket even through the upsanddownsthatareinevitableinanytrader'slife?Consistently profitable

traders, otherwise known asexperttraders,haveonethingin common: They test theirtrading systems. Thesetraders practice their tradingsystems. There are many

methods for testing a tradingsystem. Each of them hasadvantages anddisadvantages.Depending on your

personality and how youapproachyourtrading,oneofthese approaches is likely toresonate with you more thanthe others. Decide which ofthe three methods you willadopt to become an experttrader.

Each of these methods areback-testing methods. Back-testing is a common termused in trading that simplymeans “testing a tradingsystem through historicaldata.” All traders know thatusinghistoricaldataisnottheperfect solution to testing atradingsystem.Amuchbetteralternative would be to havefuturedatatotestour tradingsystems. Failing that,

historicaldataisthenextbestthing.Therearemanypitfallsandproblemsassociatedwithtesting trading systems onhistorical data; however, theconsequencesassociatedwithtrading a system in livemarket conditions when it isnot tested on historical dataaremuchmoreproblematic.

THREEGOALS

OFBACK-TESTING

Your back-testing will allowyou to do two things: First,youwillidentifyhowsuitablethetradingsystemisforyou.This does not mean you arediscovering whether thetrading system is profitable,but,rather,youareexaminingthe fit between you, thetrader, and the rules of your

trading system. Second, youwilllearntotrustyourtradingsystemand learn to let goofyourtrades.Youmaytradeina more relaxed manner onceyou have taken thousands oftrades over years of marketdata. The confidence gainedby trading your systemrepeatedlywillshowupintheformofarelaxedapproachtoyour live trading. Third, youwill gain expertisewith your

trading system. This mayonlyhappenifyoutakemanytrades, and back-testing is aquick way to accumulatemany trades.A close look ateachofthesethreegoalsmayhelp you to get themost outofyourback-testing.

IstheSystemSuitable?

How suitable is your trading

system? The first goal ofback-testing is to find outhow suitable the tradingsystem is for you. I have agood friend, who introducedme to forex, named AshkanBolour. Bolour is a well-known forex trader,youmayhave read about him in theMillionaire Traders book byKathy Lien and BorisSchlossberg. Bolour tradesthe three-minute and five-

minute charts. He doesexceptionally well tradingthese charts. No matter howmanytimesIwatchhimtradehissystemsonthesecharts,IalwaysfailwhenItrytotradeashedoes. I failbecausehistrading system does not fitwithmyviewofthemarkets.Ipreferthedaily,weekly,andfour-hourcharts. Ihavegreatdifficultywatchingmytradesfluctuate, which is precisely

what Bolour does when hetrades.Ihavelearnedtotradesystems that make sense tome. I am better at extractingprofits from the longer-termcharts.Yourjobistofindouthow you should be trading,and trade only what makessensetoyou.Perhaps you have traded

severaltradingsystemsinthepast. Most of these systemsprobably looked outstanding

at first glance. Maybe youpaid for the trading system,andthewebsiteyouboughtitfrompaintedthesystemasaninvincible profit-collectingmachine.Ormaybeyou readabout the system on anInternet forum. Or perhaps afriend told you about thetrading system. No matterhowgood the trading systemappears, it isremarkablehowyour trading results often

differ fromyour expectationsof the system. How can aperfect,profitablesystemfallapartinyourhands?Whyisitthat a system that soundsgooddoesnotworkonceyoustarttradingit?The answer is fit; if a

systemdoesnotfityourviewofthemarkets,yourapproachto trading, your ability toexecute trades, it will notmake money for you. A

system must fit with yourunderstandingofthemarkets.Ifyoubelievethefive-minutechart is “random noise,” youmay be better suited to tradethedailychart.Ifyoubelievemoving averages are uselessindicators, you will not becomfortable with a moving-average-based system. If youthink that the USD/JPY is aterrible pair to trade, you arenotgoingtotradeasystemon

the USD/JPY. Your beliefsabout trading must fit yourtradingsystem.Your lifestyle will also

determine the types ofsystemsyoumaytrade.Ifyouhave a full-time job, andspend 10 hours of the day atan office where youwill nothave access to your tradingplatform, you probably willbe drawn toward longer-termcharts.Daily,weekly,orfour-

hour charts may be best foryou.Thisway,youmay takeyourtradesandmanagethemby checking the charts onceortwiceeachday.Your makeup as a trader

will also determine how youshould trade. Perhaps youfreak out when you are in atrade on the lower-timeframecharts, such as the five-minute charts. Perhaps it istorture watching the profit

andlossfluctuategreatlywitheach pip gained or lost ontheselower-timeframecharts.If this is the case, you willprobably want to tradehigher-timeframe charts. Ifyou are risking the samepercentage of your accountoneachtrade,it islikelythata tradeona lower timeframechart will risk more per pipbecausethestoplossisclosertotheentrypricethanatrade

on a higher-timeframe chart.Your back-testing experiencewith the trading system willshowyouwhetheryouwillbeable to find profits with asystem. Testing will alsoshow you whether yourlifestyle will fit with thesystem. Perhaps most of thetrade signals for a tradingsystem occur during theEuropeanmarket,andyouarefast asleep during that time;

this may mean that thetradingsystemisnotforyou.

ConfidenceIsLettingGo

After you have found asystem that fits yourpersonality, your view of themarkets, you need to getcomfortable trading thissystem. This will be thesecondstepyoutakeonyour

way to consistent profits inforex.Thekeyhereistogainexperienceoverabroadrangeof market conditions.Relaxing while you are in atrade will often help youmanage the trade better. Justthe simple fact that you arerelaxedmeansyourdecision-makingwillbebetter.Relaxation will come for

you once you haveconfidence in your system, a

confidence gained by tradingyour system repeatedly, overyears of market conditionsandavarietyof signals.Youwilllearntotrustyourtradingsystemand learn to let goofyour trades. Micromanagingtrades, particularly trades onhigher timeframes, is acommon mistake of novicetraders.Ifyoucanwalkawayfrom your computer aftermaking a trade, you have

confidence in your system.This confidence is onlyavailabletotraderswhohaveback-testedextensively.Accelerate your learning

curvebyback-testing.Itdoesnot matter your method ofback-testing; it only mattersthat you do it. Testing overthousands of trades willenable you to be betterprepared to make a decisiononyourtradingsystem.Once

you deem your systemprofitable, you can begin toget comfortable with thesystembytestingextensively,slowlybuildingyourdatabaseoftradingexperiencewiththesystem. Your next step willbe to become an expert withyoursystem.

YouAretheExpertThe number-one reason

traders fail in forex is this:Most traders do not haveexpertise.Most traders begintrading a system withoutmuch experience trading asystem.When the first bumpin the road appears (e.g. anextendedlosingperiod,alackof signals for a week, acoupleofdifficult-to-interpretsignals, etc.) the system isabandoned. The traders whoconsistently pull profits from

the market are experts,withoutexception.To become an expert at

anything, you must do it atleast 10,000 times. If youwant to become an expert inyour chosen trading system,youcould take10,000trades,whichwillprobablytakeyouyearstoachieve,oryoucouldback-test your system. Byseriously testing your systemoverthousandsoftrades,you

willquicklyachieveexpertisewith your system. Seriouslytesting your system meansmaking trades just as youwouldwithyourliveaccount:trading from the right-handedgeofthechart,withoutthebenefit of hindsight bias,using a strict application ofyourtradingrules.The naked trader has an

advantage over traders whotrade “normal,” indicator-

based systems.A traderwhois trading a systemincorporating sevenindicators must view andinterpret all seven indicatorsforeachtrade,before,during,and after every signal isinitiated.Thisiscumbersomeand slow. The naked traderhasachartwithnoindicators,a very clean chart. Thesechartsareeasytointerpret.Infact, the naked trader gains

experience with his systemeverytimeheseesachartinanewspaper,ontelevision,inabook, regardless of market.This is because the nakedtrader can see, at a glance,whether the chart suggests abuysignal,asellsignal,ornotrade signal. A chart on thenightlynewshelps thenakedtrader march towardexpertise. In this way, thenaked trader has a distinct

advantage over traders usingindicators. Expertise willcome more quickly, moreeasily, and allow the nakedtrader to interpret any chart,inanymarket,atanytime.Experts in cognitive

psychologyagreethatexpertsat the highest level find itdifficult to teach theirexpertise.Expertsknowwhatto do, in fact, because theirexpert behavior is automatic.

Theydonotthinkaboutwhatthey do, they just do it.Novices spend a lot of timethinking about theprocedures, setting things upcorrectly, and so forth.Experts spend time thinkingabout how they interpretinformation—averydifferentapproach.Sowhatdoesthismeanfor

your trading? It means youshould back-test extensively.

Your goal should be to pulloutof thenovicetraderstageand into the expert level asquickly as possible. The fastwaytoachieveexpertiseistogain experience trading yoursystemviatesting.Allnovicetraders spend a goodproportion of time inorientation, “Is this a goodsignal?” “Does this set-upqualify as a valid trade set-up?” “Should I take this

trade? I am not sure if thisconstitutes a good signal…”Expert traders spend moretimeevaluatingthetradeonceit is initiated. Inotherwords,experts are concerned withMarket Biofeedback, andnovice traders are concernedwith understanding thesystem rules. This isunderstandable, novicetraders spend time thinkingabout possible trade set-ups,

novice traders are stilllearning the trading system.Expert traders spend moretime managing trades andfocusingonmakingsure thatopen trades are managedefficiently, to extractmaximum profits from themarket once those profitsbecomeavailable.One of the true paradoxes

of expertise is this: Expertsfind it difficult to verbalize

the decision-making process.Expert traders are oftenunable to adequately explainhowtoduplicatetheirresults.This is frustrating for thenovice.Experts often relyonunconscious thinking, or a“gut feeling” when makingdecisions. The subtle cuesexperts use to make adecision are ingrained androte, often inaccessible toconscious consideration, and

this is frustrating for novicetraders who are seekingexpertise. Novice traders arebetter off spending timegaining experience throughtesting, building towardexpertise,ratherthantryingtofindashortcuttoexpertisebymirroringexperts.Unlessyouwanttoallowa

computertodoallthetradingfor you—in other words youtrade only fully automated

trading systems—youprobablywillwanttoachievetrading expertise. Yourshortcut to trading expertiseis to back-test. Although itmayseemlikehardwork,thefact is you can simplyaccumulate years ofexperience over hours whenyoudecidetomanuallyback-test. It is, quite simply, thebest shortcut to tradingsuccess. The very successful

traders, who are consistentlyfinding profits in themarket,who are trading for a living,all of them share onecharacteristic: They back-testtheir systems and earn theirpips on their back-testingsoftware. Why not join thissuccessful group of traderstoday?

MANUAL

BACK-TESTING

Manual back-testing is themost readily available formof back-testing available.Most traders understand it ispossible to manually back-test their tradingsystems,butmost traders choose not tomanually back-test. Manycharting packages make iteasy to back-test. The vast

majority of charts will allowthe historical price, so thatyou may advance priceslowly and “trade” the chartasitunfolds.Forexample,inMetaTrader™yousimplyhittheF12keyonyourkeyboardto advance the charts onepricebaratatime.Thisisallthat is needed for manualback-testing.

CANDLESTICKThecandlestickisapopularchart that displays theopening price, the closingprice,thehighpriceandthelow price for a marketduringagiven timeperiod.Each candlestick clearlyrepresents the importantmarket activity for thegiventimeperiod.

Tomanuallyback-test, yousimplyscrollbackintimeand

recordyour trades, the tradesyou would have taken hadyoubeen trading the chart inlive market conditions. Youcan advance the candlesticksslowly, one at a time, recordyour entry price, the numberof lots traded,yourstop loss,and your profit target. Youmay be concerned thatmanual back-testing involvesa lot of notes, spreadsheets,and recordkeeping. It is a

meticulous, involved, andlaborious method of back-testing. It is also extremelypowerful. If you aspire totrade by looking at a chartand making a tradingdecision, you are nearlyduplicating the tradingprocess with this form ofback-testing.Most traders employ

discretionarytradingsystems,so it follows that manual

back-testing is the mostappropriate form of back-testingformosttraders.Obviously manual back-

testing will take some time,and it is sometimes difficultto avoid “cheating”with thistype of back-testing.However,youmust takecaretoavoidgoingforwardonthechartandthenreversingbackin time to take a trade youwouldhavetaken.Thekeyis

to trade as if you are in thatmoment in time, with noinformationofthefuture.Theexperience gained withmanual back-testing ispriceless. You can quicklyaccumulate experience withyour trading system if youback-test correctly. Manualback-testing will yieldstatistics to help youunderstandthenatureofyourtrading system. These

statistics, aswewill see laterin this book, will becomeinvaluable for determininghowyoushouldtradeastheymay be utilized to projectyourresultsintothefuture.Anoteaboutmanualback-

testing—itmayseemtedious,it will take some time, youmaywant togiveupwhen itprogresses slowly,particularly when you arelooking to accumulate

hundredsoftrades.Resistthetemptation to avoid manualback-testing. Make progressin small chunks, an hour oftestingperdaycangiveyouahugeadvantage.Thepayoffisgreat and your experiencetestingyoursystemwillallowyou to gain “experience”trading the system throughdifferent market conditions.Each trade during manualback-testing will march you

closer to expertise. Thisexpertise may be thedifference between youabandoning your tradingsystem during the inevitabledrawdown, and maintainingconfidence in your tradingsystem through a drawdown.However, there are pitfallsassociatedwithmanualback-testing.The most common pitfall

traders fall into with this

testing is engaging in futuretrading by advancing thechart, either by accident orintention, and then decidingthat a tradewouldhave beentaken. Traders at times havedifficulty discerning whenfuture price data creeps intomanual back-testing. Traderswho are strict about notallowing trades after futuredata is viewed will avoidcontaminating back-testing

data. By trading only fromthecurrentcandlestickonthechart, serious back-testersavoidgoingforwardintime.Hindsight bias is a critical

killer that may creep intoyour manual back-testing ifyou allow it to happen. Agood rule of thumb is toadvance the charts slowlyduring your testing, and ifyou accidentally advance thechart too quickly, you must

keepyour trades to theright-handedgeofthechart.Ifyouadvancethechartandthengoback to take a trade, you areleaving yourself open to thehindsightbias.

HINDSIGHTBIAS

The tendency tooverestimate thepredictabilityof themarketafter the future outcome is

known.

Evenifyouonlytaketradesduring testing by advancingthechartonecandlestickatatime, hindsight biasmay stillsneakintoyourtesting.Ifyouare testing historical data onthe EUR/USD in 2008, andyouhadexperiencetradingin2008, you may have aproblem. Your subconsciousmay be pulling up the 2008

EUR/USD chart and you areobviously not even aware ofit. To fight hindsight bias,take trades on the right-handedge of the chart, do not goforwardonthechartandthenreverse back, and if you doaccidentally go forward,resign yourself to skippingover any signals that pop upand stick to trading on theright-handedgeofthechart.

USINGBACK-TESTING

SOFTWAREBack-testing software is astep up from manual back-testing.Mostforextradersarenot even aware of the factthat manually back-testingyour trading system ispossible. Back-testingsoftware is an

underappreciated tool, onethat will allow you tomanually back-test yourtrading system at anaggressive pace. Manualback-testing software recordsyour trades for you andenables you to quickly taketrades as you advance thehistorical charts. In manyways, manual back-testingwith software is not muchdifferent from manual back-

testing. The advantages tousingsoftwareareasfollows:Software will allow fastertesting, so you mayaccumulate experiencequicker; the softwarewill dotherecordkeepingforyouandallow you to concentrate onthe trade signals; you mayeasily export your data foranalysis; and softwarediscourages cheating—manual back-testing software

isahindsightbiaskiller.Of themanymanual back-

testing software packagesavailable, my favorite isForexTester.ForexTester isa manual back-testingsoftware package that willallowyoutoimportanydata.You may decide to importforexdata,futuresdata,stockdata—any data will work.Forex tester will record yourtrades and allow you to

export your trading data intoa spreadsheet, after youhavecompleted your testing, foranalysis. The beauty ofsoftware-based testing is thatit allows you to concentrateon trading your system. Inmany ways, it mirrors livetrading with an accountplatform.Ifyouwouldliketosee a video demonstration ofForex Tester please go towww.fxjake.com/book.

There are many traders,myself included, who willspendmore timeback-testingwith software because it ismuch easier than manualback-testing. Back-testingwith software helps tradersgain years of tradingexperience in a few hours.However, the real work inback-testing is examining theresults. Exporting andanalyzingthedatafromback-

testing is where serioustraders validate tradingsystems, find behavioralpatterns, and developstrategies to augmentprofitable trading strategies.These data are gold for theserioustrader.Yourback-testingdatawill

help you determine yourtradingpatterns (Doyoufindprofits more easily on thedaily charts? Are most of

your winning trades initiatedduring theEuropean session?Doyoutradeparticularlywellwith your system on theCAD/JPY?),andthiscanleadto more fruitful back-testingsessions.Youwillalsoknow,afterback-testingyoursystemover several hundred trades,if the system makes moneyfor you. In fact, before youeverriskonecent,youshouldmake hundreds of trades

while back-testing to verifythat your trading systemwillcapture profits and also togain expertise with yoursystem.Manual back-testing with

software is not withoutproblems.Youmust lookoutfor the same pitfalls thatcreep up with manual back-testing, namely hindsightbias. Manual back-testingsoftware makes it easier to

avoidhindsight bias, but youstill must be careful to onlytake trades if you have notadvanced forward on thechart.Cheatingisnotallowedwhen back-testing; your goalis to generate realistic traderesults during your back-testing. Also, because it isvery easy to quickly executetrades with the testingsoftware,youmustwatchoutforsubpar trades.Tradesyou

would not take on a livetrading account should bebypassed no matter howtempting it may be to takethemduringback-testing.Tryto back-test as if you haverealmoneyatrisk.Thisistheonlyway to ensure that yourstatistics and experience inback-testing will closelymatch your live trading. Ifyou remain vigilant andconscientious during testing,

your results will be moremeaningful.

AUTOMATEDBACK-

TESTINGAutomatedback-testingisthemostwell-knownmethod fortestingatradingsystem.Mostforextradersareawareofthe

fact that it is possible to dosome automated testing on atrading system. However,most forex traders usediscretionary, or manual,tradingsystems,soautomatedback-testing is not the idealmethod for back-testing; itdoesnotcloselyduplicatethediscretionary trading mosttraders engage in. There aremany reasons fordiscouragingautomatedback-

testing for discretionarytraders:

There may be toomuch humaninterpretation in thetrading system.Automated back-testing does notallowforthehumaninterpretation oftradesignals.The trading systemmay involve

variables that arenot available on theprice chart (newsreleases, economicdata records,interpretation ofworldevents,etc.).It is impossible toautomatethetradingsystem (fuzzy logic,parameters difficulttodefine,etc.).Youmaynotbeable

to articulate yourtrading system.Automated back-testing is onlypossible for tradingsystemswithclearlydefinedrules.

Most forex traders shouldnot use automated back-testing. Automated back-testing is appropriate forthose traders who useautomated trading systems.

Automated trading systems,known as trading robots, orexpert advisors, are popularwith forex traders. However,most traders are morecomfortable withdiscretionarytradingsystems.So, while it may be possibleto use automated back-testing, it may not beappropriateformosttraders.Here is a test to help you

decide whether automated

back-testingisforyou.Ifyouturn on your automatedtradingsystemandcanallowittotradewithoutanyofyourinterventionforamonth,thenautomated back-testing maybe for you. If your systemneeds your input for anyreason, then you are adiscretionary trader, and youshould use manual back-testingormanualback-testingwithsoftware.

There are otherdisadvantages to automatedback-testing.Itdoesnotallowyou to gain experience withthe trading system. You willnotgaintheexpertisethatyouwould ifyoumanually testedthe system because thecomputer takes all of thetrades over the course of theback-testing. Automatedback-testingwillnotgiveyouexperience trading your

system throughmanymarketconditions. Automated back-testing will probably nothighlight the weaknesses ofyour trading system; theseweaknesses will be readilyapparent when manual back-testing is done. However,with automated back-testing,theweaknessesareabitmoredifficult to identify. In short,automated back-testing isreallyonlyanoptionforthose

traders who are not using adiscretionarytradingsystem.There are unique pitfalls

associated with automatedback-testing. For example, itisquiteeasytousetoomanyvariables in an automatedtrading system. Using toomany variables often impliesthat there are too manyindicators in the tradingsystem. Seasoned tradersunderstand how simple

trading systems are robust,andmay be applied tomanymarkets over varyingtimeframes. (All of thenaked-trading systems in thisbook are incredibly simpleand robust.) It is difficult forsome automated-systemdevelopers to keep theirtrading systems simple androbust; the temptation to addmore indicators and rules isgreat.

It is exceptionally easy forautomated traders to use toomany indicators whendeveloping and testing asystem. Adding too manyvariables to any tradingsystem increases the chancesthat the trading system willwork quite well on one datasetbutwillnotworkwellonanother. With too manyvariables the system is likelyto do exceptionally well

during some marketconditions and then breakdown and perform poorlywhen market conditionschange. This is a very realrisk with automated back-testing. It is almost too easyfor a trader to decide to addmore conditions andindicators to the tradingsystem, which will increasetheprofitabilityofthetradingsystemoverthecourseofthe

historical data in the back-test,oftenmaking thesystemlook very good. However,theseresultsoftencompletelyfallapartafteryouapply thisverysametradingsystemtoadifferentdata set or to futuremarket conditions. In a veryreal sense, the Achilles heelof automated back-testing isthatitistooeasy.Becausetheautomated back-tests can begenerated so quickly, the

automatedback-testerwillgooverboard tweaking andtesting the system. The endresult is often a system thatworks exceptionally well onthehistoricaldataintheback-testbutfallsapartcompletelyinlivemarketconditions.There is another issue that

often comes up withautomated back-testing. Thisis the postdictive error, afancy way of saying that a

trading system uses futureinformation to make adecision in the present time.This is actually somethingthatisrelatedtothehindsightbias. Traders back-testingautomated trading systemsmust be extremely careful. Itispossiblefortheback-testerto pull data from the futurewithout knowing about it.This is obviously a very bigproblem, because as a rule,

future data is not generallyavailable, despite any claimsto the contrary by technicalindicator salespeople(psychics and palm readersare the obvious exceptions).When future data is used inan automated back-test, thesystem looks incredible, butonce the trading system isapplied to real marketconditions, without thecritical (future) data, the

systemfallsapart.There is one advantage to

automated back-testing, thatis, it allows you to quicklydetermine whether anautomated trading strategy isviable. The back-testmay bedone in seconds, which is atrue advantage for theautomated trader.Remember,the automated traderwill notgain the same expertise andcomfort level as the trader

who uses manual back-testing. This is the biggestweaknessofautomatedback-testing, the back-tests arecheap.Thereisnoexperiencegained each time a back-testis run. The manual back-testing trader accumulatesexperienceeverytimeatradeset-up is executed. Thisexperience should not bediscounted. An automatedback-test may clarify the

worthiness of an automatedtrading system, ofteninvolving hundreds, orthousands of trades, butremember the trades are alltaken by computer and willnotleadtotraderexpertise.Inthis sense the trades arewasted, the trader does notaccumulateexperienceduringthe back-testing, this is onlypossible with manual back-testing.

If you use automatedtrading systems, then,perhaps, automated back-testing is appropriate, but ifyou use manual tradingsystems, it may be best toavoidautomatedback-testing.

TOPTHREEBACK-

TESTINGTIPS

There is one distinguishingcharacteristic between thosetraders who continuallystruggle to find consistentprofits and those traderswhoconsistently pull profits fromthe market. The traders whoare still looking forconsistency, who are stilllookingforprofits,aretraderswho usually do not back-testtrading systems. Thesetraders fall in love with a

systembeforeestablishingtheveracityof thesystem.Thesetraders often move fromtrading system to tradingsystem, hoping that the newsystem will yield betterresults than the previoussystem. The consistentlyprofitable traders take adifferent approach. Thesetradersknow that theyhaveaprofitable system becausethey back-test their system

extensively. These tradershave seen their system workoveryearsofmarketdataandknow precisely the type ofdrawdown they are likely tocomeupagainstinthefuture.The choice is yours; you

maydecide to join thegroupof struggling traders whojump from system to system,never really finding comfortwith any trading system, oryou may decide to join the

successful traders, theprofitable group who spendtime back-testing theirsystems.Ifyoudecidetojointhe latter group, I have threeback-testing tips for you.Thesetipsweredevelopedbyworkingwithtradersjustlikeyou, around the world. Thekeyistoapproachyourback-testingasyouwouldanyskillyou are working toward. Ifyouwerelookingtolearnthe

bass guitar, you wouldprobablywanttotakelessonsand spend time playing yourguitar to hone your skills.However, it is important thatyou play the bass guitar inyour own style. Back-testingismuch the same.Youmustapproachitseriously,butyoumust also keep this in mind:You will consistently findprofitsonlyifyoustaytruetoyourtradingstyle.

ConsiderYourStyleUse a back-testing methodthat fits your trading style. Ifyou are an automated trader,then use automated back-testing; if you are adiscretionary trader, usemanual back-testing. Themostimportantthinginback-testing is to duplicate yourtrading style. Back-test in away that will be meaningful

and bring you closer toexpertisewithyoursystem.

TakeTimetoTestThere is a real temptation,particularlywhenengaginginmanual back-testing withsoftware, to do it much tooquickly. Back-testing is alearning process. Just as youwouldnotexpecttocompletea 16-week course in a day,

you will need to break upyour back-testing sessions,particularly if you are doingmanual back-testing. Try tokeep your sessions short—undertwohours—sothatyouapproacheach sessionwithafresh mind and you areunlikely to get sloppy.Back-testing for six ormore hourswill usually lead to poorresults simply because youwere not as sharp for your

last trades as you were foryourfirsttrades.

MistakesArePartofBack-Testing

Makingmistakes is also partof the learning process. Wehave a natural tendency toavoid mistakes. So when atrading mistake pops upseveraltimes,itistemptingtomodify the trading systemso

that it accounts for thismistake.However, this is theroad that leads to too manyvariables ina tradingsystem.Avoid too many variables.Trytokeepyoursystemrulessimple.Itmaybetemptingtoaddanewruletoavoidsomelosing trades, but this mayblunt the effectiveness ofyoursystem.If you are interested in

naked trading, trading

without indicators, then youare likely to avoid the “toomany rules”mistake. This isanother reason why nakedtrading allows traders torealizetheirfullpotential.Nakedtradingalsoinvolves

using the history of themarket. If you ask anypsychologist how to bestlearnaboutsomeone,youwillhear that it is best to followthat person around.

Psychologistsdonothavethetimetofollowpeoplearound,so questionnaires are used todetermine what somebody islike—their personality, theirhabits, and their history.Likewise, the naked tradermay use the history of themarket to determine what islikelytohappeninthefuture.Everyonehasdonesomethingandsaid,“WhydoIdothat?”People like tobelieve in free

choice, butmost humans arecreatures of habit. Likewise,the market is a hugeamalgamation of habitualtraders.Themarketisnothingmore than a community ofcreatures of habit. Peoplemake up the market. Thenaked trader uses this to hisadvantage, by closelyfollowing historical turningpointsinthemarket.Wewillget into this issue in detail

laterinthebook,butfornowit is important to rememberthat the naked trader equatesthe market to a herd. Herdswilloftenfollowoneanotherforsafety.Membersofaherdwill also fall on one anotheras they run off a cliff. Thenaked trader uses specifictools to tune into and takeadvantage of the herdbehavior that we call themarket.

CHAPTER4

IdentifyingSupportand

ResistanceZones

There's an old sayingabout those who forget

history. Idon't rememberit,butit'sgood.

—StephenColbertYou have to pay closeattention to one thing on thechart if you trade naked:price.Priceisking.Pricewilltellyouallyouneedtoknow.The wonderful thing that allmarkets have is this: ahistory. The market will tellyou where the sweet spot ison the chart. These sweet

spots will be the foundationfor everything you do as anakedtrader.Asweetspotonthechartis

asupportandresistancezone.Youmaybefamiliarwiththeconcept of support andresistance, however, supportand resistance zones aredifferent from what manytraders characterize assupport and resistance. Iwillcall these support and

resistancezonesbyoneword—zones.Theeightimportantcharacteristicsofzonesareasfollows:

1.Zonesareanarea,notapricepoint.2. Zones are like finewine; theygetbetterwithage.3. Zones are spots on thechart where pricereverses,repeatedly.4. Zonesmay be extreme

highsorlowsonthechart.5.Zonesarewherenakedtraders find tradingopportunities.6. Support and resistancezones rarely need to bemodified.7. Line charts help nakedtradersfindzones.8.Zonesareoftenseenbymanytraders.

You may want to take acloser look at each of these

eight characteristics. It isincredibly important that youunderstand how to drawzones, why you should drawzones on your charts, andunderstandwhen these zonesbecome critical for yourtrading.

ZONESAREBIGFATBEER

BELLIESA zone is simply a big fatbeerbelly.Manytradershavemisconceptions concerningzones. Traders may befamiliar with the concept ofsupport and resistance butunfortunately,manymisapplythis concept to technicaltrading. The naked traderunderstandsthatzonesareanarea on the chart. This is a

very distinct concept to asupportandresistanceline.Asupport and resistance lineindicates a specific price onthe chart, but zones aresomething different. Zonesarenotaspecificprice.Thesezones are, instead, an area, arange, or, as I prefer, a beerbelly.Letme explain. I prefer to

think of these zones on thechart as if they were beer

bellies. Before you disregardthis idea, consider what abeer belly is:A beer belly issomewhat firm, maybesomewhat repulsive, and hassome predictablecharacteristics. My friendJason has a beer belly.He isquite proudof it; he tellsmeitisquiteexpensive,ashehaspaidgoodmoneyforthewineand beer that have enabledhim to grow this belly. If I

weretopushintoJason'sbeerbelly with my fist (I wouldnever push into a beer bellywithout permission, and Isuggest you, too, first obtainpermission before pushinganybeerbellies),eventuallyIwouldfindresistance.Evenifat first I did not findresistance, eventually therewouldbeapointatwhichthesquishybeerbellywouldstopmefrompushingfurther.This

is acritical characteristic, forI know that Imaybe able topush a little bit into the beerbelly,buteventually thebeerbelly will offer someresistance.Perhaps you may also

decide to push into Jason'sbeerbellywithyourfist.Youmay have a differentexperience. Perhaps, whenyou start topush into Jason'sbeer belly, you become

somewhat unsettled anddecidetopullbackafteronlyslightly brushing the haircovering his beer belly. Thisiscompletelyreasonable,andI am sure that many otherswill have the same reaction.However,theimportantthingtonotehere is thatyouandIare pushing into the samebeerbelly,Jason'sbeerbelly,but we find resistance atdifferent spots on the beer

belly.This isasignificant feature

of zones. Zones are just likebeer bellies. Zones are spotson the chart where price haspushed and probed, and thenreversed. Naked traders lovebeer bellies. They love thesezones.Nakedtraderswaitforprice to reach these zonesbefore initiating a trade. Thezone is the sweet spoton thechart for the naked trader. It

is absolutely critical that thenaked trader identifies thezones on the chart. Thesezones are the foundation ofnakedtrading.

OLDZONES,NEWZONES

The age of zones, and theimportance of the age of azone,isahotlydebatedtopic

among traders. Some tradersbelieve that only those zonesthat have been establishedrecently are important, andother traders believe thatzones that were establishedlongagoarejustasimportantas the newlyminted zones. Ibelieve that zones arerecycled.If you take a look at any

chart for any currency, youwill find historical price

levels. What you will noticeisthatpricehasatendencytoreverse at the same levelsrepeatedly. This is adistinguishing trait of zones,and you may use thischaracteristic to define anddiscover zones on yourcurrencycharts.

HotPizzaandZonesWhenIwasayoungchild,at

aboutsix,Iusedtowatchmymother in the kitchen. Itwasfun.Infact,someofmyveryfirst memories are of mymother singing to me in thekitchen.Oneday,whileinthekitchen, I had a terribleaccident. On this day mymotherwasbakingpizza,andit smelled delicious. In fact,you may find it hard tobelieve,but to thisday I stilllove pizza. My mother was

busy chopping up theingredients for the pizza,making the sauce, becauseshe had several pizzas tomake.Iwanderedovertothefirst pizza. It was still on ahot pan because it had onlyjust been removed from theoven.Now, my mother had

warnedme tobewaryof thehot pizza pan. I had eitherforgotten or disregarded her

warning, and I decided tograb the pizza pan becausethepizzasmelledsogood.Asyou may imagine, Icompletelyburnedmyhand.Istill remember it beingextremely painful and stillhavethescars.Ilearnedalessonthatday.I

stilllovepizza,butIamwaryofhotpans.Itwasavaluablelesson I learned, and issomething that I think about

every time I look at acurrency pair on the chart, Ithink about that pizza day.Every time I see a chartapproaching a zone, Iconsider that themarketmayrememberthelasttimeitwasburnt at that price level, atthatzone.

DoZones=MarketScars?

TakealookattheFigure4.1.This is thedailychartfor theEUR/CAD currency pair.Note that this pair foundsupportatthecriticallevelof1.4350 back in July andAugust of 2006 (up arrow).The pair repeatedly foundsupport at this level overmany weeks. Then, inSeptember and October of2006, the pair trades back tothiszoneandfindsresistance

onthreeseparateoccasionsatthe 1.4350 level (downarrow).

Figure4.1Support/ResistanceZoneontheEUR/CADDailyChartin2006.ThemarketfindssupportinJulyandAugust2006at1.4350,andtheninSeptemberandOctoberof2006themarketfindsresistanceontheverysamezoneat1.4350.

©2000–2011,MetaQuotesSoftwareCorp.

Nowtakealookatthenextchart, same pair, the

EUR/CAD in Figure 4.2.Here the pair has foundresistance back up at the1.4350level,fouryearslater.The market moves back tothis critical 1.4350 level,finds resistance there andpromptly falls. The chart hasa memory! This is a veryclear zone for this currencypair. Do you think thatknowing where price mayturn around is an advantage

foryou,asanakedtrader?

Figure4.2Support/ResistanceZoneontheEUR/CADDailyChartin2010.Aftertradinghigherandhigher,themarketfindsresistanceatthe1.4350zoneandpricefallslower.©2000–2011,MetaQuotesSoftwareCorp.

Perhaps you may bethinkingthatothermarketsdonothaveamemoryforzones.

Maybe this EUR/CADexample is just an exceptionratherthantherule.Ifyouarethinking this, please take afewmomentstolookatafewcharts for yourself. AnotherexampleinFigure4.3, this isthe USD/CHF daily chartfrom July 2008. Notice howthe market came down andtouched the 1.000 zone(arrow) and then rocketedhigher.

Figure4.3TheUSD/CHFdailychartshowsadistinctzoneatthe1.0000wherethemarketfindssupportin2008.©2000–2011,MetaQuotesSoftwareCorp.

Over a year later, in 2009the USD/CHF falls backdown to the same 1.0000

level and finds support onthree occasions, as you canseeinFigure4.4.Themarkettradedsharplyhigherafterthethird touch on the 1.0000zone. Again, the market hasmade a critical reversal at aprice that has historicallyserved as a turning point.This is what zones are,historicalturningpoints.

Figure4.4In2009,theUSD/CHFagainfinds

supportonthecritical1.0000zone.©2000–2011,MetaQuotesSoftwareCorp.

Another example is shownin Figure 4.5. This time it istheEUR/USDdaily chart. In2003 this pair topped out at1.1930, there were severaltouches on this zone (seethreearrows).

Figure4.5ThedailyEUR/USDhasaclearzoneatthe1.1930levelin2003.Themarketfindsresistancethreetimesinquicksuccession.©2000–2011,MetaQuotesSoftware

Corp.

Years later the EUR/USDwasfreefallingfromahighofover 1.5100 and the pair

eventually found support3000 pips lower, on a verycriticalzone(seeFigure4.6).The 1.1930 level served ascritical support seven yearslater. The chart has amemory!

Figure4.6ThedailyEUR/USDfallsover3000pipsandeventuallyfindssupportatthe1.1930zonein2010,sevenyearsafterfirstfindingresistanceonthis

zone.©2000–2011,MetaQuotesSoftwareCorp.

Thesezonesarecritical forthe naked trader; once pricereaches a zone, the nakedtrader is on alert for apossible trade set-up. Whywould the naked trader wanttoknowonceprice reachesazone? Because price hasrepeatedly turned around atthesezones!Knowingwhatamarkethasdoneinthepastiscritical for the naked trader,not because the naked trader

assumes themarketwill turnaroundagain,butbecausethenaked trader is on high alert,and the market may turnaround again. Some tradersare literally on alert, if youwouldliketoseeafreevideoon how you can set up pricealertssothatyourchartssendyou an e-mail when pricereaches a zone, go towww.fxjake.com/book.The naked trader does not

take trades based on pricereaching a zone, the nakedtrader uses several tools todecide when to take a trade.However, the naked traderwill not take a trade unlesspricehasreachedazone.Thisis the first step (pricereaching a zone) for thenakedtrader,whensettingupatrade.

HOWTOFINDZONES

Zones are those spots on thechart where price hasrepeatedly reversed.However, it may be difficultat first for you to find thesezoneson thechart.Thereareseveral sneaky shortcuts thatyou can use to help developan eye for finding zones.Some zones are extremely

obvious and easy to find.Other zones are a little bittrickier and may be difficultforyoutoidentifyifyouhavenot had experience findingzones on the chart. Pleasekeep in mind these threeshortcuts when you aredrawing your zones on thechart.

1. Start with a highertimeframechart.2.Usea linechart tofind

thezonesonthechart.3.Ignoreminorzones.

UseaHigherTimeframeChart

Question: When you meetsomeone new, how do youdecide what they are like?You learn their history, youask people about them, youtry and decipher what theyhave done in the past, in the

hopes of understanding thembetter. Why do you do this?The implicit assumption isthat they will do the samethings they have done in thepastinthefuture.Marketsarenodifferent.Whenthemarketis on a runaway uptrend,traders look to the oldercharts to see where thecriticalzonesareonthechart.This is also where we seehistoryrepeat itself,overand

overandoveragain.This shortcut for finding

zones on the chartwillworkregardless of the timeframeyouaretrading.Simplymoveup one timeframe. This is avery powerful method forfinding the most importantzones on the chart.Examining the highertimeframe chart will enableyoutoidentifyzonesthatwillbe the most critical areas on

the chart for the timeframeyou choose to trade. A fewtouches on the highertimeframechartwill translateinto many touches on thelower timeframe chart. Thistechnique will work on anytimeframechart.Take a look at Figure 4.7,

theGBP/USDone-hourchart.This pair has made anextreme low at the 1.6291level. This touch at 1.6291

suggeststhemarkethasmadea significant low, and thislevel may become importantlater. You may recall thatextreme touches (lows orhighs)arealsocritical zones.Although most zones willhavetouchesfromaboveandbelow(supportandresistancetouches), touches at extremelevels are also very critical,such as the extreme low inFigure 4.7. Later, themarket

willoftencomebacktotheseextremelevels.

Figure4.7The1.6291levelontheGBP/USDone-hourchartappearstobeanextremelow,soazoneisassumedatthislevel.©2000–2011,MetaQuotesSoftwareCorp.

A month later, theGBP/USD four-hour chart(Figure 4.8) suggests two

very interesting conclusions.First, the market has indeedfound support and resistanceon the 1.6291 level; themarket has a memory.Second, the four-hour chartshows a very clearperspectiveforthismarket.

Figure4.8Themarketcomesbacktothe1.6291zoneonemonthlaterontheGBP/USDfour-hourchart.Noticetherepeatedtouchesfromabove

andbelow.©2000–2011,MetaQuotesSoftwareCorp.

Moving up to a higher

timeframeisanexcellentwayto gain perspective.Only themost important zones willbecome evident on a higher-timeframe chart. If you areusingMetaTrader™foryourcharts, you will have thefollowing time framesavailable: one minute, fiveminutes, 15 minutes, 30minutes,onehour,fourhours,daily, weekly, and monthly.Thus, if you are trading the

one-hourchart, amoveup tothe four-hour chart will helpto identify the critical zones.The GBP/USD zone at1.6291 is clearly a criticalzone, as the market touchesthiszonemorethansixtimesoverthecourseofonemonth(Figure4.8).Thisbringsupanimportant

point about zones. Theimportance of a zone isdirectlyrelatedtothenumber

of touches on that zone. So,for instance, if a daily chartshows a zone with fivetouches over the past year,this would indicate a verycriticalzoneonthatparticularchart. Here is anotherexample: Notice on Figure4.9, the EUR/CAD dailychart, that the 1.4350 zonehasservedasresistancethreetimesovertwomonths.

Figure4.9ACriticalZoneat

1.4350ontheEUR/CADDailyChart.©2000–2011,MetaQuotesSoftwareCorp.

Moving back a bit further,weseeinFigure4.10thatthe1.4350 area was an area ofresistancesevenmonthspriorto the recent touches on thezone.

Figure4.10Sevenmonthsprior,theEUR/CADfindsresistanceatthe1.4350zone.©2000–2011,MetaQuotesSoftwareCorp.

Ifwegobackevenfurther,we can see in Figure 4.11how there are many touches

on this very same zone, the1.4350 zone, as price hasfound both support andresistanceonthiszone.Thesetouchesoccurredonthisverysamecriticalarea, the1.4350area,almostfiveyearsprior.

Figure4.11Nearlyfiveyearsprior,theEUR/CADrepeatedlyfindsresistanceandsupportatthe1.4350zone.©2000–2011,MetaQuotesSoftware

Corp.

Some traders will say thatold zones no longer matter.

Traders say things like“things have changed,” or“with inflation these oldlevels do not mean as muchanymore,”or“whywouldthemarketrememberalevel thatit has not been to in over adecade?”Ifthisiscurrentlyyourway

of thinking, I wouldencourageyoutotakeacloselook at the zones on a chart15yearsago.Justscrollback

on the chart, do not considerthe current price. Draw yourlines on the chart based onwhere you find support andresistancezones15yearsago.If your chart doesn't go back15 years, try to go back atleast 5 to 10 years. Youshould be able to identifycritical areas on the chartfrom a long time ago. Nowscroll forward and you willsee that price in the future

bounces off of these supportand resistance zones. Thechart has a memory. Asamazingasthismaysound,itis true: Price has a memory.This is true for any market,onanytimeframe.Ihopeyougo out and see this foryourself. Please do—yourfuture as a naked tradermaydependonit.Themarketsdoremember the critical zones,thisiswhyitisimportantfor

you, too, to remember thesecriticalzones.

TheLineChartIsYourFriend

Marking the zones on yourchart isas simpleasdrawinga lineon thechart.However,if you have not looked atchartsintermsofsupportandresistance zones before, itmay be a bit difficult to find

precisely where these zonesare located. It is importantthat, as a naked trader, you“see” these zones. Onebrilliant method for findingzones on the chart, and thisworks particularly well forthose traderswhoarenew tofindingzoneson thechart, istomovetoa linechart.Mostcharting packages will allowyou to view themarket on aline chart. A line chart is a

chart thatoffersacontinuousline, connecting the closingprices. Rather than showingthe open, the high, the low,and the close, such as acandlestick chart, or a barchart, the line chart simplyconnectstheclosingprices.Take a look at the daily

GBP/CHF chart (Figure4.12).Wherewouldyoudrawthezone?

Figure4.12Sometimeszonesarenotveryobvious,suchasonthisdailyGBP/CHFchart.©2000–2011,MetaQuotesSoftwareCorp.

Now,takealookattheline

chart in Figure 4.13. Wherewouldyoudrawthezonesonthischart?

Figure4.13Alinechartwilloftenmakezoneseasiertospot.©2000–2011,MetaQuotesSoftwareCorp.

ItisveryobviousinFigure4.13 that a zone should bedrawn at 2.2713, and this is

the beauty of the line chart.The line chart allows you tofind those areas on the chartwhere price has “bent”—thelinecharthelpsusto identifyzones because the line chartshows where price hasrepeatedlybent,eachbendonthe line chart is a potentialzone.Thoseplacesonthelinechart with several bends arezones.Line charts may also be

extremely useful for thosecharts where price doesn'tseemtoberespectingazone.TakealookattheNZD/USDfour-hour chart in Figure4.14. See how market pricesareallovertheshopandpricedoesnot seem to respect anyzone? Perhaps there is asupport and resistance zonehiddenonthechart.Maybeitis there, but it is notimmediately obvious where

thiszoneislocated.

Figure4.14Sometimeszonesarenotveryobvious.PriceseemsverychoppyonthisNZD/USDfour-hourchart.©2000–2011,MetaQuotesSoftwareCorp.

When a chart looks likethis,itmaybedifficulttospotthe zone. Perhaps there is no

zoneon this chart?For thesecharts, the line chart maycome to the rescue. A linechart may save you fromsloppy price action on thecharts.Alinechartmaymakeclear what is otherwisemuddled and difficult todecipher. Line charts areabsolutely critical for thenaked trader.Notice how thepricemovement on the chartinFigure4.15 becomes clear

andthezoneisnowobvious.Because the line chart takesinto consideration only theclosing price, it is a verysimple way to view priceaction.

Figure4.15ThelinechartfortheNZD/USDfour-hourchartsuggestsaclearzoneat0.6937.Noticethatthereareseveralbendsinthelinechartatthiszone.©2000–2011,MetaQuotesSoftware

Corp.

WhytheClosing

PriceIsImportantNow,youmaywonder,“Whylookatachartthatonlytakesintoconsideration theclosingprice?”Thelinechartismadeup of only closing prices.This is true, but the closingpricesare themost importantprice. It is important to notethat the closing price for theforex market is usuallyconsidered the end of the

North American tradingsession, at 5:00 P.M. NewYorktime.Everyday,thereisa battle between the bulls(buyers) and bears (sellers).Traders run through the fullgamut of emotions and oftenswingfromfear togreedandbackagainduringthetradingsession. However, once theend of the day approaches,traders begin to concentrateon answering this one

importantquestion:“ShouldIhold this trade through totomorrow or should I closethis trade now?” This isprecisely why the closingprice is critical, and not onlyinNorthAmerica.The traders in Europe also

seetheclosingprice,andmayreact to it. This is animportant point because theclosing time may be only10:00or11:00intheevening

in Europe, depending on thecountry. Traders in theAmericasandEuropespendagood portion of the daytradingduringthesametime.Thisisasignificantaspectofforex, because European andNorth American marketscapture the overwhelmingmajority of the volume inforex. Therefore, this closingprice, the last price for theNew York session, is

extremely important. Bothtraders in the Americas andthe European Continentinfluenceit.Afterthisclosingprice, themarketslowsdownconsiderably and shifts intothe interbank market, a veryslow trading periodpunctuated by occasionalbank-to-bank transactions. Ina very real sense, the NorthAmericanclosingpriceis thelast price of the day before

Asia wakes up and starts anewtradingday.

ZonesonaLowerTimeFrameChart

Youmaywonderattimesifazone is important enough todraw a line on the chart.Sometimesitmaynotbeveryclear,perhapsthereareafewtouchesonanarea,butitmaynot be a strong area of

supportandresistance.If thisis the case, you are probablyseeingwhat iscalledaminorzone. A minor zone isnothing more than a supportand resistance zone on thenext-lower-timeframe chart.These zones are veryapparent on the lowertimeframe chart, and withpractice you will spot themon the higher timeframechart,buttheyarenotcritical

areas. Marking minor zonesonyourchartwillonlymakethechartconfusing.

MINORZONES

A support and resistancezonethatisapparentonthetimeframe one step lowerfromthetimeframeyouaretrading.

Later we will look at the

importance of minor zones,butfornowit is important tonote that, although theymaybe apparent, they are notcriticalandtheyshouldnotbemarked on your chart. Theonlyzonesthataremarkedonyourchartarethosezonesonthe timeframe you aretrading, and the timeframeonestephigherfromthechartyou are trading. Any of theotherzonesarenotimportant

for defining your trade setups.InFigure4.16,youcansee

anobviouszoneatthe113.85level on the EUR/JPY four-hourchart.

Figure4.16Thefour-hourEUR/JPYcharthasanobviouszoneatthe113.85level.©2000–2011,MetaQuotesSoftwareCorp.

However, the minor zonesmaynotbesoobvious.Thereis also a minor zone on the

EUR/JPY four-hour chart inFigure4.17.Thisminorzonemay be identified by thecandlestick lows and thecandlestickhighs.Itmaytakesome practice to see theseminorzonesonthechartyouaretrading.

Figure4.17Aminorzoneonthefour-hourEUR/JPYchartismarkedbythearrowat114.90.Minorzonescanoftenbeidentifiedby

candlestickhighsorlows.©2000–2011,MetaQuotesSoftwareCorp.

However,itisquiteeasytosee this minor zone on theEUR/JPYchartbyexamininga lower timeframe. Movingfrom the four-hour chart totheone-hourchartisonewayto clearly identify thisminorzone. In Figure 4.18, theminor zone on the EUR/JPYone-hour chart is clearlyidentified at 114.90, themarket finds support at114.90 for several one-hour

candlesticks before fallingthrough the level, and thenlater, the market trades backup to 114.90 and findsresistance. This minor zone,whichwasdifficult to seeonthe four-hour chart, is noweasier to see because thetouches from above andbelow are more clearlydefined. Minor zones arecritical for managing trades.Minor zones are hurdles,

spots where price may getstuck for some time. Whentrading the higher timeframechart, the only importantzonesarethosemajorsupportand resistance zones, thestandardzones.

Figure4.18Theminorzoneat114.90iscleartoseeontheone-hourEUR/JPYchart.©2000–2011,MetaQuotesSoftwareCorp.

If you find that you havetoo many zones drawn onyour chart, then youmay be

identifying minor zones onyour chart. Too many zoneson your chart will mean thatyou will find it difficult toidentify trade set-ups andprofit targets for your trades.Zones may appear at anyplace on the chart. Somenaked traders will attempt toonlydrawzoneson thechartat round numbers, such as1.3500 on the EUR/USD.This is not necessary. Zones

may appear anywhere. If azoneisidentifiedat1.1097,itmaybeacceptable tomark itas 1.1100, but it is notnecessaryforallzonestofallonaroundnumber.Mostofthetimeyourzones

will be scattered throughoutyour chart. Therefore, it isimportant to note that youmay have two significantzones nearby, but in generalyour zones should be spread

out throughout the chart (seeFigure 4.19). Here are a fewexamples. In this chart, thereare several hundred pipsbetween zones. On a dailychart, this is common.Usually zones are separatedbyabout100pipsormoreonadailychart.

Figure4.19ThedailyEUR/AUDcharthaszonesthatareapproximately100–200pipsapart.

©2000–2011,MetaQuotesSoftwareCorp.

The higher the time frame,the more separation between

zones.Here is theEUR/USDweekly chart in Figure 4.20,and the zones are severalhundred pips apart. Onaverage, there are about 500pipsbetweenzones.

Figure4.20TheweeklyEUR/USDcharthaszonesthatareabout500pipsapart.©2000–2011,MetaQuotesSoftwareCorp.

Zones are critical for thenaked trader. It is importantfor you to become

comfortable identifying andworking with zones. Zonesarewheretheactionisforthenakedtrader.Atfirstyoumayhave difficulty with zones;listed are five commontrouble spots and solutionsforeach.

FIVETIPSFORFINDING

ZONESFirst, you may not knowwheretofindyourzones(seeFigure 4.21). If you arehaving difficulty identifyingthe zones on your chart, theeasiest solution is to simplyload a line chart. The linechartwillshowallthezones,because the zones will beidentifiedbythebendsintheline (see Figure 4.22). At

each spot where you seerepeat bends in the line, youare probably looking at azone.

Figure4.21ThisisthedailyUSD/CHFchart.Doyouseeazoneonthischart?©2000–2011,MetaQuotesSoftwareCorp.

Figure4.22ThisistheUSD/CHFdailylinechart.Theobviouszoneat1.2685is

nowapparent.Themarketrepeatedlyfindsbothsupportandresistanceonthezone.©2000–2011,MetaQuotesSoftwareCorp.

Second, you may have toomany zones drawn on yourchart(seeFigure4.23).Ifyou

have too many zones drawnyour chart, then you willprobably experience twolikely problems. The firstproblem is that you willnotice many tradeopportunities. If you aretrading the daily chart andnotice that you have a tradenearly every day, youprobably have too manyzones drawn on your chart.Thezonesshouldbemoreor

lessevenly spreadout, and itmay take some time for themarket to reach these zones,and trigger a trade. Patienceis important for the nakedtrader.Zonesarecriticalareason the chart, and price doesnotalwaysreachthesecriticalareas—zones—every day.Thesecondproblemthatyouwill likely have is that youwill notice many trades endup being losers. This is

because the zones on yourchart are not solid zones;perhapsthereareminorzonesidentified on your chart. It isimportant for you to drawcritical zones only, thosespotsinthechartwherepricehas repeatedly reversed. Byonly identifying those zoneson the chart where price hasrepeatedly reversed, the oddsare inyour favor. It isnearlyalways better to err on the

side of caution. To do this,simplydrawfewerzones(seeFigure 4.24). If you markonly those zones on yourchart where price hasrepeatedly reversed, youwillavoid identifying the minorzones.Youmaymiss out onsome trades, but the tradesyoudomakeshouldbegreatopportunities.

Figure4.23Toomanyzonesareidentifiedonthisdaily

USD/CADchart.Themarkettouchesazonenearlyeverydayonthischartbecauseseveralminorzonesaremarkedonthischart.©2000–2011,MetaQuotesSoftwareCorp.

Figure4.24ThisistheUSD/CADdailychartagain,withonlythemajorzones

identified.Noticehowthemarketdoesnottouchazoneeveryday.©2000–2011,MetaQuotesSoftwareCorp.

Thethirdcommonproblemyou may incur when dealingwith zones is this: It often

becomes very difficult todetermine precisely where azoneshouldbedrawn.Thisisthe nature of the zone. Thezone is squishy, it is fat, itidentifies an area on thechart,andnotaspecificpoint(seeFigure 4.25). Rememberthatyoudohavesomeleewayindrawingyourzone.Itisnotessential to nail down thezone toa specificpricepointonyourchart,but rather it is

important that you identifythe area on the chart whereyou will look for a reversal.The toucheson thezonewillnot beperfect. Some toucheswill come close to the zone,other touches will extenddeepintothezone.

Figure4.25ThedailyCHF/JPYcharthasaclearzoneat89.35;themarkethasfoundresistanceatornearthiszoneonseveral

occasions.Noticehowsomeofthevalidzonetouchesareadeepintothezoneandothersarenearthezone.©2000–2011,MetaQuotesSoftwareCorp.

Notice how the 89.35 zonein Figure 4.25 has providedresistance for the daily

CHF/JPY trade on severaloccasions. The market hasfallenafterreachingthiszoneeach time, but the first twotouches extended deep intothe zone, and the third touchcame near the zone. This isvery common with zones;sometimes the market willbrush against the beer bellyandatother timesthemarketwillpushintothebeerbelly.The fourth problem that

manytraderscomeupagainstwhen drawing zones is thatthemarketseemstodisregardzones.When this occurs, ourtrustyfriendthelinechartcanoftencometotherescue.Theeasiest way to illustrate thisissue is to take a look at anexample. Take a look at thischart inFigure4.26,andyouwill notice that it appears asthough the market is notrespecting the area at 81.83,

whereazonecouldbedrawnon the chart. However, thesame chart viewed as a linechart(seeFigure4.27)showsthe important touches asbendsinthelinechart,anditisobviousthatthemarkethasrespectedthiszone.

Figure4.26Theone-hourAUD/JPYcharthasseveralcleanreversalsaroundthe81.83zone;however,thereareseveralsloppytouches

markedwitharrows.Themarketdoesnotappeartorespectthezoneduringthesetouches.©2000–2011,MetaQuotesSoftwareCorp.

Figure4.27Thelinechartclearsuptheconfusingpriceactionaroundthe81.83area

ontheAUD/JPYone-hourchart.Thelinechartindicatesthatthemarketfoundresistancetwiceandsupportonceonthe81.83zone,soitisawell-placedzone.©2000–2011,MetaQuotesSoftwareCorp.

The fifth problem that youmay come up against whentrading with zones is this: If

themarket trades beyond thezoneitdoesnotmeanthatthemarket has broken the zone.This is an important andcritical point for the nakedtrader. Remember zones arebeerbellies,theyaresquishy,they are fat, and they consistofawide rangeon thechart.This means that sometimesthemarketwill push into thezone,anditmaylooklikethemarkethasbrokenbeyondthe

zone, this is often not thecase.TakealookatthedailyNZD/CHF chart in Figure4.28, the market findsresistance at the 0.7590 zoneat least five times betweenNovember 2009 and March2010.

Figure4.28TheNZD/CHFdailychartshowsatleastfivetouchesonthe0.7590zone;sometouchesgobeyondthezone,othersarejustbelow

thezone.©2000–2011,MetaQuotesSoftwareCorp.

The NZD/CHF chart from

November 2009 to March2010showsaclearlydefinedzone at 0.7590, the marketfinds resistance at this levelon at least five occasions.Fromlefttoright,thereareatleast five touches on the0.7590 zone. The first touchisanearmiss;thepricecamevery close to 0.7590, butultimately found resistancejust below this price. Theremaining touches are a bit

beyondthezone,buteacharevalid touches on the zone.The second touch includesthree daily candlesticks insuccession; each day themarket pushes a bit beyondthe 0.7590 zone. Ultimately,the market closes below thezone,andafterthethirddailycandlestick falls, the markettrades lower once again. Thethird touch occurs five dayslater and includes a piercing

kangarootailcandlestick(seechapter 8 for more on thekangaroo tail), clearly themarkethastradedbeyondthe0.7590zone,butthemarketisunable to close above thezone, and it falls down afterthistouch.Thefourthtouchismadeupof twocandlesticks,the first on the 0.7590 zoneand the second pushes a bitfurther beyond the zone, butitisstillavalidtouch.(There

isanothernearmissafterthistouch, not marked on Figure4.28, but the market doescomeveryclosetothe0.7590zone.) The fifth and finaltouch again penetrates thezone before falling sharply;notice how the market wasonceagainunabletocloseontheothersideofthezone.Attimes,themarketmaytouchazone and then close brieflybeyond the zone before

movingback,butmostofthetime if the market touches azone,itmaytradebeyondthezone, but it will not closebeyondthezone.Havealookatsomecharts.

You will notice how pricewill often push into andbeyond a zone, only toeventually turn around. Thisis a common behavior. It isalso the reason why mostnaked traders find it much

easier to trade reversal set-ups than breakouts. Reversalset-ups are based on themarket turning around at azone,andbreakoutsarebasedonthemarkettradingbeyonda zone. Perhaps you aresimilartomosttradersinthatyou find it a very trickyproposition to determinewhen themarket hasmade abreakoutandtradedbeyondazone. If this describes your

experience,youmayconsideravoiding breakout trades andfocusing on reversal trades.Theeasiestandsafestwaytotrade breakouts is covered inChapter 5, The Last-Kiss. Ifyouareinterestedinbreakouttrading, the last kiss may bethetradeforyou.Once you begin to closely

attend to the clues in themarket, your trading willbecome more consistent.

Once the market reaches azone, the naked traderwatches carefully, and if acatalyst appears, a trade istriggered. The key tosuccessful trading is to waitfor the very best tradingopportunities. Theseopportunities occurwhen themarketreachesawell-definedzone and then prints acatalyst. These are goldenopportunities. The next

section is all about tradingcatalysts, how to identifythem and specific rules fortrading each of the highprobability, naked-tradingset-ups.

PARTTWO

Naked-TradingMethodology

CHAPTER5

TheLastKiss

Tome,thereisnogreateractofcouragethanbeingtheonewhokissesfirst.

—JaneaneGarofaloAll of the naked-trading

strategies in this book havethree parts: The first is toidentify the support andresistance zones, the secondis to wait for the market toreachoneofthesezones,andthe third is to take a tradeonce a catalyst prints on oneofthesezones.You now understand how

tofindzonesonthechart,andyou are ready to learn aboutcatalysts. Catalysts are

powerful price patterns.These simple price patternssuggestwhat themarketmaydooncethemarketreachesazone.Thesecatalystsareonlyuseful when they print on azone; catalysts that are notlocated on a zone are simplyinterestingpriceformations—they are not high-probabilitytrade set-ups. A very simpleand extremely powerfulcatalystisthelast-kisstrade.

Ifyouhavebeentradingforsometime,youhaveprobablyseenenoughofthemarketstoknowthattherearetwobasicmoods of the market, andthese moods will be seen inany market in the world.There is the calm, drifting,directionless, choppy marketasisevidentinFigure5.1.Attimes, the market will alsoexhibit strong, powerfulexplosions characteristic of

thetrendingmarketascanbeseen in Figure 5.2. Themarket is always in one ofthesetwomoods.

Figure5.1ThisEUR/USDfour-hourchartisintheclassicconsolidationphase.Noticepricemovementischoppy,anddirectionlessanddoesnotseemtogoanywhere.©2000–2011,MetaQuotesSoftwareCorp.

Figure5.2AnotherEUR/USDfour-hourchart,herethemarketis

consistentlymovingupwardinastrongtrendingphase.©2000–2011,MetaQuotesSoftwareCorp.

Continually, the marketmoves between these twostates: the hyperactivetrending market and therelaxed, drifting market (seeFigure 5.3). Just as there arelow tides and high tides, hotdays and cool days, themarket also projects days oflaziness (choppy markets)and days of overwhelmingactivity (trending markets).Traders take advantage of

these two moods in themarket.

Figure5.3TheEUR/USDfour-hourcharttransitioningbetweenadirectionless,driftingmoodtoastrongtrendingphase.©2000–2011,MetaQuotesSoftwareCorp.

Most trading systems willtake advantage of either thechoppy market or the strong

trending market. This meansthatmosttradingsystemswillperform exceptionally wellduring either the choppymarketor a trendingmarket,but never in both types ofmarketmoods.For example, if you decide

to trade the trendy kangarootail,butinsteadofwaitingfora strong trend, you decide toapplythetrendykangarootailtoadirectionlessmarket,you

may find that the trendykangaroo tail does not offerthe type of profit potentialyou are looking for in atrading system (the trendykangaroo tail is a nakedtrading set-up for trendingmarkets,describedindetailinChapter 10). This is simplybecause the trendy kangarootailsystemisdesignedtotakeadvantage of a strongtrending market. Applying

thissystemtoadirectionless,choppy market that isn'tinterested in going anywherewilllikelyleadtoundesirableresults. This simple factmeans that youmust keep inmind which type of marketyourchosentradingsystemisdesignedtoworkwellin,andtry to restrict the applicationofyourchosentradingsystemtoonlythistypeofmarket.Thereis,however,oneage-

oldstrategythatworksontheprecipice of the transitionfrom the choppy,directionless market to thestrong trending market. Thisis thebreakout strategy.Thistrading strategy is extremelycommon; there are manyversions of the breakouttrade.

WHATISA

BREAKOUTTRADE?

The breakout strategyinvolvestwophases.Thefirstphaseinvolveswaitingforthemarket to consolidate. Aconsolidatedmarket becomesvery choppy anddirectionless,thetraderwaits,andwatches themarket. Thebreakout trader is a patienttrader.Thisstrategyislargely

basedonpatienceandtiming.Perhaps you have traded a

version of the breakout tradein the past. There are manyversions of this trading set-up, so you might know thedrill:Youwaitandwatchthemarketwhen it is calm.Youare waiting when the marketistradingwithinatightrange.Then, eventually the marketbreaks out and extendsbeyond the restricted range

and rockets off in onedirection for a strong,sustainedtrendingmove.Thisiswherethewell-placedentrywill capture a quick profit atthe very least, andmay evenafford an early entry into astrong,sustainedtrend.

IdentifyingtheTransition

Asabreakouttraderyoutake

advantage of the naturalrhythmof themarket and, inparticular, the transitionbetweentheboring,restrictedmovementoftherange-boundmarket and the fierce strongmovesofthetrendingmarket.Whenwillyouknowthat themarket is changing?How doyou determine that theconsolidation period is over?Will the market offer a cluewhenitisabouttomoveinto

atrendingphase?Is it possible to determine

when the market ends thedirectionless phase andbegins the strong trendingphase?Theanswerisyes,andyouwill use your old friend,the support and resistancezone. The support andresistance zone will be thethresholdbywhichyoujudgethe movement of the marketonce again. This time the

support and resistance zonewillmarkthelineinthesandfor the naked version of thebreakout trade—the last-kisstrade.The first step of the last-

kiss trade is to identify theconsolidation zone.Onewayto visualize a consolidationzone is todrawaboxon thechart. This box will containthechoppymovementsofthedirectionless market. This

box should encompass themarket movement during thechoppy,drifting-marketphase(seeFigure5.4).

Figure5.4ThisboxontheUSD/JPYfour-hourchartmaybeusedtocontainthepriceactioninthemarketduringthedrifting-marketphase.©2000–2011,MetaQuotesSoftwareCorp.

The important thing toremember here is that thebox, which contains the

market activity, is formedbyboth a support zone and aresistance zone. This box ofmarket activity should popoutonthechart—itshouldbeobvious that the market isstuck between both of thezones. Typically, there willbe several touches on eitherside of the zones. In Figure5.5weseethattherearethreetouches at the topof thebox(marketfoundresistance)and

two touches at the bottomofthe box (market foundsupport).

Figure5.5Theconsolidationzoneshouldbeveryobvious.Noticehowthemarketbouncesoffofthesupportzoneandtheresistancezoneseveraltimesonthefour-hourUSD/JPYchart.Twicethemarketfindssupportatthebottomoftheboxandthreetimesthemarketfinds

resistanceatthetopofthebox.©2000–2011,MetaQuotesSoftwareCorp.

The consolidation phaseinside of the box maycontinue for some time.However, once the marketbreaks out toward either thesupportzoneortheresistancezone,thelast-kisstradertakesnotice. For many breakouttraders, the move outside ofthe consolidation box willtrigger a trade.However, thelastkisstradeisnottriggeredatthisstage.

A close examination of atypical, standard breakouttrade may be in order. Thetypical breakout strategywillfollow a series of events.First,themarketconsolidates,andaboxisdrawnaroundtheconsolidation. Second, themarket pushes beyond eitherthe support zone or theresistance zone to trigger atrade(seeFigure5.6).

Figure5.6Thisfour-hour

chartontheUSD/CHFshowsastandardbreakouttrade.Thetradeistriggeredoncethemarketmovesbeyondeitherthesupportzoneortheresistancezone.Inthisexample,themarketbreaksouttotheupside,signalingabuytrade.©2000–2011,MetaQuotesSoftwareCorp.

Thismovebeyondthezoneis the trade signal. In fact,standard breakout traders

often place buy stop ordersabove the resistance zone,andsellstopordersbelowthesupport zone in anticipationofthebreakout.Thereare,ofcourse, varying degrees ofdifferences among breakoutstrategies; however, the coreprinciplethatguidesbreakoutstrategies is this: Once themarket breaks out beyond azone,atradeistriggered.However, the standard

breakout strategies have averycommonproblem.Manybreakout trades end up aslosingtradesbecausetheyaretriggeredbyafake-out.Whatisafake-out,youask?

TheFake-OutThe fake-out is the breakouttrader's nemesis. This is thebiggest problem with mostbreakout trading strategies.

Many breakout signals offerexcellent tradingopportunities, but others aretriggered by fake-outs. Afake-out isamoveoutsideofthe consolidation zone thatappears tobeabreakout,butinstead of continuing on inone direction a strong trend,the market retraces backinside of the consolidationzone. The fake-out alwaysends up with the market

eventually fallingback insidethe zone defined by both thesupport and the resistancelevels (back inside the box).The USD/CHF four-hourchart in Figure 5.7 is anexample of a fake-out. Thestrong move outside the box(seearrow)isassumedtobeabreakout, but the marketretraces and eventually fallsbackinsidethebox.

Figure5.7Thisfake-outis

markedwiththearrowontheUSD/CHFfour-hourchart.Themarkettradeshigherthanthetopofthebox,butlaterquicklyfallsbackinsideofthebox.Formoststandardbreakoutsystemsthiswouldbealosingtrade.©2000–2011,MetaQuotesSoftwareCorp.

Thus, a fake-out is abreakout trade that istriggered by a convincing

candlestick that extendsbeyond a support orresistancezone.Thisactionisfollowed by the marketmoving back inside theconsolidationbox(seeFigure5.8).Oncethemarketretreatsback into the consolidationbox after a fake-out, pricewilloften languish inside theboxforsometime.

Figure5.8Anotherfake-out,thistimeontheAUD/USD

dailychart.Themarkettradesbeyondthebottomofthebox,triggeringaselltrade,butthenthemarketquicklyjumpsbackupinsidetheconsolidationbox.Thiswouldbeafailedbreakouttradeformostbreakouttradingsystems.©2000–2011,MetaQuotesSoftwareCorp.

The fake-out is actuallyquite common, and a quicklook at the charts will show

howoftentheydooccur.These failed breakouts, the

fake-outs, are the primaryreasontradersfinditdifficulttoconsistentlyapplybreakouttrading systems. Breakoutsystemsaresimplywrongtoooften. Breakout systemsmayoccasionally grab a greattrend early, but fake-outssignal many losing trades.Why is this the case? Whyarefake-outssocommon?

Ask any trading guru thequestion“howoftendoes themarket trend?” and,depending on the guru, youwill be told that the markettrendsabout15to30percentof the time.This is preciselywhy conventional breakoutsystems often fail. Most ofthe time, themarkets are notready to start trending; theyspendthemajorityofthetimedrifting without direction.

This is why breakout tradesoftenfail.Would it be nice if you

could tellwhenabreakout isgoing to continue onwardbeyond the consolidationbox?Whatiftherewasawayto avoid the dreaded fake-out?Wouldyoulikeatradingsystem for identifying thebreakouts most likely tocontinue onward in thedirection of the trend? There

is such a system, and it iscalled the last-kiss trade.Thelast kiss is a specific type ofbreakout that suggests abreakout will develop into astrongtrendingmove.

WHATISALASTKISS?

The last kiss is a catalystspecificallydesignedtoavoid

the fake-out. If you havetraded breakout systems inthepast,youknowhowoftenthese fake-outs will occur.Although the last kiss is notguaranteed to avoidall fake-outs, itwillprovideyouwithavaluablemethodoffilteringout many of the very worstfake-outs that fizzle quickly.Thelast-kisstradeisasimplemethod that confirms thevalidity of the breakout

signal, and it is based on asound naked-tradingprinciple. This is known astheretouchprinciple.

THERETOUCH

Themarkettradesbeyondazonebeforereturningtothezonefromtheotherside toconfirm the importance ofthezone.

Aclose examinationof thelast-kiss trade will illustratehow this trade incorporatesthe retouch principle. Take alookatthechartinFigure5.9where a breakout candlestickprints after themarket tradesbetween two zones for sometime.

Figure5.9TheconsolidationboxformsontheEUR/GBPdailychart,followedbyabreakoutcandlestick.

©2000–2011,MetaQuotesSoftwareCorp.

The last-kiss trade is nottriggered on this initial

breakout candlestick but is,instead, triggeredmuch later.The standard breakout tradeis initiated when the marketmoves beyond one of thesupport and resistance zones.The last-kiss trade is nottriggereduntillater.Whyisitimportanttowait?Take a look at the losing

tradeson thepreviouspages.Do you notice a commontheme? The previous charts,

theUSD/CHFfour-hourchartin Figure 5.7 and theAUD/USD daily chart inFigure 5.8 illustrate theproblemwithmany breakouttrades. These trades oftenquickly fizzle as the marketmoves back inside of theconsolidation box. Not onlythat, but the market oftenmoves back inside theconsolidation box quickly.This tendency, the tendency

for failed breakouts toquickly jump back inside theconsolidation box, is thepeculiar behavior that isimportant to the last-kisstrade.Mostofthefailedbreakouts

willquicklyjumpbackinsidethe consolidation box.However, a true breakout—those trades that extendbeyondtheconsolidationboxand then keep travelling—

will often move back to thesupport and resistance zonesfor a retouch. The last-kisstrade is a specific subset ofthebreakout trade.Noteverybreakout trade is a last-kisstrade,buteverylast-kisstradeisabreakouttrade.Inotherwords,thelast-kiss

trade is based on the retouchprinciple. The market willoften come back to asignificant zone once the

market has expanded beyondthe zone, and the last-kisstrade is designed to takeadvantage of this typicalmarket behavior (once themarket retreats and movesbacktowardtheconsolidationbox). The reason for waitingfor the market to come backto theconsolidationbox is toconfirm that themarketwill,indeed, respect theboundaries that were formed

by the consolidation box. Inthisway,thetraderwilljumpon the trade only when themarket comes back to kiss aconsolidationbox(seeFigure5.10).This is why the trade is

known as the last kiss. Thetrade is initiated only whenthe market returns to theconsolidationbox tokissoneof the support and resistancezones that formed during the

consolidation. This isobviously a very differententrytothestandardbreakouttradingstrategy.

Figure5.10Thelast-kisstradeissignaledontheEUR/GBPdailychartoncethemarketreturnstotheedgeoftheboxforaretouch.©2000–2011,MetaQuotesSoftwareCorp.

Thebestwaytogetasensefor the last-kiss trade is toexamine a couple of

examples.Take a look at theEUR/USD daily chart inFigure5.11.

Figure5.11TheEUR/USDdailychartshowstwofake-outsprecedingthelastkiss.Thelastkissistriggeredoncethemarketbreaksoutabovetheconsolidationbox,andthenreturnstotheedgeoftheboxforaretouch.©2000–2011,MetaQuotesSoftwareCorp.

Herewesee theEUR/USDhas had two failed breakoutspriortothelastkissinFigure

5.11. The first fake-out is afalse breakout to the upside,but the market quickly fallsbackinsideofthebox.Thereisalsoabrief fake-out to thedownside, but the marketdrifts back inside of the boxsoon after that fake-out. Thelast break out is a truebreakout,anditisalsoalast-kissset-up.Themarkettradesoutsidetheboxtotheupside,and then returns to the edge

of the box to find supportbefore continuing onward inthe direction of the breakout(seeFigure5.12).

Figure5.12ThemarketcontinuestrendinghigherafterlastkissontheEUR/USDdailychart,noticehowtheretouchisanicebullishcandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Notice how the marketprints a very nice bullishcandlestickat theedgeof the

consolidation box in Figure5.12. It isnot enough for themarkettosimplyre-touchthezone and then pause; themarket must print a strongcandlestickinthedirectionofthebreakouttotriggerthelastkiss.Bigshadowssuchasthelast-kisscandlestickinFigure5.12arecoveredinChapter8.

TradingtheRetouch

Once the market returns tothe edge of the consolidationbox, it must print a strongcandle in thedirectionof thebreakout. Therefore, if thebreakoutisabullishbreakout(up), then the retouchcandlestick must be a strongbullish candlestick. A buystop is placed above (seearrow)thehighofthisbullishcandlestick(seeFigure5.13).

Figure5.13Forbullishlast-

kisstrades,abuystopisplacedabovethehighofthebullishretouchcandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Likewise, for the bearishbreakouts, when the marketcomes back to retouch the

edgeoftheconsolidationbox,the market must print abearishcandlestick.Theentryfor the last kiss is a sell stopplaced below the low (seearrow) of the bearishcandlestick,justasyouseeinFigure5.14.

Figure5.14Forthebearishlast-kisstrades,suchasthisoneonthedailyCAD/JPY,asellstopisplacedbelowthelowofthebearishretouch

candlestick.©2000–2011,MetaQuotesSoftwareCorp.

Once the market tradesthrough the entry price, thelast-kisstradeison.Therearetwo stop loss signals for thelast-kiss trade. The first stoploss is the emergency stoploss,and this isplacedat themidpointof theconsolidationbox. Under mostcircumstances this stop losswillnotbehit.The calculation of this

emergency stop loss is

simple.1.Subtract the resistance-level zone from thesupport-levelzone.2. Record the number ofpips; this is the width oftheconsolidationbox.3.Dividethewidthoftheconsolidationboxby2.4.Add thisamount to thesupport-levelzone.

This price level is youremergencystop (as shown in

Figure5.15).The CAD/JPY four-hour

last-kiss trade makes for agreat example (see Figure5.16). First, subtract supportzone, 85.95, from theresistancezone,88.23(85.95-88.23=228pips).Dividethisamountby2(228pips÷2=114pips).

Figure5.15Theemergencystoplossforthelast-kiss

tradeisplacedatthemidpointoftheconsolidationbox.ForthisCAD/JPYfour-hourlast-kisstrade,thestoplosswouldbeat87.09.©2000–2011,MetaQuotesSoftwareCorp.

Figure5.16Calculatingtheemergencystoplossforalast-kisstradeonthe

CAD/JPYfour-hourchart.©2000–2011,MetaQuotesSoftwareCorp.

Next, add 114 pips to the

support zone, 85.95 to findthe value for the emergencystop loss. 85.95 + 114 =87.09,so theemergencystopis placed at 87.09 for theCAD/JPY four-hour last-kisstrade(seeFigure5.17).

Figure5.17Theemergencystoplossforthefour-hourCAD/JPYlast-kisstradeis87.09.©2000–2011,MetaQuotesSoftwareCorp.

There isanotherexitsignalfor the last-kiss trade that ismore likely to be triggered

thantheemergencystoploss.If the market closes backinside the box after the last-kiss trade is triggered, thetrade is exited. This willusually mean taking a muchsmaller loss than theemergency stop loss (seeFigure5.18).

Figure5.18Thisisalast-kisstradeontheGBP/USDweeklychart.Thefirstarrowmarksthelast-kiss

candlestick,wheretheselltradeisentered.Thesecondarrowmarksthecandlestickthatclosedinsidethebox,triggeringtheendofthetrade.©2000–2011,MetaQuotesSoftwareCorp.

This exit signal is usuallytriggered for a much smallerloss than the emergency stop

loss. The GBP/USD weeklychart in Figure 5.18 shows alast-kiss trade that prints thisexit signal. The trade is overonce a candlestick closesback inside the box.Most ofthefailedlast-kisstradeswillbe exited with this rule.Undermost circumstances, itisunlikelythattheemergencystop loss at the midpoint oftheconsolidationboxwillbehit. The second stop loss is

much more likely to be hit,whichmeansthattheaveragelosing trade for the last-kisstradeisquitesmall.Thisisanattractive feature of the last-kiss trade. Many nakedtradersenjoytradingthelast-kisstradebecausethissecondstoplosssignificantlyreducesthesizeofthelosingtrades.

FindingProfitafter

KissesOne very simple exit forprofitablelast-kisstradesistoexitthetradeatthenextzone.There are other, moresophisticated methods forexiting the last-kiss tradecoveredinChapter11.

TRADINGTHELASTKISS

The last-kiss trade is a niceway to trade high-probabilitybreakout trades.Here are thestepsforthelast-kisstrade:

Wait for price toconsolidate inaboxbetweentwozones.The box shouldhave at least twotouches on bothzones.Wait for price tobreakbeyondoneof

thezones.Once price returnsback to theconsolidation box,wait for the marketto print a last-kisscandlestick on theedgeofthebox.Forselltrades,asellstopisplacedbelowthe low of the last-kisscandlestick,andforbuytrades,abuy

stopisplacedabovethe high of the last-kisscandlestick.Emergencystoplossis placed in themidpoint of theconsolidationbox.The profit target isthenearestzone.

Testthelast-kisstrade;youmaybesurprisedathowwellthis tradingsystemfiltersoutfake-outs. To see live last-

kiss trades as they unfold inthe market, go towww.fxjake.com/book.

CHAPTER6

TheBigShadow

Neverfearshadows.Theysimply mean there's alight shining somewherenearby.

—RuthE.Renkel

The big shadow is a two-candlestick, reversalformation and an importantcatalyst for the naked trader.The big shadow appears onsupport and resistance zones,precisely where the nakedtrader looks for highprobability trade set-ups.Once the big shadow printsonazone,wehaveavaluablehintthatthemarketmaysoonturnaround.

Two candlesticks make upthebigshadowformation.Aswith most naked tradingcatalysts, they must print onzones to be valid trade set-ups. Big shadows are onlyvalid when they appear onzones. A big shadow mayprint on top of the zone (themarket is finding support onthe zone, a bullish bigshadow), or the market mayprint below the zone (the

market is finding resistanceon the zone, a bearish bigshadow).Theimportantthingis this:The big shadowmustprintonazone.

WHATDOESITLOOKLIKE?

Sometradersmayrefertothe

big shadow as an engulfingcandlestick, but it is morethanthat,astherearespecificrules associated with the bigshadow, including how totrade it, and specificoptimizersforthetradingset-up. The big shadow isessentially a two-candlestickformation in which thesecond candle completelydwarfs the first candlestick.This second candlestick is

known as the big-shadowcandlestick. The definingcharacteristics of the big-shadow candlestick are asfollows: The big-shadowcandlestick is much largerthanthepreviouscandlestick,the big-shadow candlestickhasawiderange,andthebig-shadow candlestick is thelargestcandlestickthemarkethasseenforsometime.Figure 6.2 shows another

example of the big shadow.This one is another bearishbig shadow, this time on theEUR/GBPdailychart.

Figure6.1ThisbearishbigshadowontheCAD/JPYdailycharthasamuchlargerrangethanthepreviouscandlestick.©2000–2011,MetaQuotesSoftwareCorp.

DOESBIGGER

EQUALBETTER?

If you spend some timewatching the charts, youwillnoticethatsomeshadowsarelarger than others. The idealbig shadowwill have awiderange. Look at the examplesinFigure6.1 andFigure 6.2;bothbig shadowcandlestickshaveaverywiderange.Bothof these big shadows are the

largestcandlestickthemarkethas seen in some time. InFigure 6.1 the bearish bigshadow is the largestcandlestick the market hasseen in several weeks.Likewise, thebigbearishbigshadowinFigure6.2isaverylarge candlestick, the largestcandlestick inoveroneweekoftrading.

Figure6.2Thebearishbigshadowhereisonthe

EUR/GBPdailychart.Noticehowtherangeofthebig-shadowcandlestickismuchlargerthanthepreviouscandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Ideally, the big shadowshould have the greatestrange of the previous five

candlesticks. Smaller bigshadow candles may betempting because the stoploss is closer to the entryprice, but historically, theverylargebigshadowshaveamuch higher success rate.Back-test this for yourself tosee if the very large bigshadows you trade have ahighersuccessrate.

THESTOPLOSS

The big shadow stop loss isplaced beyond the bigshadow. For a bullish bigshadow, the stop loss isplaced a few pips below thelow of the big shadowcandlestick (see Figure 6.3).For the bearish big shadow,the stop loss is placed a fewpips above the high of the

big-shadow candlestick (seeFigure6.4).

Figure6.3ThisisabullishbigshadowonthedailyGBP/CHFdailychart.Thestoplossisplacedafewpipsabovethehighofthebearishbig-shadowcandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Figure6.4ThisisabearishbigshadowonthedailyGBP/AUDchart.Thestop

lossisplacedafewpipsabovethehighofthebearishbig-shadowscandlestick.©2000–2011,MetaQuotesSoftwareCorp.

ENTERING

THETRADEThesafestwaytoenterabig-shadow trade is to wait forthe market to push into anexpected direction. This willmean using a buy stop forbullishbigshadows,orasellstopforbearishbigshadows.For example, if you wouldlike toenter a sell tradeonabearishbigshadow,youmayconsider placing your sell

stopbelowthelowofthebig-shadow candlestick.Likewise, for those bullishbigshadows,placeabuystopa fewpips above thehighofthebig-shadowcandlestick.Ifthe market moves in theexpected direction, your buystop order will be triggered(seeFigure6.5).

Figure6.5Abuystopentryisthesafestwaytoenterabullishbig-shadowtrade.

Here,themarkettriggersthebuystopofthebullishbigshadowonthedailyUSD/CHFchart.©2000–2011,MetaQuotesSoftwareCorp.

Manytraderslooktoenteratrade on retracements, whenthe market moves against a

trading set-up. Although thismay seem like a good idea,becauseitenablesanentryata “cheaper” price, it is alsorisky. Remember that mosttraders find it difficult toachieve consistent profits.One of the reasons for thismay be because all failedtrade set-ups will retrace inthe opposite direction, butvery few failed trade set-ups,such as the big shadow, will

take out a new high (forbullishbigshadows)oranewlow (for bearish bigshadows). This is why sellstops and buy stops arerecommended for trading thebig shadow (and all naked-tradingstrategies).SeeFigure6.6 for an example of how asellstopavoidsalosingtradeon a CAD/JPY four-hourbearishbigshadow.

Figure6.6Asellstopentry

ontheCAD/JPYfour-hourchartavoidsalosingtrade.Themarkettradeshigherandnevertriggersthesellstopentry.Sellingthisbearishbigshadowatahigherpricewouldhaveresultedinalosingtrade.©2000–2011,MetaQuotesSoftwareCorp.

It may seemcounterintuitive to enter a

tradeatapoorentryprice,butifyoudecidetousebuystopsand sell stops to enter yourtrades, you will eliminatemanylosingtradesfromyourrecord. This is an extremelysimple method for avoidinglosingtrades.

IMPORTANCEOFTHE

CLOSINGPRICE

Theclosingprice is themostimportant price for the big-shadow candlestick. A bigshadow may completelyengulf the prior candlestick.Abigshadowmayprintonabrilliant zone. A big shadowmay even be the largestcandlestick, with the widestrange for a particularmarket

inaverylongtime.However,if the closing price is not inthe correct location for thebig-shadow candlestick, thetrademayfailmiserably.Theidealclosingpricefora

bullish big shadowcandlestick is the high. Thebig-shadow candlestick has avery good chance of successif the candlestick closes onthehigh.Obviously,itisrarefor the closing price of a

bullish big-shadowcandlesticktobeequal to thehigh. The closer the closingprice is to the high for thebullish big-shadowcandlestick, the better thetrade signal. Bullish bigshadows with closing pricesnear the midpoint of thecandlestick are very poortrading set-ups. The nakedtrader is only interested inhigh-probabilitytradeset-ups,

so if the bullish big shadowhasaclosingpricedownnearthe midpoint of thecandlestick,thetradeset-upisprobablynot good enough totake(seeFigure6.7).

Figure6.7ThisbullishcandlestickonthedailyUSD/JPYcharthasaclosingpricedownnearthemidpointofthecandlestick.Thisisnotabullishbig-shadowcandlestickformation.Notice

howthistradeisaloser;themarkettradesbelowthestoploss.©2000–2011,MetaQuotesSoftwareCorp.

Figure 6.7 is an interestingbullish candlestick, but it isnot a bullish big shadowbecause the market nevertradeshigherthanthehighofthe candlestick. Recall thatone of the rules of the bigshadow is that the marketmust trade higher than thehigh to trigger the buy stopwhich is placed a few pipsabovethehigh.Applyingthisentry rule would havemeant

avoiding this losing trade.Therefore,thetradeinFigure6.7 has two faults: Themarket fails to trade higherthan the high of the bullishbig-shadow candlestick, andclosing price of the bullishbig-shadowcandlestickistoolow.Forbearishbigshadowset-

ups, the closing price of thebearish big shadowcandlestick is also important.

Theidealbearishbigshadowwill have a closing pricedown near the low of thebearish big-shadowcandlestick. A bearish big-shadow candlestick with aclosing price near themidpoint is a subpar set-upand should be disregarded(see Figure 6.8). The verybest bearish big-shadow set-upswill have a closing pricedown near the low of the

candlestick.

Figure6.8ThisbearishcandlestickontheAUD/NZDdailychartisnotanidealbearishbigshadowbecausetheclosingpriceisnotnearthelowofthecandlestick.Thistradeendsupaloser.Themarketpusheslowerthanthelowofthebigshadowtotriggerthetrade,butthreecandlestickslaterthemarkettakesoutthestoploss.

©2000–2011,MetaQuotesSoftwareCorp.

ROOMTOTHELEFT

Would you like to find thetrade that captures a criticalturning point in the market?You're probably like mosttraders: You would like tomakea trade thatcatches themarketjustasitstartstoturnaround and never returns totheturningpoint.

If you study these criticalturning points in the market,youwillnoticeonething:Allthese turning points have asimilarlook.Thepriceactionat these turning points is,generallyspeaking,extendingbeyondwherethemarkethasbeen trading prior to theturning point. These turningpoints are typicallyexhaustion turning points,that is, places where the

markethasjustgonetoofar.There is a far simpler way

of characterizing theseturning points in the market.These turningpointscome intwo flavors: all-time highs,where the market trades at avery high price, beforefalling,andneverreturningtothat high, and all-time lows,placeswhere themarket fallsmuchlowerthanmostmarketparticipants had anticipated,

and thenrockethigher,nevertoreturntothedepthsofthatlow. Traders around theworld stare at these spots onthe chart, wishing that theyhad entered a trade at theseprecise prices, to capture awindfallprofit.There is something that all

these turning points have incommon.Thesecriticalpricesare usually stabbed by themarket—an exploratory stab,

a probe into no man's land.Look to the left of theseturning points, and you willfindacommontheme.Nearlyalltheseall-timelowsandall-time highs have one thing incommon: There is no priceaction to the left. Go aheadand take a look right now.Pull up your chart and see ifyoucanfindanypriceactionto the leftof theverycriticalall-time highs and all-time

lows. Obviously, bydefinitionyouwillnot findalower price than an all-timelow,andneitherwillyoufindahigherpricethananall-timehigh. What you will find isthat the price patterns are allalone. To the left of thesepatterns is wide-open space.Haveyounoticedthisonyourcharts?Youdonothaveto lookto

all-time highs and all-time

lows;youcansimply look tocritical turning points—placeswherethemarketdoesnot return to for years. Thespots will also have thischaracteristic: The marketdoes not return to thoseplacesonthechartwherethemarketrarelytrades.So,ifwelook to take our reversal set-upsatthosespotsonthechartwhere the market has nottraded in some time, we are

puttingtheoddsinourfavor.The easiest way to

conceptualize this idea is tolook to the left of your pricepattern. Ifyouseewide-openspace on the chart to the leftofyourcatalysts,youmaybelooking at a critical turningpoint(seeFigure6.9),agreatopportunity for you toparticipate in a long-lasting,profitable trade. The generalruleisthis:Themoreroomto

the left, the more likely thisspot is a long-term high orlong-termlow.

Figure6.9TheEUR/USDweeklychartprintsabearishbigshadow.Theformationhasmuch“roomtotheleft”—themarkethasnottradedatthiszoneinover74weeks.Afterthisbig-shadowformationprinted,themarkedspentover22weeksawayfromthisprice.

©2000–2011,MetaQuotesSoftwareCorp.

Sometimes the market willprintabigshadowonazone

thathas recently seenmarketactivity. For example, inFigure 6.10 we see theGBP/JPYweeklychartprintsa bearish big shadow.Because the market has notprintedonthiszoneforsevenweeks,thereissomespacetothe left of the bearish bigshadow.Althoughitwouldbebetter if the market had notprintedonthiszonefor20or30 candlesticks, the fact that

themarkethasnotprintedonthis zone for sevencandlesticks is perfectlyreasonable,andthusthistradequalifies as having “room totheleft.”

Figure6.10TheGBP/JPYweeklychartprintsabearishbigshadowwith“roomtotheleft.”Themarkethasnotprintedonthiszoneforsevenweeks,givingthisbigshadowsomereasonable“roomtothe

left.”©2000–2011,MetaQuotesSoftwareCorp.

When choosing a big-shadow trade, or any otherreversaltrade,looktotheleftof the catalyst. If you seeopen space to the left, thenperhaps the set-up willcapture a critical turningpointinthemarket.However,ifyoulooktothe

left and you see recent priceaction at the same level,perhaps the market has notreached theexhaustion stage.

Figure 6.11 illustrates abearish big shadow on theGBP/USD four-hour chartwithvirtuallyno room to theleft. These set-ups are rarelyidealbig-shadowtrades.Mostnaked traders will onlyconsider taking a reversaltrade if the market has notprinted on the zone for atleast seven candlesticks.Reversalsetupswithroomtothe left usually have a much

highersuccessratethanthosethat print in an area on thechartwithrecentpriceaction.

Figure6.11AbigshadowsuchasthisoneontheGBP/USDfour-hourcharthasprintedonazonewithalotofrecentpriceaction.Perhapsthemarkethasnotreachedaturningpointyet.©2000–2011,MetaQuotesSoftwareCorp.

An easy way to visualizethis“roomto the left” rule isto draw a rectangle on your

chartthatcapturestheareaofthechartthatisuniquetothetwo-candlestick big-shadowformation and extend thisrectangleasfaraspossibletotheleft.

TWO-CANDLESTICKFORMATIONApricepatternmadeupoftwo candlesticks. The

definition and validity ofthe price pattern isdependent uponcharacteristics of bothcandlesticks.

It is important to note thatthebig-shadowformationisatwo-bar formation. Thismeans that any unique spaceoccupiedbythiscatalystmaybe occupied by bothcandlesticks. Contrast this toother catalysts such as the

kangarootail(Chapter8)andthe big belt (Chapter 9)—these single candlestickformations mayindependently occupy uniquespace on the chart.Remember, the further thisrectangle extends beforerunning into othercandlesticks, the better. Thevery best big shadows willprint at an area on the chartwhere the market has not

recentlytraded.Takealookattheone-hour

CAD/JPY chart in Figure6.12.Youcanseethemarkethasprintedthebigshadowonan area on the chart that hasnotseenrecentpriceactioninavery long time.Thebox tothe left of the big shadowrepresentsallofthe“roomtothe left” for this tradeset-up.The market moved 200 pipshigheraftertriggeringthebuy

stop on this bullish bigshadow.

Figure6.12Waitingforbigshadowswithspacetotheleft,suchasthisbullishbigshadowontheCAD/JPYone-hourchartwillaidyouinpickinghigh-probabilityreversaltrades.©2000–2011,MetaQuotesSoftwareCorp.

PROFITING

FROMBIGSHADOWS

There are many methods forexiting the big-shadow trade,many of these methods areexplored in Chapter 11. Avery simple method forexiting the big shadow is tosimply place a take-profittargetatthenearestzone.Forbullish big shadows thiswould mean placing a profit

target a few pips below thenearest resistance zone, andfor bearish big shadows thatwould mean placing a profittarget a few pips above thenearest support zone (seeFigure6.13).

Figure6.13Thenearestzonemakesforaveryclearprofittarget.ThebearishbigshadowontheEUR/USDfour-hourchartisanexcellentsellsignal.Themarketfalls

171pipsdowntothenextzoneat1.3200.©2000–2011,MetaQuotesSoftwareCorp.

THERULES

Thebig-shadowtrade iseasyto identify, and it oftensignalsacriticalturningpointin the market. Here are therules associated with the bigshadowtrade:

Big shadows aretwo-candlestickformations.The secondcandlestick of theformationisthebig-shadowcandlestick.

The big-shadowcandlestick has ahigher high and alower low than thepreviouscandlestick.Big shadows mustprintonthezones.Bigshadowsprintatextreme highs orextremelows.Bearish big-shadowcandlesticks have a

closing price nearthelow.Bullish big-shadowcandlesticks have aclosing price nearthehigh.Big-shadowcandlesticks havewider ranges thanthe nearbycandlesticks.For bullish bigshadows, the stop

loss is placed a fewpips below the lowof the big-shadowcandlestick.For bearish bigshadows, the stoploss is placed a fewpips above the highof the big-shadowcandlestick.The very best big-shadow candlestickshave room to the

left.There are also several

optimal characteristics thatthe best big shadows share;thesefeaturesinclude:

The two-candlestickformation prints atan extreme high orlow on the chartwhere the markethas not traded in atleast sevencandlesticks.

The big-shadowcandlestick has agreater range thanthe previous 10candlesticks.For bullish bigshadows, thecandlestickfollowingthebullishbig shadow triggersthe buy stop orderplaced above thehigh of the big-

shadowcandlestick.For bearish bigshadows, thecandlestickfollowing thebearish big shadowtriggersthesellstoporder placed belowthe low of the big-shadowcandlestick.For bullish bigshadows,theclosingprice for the big-

shadow candlestickiswithin a fewpipsofthehigh.For bearish bigshadows,theclosingprice for the big-shadow candlestickiswithin a fewpipsofthelow.

Many traders do extremelywell trading only the big-shadow trade. If you wouldliketobecomeanexpertwith

this trading system, spendtimetestingitsothatyougetcomfortable trading bigshadows.Ifyouwouldliketofollow along with live big-shadow trades, go towww.fxjake.com/book.

CHAPTER7

WammiesandMoolahs

It's like déjà-vu, all overagain.

—YogiBerraThe market moves up, the

market moves down. If youare a naked trader, you willprobablynotethattheturningpoints in themarketcoincidewith the support andresistance zones. Theseturningpointsarerarelysharpand quick and are, instead,often rather slow to unfold.(Thereareobviousexceptionssuchasbigshadows,coveredin Chapter 6, kangaroo tails,which are examined in

Chapter 8, and big beltsexplained in Chapter 9.) Themarketusuallypreferstohitazone several times beforemovingawayfromthatzone.Wammies and moolahs takeadvantageofthistendencyinthemarkets.There are five steps to

understanding wammies andmoolahs. Each of these stepsiscoveredinthischapter.Bythe end of the chapter you

will understand the theorybehind these two trading set-ups, and you will knowpreciselyhowtotradethem.First, the basic double-

bottom and basic double-topformations are defined.Second, you will learn thecritical characteristics uniqueto wammies, which are aspecial case of the double-bottom formation.Third,youwill learn all about the

moolah, a special caseof thedouble-topformation.Fourth,youwillseemarketexamplesof both wammies andmoolahs so you may clearlyunderstand the idiosyncrasiesunique to these formations.Fifth, you will see what anoptimal wammie or moolahtradelookslike.Bytheendofthis chapter, youwill have aclear understanding of bothtrade set-ups, which are

invaluable for the nakedtrader who is interested infinding important turningpointsonthecharts.Before you jump into the

world of wammies andmoolahs, it is important tounderstand both the double-bottom and the double-topformations.

THEDOUBLE

BOTTOMThe double bottom is aclassic formation known tomany technical analysts. Thedoublebottomiswellknownbecause it occurs quitefrequently in the markets.Take a look at the chart foranymarketandyouwill findmanyexamplesofthedoublebottom; these are places onthe chart where the market

touches a zone from aboveand finds significant supportafterbothtouches.

DOUBLEBOTTOM

A price patterncharacterized by twotouches from above on azone. The market falls tofind support on a zonefollowed by a rally higherand then the market againfalls to find support on the

same zone. After thissecond touch of the zone,themarket begins a steadyclimbhigher.

Many critical marketturnaroundsbeginasadoublebottom. A double bottomoccurs when the marketmoves downward for sometime, the market reaches asignificant support andresistance zone, the marketpauses at this zone and then

turnsaround tobegin tradinghigher.Themarketeventuallystalls and starts to movedownward again untilreaching thezoneonceagainand finding support on thezone.Onceagain, themarketstarts to trade higher andcontinues trading higher forsome time. This is thetraditionaldoublebottom.Take a look at Figure 7.1;

this is a typical double-

bottom formation. Noticehow the market reaches azone twice and each time itturns around and starts tradehigher. It is only after thesecondtouchofthezonethatthe market starts a newuptrend. This is the definingfeature of the double bottom—the market begins a newuptrend after finding supportwith the second touch of thezone.

Figure7.1ThedoublebottomisindicatedonthisdailyGBP/CHFchartbythemarkettouchingthezone,tradinghigher,andthentouchingthezoneagain.©2000–2011,MetaQuotesSoftwareCorp.

This GBP/CHF daily chartin Figure 7.1 is a typicaldouble bottom. After trading

lower and lower for sometime, the market touches thecriticalzoneat1.5890beforetrading higher for a shortperiod of time, the marketonce again falls down andfinds support on the 1.5890zone and bounces higher.After the second touch, themarketbeginsanewuptrend.This double-bottom

formation is reliable; undermost circumstances, if the

market falls down to animportant zone and findssupport on the zone twice, itwillbelikelytotradehigher.These double bottomformations are prevalentacross markets, much moreubiquitous than the “singlebottom.” A single bottom is,of course, a single touch (ofsupport) on an importantzone. Although the singlebottomdoesoccur from time

to time (single bottomssometimesprintasbullishbigshadows, bullish big belts,and bullish kangaroo tails),the double bottom is muchmorecommoninthemarkets.The market will usually falldown to the zone to test ittwice before turning aroundandmarchingupward.Figure 7.2 illustrates

anotherdoublebottomontheUSD/CADdailychart.Notice

howeachtouchonthe1.5105zone is distinct. The marketfallsdown, touches thezone,andthenbrieflytradeshigherbefore falling down onceagain to find support on thevery same zone. This is thedefining characteristic of thedouble bottom: There is abrief interlude between eachtouch.

Figure7.2Thestandarddouble-bottomformationis

createdwhenthemarketfindssupporttwiceinquicksuccession.TheUSD/CADformsadoublebottomonthedailychartwhenthemarketfallstwiceto1.5105tofindsupport.©2000–2011,MetaQuotesSoftwareCorp.

The USD/CAD traded 715pips higher after the doublebottomonthedailychart(see

Figure 7.2). This is the kindof move traders dream ofcapturing. However, not alldouble bottoms will yield agiantpileofpipssuchasthisone. Some double bottomsendupaslosingtrades.In Figure 7.3, the

EUR/GBP makes a doublebottomat0.8800onthedailychart. The market tradeshigherafter the second touchon the zone at 0.8800, a

classic double-bottomformation.

Figure7.3Adouble-bottomformsontheEUR/GBPdailychart.Themarkettwicebouncesoffthezoneat0.8800.©2000–2011,MetaQuotesSoftwareCorp.

Soonafterthesecondtouchat 0.8800 zone, the moveupwards stalls, and the

market falls through the0.8800 zone, as shown inFigure 7.4. This trade wouldhave been a loser for manytraderslookingtofindprofitson this classicdouble-bottomformation.

Figure7.4Themarkettradesashighasthe0.9020areabeforefallingbackdown.ThisclassicdoublebottomontheEUR/GBPdailychartwouldhaveendedupasa

loserformanytraders.©2000–2011,MetaQuotesSoftwareCorp.

This is the problem with

double bottoms, while manyof them identify excellenttradingopportunities,someofthem are losing trades.Perhaps you have traded thisformation in the past andhave experienced somewinning double bottoms andsome losing double bottoms.You may have decided thatthe double bottom is not areliable trading formation. Ifyou have dismissed the

double bottom, please waituntil you learn about thewammie trade, because youmay find that there is stillhope for the double-bottomtrade, or at least for a veryspecific type of the doublebottom.Nextupisthedoubletop, the mirror image of thedouble-bottomformation.

THEDOUBLE

TOPThe double bottom has asister formation, the doubletop.

DOUBLETOP

A price patterncharacterized by twotouches from below on azone. The market rises uptofindresistanceonazonefollowedbyafallandthen

the market again rises tofindresistanceon thesamezone. After this secondtouch of the zone themarket begins a steadymovelower.

The standard double toplooks like thechart inFigure7.5:Themarkettradeshigherfor some time before findingresistance on a zone. Themarket briefly trades lowerbefore once again rising up

and finding resistance on thezone, and then the marketbegins to trade lower andlower.Thedefiningfeatureofthe double top is that themarket begins a newdowntrend after the secondtouchofthezone.

Figure7.5Thestandarddouble-topformationiscreatedwhenthemarketfindsresistancetwiceinquicksuccession.TheUSD/CHF

formsadoubletoponthefour-hourchartwhenthemarkettradesupto0.8500twicetofindresistance.©2000–2011,MetaQuotesSoftwareCorp.

Doublebottomsarereversalformations, and they aremuch more common than

other reversals, such as thebig belt or kangaroo tail.Markets love to touch zonestwice before turning aroundand moving in the oppositedirection. This is why thedouble top has becomewell-known in the tradingcommunity over the years. Itisaclassicchartformation.The problem with this

classicchartformationisthis:It often fails.The double top

will often print on the chartsand then completely fallapart. Some double topssimply do not behave. Thedouble top in Figure 7.6 is aclassic example of a doubletop gone bad. Some doubletopssimplylose.

Figure7.6TheUSD/CADfour-hourchartprintsaclassicdouble-topformation.Themarketdoesfallafterthesecondtouchatthe1.0450

zone,butsoonafterthemarkettradeshigherandhigher.©2000–2011,MetaQuotesSoftwareCorp.

Perhaps it is possible totrade a classic double-topformation,eventhoughmany

double tops endup as losers.Mighttherebecharacteristicsthat winning double topsshare? Is there a way todiscriminate those doubletopswhicharemorelikelytofail from those double topswhicharemorelikelytofindpips?The moolah trade is a

specific type of double-topformation. A closeexamination of the definition

ofthemoolahwillenablethenaked trader to decidewhether this specific type ofdouble-top formation mayimprove on the success rateof the classic double-toptrade.

IDENTIFYINGWAMMIES

AND

MOOLAHSWammiesandmoolahsoccuron any timeframe, in anymarket, so thesecatalystsaresimilar to most of the othernaked tradingpatterns in thisbook.Wammiesandmoolahsare unique versions of thedoublebottomanddouble-topformations, respectively.Youwill learn how to filter outsubpar double-bottom and

double-top trades.Concentrating on only thosedouble bottoms and doubletops with optimal tradecharacteristics (such aswammies and moolahs) willallowyoutotradeonlythosedouble bottom and doubletops that offer the highprobabilityofapayoff.Wammiesandmoolahsalso

fit into the general categoryof reversal patterns. Naked

traders who enjoy enteringtradesatturningpointsinthemarket will find wammiesand moolahs particularlyinterestinganduseful.Beforewe jump into these pricepatterns, it may be useful tolist several important markettruths. We will incorporatethese seven market truthswhen we look at tradingwammiesandmoolahs.

1. If themarket touchesa

zone twice in succession,it will often move awayfromthezone.2.Twotouchesonazonefrom above suggests amarketbottom.3.Whenthemarketmakeshigher lows, it will oftencontinueupward.4.Twotouchesonazonefrom below suggests amarkettop.5.Whenthemarketmakes

lower highs, it will oftencontinuedownward.6.Abullishcandlestickona support zone suggeststhe market will tradehigher.7. A bearish candlestickon a resistance zonesuggests the market willtradelower.

Wammies andmoolahs arebased on these marketobservations. If you agree

with these marketobservations, then you mayenjoy trading wammies andmoolahs.

HOWTOTRADE

WAMMIESAs a naked trader, you getpaid to observe market

patterns,testthesepatternstovalidate their usefulness, andthen execute trades based onthese patterns. These nakedtrading patterns occur overand over again, in manymarkets, on manytimeframes. Wammies are aspecificsubsetofthedouble-bottomformation.Just like the standard

double bottom, the wammieformation includes two

touches on the zone,suggesting that the marketfinds support on the zone.The market will drift higherbetweenthefirsttouchonthezoneandthesecondtouchonthezone.Thewammiediffersfrom the standard doublebottom because the depth ofthe touches on the zone iscritical.Awammieformationis identified by a secondtouch that is higher than the

first touch on the zone. Inother words, a wammie isdefined by a higher low.Recall that a higher low isone way to determine if themarket is in an uptrend, thiswas one of the sevenmarkettruths. This subtle differencebetween a wammie and astandard double bottom mayseeminsignificant,but this isa critical characteristic of themarket'sturningpoints.

In Figure 7.7 we see anexample of a wammie trade.The AUD/USD four-hourchartprintstwotouchesinthe1.0560 zone. The secondtouch on the zone is higherthanthefirstby34pips.

Figure7.7TheAUD/USDfour-hourchartprintsawammieinthe1.0560zone.Noticethesecondtouchishigherthanthefirst.Themarkettraded456pipshigher

afterthissecondtouch.©2000–2011,MetaQuotesSoftwareCorp.

The entry strategy for the

wammie is as follows: Oncethe market prints a strongbullish candlestick on thesecond touch, a buy stop isplacedabove thehighof thiscandlestick.Usingabuystopensures that the trade willonly be triggered if themarket tradeshigher than thebullish candlestick. In Figure7.8, the market prints abullish candlestick on thesecond touch of the 1.0560

zone.Thebuystopisplacedafew pips above the high ofthe bullish candlestick. Oncethemarket tradeshigher thanthe bullish candlestick, thetradeistriggered.

Figure7.8TheAUD/USDfour-hourwammietradeistriggeredoncethemarkettradeshigherthanthebullishcandlestickonthesecondtouch.©2000–2011,MetaQuotesSoftware

Corp.

The stop loss for thewammie trade is placedbelow the low of the first

touch (see Figure 7.9).Placing the stop loss hereensures that if the market isbeginninganewuptrend, thestop loss will not betriggered. If the market ismovinghigheritwillnottakeout the lowest low of thewammieformation.

Figure7.9Thestoplossforthewammietradeisafewpipsbelowthefirsttouchonthezone.Ifthemarketbegins

anewuptrend,thestoplosswillnotbehit.©2000–2011,MetaQuotesSoftwareCorp.

Wammie trades aredesigned to capture strongtrends. There are severalcluesprovidedby themarketwhen awammie tradeprints.First, the market has twicefound support on a criticalzone.Second, themarkethasmadeahigher low.This is acritical characteristic of thewammie, because it suggeststhedownsidemomentummaybe dying out. Third, the

market has printed a strongbullish candlestick on thezone and the market hastraded higher than thisbullish candlestick, a stronghint that the market may beready to trade higher. Takenindividually, each wammiecharacteristic is indicative ofa market likely to tradehigher, but collectively thesecharacteristics suggest amarketreadytotakeoff.

Takea lookatFigure7.10.Thisisanotherwammietradeon theGBP/USDdailychart.Theimportantfeaturesofthistrade are marked with thenumbers1,2,and3.At1,thebuystopisplacedafewpipsabove the first bullishcandlestick after the secondtouch on the 1.9400 zone.Notice that the previouscandlestick is not a bullishcandlestick, because this

candlestick closed near themidpoint.Thisiswhythebuystop isplacedabove thenextcandlestick, the firstcandlestickwith a close nearthehighofthecandlestick.At2, the stop loss is placed afewpipsbelowthefirsttouchon the 1.9400 zone. Placingthe stop loss here improvesthechancesthatthetrademaysurvive another touch of thezone. At 3, the market falls

back down and touches thezoneonce again.Notice herehow the trade survives thisthird touch on the zonebecause the stop loss isplaced below the first touch.This third touch on the zonewill occur after somewammie trades, so it isimportant to place the stoploss below the lowest (first)touch. If the stop loss isbeneaththesecondtouch,this

trade would have been alosing trade.With thecorrectstop-lossplacement,thetradesurvives this third touch andcollects716pips.

Figure7.10TheGBP/USDdailychartprintsawammietradeset-up.1.Thebuystopisplacedafewpipsabovethefirstbullishcandlestickafterthesecondtouch.2.Thestoplossisplacedafewpipsbelowthefirsttouch.3.The

marketunexpectedlyfallsbackdownandtouchesthezoneagain,butthestoplossisnottriggeredandthemarketsoonaccelerates716pipshigher.©2000–2011,MetaQuotesSoftwareCorp.

The simplest way to profitfrom the wammie trade is tosimplyplaceaprofittargetat

the nearest zone. Morecomplex exit strategies arecoveredinChapter11,butfornow it is important to notethat taking profit at the nextzoneisagreatwaytomanageexitswiththewammie.In Figure 7.11 we see

another wammie on a dailychart, this time it is theAUD/JPY. There are fiveimportant tradecharacteristics, each of them

marked in Figure 7.11. At 1themarket first finds supportonthe75.00zonewithanicebullish candlestick; the closeof the candlestick is up nearthe high. At 2, the secondtouch is a few pips higherthan the first touch, whichqualifies this double bottomas a wammie. At 3, the buystop is placed a few pipsabove the second bullishcandlestick after the second

touch. Notice that there areseveral candlesticks after thesecond touch, but the buystop is placed above the firstbullish candlestick with aclosingpricenearthehighofthe candlestick. Only thesecond bullish candlestickafter the second touchqualifies as a valid wammieentry candlestick. Thewammie buy stop should beplaced a few pips above the

first strong bullishcandlestick. At 4, the stoploss is placed a few pipsbelow the first touch for atotal risk of 150 pips. At 5,themarketachievestheprofittarget at the next zone at78.20foratotalof235pips.

Figure7.11TheAUD/JPYwammietradeonthedailycharthasallofthetypicalwammietradecharacteristics.©2000-2011,MetaQuotesSoftware

Corp.

One final note about thewammietrade:Itisimportant

to only take those wammietrades that touch the zoneonce, move away from thezone,andthentouchthezoneagain.Movingawayfromthezone after the first touch iscritical, and this iswhy thereis a rule for the number ofcandlesticks between the twotouches. A wammie trade isonlyvalidifthereareatleastsix candlesticks between thefirst and second touches. If

there are fewer than sixcandlesticks, it is likely thatthemarketmaybegearingupfor a push beyond the zone.This is because breakoutsoften occur when themarketrepeatedly touches the zonein quick succession. Take alook at the charts, you willprobably notice that manybreakouts occur after themarket repeatedly touches azone (see Figure 7.12 for an

excellentexampleofthis).

Figure7.12Therearemultipletouchesonthe0.9400zoneontheUSD/CHFfour-hourchart.Thisisahintthatthemarketislikelytopushthroughthezone.©2000--2011,MetaQuotesSoftwareCorp.

The very best wammieswill not have very quicktouches on the zone, but

rather the market will touchthezone,starttotradehigherfor some time, and then fallbackdown to touch the zoneagain. Be wary of wammieswith quick touches on thezone,as thismaysuggest themarket is going to pushthrough the zone in theimmediatefuture.The wammie trade is a

simple but powerful trade.Nowgobackandtakealook

at the charts in the doublebottom section of thischapter. Do you noticeanything about the twodouble-bottom trades?Compare the double bottominFigures 7.1 and 7.2 to thedoublebottom inFigures 7.3and 7.4.What do you noticeabout those trades?Formoreon these set-ups and otherlive wammie trades, go towww.fxjake.com/book.

WammieCharacteristics

Thesearethesevenimportantcharacteristicsofthewammiepattern.

1.Themarkettouchesthesupportzonetwice.2. The second touch ishigherthanthefirsttouch.3. There are at least sixcandlesticks betweentouches.

4. The market prints abullish candlestick on thesecondtouch.5. The trade is enteredwithabuystopafewpipsabove the bullishcandlestick.6.The stop loss is placeda fewpipsbelow the first(lower)touch.7. The profit target is thenext zone above thewammie.

HOWTOTRADE

MOOLAHSNow you understand thewammietrade,itwillbeveryeasy for you to understandhow to apply the sameprinciples to the moolahstrategy. The moolah issimply thewammie tradebutin reverse. So, where the

wammie is a special case ofthe double bottom, themoolah is a special case ofthe double top. Like thewammie, the moolah hasseveralcharacteristicsthatarecriticaltotheidentificationofthe moolah set-up. Also, themoolah has specific rules formanaging the stop lossandasellstopentryforthistrade.The moolah is simply a

double top on an important

support-and-resistance zone.See Figure 7.13 for anexample of themoolah tradeon the daily USD/JPY chart.The importantaspectsof thistrade are marked withnumbersinFigure7.13.At1,the market makes the firsttouchonthe119.75zoneandthensoon falls lower.This isalso where the stop loss isplaced,afewpipsbeyondthefirst touch at 1 on the chart.

Themarkettradeslower,thenmakesanotherrunhigherandtouches the119.75zone, thistime lower than the firsttouch,atthespotmarked2inFigure7.13.Noticethattherearemorethansixcandlesticksbetween the candlestick thatfirsttouchesthezoneandthecandlestick that touches thezone again at 2 on the chart.At3, thesellstopisplacedafewpipsbelowthelowofthe

first bearish candlestick afterthesecondtouch.Themarkettriggers this sell stop on thenext candlestick and falls tothe first zone at 118.15, butbecause this zone is only 67pips lower than the entryprice(andthestoplossis108pipsfromtheentryprice),thetradeisheldallthewaydowntothenextzoneat117.50,at4on thechart, for anoverallprofitof133pips.

Figure7.13MoolahtradeontheUSD/JPYdailychart.Theimportantcharacteristicsofthistradearemarkedwithnumbers1through4.©2000–2011,MetaQuotesSoftwareCorp.

The moolah trade is asimplebutpowerfultrade,therules are simply the same as

for the wammie trade, butreversed for double tops.Take a look at the charts inthedouble topsectionof thischapter. Do you noticeanything about the twodouble-top set-ups?Comparethedouble top inFigures 7.5and 7.6.What do you noticeaboutthosetradeset-ups?Fora video about these specifictradeset-upsandlivemoolahtrades, go to

www.fxjake.com/book.

MoolahCharacteristics

Thesearethesevenimportantcharacteristics of the moolahpattern.

1.Themarkettouchestheresistancezonetwice.2. The second touch islowerthanthefirsttouch.3. There are at least six

candlesticks betweentouches.4. The market prints abearish candlestick afterthesecondtouch.5. The trade is enteredwithasellstopafewpipsbelow the bearishcandlestick.6.The stop loss is placeda fewpips above the first(higher)touch.7. The profit target is the

next zone below themoolah.

TIPSFORWAMMIES

ANDMOOLAHS

It may be tempting to takeevery wammie and moolahthat appears on your charts,

butitisimportanttonotethatsome wammies and moolahsare better than others. If youwant to pick only the verybest wammies and moolahs,trytodothefollowing:

Choose the set-upswith manycandlesticksbetween touches.Six candlesticksbetween touches isnice to see, but 20

candlesticksbetween touches isbetter.Take trades withcatalysts on thesecond touch. If thesecond touch is abig shadow or akangaroo tail, theodds are probablystrongly in yourfavor.Picktradesthathave

a second touchmuch further fromthe zone. Figure7.13 is a greatexampleofthistypeoftrade.Thesecondtouch is a full 22pips lower than thefirst touch,suggesting that themarket is runningoutofsteam.Only choose

wammies andmoolahs that are instrong, well-definedzones.If thezoneisnot an importantone,thenthemarketmay only tradeaway from the zonebriefly beforebreakingbeyondthezone.Find set-ups thathaveveryfewzones

nearby. This willenable you to placea profit target veryfar from the entryprice and maximizeprofits.Trade thosewammies andmoolahs that have“room to the left.”This idea iscoveredin the kangaroo tailchapter (Chapter 6).

Major reversalsoftenoccuratplaceson the chart withvery little priceaction to the left ofthetradeset-up.

CHAPTER8

KangarooTails

Whenever you find thatyouareonthesideofthemajority, it is time toreform.

—MarkTwain

The kangaroo tail is anextremely powerful catalyst.It is an obvious clue to thenaked trader that the markethas gone too far. There aremany traders around theworld who simply trade thisone simple yet powerfultradingsetup.

WHATISA

KANGAROOTAIL?

A kangaroo tail is a distinctprice pattern. It is onecandlestick that is easy tospot. Once you becomefamiliarwiththiscatalystyouwillseethemeverywhereandoften at reversal points.Kangarootailsmayprintbuysignals—bullish kangarootails---and bearish kangaroo

tails, which are sell signals.The kangaroo tail has twoparts: thekangaroobodyandthe kangaroo tail. Allkangaroo tails are single-candlestickformations.

SINGLE-CANDLESTICKFORMATIONApricepatternmadeupofa single candlestick. The

definition and validity ofthe price pattern isdependent oncharacteristics of thecandlestick relative to thesurroundingcandlesticks.

Ideally, thekangarootail ismuchlongerthanthebodyofthe kangaroo. The bestkangarootailshaveverylongtailssuchasthekangarootailin Figure 8.1. The long tailsuggests that the market has

extended too far into a zoneandislikelytoreverse.Thereare other characteristicsunique to the kangaroo tail,and all kangaroo tails mustmaintain all thesecharacteristics. If you see aprice pattern that does notinclude all thesecharacteristics, it may be avery interestingpricepattern,but itwill not be a kangarootail.

Figure8.1ThiskangarootailontheAUD/USDdailychartisanidealkangarootailbecausethetailismuchlongerthanthebody.©2000–2011,MetaQuotesSoftwareCorp.

THEOPEN

ANDCLOSEAll kangaroo tails have anopen and close near theextreme end of thecandlestick. For bearishkangaroo tails (sell signals),the open and close of thecandlestick should be in thebottom third of thecandlestick (see Figure 8.2).Iftheopenorthecloseisnotin the bottom third of the

candle, it is not a kangarootail.Thereisasimilarruleforbullish kangaroo tails: Thesebuy signals must have theopenand theclose in the topthird of the candlestick (seeFigure8.3).Iftheopenorthecloseisnotinthetopthirdofthe candle, it is not akangarootail.

Figure8.2ThisisavalidbearishkangarootailontheAUD/USDone-hourchart

becausetheopenandthecloseofthekangarootailarebothinthebottomthirdofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Figure8.3ThisisavalidbullishkangarootailontheEUR/GBPweeklychart

becausetheopenandthecloseofthekangarootailarebothinthetopthirdofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.

The open and the close ofthe kangaroo tail should benear the extreme end of the

candlestick.Thekangarootailis a reversal signal, so whenwe see a long tail on akangaroo tail, and the openandcloseofthekangarootailare at the extreme oppositeend,weknowthatthemarkethas moved too far. Thekangarootailisacluethatthemarket has extended beyonda zone, perhaps a bit too farbeyond the zone. Mostkangaroo tailswillprintafter

surprisingnews;forexample,kangaroo tails printed in theforex market during thetsunami in Japan in 2011.Kangarootailsalsoprintedinthe forex market during theglobal financial crisis in2008. Kangaroo tails do notonly print during extremelysurprising news. However,they will often appear whenthemarkets get very excited,and this isoftendue to some

extremely unusual events intheworld.

KANGAROOTAILSARE

LONGMost kangaroo tails arelonger candles. This meansthat thekangaroo tailwill bea bit longer than the

surrounding candlesticks.Longerkangaroo tailshaveatiny body and a long tail.Take a look at the kangarootailontheUSD/CHFmonthlychart inFigure8.4.The longtail is ideal. The bestkangaroo tailswillhaveverylong tails and very shortbodies.

Figure8.4ThisisanicebullishkangarootailontheUSD/CHFmonthlychartwith

averysmallbodyandaverylongtail.©2000–2011,MetaQuotesSoftwareCorp.

Why is it important for akangaroo tail to have a longtail?Alongtailsuggests thatthemarkethasgoneabit toofar when testing a zone,whereas a short tail maysuggest that the marketsimply brushed up against azone. Remember, as a nakedtrader, you want to look fortrade opportunities on zones.Zones,asyourecall,arethosespots on the chart where the

marketrepeatedlyreverses.Akangaroo tail is a valuableclue, a particularly valuablecluewhenitoccursonazone.Thekangarootailwithaverylong tail suggests themarkethasbecomeextremelyexcitedbefore reversing sharply. So,akangarootailonazoneisahigh-probability reversalcandle at a spot on the chartwhere the market hashistoricallyreversedtimeand

timeagain.Here you see how this

kangaroo tail penetratedthrough the zone, suggestingthat the market became veryexcited when pushing pricethrough the zone, and thenretreated for the close of thekangaroo tail (Figure 8.5).This is a common kangaroo-tailformation.Mostkangarootails will push through thezoneandthencomebackand

closeon theothersideof thezone.

Figure8.5Kangarootailsoftenpenetrateazonebeforeclosingontheothersideofthezone.ThisbullishkangarootailontheGBP/JPYdailychartpenetratesthesupportzonebeforeclosingbackabovethezoneat167.00.©2000–2011,MetaQuotesSoftwareCorp.

The kangaroo tail is acatalyst that suggests themarket has gone too far, and

has quickly reversed course.Recall that zones are thosespots on the chart where themarket has reversedrepeatedly. Therefore, akangaroo tail on a zone is areversal candle on a reversalzone. It is important toremember that as a nakedtrader you are using pricepatterns that are clues---hintsabout where the market maybe headed. By trading these

price patterns only on thosespots on the chart where themarket has repeatedlyreversed,theoddsareinyourfavor.Kangaroo tails exhibit

extreme market behavior.Kangaroo tails often pushthrough a zone briefly (seeFigure 8.5) before returningtotheothersideofthezone.This is typical of the

kangaroo-tail formation, and

it is good to see. It is a signthat themarkethastestedthezone and rejected this level.Exceptionally long-tailedkangaroo tails arewonderful,as they suggest that themarket,afterpushingthroughthe zone, has gone too far,and then settles back on thezone.Very small tails on

kangarootailsarenotideal.Asmall tail suggests that the

market may come back andtest thezoneonceagain.TheUSD/CAD daily chart inFigure 8.6 is an excellentexample of what oftenhappens after small-tailedkangarootailprints.

Figure8.6ThisbullishkangarootailontheUSD/CADdailycharthasaveryshorttail.Noticehowthemarketcamebackdownafterthekangarootailtotest

the1.0450zone.©2000–2011,MetaQuotesSoftwareCorp.

The long-tailed kangaroo

tails are often better tradesignals than the very smallkangaroo tails.The long tailssuggest that the market hasmadeagoodtestofthezone,and then, the zone rejects it.(SeeFigure8.7).

Figure8.7ThekangarootailontheAUD/USDfour-hourchartisexceptionallylong.Thissuggeststhat,althoughthemarkethaspushedthroughthe1.0000zone,it

hasbeenstronglyrejectedbythe1.0000zone.Themarketmovesover600pipshigherafterthekangarootail.©2000–2011,MetaQuotesSoftwareCorp.

When the market prints along-tailed kangaroo tail, thesuggestion is that themarket

hasgonetoofar.Eventhoughthe market went through thesupport and resistance zone,in the end, themarket closedon top of the zone.This is ahint—averystronghint—thatthe zone will likely hold themarket.A smaller tail on thekangarootaildoesnotinspireasmuch confidence, becauseahalf-heartedtestofthezonesuggests that themarketmaydecide to come back for a

good test of the zone again.Also, during runawaymarkets, kangaroo tails mayprint, but smaller kangarootails are often simply weakpauses in the market (seeFigure 8.8 and Figure 8.9).They often have very smalltailsandwillprintinbetweensignificant zones; in otherwords they are not reliablesignals.

Figure8.8TheGBP/CHF

four-hourchartisinaverystrongdowntrend.Noticethesmall-tailedkangarootailinbetweenthezones.Thisisnotareliablekangarootailtrade.©2000–2011,MetaQuotesSoftwareCorp.

Figure8.9OntheEUR/USDdailychartabearishkangarootailprintsinthemidstofa

stronguptrend.Alongertailonthiskangarootailwouldhavebeenabettersellsignal.©2000–2011,MetaQuotesSoftwareCorp.

KANGAROO

TAILPLACEMENT

Kangarootailsshouldbenearthe previous candle. If akangaroo tail is too far fromrecent price action, it maysuggest a “runaway” market,suggesting the market is notready to reverse.Oneway toquantify whether a kangarootailisnearrecentpriceactionis to look at the open and

close relative to the nearestcandle. If the open and closeofthekangarootailareinsidethe range of the previouscandlestick, thekangaroo tailis valid (Figures 8.10 and8.11).

RANGEThe range of a candlestickis the distance in pipsbetween the high and lowofthecandlestick.

The easiestway to see thisrule inactionis to lookatanexample.

Figure8.10ThisAUD/NZDfour-hourcharthasabearishkangarootail.Noticetheopenandcloseofthekangarootailarebothcontainedbytherangeofthepreviouscandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Figure8.11ThiscandlestickontheNZD/USDfour-hourchartisnotavalidbullish

kangarootail.Thecloseofthekangarootailisbelowtherangeofthepreviouscandlestick.©2000–2011,MetaQuotesSoftwareCorp.

The kangaroo tail on thefour-hourAUD/NZDchartinFigure 8.10 is an ideal

example.Noticetheopenandthecloseofthekangarootail;both are inside the range ofthepreviouscandlestick. It isimportant for the open andclose of the kangaroo tail tobe inside the previouscandlestick's range becausethis suggests that the marketis not in a runaway trendingphase.Sometimes themarketwill print a kangaroo tailduring a very strong trend.

When this occurs, you maysee the market pause at azone, but often the marketeventuallypushesbeyond thezone. The four-hourNZD/USD chart in Figure8.11 shows an example of arunawaymarket.Notice howthe closing price on thekangarootailisoutsideoftheprevious candlestick's range.This is therefore not a validkangaroo tail. The very best

kangaroo tails will have theopen and close of thecandlestick well inside therange of the previouscandlestick. Othercandlestickswithanopenandclose not inside the previouscandlestick's range are notvalidkangarootails.

LooktotheLeftTake a look at the chart in

Figure 8.12. Notice how inthis case the market, theAUD/USD weekly chart,prints a kangaroo tail at anarea on the chart that is anextremehigh.Themarkethasnottradedhereinsometime,infact,onthechartwecannotsee the last time that themarket traded at this level.We could say that thiskangaroo tail has much“roomtotheleft.”

Figure8.12TheAUD/USDweeklychartprintedakangarootailatanareaonthemarketchartwherewehavenotseenpriceactioninover20years.Thus,wecansaythatthiskangarootailhasmuchroomtotheleft.Thepairfellover3,000pipsafterthiskangarootailprinted.©2000–2011,MetaQuotesSoftwareCorp.

Why is room to the leftimportant?Why is it that thenaked trader seeks outreversal signals that print onthe chart on areas that havenotseenpriceactioninalongtime? The answer is simple:Thenakedtraderislookingtocatch extreme reversals,trades that will capture largemoves in themarket. Ideally,the naked trader will take atrade just as the market is

turning around, at places onthe chart where the marketwill not comeback for sometime. Remember, the nakedtrader is not held hostage toindicators,sothenakedtraderhas the ability to be nimbleand jump into a trade just asthemarket is turning around,the naked trader does nothave towait for the indicatorto rolloveror to indicate themarket is turning around.

Obviously, the naked traderneverknowsforcertainwhenthe market will make anextremehighorextremelow.The naked trader does,however,knowthatwhenthemarket turns around at anextreme high or an extremelow,ataspotonthechartthathas not seen recent priceaction, themarket oftendoesnotquicklyreturntothatspot(seeFigure8.13).

Figure8.13TheweeklyEUR/USDchartprintedakangarootailinJulyof2001.Thiskangarootailhasplentyofroomtotheleft,aftertradinghigherthanthekangarootail,themarkethasnotbeenbacktothiszonesincethiskangarootailprinted.©2000–2011,MetaQuotesSoftwareCorp.

BewareofGiantCandlesticks

When the market is in arunawaytrend,kangarootails

oftenlooksmallcomparedtothe surrounding candlesticks.Take a look at Figure 8.14.Thiskangaroo tailprintedonthe EUR/USD daily chart onabrilliantzone.Additionally,the open and the close areinside the range of theprevious candlestick, theopenand thecloseare in thebottom third of thecandlestick, and there isplentyof room to the left; in

fact it hasbeenover46dayssincethemarkethastradedatthiszone.

Figure8.14AlthoughthisappearstobeanidealkangarootailontheEUR/USDdailychart,thegiantbullishcandlestickspriortothekangarootailhintthatthestronguptrendmaycontinue.©2000–2011,MetaQuotesSoftwareCorp.

Is this an ideal kangarootail? Unfortunately, it is notan ideal kangaroo tail. The

big bullish candlesticks priorto the kangaroo tail hint thatthe market may have furtherupsidemomentum.Thus,thisis not an ideal kangaroo tailsimply because themarket isprinting giant bullishcandlesticks immediatelyprior to the kangaroo tail.Many failed kangaroo tailsfollowlargecandlesticks.Thebest kangaroo tails have averylargerange,oftengreater

than the candlesticksimmediately prior to thekangarootail.Figure 8.15 illustrates

another example of a bullishkangaroo tail. Notice thelarge bearish candlesticksprior to the kangaroo tail,these candlesticks offer aclue---downside momentummay remain in the market.Optimal kangaroo tails willhave a large range, usually

greater than the range ofthose candlesticksimmediately prior to thekangaroo tail. Be wary ofsmall-tailedkangaroos.

Figure8.15ThisbullishkangarootailontheAUD/JPYfour-hourchartwouldhavebeenalosingtrade,ashintedbythegiantbearishcandlestickspriortothekangarootail.©2000–2011,MetaQuotesSoftware

Corp.

ENTERING

THETRADETheobviousentry trigger forthe bullish kangaroo tail is abuystopafewpipsabovethehigh of the kangaroo tail.Once the market pushesthrough the high of thekangaroo tail, it will triggerthe buy stop, triggering anentry for the trade. For thebearish kangaroo tails, asimilar entry works well: a

sellstopafewpipsbelowthelowofthekangarootail.Many traders wonder if a

differententrytechniquemaylead to greater profits.Specifically, some traderswish to enter the kangarootail after the market hasretraced or traded in thewrong direction. This mayseemlikeagoodideabecausetheentrymaybeclosertothestop loss and, therefore,may

reduce the risk on the trade.However, the suggested buystoporsellstopentrystrategyis a much safer strategybecauseitwillavoidmanyofthelosingtrades.Oftenafailedkangarootail

will never see the markettrade beyond therecommended entry price.For bullish kangaroo tails, ifthe market keeps fallinglower, it may never trade

higher than the high of thekangaroo tail (see Figure8.15). Likewise, for bearishkangaroo tails, if the marketkeeps trading higher, it willusually never trade lowerthan the lowof thekangarootail(seeFigure8.16).Thus,itis much safer to enterkangarootailswithabuystop(forbullishkangarootails)ora sell stop (for bearishkangaroo tails). Using a buy

stop above the high (forbullish kangaroo tails) or asell stop below the low (forbearish kangaroo tails) willdelaythetradeentryuntilthemarketmovesintheexpecteddirection. This simple tradeentry technique will avoidmanylosingtrades.

Figure8.16ThisisaclassicfailedbearishkangarootailontheUSD/CHFfour-hourchart.Noticehowthemarket

nevertradeslowerthanthelowofthekangarootail.Usingasellstopbelowthelowofthiskangarootailenablesthenakedtradertoavoidacertainloss.©2000–2011,MetaQuotesSoftwareCorp.

THESTOP

LOSSThe stop loss for thekangarootailisplacedontheother side of the tail, just afewpipsbeyond the tail (seeFigure8.17).Thisemergencystoplossisthemaximumstoploss for the trade. Theemergency stop loss is themaximumlossforakangarootail trade. Ideally, the nakedtrader will close out a

kangarootailtradeifthetradeis in a drawdown andmoves75 percent toward the stoploss.Closing the tradebeforethestoplossishitwillreducethe average losing trade, avery desirable outcome forthenakedtrader.

Figure8.17Thestoplossisplacedafewpipsbeyondthetailofthekangarootail.ForthisbullishkangarootailontheweeklyNZD/USDchart,

thestoplossisplacedafewpipsbelowthelowofthebullishkangarootailat0.5480.©2000–2011,MetaQuotesSoftwareCorp.

PROFIT

TARGETSChapter 11 covers exitstrategies. There are manyexit strategies in that chapterthat are compatible with thekangaroo tail trade. Onesimple way of managing thekangaroo tail trade is to takeprofit at the very next zone(seeFigure8.18).

Figure8.18Averysimpleandpowerfulexitstrategyfor

thekangarootailisthis:Takeprofitattheverynextzone.AfterthebullishkangarootailontheNZD/USDweeklychart,themarkettradeshigherandeventuallyfindsthe0.6600zoneforaprofitof853pips.©2000–2011,MetaQuotesSoftwareCorp.

KANGAROO-

TAILTIPSThere are several optimizersassociatedwiththekangaroo-tail trade. If you have thepatience to wait for only thevery best kangaroo tails,watch for the followingcharacteristics:

Kangaroo tails withaverylongtails.Kangaroo tails withmuch room to the

left. The idealkangaroo tails printat an area on thechart that has notseen price action inalongtime.Bullish kangarootails with a closingprice that is higherthan the openingprice.Bearish kangarootails with a closing

price that is lowerthan the openingprice.The candlestickafter the bullishkangaroo tail tradeshigher than thehighofthekangarootail.The candlestickafter the bearishkangaroo tail tradeslower than the lowofthekangarootail.

Kangaroo tails witha greater range thanthe previous 10candlesticks.Kangaroo tails thattrigger the buy stoporsellstopentryonthe first candlestickafter the kangarootail.

There are also several redflags,sowatchoutforthese:

Kangaroo tails with

veryshorttails.Kangaroo tails thatdo not print on azone; these are notvalidkangarootails.Kangaroo tailspreceded by giantcandlesticks. Thissuggests that thetrend may continue,and the kangarootail may only be apause.

When the open andthe close of thekangaroo tails arenotcontainedbytherange of thepreviouscandlestick.

If you back-test thekangaroo tail, you may findthat this trade set-upconsistently identifies keyturning points in the market.Go to www.fxjake.com/book

for live market kangaroo-tailupdates.

CHAPTER9

TheBigBelt

It isgreat tobeablonde.Withlowexpectationsit'svery easy to surprisepeople.

—PamelaAnderson

There are a few moments inlife that eclipse all others.Some of them are obvious,and you anticipate them: thebirthofyour first child, youradventures at an exoticfaraway land, meetingsomeone who will becomeone of the most importantpeople in your life, and soforth.Othermomentsseemtocome from nowhere, out ofthe blue, but they are often

just as critical and just asimportant.The first timeyourealize you will become aprofitable as a naked tradermay be one such moment.The tricky thing about thesesurprising moments is this:You never know when theywilloccur,andwhentheydo,it is important to seize them.These critical, beautifulmoments come and go, butyoumustbereadyforthemat

anytime.

WHATISABIGBELT?

This next catalyst, the bigbelt, is much like a brilliantpeakexperienceinlife.Abigbelt is a very significantoccurrenceinthemarket.Bigbelts rarely occur, and whenthey do they will nearly

always occur on a supportand resistance zone. The bigbeltwill nearly always occuron the very first day of thetradingweek,afterthemarkethas had some time to thinkabout a fair price over theweekend.Unfortunately,manytraders

areabittooexcitedwhenthemarketstartstradingagainforanewweek.Manytradersarethinkingaboutwhathappened

the previous week. Becausetradersarethinkingabouttheworld events of the previousweek,themarketoftenmakessome extreme jumps on thefirst tradingdayof theweek.Unfortunately, this earlyexcitement is oftenmisplaced, and pushes themarkettoaplacethatisabittoo far. When this occurs abig belt will often appear onthechart.

There are two types of bigbelts: bearish big belts andbullish big belts. Once youunderstand the basics of thebearish big belt, you caneasily apply your knowledgeto the bullish big belt, sincethe trade set-ups are simplyopposites.

THEBEARISH

BIGBELTAbearish big beltwill occuratamarkethighandabullishbig belt will occur atmarketlow. In both cases the beltswillprintonazone.InFigure9.1we see a bearish big beltontheAUD/USDdailychart.Thedefiningcharacteristicofthe bearish big belt is thejump in the market price. Inforex,bearishbigbeltsnearly

always surface on the firsttradingdayof theweek.Themarket opens much higherthan the closing price of theprevious week and thensteadily trades lower,eventually closing near thelow of the candlestick. Thus,the candlestick has a beltlikeappearance. The openingpriceisnear thehighandtheclose is near the low.Naturally, bearish belts will

also stick out above recentprice action. Notice that thebearish big belt prints on the0.9335zone.Thisisacriticalzone because the marketreversed here after touchingthe zone four months prior.Bearish big beltswill alwayshave an opening price nearthe high of the candlestick,and the closing price will benear the low of thecandlestick.

Figure9.1ThisisabearishbigbeltontheAUD/USDdailychart.Thecandlestickprintsonanimportantzone,thebearishbigbeltopenshigherthanthepreviouscandlestick,openisnearthehigh,andthecloseisnearthelow.©2000–2011,MetaQuotesSoftwareCorp.

A bearish big belt has anentryverysimilartoabearishkangarootailorabearishbigshadow.Asellstopissimplyplaced just below the low ofthe bearish big belt. Placingtheentryhereensuresthatthemarketmustmakeanewlowbefore the trade is triggered.This will, of course, enableyou to avoid many losingtrades, particularly thosesignals that follow a rising

market. If the market neverfalls to the entry price, thetradewillnotbetriggered.Bearish big belts often

occur at critical turningpoints, when the market hasbecome extremely excited.This excitement is translatedintoabearishbigbelt; it isasignal that the market hasgoneuptoofar.Ifyoutakealook at the bearish big beltson your charts, you will see

that, historically, the dailybearish big belts have anexceptionally high win rate.Test this for yourself; scrollthrough the historical chartsand record the marketmovement after big belts, ortest themina forex tester,oryourchosenprogramforbacktesting.Youmaybesurprisedwith the win rate of the bigbelttradingset-up.Although it is common to

seebearishbigbeltsonlowertimeframes,suchastheone-hour chart and the four-hourchart, sticking to the dailychartsonlywillenableyoutomaintain a high win ratewhen trading this set-up. So,although it may be temptingto multiply your trades bytaking big belts on a lowertimeframe, it is probably abetter idea to either stick tothedailychartsforthisnaked

trading set-up or be veryselective with the trades thatyou decide to take on thelowertimeframes.Aswithmany of the other

nakedtradingset-ups,aneasyway to exit your bearish bigbelttradeistosimplywaitforthe market to reach the verynext zone (see Figure 9.2).This isoftenasimplewaytocapture a large chunk of themove. Again, remember that

the bearish big belts oftenprint at criticalmarket highs,so they offer an excellentopportunity foryou to take abiteoutof abigmove in themarket.

Figure9.2AnotherbearishbigbeltontheGBP/USDdailychart.Aprofittargetatthenextzonecaptured385pipsonthistrade.©2000–2011,MetaQuotesSoftwareCorp.

Thestoplossforthebearishbig belt is placed above thehighofthebelt.Ifthemarket

tradeshigherthanthehighofthe bearish big belt, then,obviously, the belt has notidentifiedakey turningpointin themarket.Takea lookatthe bearish big belt trade inFigure9.3.

Figure9.3ThisisthebearishbigbeltontheGBP/USDdailychart.Noticethesellstopisplacedbelowthelowofthebeltcandlestickandthestoplossisabovethehigh.

Theprofittargetatthenextzonecaptured163pipsonthistrade.©2000–2011,MetaQuotesSoftwareCorp.

The bearish big belt is anexcellent trade set-up, yousimplyhave towait for them

tooccur. Ifyouarewatchingonlythemajorcurrencypairs(EUR/USD, USD/CHF,USD/JPY, GBP/USD) youmay occasionally luck into abearish big belt trade. But ifyou expand your scope, andlook at many of the othercurrency pairs (NZD/JPY,EUR/CAD, GBP/CAD, etc)you obviously have a muchbetterchanceofcatchingoneof these bearish big belt set-

ups.Backtestthebearishbigbelt onyour own to seehowprofitable and successfulthese tradesmay be for you.All you have to do to bereadyforthedailybearishbigbelt is to watch the marketafterthecloseoftheveryfirsttradingdayoftheweek.

THEBULLISH

BIGBELTThe other big belts are, ofcourse, the bullish variety,bullishbigbeltsareimportantcatalysts that hint at themarket moving higher. Abullish big belt will oftenprint at an important marketlow on a zone. The bullishbig-belt candlestick has anopening price much lowerthan the closing price of the

previous candlestick. Thebullish big belt will have anopening price down near thelow for the candlestick, andthe closing price will be upnear the high of thecandlestick. In Figure 9.4 abullish big belt is on theEUR/CAD daily chart. Thisbullish big belt prints on the1.3430zone.Thisisacriticalzone because the marketreversed here after touching

the zone three months prior.The bullish big belts willalwayshaveanopeningpricenear the low of thecandlestick, and the closingpricewillbenear thehighofthecandlestick.

Figure9.4AbullishbigbeltontheEUR/CADdailychart.Thecandlestickprintsinanimportantzone,the1.3430zone.Noticehowthebullishbigbeltopensmuchlower

thanthecloseofthepreviouscandlestick,theopenisnearthelow,andthecloseisnearthehigh.©2000–2011,MetaQuotesSoftwareCorp.

The bullish big belt on theEUR/CADdailychart(Figure9.4) is an excellent examplebecause the bullish big beltdailycandlestickprintsontheimportantzoneat1.3430.Theinteresting thing about thisparticular bullish big belt isthatthelowofthecandlestickis a bit lower than theopening price. This is notideal, but themost importantcharacteristic of the bullish

bigbeltcandlestickholdstruein this example. The closingprice is very near the highprice, and this is absolutelycriticalforthebullishbigbeltset-up(justasitiscriticalforthe bearish big belt set-up tohave a close near the low ofthe candlestick). Take a lookat the chart again in Figure9.5,hereyouwillseethatthestop loss is down below thelowofthebullishbigbeltand

the buy stop is placed a fewpips above the high of thebullish big belt candlestick,the trade is triggered onlyoncethemarkettradeshigherthanthebullishbigbelt.Thistrade easily achieved theprofit target at the very nextzone, the 1.3885 area for aprofitof313pips.

Figure9.5TheentrypriceforthebullishbigbeltontheEUR/CADdailychartisa

fewpipsabovethehighofthebullishbigbeltcandlestick.Thestoplossordertradeisbelowthelowofthebullishbig-beltcandlestick.Theprofittargetistheverynextzoneat1.3885,aprofitof313pips.©2000–2011,MetaQuotesSoftwareCorp.

Although the bullish bigbelttradeisanexcellenttradeandmany traders will find a

high win percentageassociated with this trade,therearelosingtrades,justasthere are for all tradingsystems.ThenextbullishbigbeltexampleisinFigure9.6,this is a weekly USD/CHFchart.Note that the stop lossisplacedbelowthelowofthebullish big belt candlestick.The candlestick has goodform, the open of thecandlestick is down near the

low of the candlestick, andthe closing price is up nearthe high. The buy stop entryisplacedafewpipsabovethehigh of the candlestick, andthis entry price is easilytriggered during the nextcandlestick, in fact, themarketpushesall thewayuptotheverynextzone.

Figure9.6TheweeklyUSD/CHFbullishbelthasastoplossbelowthelowand

thebuystopentryisabovethehigh.Themarketdoesreachthenextzone,butsoonafterquicklyfallsbeyondthestoplossprice.©2000–2011,MetaQuotesSoftwareCorp.

However, the risk on thistrade is 210 pips (from thebuystoptothestoploss),and

thefirstzoneisonly180pipsaway. Therefore, sometraders may be morecomfortable with a profittargetplacedatthenextzoneat 1.2450, a full 425 pipsaway. This further profittarget obviously allows for amuchmore favorable rewardto risk ratio. Exit strategiesare covered in Chapter 11,where scenarios such as thisoneareexamined.Fornow,it

is important to note thatalthoughthemarketdidgointheexpecteddirection,itonlywentashighastheverynextzone.Yourwin ratewith thebullish big-shadow strategymay depend on howaggressive you arewith yourprofittargets.Take some time to test the

bullish big belt strategy. Aswith all these catalysts, youmay decide to use this

strategyalongwithoneoftheexit strategies from the exitchapter(Chapter11).

TIPSTOTRADINGTHE

BIGBELTThe rules for the bearish bigbelt and the bullish big beltare essentially the same, but

in reverse. The importantthings to remember for thiscatalyst are as follows: Allbullish big belt candlestickshaveanopeningprice that islower than the closing priceof the previous candlestick;likewise, allbearishbigbeltshaveanopeningprice that ishigher than the closing priceof the previous candlestick.The bullish big belt musthave an opening price near

the low of the candlestick,and it must also have aclosingpricenearthehighofthe candlestick (see Figure9.7). The reverse is true forthe bearish big belts: Theopening price must be nearthe high of the candlestick,andtheclosingpricemustbenear the low of thecandlestick (see Figure 9.8).Even more critical, the bigbeltcandlestickmustprinton

a zone. If the big beltcandlestick is not on a zone,theoddsofthetradeworkingout fall considerably.Likewise, the very best bigbelts have room to the left,similar to the ideal kangarootail. Those big belts that donot have much space have alow rate of success (seeFigure9.9).

Figure9.7Bullishbigbeltsmusthavetheopeningprice

nearthelowofthecandlestickandtheclosingpricenearthehighofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Figure9.8Bearishbigbelts

musthavetheopeningpricenearthehighofthecandlestickandtheclosingpricenearthelowofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Figure9.9Bigbeltsmustprintonazone,andtheyshouldhaveroomtotheleft.Thosebeltsthatdonotprintinazoneanddonothaveroomtotheleftareunlikelytosucceed,suchasthisEUR/USDweeklybullishbigbelt.©2000–2011,MetaQuotesSoftwareCorp.

In summary, big belts areextremely powerful catalystsprovided they print at the

right spot on your chart. Inthe list that follows,youwillfind a summary ofcharacteristics of both thebearish big belts and thebullishbigbelts.Characteristics of the

bearishbigbelts:Theopeningpriceishigher than theclosing price of thepreviouscandlestick.

Theopeningpriceisnear the candlestickhigh.The closing price isnear the candlesticklow.The big belt printson an importantzone.The big belt shouldhave room to theleft.The stop loss is

placed above thecandlestickhigh.The sell stop isplaced below thecandlesticklow.The closest zone istheprofittarget.

Characteristics of thebullishbigbelts:

Theopeningpriceisnear the low of thecandlestick.The closing price is

near the high of thecandlestick.The big belt printson an importantzone.The big belt shouldhave room to theleft.The stop loss isplaced below thecandlesticklow.The buy stop isplaced above the

candlestickhigh.The closest zone istheprofittarget.

Everyweekwe takea lookat big belt trades as theyunfold in real time. To jointhisfreeonlinewebinargotowww.fxjake.com/book.

CHAPTER10

TheTrendyKangaroo

Thosewhotrytoleadthepeoplecanonlydosobyfollowingthemob.

—OscarWilde

Attimesthemarketwill takeoff in a strong trend. Thesetrends make for pretty-looking charts. The marketmight be marching upward,with very few pauses alongtheway, or themarket couldbeinafreefall,stoppinghereandthereonthewaytolowerlows.Any traderwho scrollsback through the charts willnotice these exciting timesandmaywishforamethodof

capturing easy profits fromthese trending markets. Thetrendy kangaroo is one suchmethod. This is a way foryou, the naked trader, toidentifythetrendandcapturehealthy profits from atrendingmarket.

WHATISATRENDY

KANGAROO?The trendy kangaroo is aspecial caseof thekangaroo-tail trade. This is a specificmethod for jumping ontrends.Thispricepatterndoesinvolve a kangaroo tail, butthe overall set-up in relationto the nearby candlesticks isvery different from thestandard kangaroo tail. Infact, the defining feature of

the trendykangaroo is that itmust print during a trendingmarket.Obviouslyitdoesnotmatter if the market istrending upward ordownward; the keycharacteristic here is that themarketistrending.Itseemsnearlyeverytrader

hasadifferentdefinitionofatrending market. The largemajority of technicalindicatorsareusedtoidentify

atrendingversusnontrendingmarket.Naturally,asanakedtrader, you have no need forindicators,evenwhenyouaredetermining whether anymarket is trending. Todetermine whether anymarket is trending, you willneedaconsultant.

TREND

INDICATORSYouwill need several thingsto identifya trendingmarket.First, you will need somecookies or otherwise tastytreats (maybe somestrawberries, some chocolate,oranapple).Secondyouwillneedyour favorite charts, setto a line chart. Third, andfinally, you will need aconsultant. This consultant

shouldbebetweentheagesof6 and 10 years. You mayneed to call around to find aconsultant of the appropriateage,butthisiswellworththeeffort. Friends, neighbors,and distant relatives may beinvaluable in aiding you onyour search for yourconsultant. Once you haveyour consultant, you arereadytodeterminethetrend.Pleasedonotbetemptedto

purchase a fancy technicalindicator to determine if amarket is trending. All youreally need is an eight-year-old. All you have to do ispoint to a line chart and askyourconsultant thisquestion:“Is this linegoingmostlyup,mostly down, or mostly upanddown?”Your consultant will tell

you all that you need toknow.Afterthisbriefsession

youmaypayyourconsultanttheagreed-onfeeandgoforthwith your trading. I wouldencourage you to use thismethod whenever you areunsurewhether themarket istrendingorinaconsolidationphase.Obviously, you must

choose the chart carefullywhen you do this. If youmostly trade thedaily charts,make sure that your

consultanthasagoodlookatthedailychart.Ifyoumostlytrade the one-hour charts,make sure that yourconsultant provides anassessment of the one-hourchart. The market is alwaystrending in one timeframe oranother, so the question thatyou present to yourconsultant should be limitedto the market and timeframeyouareinterestedintrading.

If your consultant hasidentified that the market istrending, you are now readyforthetrendykangarootail.

TRADINGTRENDY

KANGAROOS:RESTING

SPOTSOnce your consultant hasfiled his report, you willknow precisely if themarketistrending.Ifyourconsultantreports that a trend hasformedonthecharts,it'stimeto look for trendykangaroos.Trendy kangaroos are placesonthechartwherethemarkethaspausedtotakearest.You will know the market

is resting when you seeseveral (usually 3–10)candlesticks in a smallconsolidation zone. This isunlike the consolidation boxused for the last-kiss trade,because this consolidationcanbesomethingassimpleasthree small candlesticks thatdo not seem to go very far.The market is resting aftersome strong trending movesupward(seeFigure10.1).

Figure10.1ThisisamarketpauseduringanuptrendontheAUD/USDdailychart.Noticehowallfourcandlestickstradeinsidethebox.©2000–2011,MetaQuotesSoftwareCorp.

If themarket is in a strongdowntrend, a market pausewill look much the same.

There will be severalcandlesticks (again, usuallybetween3and10)alltradingwithin a tight range. This isyour clue to get readybecause a trendy kangaroomayappear(seeFigure10.2).

Figure10.2ThemarketisinastrongdowntrendontheUSD/CADdailychart.Noticehowthecandlesticksarerestrictedtoatightconsolidationrange.Allthe

candlestickstradeacrossthesamepricerangeduringthemarketpause.©2000–2011,MetaQuotesSoftwareCorp.

TRENDY

KANGAROOCHARACTERISTICSThe critical characteristic ofthe trendy-kangaroo-tradingset-upis,ofcourse,thetrendykangaroo candlestick. Thiscandlestick will stick outbeyond where the marketpaused. It is critical for thetrendykangarootoprintawayfrom the other candlestickswhich are stuck in the box.

Because the trendy kangaroois always in the direction ofthe trend, it is impossible forthetrendykangarootohavealarge amount of room to theleft.This is incontrast to thestandard kangaroo-tail trade.The trendy kangaroo isjudged by how far the tailsticks out beyond the recentmarket pause. If there ismuch of the tail sticking outinanareaonthechartwhere

the recent candlesticks havenot traded, then the trendykangaroo is deemed anexcellent trading set-up. InFigure 10.3 we see theAUD/USDdailychartwithatrendykangaroowhich sticksoutbeyond therecentmarketpause. This is an excellenttrendykangarooset-up.

Figure10.3ThetrendykangarooappearsontheAUD/USDdailychart.The

trendykangaroomuststickoutbeyondthemarketpause.Itisimportantforthetrendykangarootostickoutbeyondwheretherecentmarketpausehastraded.©2000–2011,MetaQuotesSoftwareCorp.

The same holds true for atrendykangaroo thatpopsupduring a downtrend. The

trendy kangaroo has a longtail that sticks out above themarket pause. The trendykangaroo will never havemuchroomtotheleftsimplybecause it prints during astrong trend. However, thetrendy kangaroo shouldalways print away from therecent consolidation. Themore the candlestick printsaway from the market pausethebetter.Takea lookat the

chart in Figure 10.4—theUSD/CAD daily chart printsan excellent trendy kangarooduringastrongdowntrend.

Figure10.4ThisdailyUSD/CADtrendykangarooisanexcellentexampleofhowthiscandlestickshouldstickoutbeyondtherecentmarketconsolidationrange.©2000–2011,MetaQuotesSoftwareCorp.

Bearish trendy kangarootrades are traded much likestandard bearish kangaroo

tails. The sell stop is placedbelow the low of the trendykangaroo candlestick. Oncethis sell stop is triggered, thestop loss is placed above thehigh of the trendy kangaroocandlestick. See Figure 10.5for an example of a bearishtrendy kangaroo-tail trade ontheUSD/CADdailychart.Bullish trendy kangaroo

tails are similar to standardbullish kangaroo-tail trades.

Once the market prints thetrendy kangaroo, you maymanage this trade justasyouwould a normal bullishkangaroo tail trade.Youmayplace the buy stop above thehigh of the trendy kangaroo.The stop loss goes on theothersideofthetail.Soforabullish trendy kangaroo tail,the stop loss is placed belowthelow(seeFigure10.6).

Figure10.5Thetrendy

kangarooismanagedinmuchthesamewayasastandardkangaroo-tailtrade.Thesellstopisplacedbelowthelowofthetrendykangaroocandlestick.ThestoplossisplacedabovethehighforthisbearishtrendykangarooontheUSD/CADdailychart.Themarketfellover1000pipsafterthistrendykangarootailprinted.©2000–2011,MetaQuotesSoftware

Corp.

The trendy kangaroo tailwill often print on an

important zone. Take a lookat the four-hour GBP/CHFchart in Figure 10.6. Themarketpausesat the0.96500zone. Several candlesticksfind support on the 0.96500zonebeforethebullishtrendykangaroo tail prints. Thistrendy kangaroo tail offers aclue; the market is ready tostart marching higher again.After the trendy kangarooprints the market moves 317

pipshigheroverthenexttwodays.

Figure10.6ThisbullishtrendykangaroocandlestickonthedailyAUD/USDchartsuggeststhemarketwillsoonmovehigher.Withintwodaysthemarketmoves175pipshigherthantheentryprice.©2000–2011,MetaQuotesSoftwareCorp.

A few more examples ofthe trendy kangaroo set-upwill help you to identify the

difference between a goodtrendy kangaroo and a poortrendy kangaroo. In Figure10.7, themarketprintsanicebullish trendy kangaroo onthe four-hour GBP/CHFchart.Noticehow this trendykangaroohasall thestandardkangaroo tail features exceptforthe“roomtotheleft”rule.Thetailsticksoutbeyondthenearby candlesticks, butbecause the market is in a

strong downtrend, there islittle room to the left for thetrendy kangaroo tail. Trendykangaroo tails will rarelyhaveroomtotheleftbecausethey occur during trends, sothere will always be priceaction to the left. The trendykangaroo tail should,however,stickoutbeyondtherecent choppy price action.Otherwise, the standardkangaroo tail rules apply.

Noticetheopenandthecloseof the trendy kangaroo arebothinthebottomthirdofthecandlestick.Theopenandtheclose of the trendy kangarooare inside the previouscandlestick's range. The verynextcandlesticktradeshigherthan the high of the trendykangaroo, triggering the buystop. The trendy kangaroomaintains all thecharacteristicsofthestandard

kangaroo tail trade; the onlydifference is that it printsafter a pause during a strongmarkettrend.

Figure10.7Thisbullishtrendykangarooonthefour-hourGBP/CHFcharthasmanyofthestandardkangaroo-tailcharacteristics.©2000–2011,MetaQuotesSoftwareCorp.

You may notice that thedaily AUD/JPY trendykangarooset-up(Figure10.8)

isnotona zone.Thismakesthetrendykangaroounique;itisanaked tradingset-up thatis not always found on azone. However, under mostcircumstances a minor zonewill be seen at the marketpause immediatelybefore thetrendy kangaroo.Notice howthe highs of thesecandlesticks cluster near thebottom of the trendykangaroo tail. Thus, the

consolidation of candlesticksbefore the trendy kangarootail establishes aminor zone,and the bearish trendykangaroo tail extends abovethis minor zone. Obviously,ideal trendy kangaroo setupswill line up with a majorzone, but this is notnecessary.

Figure10.8ThisbearishtrendykangarootailonthedailyCHF/JPYdoesnotprint

onazone.However,thecandlesticksimmediatelytotheleftofthetrendykangarootailhavesimilarhighs,andthustheydefineaminorzone.

BEWARETHE

TRENDYKANGAROO

TRAPSOnceyouget thehangof thetrendy kangaroo, you maywant to trade them all thetime. These trades do notoccur frequently simplybecause the market does nottrend that frequently. Becareful. There are many

trendy-kangaroo-looking set-ups that are not ideal. Hereare a few of the commonmistakes naked traders makewhen looking for trendykangarooset-ups.Trendy kangaroos must

stick out from theconsolidation range. If thetrendy kangaroo candlestickdoesnothaveatailthatsticksout from themarketpause, itis not an ideal trendy

kangaroo(seeFigure10.9).

Figure10.9Trendykangaroosshouldstickoutfromrecentpriceaction.Trendykangaroosamongothercandlesticksarenothighprobabilitytrades.ThiscandlestickontheAUD/JPYdailychartdoesnotstickoutbeyondtheconsolidationrange,soitisnotanidealtrendy-kangarootrade.©2000–2011,MetaQuotesSoftware

Corp.

The best trendy kangarooswill print during a pause in

the market trend. If a trendykangaroo prints after a largecorrection, it may be a signthatthetrendisover.Bewareoftrendykangaroosthatprintafter a large correction, theymay not be ideal trendykangaroo trades (see Figures10.9and10.10).

Figure10.10Theone-hourUSD/CHFcharthasabullishtrendykangarootail.However,themarkethas

fallentoofar.Thebesttrendykangarootailsprintafterapause,thistrendykangarootailisnotidealbecauseithasprintedafteraseveremarketcorrection.©2000–2011,MetaQuotesSoftwareCorp.

Trendy kangaroos are agreatwaytojumponastrongtrend.Herearesomethingsto

keepinmindwhenlookingattrendykangaroos.Characteristics of the

bearishtrendykangaroo:The market ismoving in adowntrend.The market pausesand severalcandlesticks print ina smallconsolidationrange.A trendy kangaroo

prints above theconsolidationrange.The stop loss isplaced above thecandlestickhigh.The sell stop isplaced below thecandlesticklow.The market tradeslower than the lowofthebearishtrendykangaroo.The closest zone is

theprofittarget.Characteristics of the

bullishtrendykangaroo:The market ismoving in anuptrend.The market pausesand severalcandlesticks print ina smallconsolidationrange.A trendy kangarooprints below the

consolidationrange.The stop loss isplaced below thecandlesticklow.The sell stop isplaced above thecandlestickhigh.The market tradeshigher than the lowofthebearishtrendykangaroo.The closest zone istheprofittarget.

Optimal trendy kangarooshavethesecharacteristics:

The tail of thetrendy kangaroosticks out from theconsolidationrange.Thetrendykangarooprints on a majorzone.Themarketdoesnotmake a largecorrection beforeprinting the trendy

kangaroo.Live trendy kangaroo-tail

updates are atwww.fxjake.com/book.After some testing, you

may become comfortablewith the trendy kangaroo.Remember that the goal forthe trendy kangaroo is tocapture a market trend afterthe market decides to pause.Ifyoukeepthisgoal inmindyou will find that the trendy

kangaroo is an excellentmethod for jumping on astrong trend. In Chapter 11you will learn other exitstrategiesforcapturingprofitsduring trending markets;these may be ideally suitedfor trendy kangaroo-tailtrades.

CHAPTER11

ExitingtheTrade

There's a trick to theGraceful Exit. It beginswith the vision torecognize when a job, alifestage,arelationshipisover—and to let go. It

means leaving what'sover without denying itsvalue.

—EllenGoodmanTherearesixstagesforeverytradeyoutake.Thefirststageis the analysis: You take alook at the charts and decidewhether a trade should betaken.Thesecondstageistheplanningstage:Youdecideifyouwilltakeatrade,andnowis the time to develop a

trading plan. You will placeyour order to enter this tradeat a certain price, and youwill place your exit for thetrade at a certain price,whetheritbeatalossorgain.Thethirdstageofeverytradeinvolves the entry: the priceat which you begin yourjourney on the trade. Thisprice may have beenpredetermined;youmayhavedecided that you will enter

thetradeifthemarketgoestoa certain price, or perhapsyou just use a market orderand enter the tradeimmediately at the currentmarketprice.Thefourthstageinvolves managing the trade,this is where MarketBiofeedback™comesin,andyou are anticipating andreacting to the market datathat comes back to you viathe chart while you are

holding your trade. The fifthstage is the exit. This is themost important stage of thetrade.Youmakeyourmoneywhenyoumakeyourexitandyour paycheck is received.Thesixthand final stage isalearningphase.This iswhereyouexamineyour tradefrombeginning to end and giveyourselfagrade.Thismaybeautomated learning (yousimply dump your trade

information into aspreadsheet such as the oneavailable for you atwww.fxjake.com/book) or itmay be a more discretionaryexamination of your trade inthe form of the tradingjournal, a place where youcan write down your ideasaboutyourtrade.In each of the six stages,

you have an important goal(Table 11.1). In the first

stage, your goal is todetermine if therisk isworththe reward. In the secondstage,yourgoalistocreateatrading plan that you willsticktoforthedurationofthetrade. In the third stage, youare attempting to enter thetrade at a point where theoddsareinyourfavor.Inthefourthstage,yourgoalshouldbe tomaintain an openmindand to learn from themarket

information available on thechart. In the fifth stage yourprimary purpose is to makemoney. In this chapter weexamine several ways ofmaking money on profitabletrades;someofthesemethodsmay make sense to you andothers may not. It isimportant for you to chooseone that fits with your ideasaboutthemarket.Inthesixthstage, the goal is to improve

yourtradingbylearningfromeach of the previous fivestages. In this way you canidentifywhichofthepreviousfive stages is yourweakness.Many traders find the fifthstage incredibly challenging.Formosttraders,decidingonan exit strategy (and, moreimportantly, sticking to thisexit strategy while managingthetrade)isthemostdifficultaspectofsuccessfultrading.

Table11.1SixStagesoftheTradeStage Action Goal

OneIdentifythetradeopportunity

Weighrisktoreward

TwoCreateatradingplan

Followtradingsystemrules

Three Enterthetrade

Enterthemarketatapricethatconfirmsthevalueofthetradeopportunity

Four Managethetrade

UseMarketBiofeedbacktoadapttonewmarketinformation

Five Exitthetrade Makemoneyfromthetrade

Learnfrom Identifyweaknessesin

Six thetrade stages1–5

EXITINGWITHMONEYThetradeexitisthefunpart;this is where your money ismade.Asatrader,thisisyourpayday. When it comes toexits,alltradersfitintooneoftwo camps, runners andgunners. Runners and

gunners are competingphilosophies, and mosttraders will clearly identifywith one or the other. It isimportant for you to deciderightnowbeforeyoureadanyfurther whether you identifywith the runners or thegunners. The easiest way todetermine which camp youfallintoistothinkaboutyouranswer to this question: Is itmore important for you to

have a high win rate or is itmore important for you tohavehugewinningtrades?If youwould rather have a

high win rate, then you willprobably have relativelysmallwinners.Youmayhaveahighpercentageofwinners,buttheaveragewinningtradewill probably be relativelysmall. If this is your style oftrading, then you are agunner.This is in contrast to

the runnerbecause ifyouarea runner, then you prefer tohave huge winning trades.Thismeansthatmanyofyourtrades may end up as losingtrades, or break-even trades,but the few giant winningtradeswillmakeupfor theselosing trades. Runner orgunner, it does not matterwhichisyourstyle.Itisonlyimportant that you stick toyour chosen style of trading,

stick with what you believe.You must trade in a mannerthatmakessensetoyou.

RunnersThe runnersare those traderswho are looking out for thenext big thing. These traderswanttocapturealargechunkof profit every trade. Thesetradershaveastrongsenseofconfidence. This confidence

is unwavering and will notdiminish in the midst of alosingstreak.Therunnersarealways hopeful that the nexttrade will end up as abeautiful, long-lasting trade.The long-running trades arewhat make profitable tradingpossible for the runners.Runners look at strongtrending charts and think“now that is a trend that Iwouldlovetocapture.”

Runners understand thatmost of the time the marketwill not run in an extendedtrend.Runnersareawarethata trading system may nothaveahighwinrate.Runnerswish to capture as muchprofit as possible, but theyadmitthatitisunknownhowfar the market may moveafter entering a trade.Runnersacknowledgethatthemarket may not move very

far, but once in a while themarket may go very far andaccelerate in a trendingmarket. Therefore, the winrateisnotthemostimportantstatistic for runners. Runnersaremuchmoreexcitedabouttheprofitsthatcomewiththelong-lasting trades thatcapture a trending market.The patience exhibited byrunners is extremely difficultfor the other group to

understand.Gunners have analtogether differentperspectiveontrading.

GunnersGunnersareadifferentbreed.Winning is everything togunners. Perhaps manygunners have a difficult timesittingthroughlosingstreaks.Or, it may be that gunnersfind it difficult to watch a

trade go from profit to abreak-even result. It may bethat gunners are moreimpatientthanrunners,butinthe end it really does notmatter.Gunners may also find

profit in naked trading.Gunners, like runners, maydecide to trade the kangarootail,thebigbelts,oranyothernaked-trading strategy.However, gunners are

interested in quicksatisfaction.Patiencemaynotbe one of the defining traitsfor gunners. Gunnersunderstand thatundernormalcircumstances the market isoften moving up and down,up and down. Gunnersbelieve the chances ofcapturing a strong trend areoften quite minimal. This iswhy gunners are fine withsmall, consistent profits that

theyextract from themarket.After all, gunners understandthat these small profits willquicklyaddup.

EXITSTRATEGIES

By now, you understand therespective philosophies ofrunners and gunners. It doesnot matter if you decide to

adopt the gunner philosophyand find consistent quickprofitsinthemarketorifyoudecide to side with therunners and try to capture atrending market for hugeprofits.Theimportantthingisthat you understand whatmakes sense to you and thatyou adopt and maintain thisexit strategy in your trading.The first two exit strategiesare for the gunners: the zone

exit and the split exit. Thesecondtwoexitstrategiesarefor the runners: themodifiedsplit exit and the three-barexit.

ExitsforGunnersGunners are interested inquick profits. Gunners wantto get in and out of a trade,and gunners love winningtrades.The zoneexit and the

splitexitaredesignedtotakeprofits at the most importantspotsonthechart—thezones.Recall that the zones arethosespotsonthechartwherethe market repeatedlyreverses. There is anothercharacteristic of the zonesthatisimportantforthenakedtrader.Zones are also magnets:

The market tends to beattracted to these places on

the chart. In other words,zones are simultaneouslyprice barriers and pricemagnets. Exits based onzones take advantage of thefactthatzonesattractprice.

ZoneExitThezoneexitisthebasicexitfor the naked trader. Thenaked trader looks to initiatetradesatzones,andthenakedtrader looks to exit trades at

these same zones. The basicphilosophy of the nakedtrader is this: The markettends to bounce off zonesrepeatedly, like a pinball.Therefore, it is perfectlyreasonable to look to thesezones as potential profittargets. These zones are themost important places on thenakedtrader'schart.Takea lookatFigure11.1,

a one-hour chart on the

EUR/JPY. By now, you willrecognizethisasabearishbigshadow.Asellstopbelowthelowofthebearishbigshadownetted 48 pips using thesimplezoneexit.Notice,also,that it only took twocandlesticks to achieve thisprofittarget.

Figure11.1ThisisabearishbigshadowontheEUR/JPYone-hourchart.Usingthezoneexit,thistrademakes48

pipswithintwocandlesticks,averyquickprofit.©2000–2011,MetaQuotesSoftwareCorp.

Here is anotherexampleofazoneexit, thistimeit isthe

GBP/JPY four-hour chart inFigure 11.2. Again, you willnowbefamiliarwiththetradeset-up. In this case it is abullish kangaroo tail.With abuy stop entry placed justabove the high of the bullishkangaroo tail, the target isachieved within fourcandlesticks.Thistrademade86pips.

Figure11.2Thebullishkangarootailonthe

GBP/JPYfour-hourchartmakes86pipsfourcandlesticksafterthetradeistriggered.Noticehowthemarketimmediatelyreversedafterreachingthiszone.Thezoneexitenablesthenakedtradertoavoidmanylosingorbreak-eventradessimplybecausetheprofittargetisoftenclosetotheentryprice.©2000–2011,MetaQuotesSoftwareCorp.

It is important to note thatthe zone exit is extremelyeasytoimplement,anditmaybe applied when the trade is

initiated. Inotherwords,youwill know when you placeyour trade order exactlywhere the exitwill be.Thereis no managing the trade,there isnoneed towatch thetrade,and, therefore, this isanice tradeexit foryou ifyoudo not sit and watch thecharts.Sometimes the market will

getverynearazone,andthentradeawayfromthezone.For

thisreasonitisimportantthatyou place the profit targetnear thezone,withsufficientcushion. For sell trades, theprofittargetshouldbeseveralpips above the nearest zone,and for buy trades the profittarget should be several pipsbelowthenearestzone.InFigure11.3 you can see

where this rule enabled thenakedtradertoexitthistradewithaprofit.

Figure11.3TheAUD/USDfour-hourchartshowsanicebullishkangarootail.Thistrademade69pipsbecausetheprofittargetwasafewpipsbelowwherethiszonewasdrawnonthechart.Placingaprofittargetpreciselyonthezonewouldhavemeantmissingoutonaprofitandwatchingthemarketfalldownandgoagainstthetrade.

©2000–2011,MetaQuotesSoftwareCorp.

Thezoneexitisapowerfulexit,andmanygunnersfindit

easy to apply this exit. Thesplit exit will often enable aquickprofit, so it is ideal fortraders who do not have thepatience to wait through alongtrade.

SplitExitThe problem with the zoneexit is that often the marketwillgomuchfurtherthanthefirst zone, and thismay leadto frustration. Even gunners

liketohavetradesthatextendforalongtime.Thesplitexitis, therefore, a compromisethatgunnersmayusetoallowfor the market to go a bitfurther than the first zone.Like the zone exit, the splitexit may be used by thosenaked traders who areinterested in hands-freetrading.To use the split exit, the

naked trader must divide the

trading position into separatepositions.Onesimpleway todo this is to divide the tradein half. So, for instance, if atradehas six lots, a split exitwouldmean using one targetfor three lots and a differenttargetfortheotherthreelots.This is how a split exit is

executed: The first zone, thenearest zone to the entryprice,isusedasaprofittargetfor half the position, and the

nextclosestzoneisusedasaprofittargetfortheremainingposition. Once the marketachievesthefirstprofittarget,at the nearest zone, the stoploss is moved to break evenfor the remaining position.This obviously reduces therisk for the remainingposition. The position willeither hit the second profittargetor itwillbestoppedatbreakeven.

An example will illustratehow the split exit should beused.InFigure11.4thereisabearish kangaroo tail on theAUD/JPY one-hour chart.The market quickly falls tothe first zone, 30 pips away,and so half the position bags30 pips. The remaining halfof thepositionbecomes risk-free because the stop loss isnowmovedtotheentryprice.Themarket does retrace, but

itdoesnotmakeitbacktotheentry price. The marketinstead falls further, all thewaydowntothesecondzone,where the remaining positionexitedforaprofitof65pips.

Figure11.4TheAUD/JPYone-hourchartprintsabearishkangarootailonanimportantzone.Usingthesplitexit,thenakedtraderisabletofind33pipsofprofitonthefirstzone,andan

additional65pipsofprofitatthesecondzonebelowtheentryprice.©2000–2011,MetaQuotesSoftwareCorp.

The split exit will not

always make additionalprofit. Some of these tradeswill end up with a smallerwin simply because themarket will come back andclose out the remainingposition at breakeven. InFigure 11.5, the AUD/NZDdaily chart offers a bearishkangaroo tail on a zone.Using a split exit with thistrade,thenakedtraderfindsaprofitof73pipsatthenearest

zone, but afterwards themarketmoveshigherandhitsthebreakevenstoploss.

Figure11.5TheAUD/NZDdailychartprintsabearishkangarootailonanimportantzone.Thesplitexitenablesthenakedtradertomake73pipsatthefirstzone,butthemarketretracesbeyondtheentrypointforabreak-evenresultontheremainingtrade.©2000–2011,MetaQuotesSoftware

Corp.

The split exit will requiremore patience than the zoneexit. The fact remains thatsometradeswillbestoppedatbreakeven when following

the rules of the split exit.However, obviously, sometradeswillalsomakeittothesecond zone, and, therefore,the average size of thewinning trades will increase.Thesplitexitis,inessence,acompromise, a compromiseforthegunners.Mostgunnerswill be unable to apply theexit strategies that areappropriate for the morepatientrunners.

If you are a gunner butwouldliketoincreasethesizeof your average winningtrade,thesplitexitmaybetheexit for you. If you arethinking that both the zoneexit and the split exit do nottake advantage of the strongtrending moves that youobserve in the markets, youare probably thinking like arunner.Read thenextsectionto see how runners approach

theirtradingexits.

ExitsforRunnersRunners see things a bitdifferently. Runners lovebagging the big trade.Runners have incredibleconfidence in their tradingsystems.Runnersareinitforthe long haul. Runners useexit strategies to takeadvantage of trending

markets.The first exit for runners is

similartosomeofthegunnerexits. This exit is called theladder exit. The second exitfor runners is a little bitdifferent because it is notbased on the zones. Both ofthese exits are classified astrailing exits, which simplymeans that they takeadvantage of trendingmarkets.

TRAILINGEXITS

An exit strategy that isdynamic,withnofixedexitprice. The exit priceconstantly adjusts with themovement in themarket tomaximizeprofit.

All trailing exits are acompromise. There are twoparts to the trailing exit. Thetrailing exit must allow a

cushion so the market maymove against the position,and the trailing exit musthave a line in the sand tocapture the profit once themarketmoves too faragainstaposition.Boththeladderexitandthe

three bar exit do best duringtrending markets. The ladderexit uses zones to identifyprofit targets, whereas thethree-barexitusesanentirely

differentapproach.

LadderExitThe ladder exit is similar tothe previous exits in thatzones are used to identifyprofit targets.Thedifference,however, is that each zone isapotentialprofittarget.Whenusing the ladder exit, thenaked trader never knowswherethefinalexitpricewillbe; this is because the ladder

exit allows the market somebreathingroom.This is how the ladder exit

works: Once a trade isinitiated, the stop loss ismoved in accordance withhow far the market hasmoved. So, for example, ifthe market moves from theentry price to the closestzone, then the stop loss ismoved to breakeven. Oncethe market moves further to

thesecondclosestzonetotheentry price the stop loss ismovedfrombreakeventothefirst zone, and so forth. Theeasiest way to see how theladder exit is executed is tolookatanexample.Figure 11.6 is the

GBP/USDfour-hourchart.Abearish big belt prints on the1.6460 zone. The markettrades down to the 1.6270zone, so the stop loss is

moved from the high of thebig belt candlestick tobreakeven. Then the markethits the next zone at 1.6135,so the stop loss is moved tothe 1.6270 zone. Themarketturns around and trades backup to the1.6270zone,wherethe trade is exited for a gainof128pips.

Figure11.6ThisisabearishbigbeltontheGBP/USDfour-hourchart.1.Thestop

lossisabovethehighofthebearishbigbelt.2.Thestoplossmovestobreakevenoncethemarketreachesthefirstzone.3.Thestoplossmovestothefirstzoneoncethemarketreachesthesecondzone,thisiswherethetradeisexitedfor128pips.©2000–2011,MetaQuotesSoftwareCorp.

Patience is needed toemploy the ladder exit. Takea lookatFigure11.7.This isanotherexampleoftheladderexitontheEUR/USDweeklychart. Here we see a bullishkangaroo tail. The market

immediately trades higherthan the kangaroo tail andreaches the first zone at0.8750 quite easily. At thisstage, the stop loss ismovedto breakeven. The markettrades higher to reach thezone at the 0.9100 level.Here, the stop loss ismovedto the first zone down at0.8750. Next, the marketmakes a move higher andreaches the next zone at

0.9330, so the stop loss ismoved to the second zone atthe 0.9100 level, and this iswherethetradeisexitedforagainof575pips.

Figure11.7TheladderexitonaweeklyEUR/USDbullishkangarootail.1.Thestoplossisfirstplacedbelowthelowofthekangarootail.2.Thestoplossismovedtobreakevenoncethemarketreachesthe0.87500zone.3.

Themarkettradesuptothenextzoneat0.9100,sothestoplossismovedto0.8750.4.Themarketreachesthenextzoneat0.9330,sothestoplossismovedto0.9100,andthisiswherethetradeisexitedfor575pips.©2000–2011,MetaQuotesSoftwareCorp.

Using the ladder exit willallowthemarketa“cushion”of one zone. This may seem

frustrating, to allow themarkettocomebackandstopoutatradeforlessprofit,butthis is the nature of thetrailingexit.All trailingexits(including the three-bar exitdescribedfurtheron),havetoallow some breathing room,or “cushion” in order tocapture the large profitsavailableintrendingmarkets.

Three-BarExit

Thethree-barexitisauniqueexit because, unlike theprevious exits, it does notinvolve zones. The three-barexitgetsitsnamebecausetheexit is based on the priceaction of the most recentthree bars (or candlesticks).The exit is a simple trailingexit based on the lowest lowof the previous threecandlesticks (for buy trades),or the highest high of the

previous three candlesticks(forselltrades).The naked trader locks in

profits by trailing the stoploss behind the lowest low(for buy trades) of theprevious three candlesticks.Taketheexampleontheone-hour GBP/AUD chart. Thistrade is obviously a bullishtrendy kangaroo on anexcellent zone at 1.5868 (seeFigure11.8).Theinitialstop-

loss placement is below thelowofthetrendykangaroo.

Figure11.8ThestoplossfortheGBP/AUDone-hourtrendykangarooisfirstplacedbelowthelowofthecandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Once the market printsthree candlesticks after thetrendykangaroo,thestoplossis moved below the low ofthe lowest candlestick. Thelowest of the threecandlesticks inFigure11.9 is

the third candlestick, thecandlestick immediately afterthe trendy kangaroocandlestick. The stop loss ismoved to just below the lowof the candlestickimmediately following thetrendykangaroocandlestick.

Figure11.9Thethree-barexitappliedtotheGBP/AUDone-hourchart.Oncethemarkethasprintedthreecandlesticks,thestoplossis

movedbeneaththelowestlowofthemostrecentthreecandlesticks.©2000–2011,MetaQuotesSoftwareCorp.

In Figure 11.10, the three-bar exit is applied to

GBP/AUD one-hour trendykangaroo. One morecandlestickprints, and so thestop loss is moved higher,this time it is placed belowthe third most recentcandlestickbecauseithasthelowestlowatthisstageofthetrade.

Figure11.10Thethree-barexitappliedtotheone-hourGBP/AUDtrendykangarootrade.Themarketmoves

higher,andthestoplossisplacedjustbelowthelowestlowofthethreemostrecentcandlesticks.©2000–2011,MetaQuotesSoftwareCorp.

In Figure 11.11 themarket

moveshigheronceagainafteranother one-hour candlestickcloses. The GBP/AUD one-hour trendy kangaroo istrendingnicely,andthethree-bar exit is locking in profitsasthemarkettradeshigher.

Figure11.11Onemorecandlestickprints,andthethree-barexitisadjustedonceagain.Thistimethethirdmostrecentcandlestickisagainthecandlestickwiththe

lowestlow,sothestoplossontheGBP/AUDtrendykangarootradeisplacedbelowthethirdcandlestick.©2000–2011,MetaQuotesSoftwareCorp.

The one-hour chart for the

GBP/AUD changesdrastically as the marketmakes a strong movedownward(seeFigure11.12).At this stage, the candlestickwith the lowest low is themost recent candlestick, soaccordingtothethree-barexitrules the stop loss must beplaced a few pips below thismostrecentcandlestick.

Figure11.12Themostrecentcandlestickontheone-hour

GBP/AUDchartmakesastrongmovedown.Thestoplossisplacedbelowthiscandlestickbecauseithasthelowestlowofthemostrecentthreecandlesticks.©2000–2011,MetaQuotesSoftwareCorp.

One more candlestickprints, and the trade survivesby a whisker. The newcandlestick is slightly lowerthanthepreviouscandlestick,so the stop loss is placedbelow this most recentcandlestick (see Figure11.13).

Figure11.13TheGBP/AUDone-hourtrendykangarootradesurvivesafterthenextcandlestickprintsonthe

chart.Thismostrecentcandlesticknowhasthelowestlow,sothestoplossisplacedafewpipsbelowthiscandlestick.©2000–2011,MetaQuotesSoftwareCorp.

The next one-hourcandlestickontheGBP/AUDone-hour chart (see Figure11.14) prints slightly higher.The stop loss remains at thesame location because thissecond candlestick still hasthe lowest low of the mostrecentthreecandlesticks.

Figure11.14Thestoplossfortheone-hourGBP/AUDtrendykangarootraderemainsthesamebecausethe

mostrecentcandlestickdoesnotpresentalowerlow.©2000–2011,MetaQuotesSoftwareCorp.

The one-hour trendykangaroo trade on theGBP/AUDchartisclosedout

on the next candlestick (seeFigure 11.15). The mostrecent candlestick pushesthrough the stop loss, and sothe trade is closed for amodestgainof13pips.

Figure11.15Thenextcandlesticktriggersthethree-barexitstoploss.Themostrecentone-hourGBP/AUDtradeslowenoughtohitthestoploss,andsothetradeisoverafteragainof13pips.

©2000–2011,MetaQuotesSoftwareCorp.

Someof the trades that aremanaged according to thethree-bar exit will end upwith similar results to thisGBP/AUD one-hour trendy

kangarootrade.Thethree-barexit is ideal for a strongtrending market, but if themarket does not continuemoving with a strong trend,the three-bar exit will onlycapture minimal profits.Although this may seemdiscouragingforsometraders(particularly gunners), forrunners,whotakealong-termperspective, a few losingtrades or minimal gains are

acceptable. Runnersunderstand that the largegainswillcomefromtime totime and make the three-barexit a worthwhile exitstrategy.Another example of the

threebarexitisinorder.Thistime,itistheAUD/JPYdailychart,andthetradeset-upisabearish big shadow (somenaked tradersmay argue thatthisset-upisnotabearishbig

shadow, but something else;go to www.fxjake.com/bookto watch a video about thistrade).Theoriginalplacementforthestoplossisjustabovethe high of the bearish big-shadow candlestick (seeFigure11.16).

Figure11.16Theinitialstop-lossplacementforthedailyAUD/JPYbearishbigshadowisjustabovethehighofthebigshadow.

©2000–2011,MetaQuotesSoftwareCorp.

The stop loss remainsabove the high of the bigshadow until three morecandlesticks print after the

bearishbigshadow.Thestoploss is moved a few pipsabove thehighesthighof thethree most recentcandlesticks.AsFigure11.17illustrates,thehighesthighofthe previous threecandlesticksisthecandlestickimmediately following thebigshadow,sothestoplossisplacedabovethiscandlestick.

Figure11.17Accordingtothethree-barexit,oncethe

thirdcandlestickprintsthestoplossmaybeadjusted.Inthiscase,thefirstcandlestickaftertheAUD/JPYdailybearishbigshadowhasthehighesthighofthethreecandlesticks,thusthestoplossisplacedafewpipsabovethiscandlestick.©2000–2011,MetaQuotesSoftwareCorp.

The next chart (see Figure11.18) shows fourcandlesticks after the bearishbigshadow.Thehighesthighof the most recent threecandlesticks becomes the

most recent candlestick.Therefore, the stop loss isplaced a few pips above thehigh of the most recentcandlestick. It is important tonote that according to therulesofthethree-barexit,thecandlestickmustclosebeforethestoplossmaybemoved.

Figure11.18ThemostrecentcandlestickonthedailyAUD/JPYchartbecomesthecandlestickwiththehighest

high.Thus,accordingtothethreebarexit,thestoplossisplacedafewpipsabovethehighofthemostrecentcandlestick.©2000–2011,MetaQuotesSoftwareCorp.

Another candlestick printsand the candlestick with thehighest high remains thesame. The stop loss is notmoved because the secondmost recent candlestick still

has the highest high (seeFigure11.19).

Figure11.19Usingthethree-barexit,thestoplossplacementontheAUD/JPYdailybearishbigshadowtraderemainsthesameafteronemorecandlestickprints.©2000–2011,MetaQuotesSoftwareCorp.

The next day, the markettakesanother fall (seeFigure11.20).Thestoplossremainsthe same, above the thirdmost recent candlestick. Thetwomore recent candlesticks

have lower highs, and,according to the three-barexit, the stop loss placementis above the highest high ofthepriorthreecandlesticks.

Figure11.20Themarketmakesanothermovedown,butthestop-lossplacementontheAUD/JPYdailybearishbig-shadowtraderemainsthesame.Thestoplossremainsafewpipsabovethehighofthethird

candlestick.©2000–2011,MetaQuotesSoftwareCorp.

This time the stop loss forthetradeismovedonceagainas shown in Figure 11.21.

The next candlestick printsandthehighesthighbecomesthe third most recentcandlestick,sothestoplossisplaced a few pips above thehigh of that candlestick.When using the three-barexit, if thestoplossisplacedabove the third candlestick,thenitisknownthatafterthenext candlestick prints, thestoplosswillbemoved.

Figure11.21Themarket

printsanothersmallcandlestickandtheAUD/JPYtradehasanewstoplossplacementabovethethirdmostrecentcandlestick,accordingtothethreebarexitrules.©2000–2011,MetaQuotesSoftwareCorp.

Another candlestick prints,and the highest high is onceagain the third most recentcandlestick,sothestoplossismoved a few pips above thehigh of this third candlestick

as is seen in Figure 11.22.Again,sincethestopisabovethe third candlestick, therewill be another stop-lossadjustment once the nextcandlestickprints.

Figure11.22Afteranewcandlestickprints,thestoplossisplacedafewpipsabovethethirdmostrecentcandlestick,thecandlestickwiththehighesthighofthepreviousthreecandlesticks.

©2000–2011,MetaQuotesSoftwareCorp.

One more candlestickprints, and the new highesthigh is the most recentcandlestick,sothestoplossis

placed a few pips above thiscandlestick (see Figure11.23).

Figure11.23Themostrecentcandlestickhasthehighesthighofthethreemostrecentcandlesticks,soaccordingtothethree-barexit,thestoplossisplacedabovethiscandlestick.©2000–2011,MetaQuotesSoftwareCorp.

The market has finallytriggered the three-bar exitshown in Figure 11.24 andthe trade is over. The mostrecent candlestick takes outthestoploss.Thisbearishbig

shadow on the AUD/JPYdaily chart has netted 137pips by using the three-barexit.

Figure11.24Themostrecentcandlesticktradesthroughthestoploss.Thebearishbig-shadowtradeonthedailyAUD/JPYcharthascaptured137pips.©2000–2011,MetaQuotesSoftwareCorp.

The three-bar exit worksbest when the marketaccelerates into a strongtrend. As long as the threemost recent candlesticks arefollowingthetrend,thethree-

bar exit will trail slightlybehind the advancingcandlesticks, capturing profitalong the way. This exit isideal for runners who areinterested in capturing largeprofits.At times, the three-bar exit

may be frustrating, sometrades will end up as losers,other trades may give backmuch profit, but if usedconsistently, this trailing exit

will capture big moves. Thekey to this exit is to use itconsistently, for every trade.Runners are like all traders:They never know when thenext big trend will pop up.But gunners who applytrailing exits such as thethree-bar exit are ready tocapture profits from the nexttrendinthemarkets.

MANAGINGEXITS

A common problem fortraders isre-trading themostrecent trade. This issue isextremely common fortradersstrugglingwithanexitstrategy. Traders will take aclose look at a recent trade,see where improvementscould have been made, andthen decide to change things

for the next trade. Theproblem with this strategy isthat every trade is different.The previous trade hasnothing to do with the nexttrade. Every trade is anindependent event. Whentraders fall into this trap ofre-trading theprevious trade,badthingsoftenhappen.If you have found yourself

adjusting your strategy ingeneral,orchangingyourexit

strategy in particular, basedon what occurred in theprevioustrade,youarefallingintothistrapaswell.Perhapsyou take a trade and themarket runs for severalhundred pips in the expecteddirection,longafteryouhaveexited the trade. This mayencourageyoutochangeyourexit strategy on the nexttrade. The problem with thisis thenext trademaynot run

for severalhundredpips, andmayonlygotothenextzone,which means that you willreduceyourprofitabilityevenfurther.Decidewhichtypeoftrader

you are going to be. Eitheryouwill be a runner, or youwillbeagunner.Sticktooneexitphilosophy.Decidewhatmakes sense to you. If youareagunnerdonotgetupsetif the market runs for 500

pips after you exit the trade.Ifyouarearunnerdonotgetupset when you get stoppedout after the market goes inthe expected directioninitially. It is important tostay true to your tradingbeliefs. The best way to dothisistoavoidre-trading thelast trade. In fact, re-tradingthe last trade may send youinto a cycle of doom—neverafunplacefortraders.Inthe

nextchapterweexamine thiscycleindetail.

PARTTHREE

TradingPsychology

CHAPTER12

TheForexCycle

Insanityisdoingthesamethingoverandoveragainbut expecting differentresults.

—RitaMaeBrown

It is true thatmost tradersdonot consistently find profits;the vast majority of forextraders lose moneyconsistently. Because of this,many traders find it difficulttostickwithatradingsystem.The vast majority of tradersarealways lookingforanewandimprovedtradingsystem.The trading system gets theblameforallthelosses.Mosttraders are, therefore,

constantly searching for abettertradingsystem,lookingforasolutiontotheconsistentlosing.Theironicthingisthatthesolutionhasnothingtodowiththetradingsystem.Anexplanationofthecycle

ofdoomwillhelpyou to seehowyoucanbreakoutofthiscycle if you are currentlyfinding it difficult to reachconsistentprofits.

WHATISTHECYCLEOFDOOM?

Thecycleofdoomconsistsofthree phases. The first phaseis the search. The secondphase is the action. And thethird and final phase is theblame. A close look at eachof these phases reveals thatthe cycle of doom

characterizes a logicalapproach to trading. Tobecome a successful trader,however, you will have tobreak out of the cycle ofdoom.Howdoyoubreakthecycle

of doom?The first step is tounderstand the cycle. Onceyou understand the cycle ofdoom, you may break freefrom thecycleofdoom. It isimportant for you to

understandwhatishappeningso that you may identify it,and then move beyond thecycle of doom and into theworldofconsistent,profitabletrading.

Phase1:TheSearchIn this phase you aresearching for a tradingsystem. You may look foryourtradingsystemintrading

books, in online tradingforums, trading educationwebsites, or you may findyour trading system fromspeakingtoanothertraderataconferenceormeeting.Intheend,itisnotimportantwhereyou find a trading system,only that you find a tradingsystem that appears to besuccessful.If you are unable to find a

trading system that you are

comfortablewith, thenyou'reprobablyinphase1.Youwillleave phase 1 only once youfind a trading system that istruly exciting, a system thatyou look forward to trading.In fact, phase 1 of the cycleofdoomiscompleteonceyoufindatradingsystemthatyousimply cannot wait to trade.Thedefiningfeatureofphase1isthatthetradingsystemisthe solution. Once you have

foundatradingsystemthatisexciting, you will movebeyondphase1.

Phase2:TheActionPhase 2 is the action phase.Thisisthefunpart;youbeginto trade your system. If youarelikemosttraders,youwillleap into phase 2 with justabout every trading systemthat looks decent. The

excitement of using a newtrading system isirreplaceable.Thisexcitementcomes from the unknown(more about this later). Willthis new trading systemwork? Will you become abillionaire trading thissystem? Is it everything youhopeittobe?Amid this excitement you

begintotradethesystemwithhigh hopes. It is highly

unlikely, given that you areextremely excited to starttradingyournewsystem,thatyou would have time to testyour trading system. Theproof for your new tradingsystem is so overwhelmingthat there is no need to testthe trading system. If youdodecide to test your tradingsystem before jumping intothe action phase,congratulations, you are a

member of the cautiousminorityoftraders.This is the exciting phase

because you're able to putyour trading system to thetest. You may not havedecided to test your tradingsystem before moving intotheactionphase.Infact,onlya small percentage of tradersdo test a trading systembeforemovingintotheactionphase. This action phase is

punctuated by excitement. Itis exciting to trade a newsystem, not knowing whatmay happen. You may findthat the trading system doeswellforanextendedperiodoftime. Perhaps you find thatoptimism abounds.However,at some stage things lookbleak.Maybe profits pour inearly, but eventually thelosingtradespileup.A drawdown eventually

appears. There are severallosing trades in a row.Thesetradesmayhaveappearedjustasyoudecide to increase theriskpertrade.Obviously,thiswasan ill-timedmodificationto your trading system. Justasyoudecidedtoincreasetheriskper trade, the systemraninto a bumpy road. Thisdrawdownisthebeginningofthe end of phase 2. Thisdrawdownwillmeanthatyou

lose faith in your tradingsystem, and begin to moveintothenextphase.

Phase3:TheBlamePhase 3 is the blame. Theblame is the phase in whichthe trading system isscrapped.Becausethetradingsystem has not foundconsistentprofits, youdecideto dump the trading system.

Thetradingsystemisatfault.Thetradingsystemfoundthelosing trades. The tradingsystem must be responsibleforthedrawdown.Frustrationsets in because the systemthat looked so fool-proofended up being a loser. Youdecide it is time tomove ontoanewtradingsystem.

ReturntoPhase1

The cycle of doom ispunctuated by a return tophase 1 after phase 3. Onceyouhavecompletelygivenuponyoursystem,youdecidetofind another system, a bettersystem. The search is onagain.Thecyclerepeatsitselfonceagain(Figure12.1).

Figure12.1Mosttradersfinditdifficulttobreakoutofthecycleofdoom.

The cycle of doom makessense to the trader who isconvinced that profits comefrom trading systems. Theproblemisthis:Profitsdonotcome from trading systems.Profits come from traders.

Traders find profits in themarkets,andthetool(tradingsystem) used to extract theseprofits is not as essential asthe trader's execution. Thefatalmistakethatmosttradersmake is to assume thattrading systems areresponsibleforprofits.

LIVINGIN

THECYCLEThe cycle of doom may befamiliartoyou;itiscertainlyfamiliartome.Iwasstuckinthe cycle of doom for years.Losingconsistentlyisnofun,I shouldknow, Idid itoften.Itmaybedifficulttobelieve,after spending years tradingand losing, that it is possibleto reach the land of profits;however, it is possible to

achieve consistent profitstrading forex. The first steptoward profitability isidentifying that you havebeen stuck in the cycle ofdoom.Acloseexaminationofhow

many traders approachtrading reveals that the cycleofdoomisduetohowtradersapproach their trading, andnot the viability of a tradingsystem.

Anotherwaytolookatthisistoconsiderthattwotradersmay be trading using thesame system. One trader isconsistently findingsuccessful, profitable trades,and the other trader isconsistently losing money.What is the differencebetween the two traders?They both trade using thesame system. The differenceisinthetrader.

The key to breaking thecycle is to recognize that thetrading system is notresponsiblefortradingprofitsorlosses.Youareresponsiblefortradingprofitsandlosses.

DEFEATINGTHECYCLE

It is possible to defeat thecycleofdoom.Ihavedoneit,

andmanyothernakedtradershave also broken the cycle.You can certainly defeat thecycle of doom. You mustwant to become aprofessional trader. If youwant to trade consistently,and if you want to findprofits,itmaybebestforyouto stick to a trading systemthatyoubelievein.Onewaytogainconfidence

in your trading system is to

back-test it. You alreadyknowthis.Haveyoudoneit?Have you tested any of thetradingsystems in thisbook?If you have not, perhaps youare not ready to defeat thecycle. But do not lose hope,for there may be anotheropportunity for you to findconfidence in your trading.There may be a very goodreason why you have notback-tested any of these

systemsatthisstage.It may be that you are

waiting for a trading systemthat resonates with you.Perhaps once you find thistrading system you will beable to go and test itextensively, and build yourconfidence in this tradingsystem before using it in alive market. If this soundslike you, then the nextchapter is for you. You are

the type of trader who mustcreate your own tradingsystem. You must trade asystem that is completelyyours.Thisisfine,youareingood company, and there aremany traders who, like you,musttradeonlyahomegrownsystem. Trading your ownsystem may be the best wayto avoid the cycle of doom,and this is explored in detailinthenextchapter.

CHAPTER13

CreatingYourTradingSystem

My parents taught mehow to listen toeverybody before Imadeup my own mind. When

youlisten,youlearn.Youabsorb like a sponge—andyour life becomes somuch better than whenyou are just trying to belistenedtoallthetime.

—StevenSpielbergYears ago, I met a tradernamedMiguel.He,likemanyothers before him, wasinterestedinbecomingafull-time forex trader. We spokeabout trading psychology,

trading systems, reasons forbecoming a professionaltrader, and we talked abouthow boring trading is. Myfriend was a professional inthe finance world, whoworked at a bank inSwitzerland. He reallywanted to learn how to tradeforconsistentprofitsinforex.I told him that once helearned to be an efficienttrader, his trading would

become very boring.Hewasshockedtohearthis.Itistrue,successful trading often isboring. He did not believeme, but nevertheless hethought it would be great ifhe became a boredprofessionalforextrader.Manyyearslater,myfriend

has left his job at the bank,moved from a chilly countryto a nice, warm tropicallocation,andhenowtradesa

few times each month. Hewrote to me to say, “Now Iknow what you mean whenyou said that ‘trading willbecomeboring.’”Ihopethishappens for you. I hope thattrading becomes boring. Ihope that you do the samethingoverandoverandoveragain,andfinditveryeasytopull profits out of the forexmarket. If you work hard,your trading may become

boring. The key is to definewhoyouareasatrader.Onceyou do that, you may put aplan to action thatwill allowyour trading to becomeboring.So, how will you define

yoursystem?Theanswerliesinwhoyouare.Whoyouarewill define how you trade.Whatmakessensetoyouasatradermaynotmakesensetome. This is fine. There are

manyways to find profits inforex. If a trader tells youthereisonlyonewaytomakeprofits in forex, he iswrong.There aremany ways to pullconsistent profits in forex.Yousimplyhavetofindyourway.

WHATDOYOU

BELIEVE?Your beliefs will drive yourtrading. If, for example youbelieve it is impossible tomake money scalping, thenyouwillhaveaverydifficulttimemakingmoneyscalping.Ifthisisyourbelief,focusonlonger-termcharts.

TheRulesThe rules of your trading

system will define how youinteract with the market. Itmay seem like this is a verysmall detail, but in fact it isthe definition of the game.Those traders who do nothaverules—andmanytradersenterthemarketwithoutrules—are simply gambling. It isimportant for you to definewhatyoursystemrulesare,ifonly for the fact that havingtheminfrontofyouwillhelp

toremindyouthatyouhaveamethodforextractingprofits.Beyond that, it is importantforyoutorememberthatyoursystemrulesalsodefinewhatyou should do in anysituation. Your entries, yourexits,yourtrademanagementandyour risk strategyshouldall be contained in yoursystemrules.Itmaybetemptingtocreate

a system without precisely

defined rules, but know this:A well-defined tradingsystem is more likely towithstand your personalpsychological attacks againstyour trading system. Lessinterpretation often meansbetter trading, and the best-defined systems are “just-this” resistant. If you haveexperience trading you knowhow tempting it is tomodifyyour trading system just this

time, or perhaps you havefound yourself willing tooverride a trade signal yoursystem offers just this time,or maybe just this time youhave decided to move yourstop loss to give a trade alittle more breathing room.Just-this trading leads todisasters, and it is importantfor you to develop a tradingsystem that is just-thisresistant.

AreYouaMarketSpecialist?

The first decision to makewhen designing your systemis to decide which pairs,which markets you will betrading. All the systemscontained in this book willwork on many markets, andmost timeframes. Thequestionbecomesthis:Whichtype of trader are you? You

may decide between twobasictraderprofiles.Thefirstis themarket specialist.As aspecialist you willconcentrate on one market.There are many successfultraders who do just this.Perhaps you only want totrade the EUR/USD. If youdecide to be a EUR/USDspecialist, you will learn theintricacies of the pair. Eachmarkethasapersonality,and

asaEUR/USDspecialist,youwill learn the personality ofthe euro. You might alsolearn the correlationsassociatedwiththepair,whenthe pair is reacting in anunusualway,andsoforth.Atthetimeofthewritingof

this book, Ashkan Bolour, aprofessional forex traderwhois very familiar with theEUR/USD market, haddiscovered a very peculiar

correlation. Bolour has beenexploiting this correlationwith a scalping strategy forover one month. He haddetermined that theEUR/USD had been closelyfollowing the Dow JonesIndustrial Average. Bywaiting for the Dow toestablish a direction for thetrading day, he knewprecisely which direction toscalptheEUR/USD.Hesaid,

“I don't know how long thecorrelation will last, but fornowitdoesmakeaconsistentprofit.”Nowit is important tonote

that, as a market specialist,you will probably uncoversimilar relationships such asthis one in your trading.Remember that theserelationships will not alwayslast; they are transient.Althoughitisgreattoexploit

these relationships, youmustalways be on your guardwhentheystarttofallapart.As amarket specialist, you

will discover relationshipssuch as the one Bolour usedin his trading. You willbecome familiar with themarket,youwillknowwhatitdoes around the nonfarmpayrollreport,youwillknowwhen the interest-rateannouncements are for your

market, and you will beaware of what the currencypairislikelytodo.Ingeneral,youwillhavea feel foryourchosen market. This is thegreatadvantage.Some traders begin trading

withthebeliefthattheymusttrade everymarket available,and that simply is not thecase. Market specialists aresome of the most profitabletraders on the planet, and

many of them have anexceptionally high win rate.This comes with theunderstanding of the marketand having an intimaterelationship with the market,the factors that affect themarket, and a method fordetermining the mood of themarket. If you think thatbecoming amarket specialistis for you, then make surethat you back-test your

chosen trading systemextensively on your market.Youmaybesurprisedatwhatyoufind.Market specialists will

sometimes use severaldifferent trading systems onthesamemarket.Perhapsyoudecideyouwant tobecomeamarket specialist and workonlywiththeGBP/USD.Thismaymean thatyouareusingseveraltradingsystemsonthe

GBP/USD.For example,youmay decide to trade dailykangaroo tails on theGBP/USD. You may alsodecide that you are going totake last-kiss trades on four-hourGBP/USDcharts.As amarket specialist, you

may even find that you aresimultaneouslylongandshort(buying and selling) yourcurrencypair,simplybecauseyou are trading multiple

timeframes and strategies.This may seem confusing orunlikely,butifyouchoosetofollow the path of thespecialist, you may find itmakes sense to follow theshort-term and long-termimpulses of your chosenmarket simultaneously.Perhaps buying your marketon the one-hour chart, andsellingitontheweeklychart.These seemingly

contradictory positions makesense only to the marketspecialist, the traderwhohasintimate knowledge of themarkethetrades.

AreYouaTradeSpecialist?

If the idea of trading onemarket does not appeal toyou, then you may want toconsider the alternative:

becoming a trade specialist.Asatradespecialist,youwillfocusononetradingset-up,itmay be the moolah trade orbig belts, or perhaps trendykangaroos. The set-up youchoose does not matter, youmust simply be comfortabletrading the system. You willgaincomfort trading this set-up across markets by back-testing. Obviously, this willinvolve back-testing. It is

onlythroughback-testingthatyou can accumulateexperience and confidence inyourtradingset-uptoapplyitacross markets consistentlyand repeatedly for profits.Additionally, to become atrade specialist,youmustgetcomfortable with all phasesofthetrade.All trades are similar to a

good story, they have abeginning, middle, and an

end. In the beginning, thequestion is: Do you want totakethistrade?Istheriskforthis trade worth it in yourmind?Haveyouseensimilarset-ups in the past that haveworked out? If you feel asthough you simplymust takethe trade, because it is toogood to be true, then youshould take a trade. Thebeginning, in some ways, isthe most difficult part of the

trade.Thebeginningphaseofyourtradeiswhenyouactasa filter. You are filtering outthose subpar trading set-ups.You, as a trade specialist,know precisely what thosegrade-A set-ups look like.This will obviously comefrom your back-testing. Youwill have gained experiencethroughyouraccumulationofknowledge; this only comeswith exposure to charts,

which only comes withtrading live accounts anddemo accounts and back-testing.Basedonyourtradingexperience, you will knowwhich trades to filter out.This is the most importantandcriticalphaseofthetradeasatradespecialist.Thesecondpartofthetrade

occurs when you aremanaging the trade. This iswhereMarketBiofeedback™

comes in. Does the marketprovide any criticalinformation about the trade?How do you feel about thetrade, given the price actionthathasprintedafterenteringthe trade? When the markettells you what to do, makesure you are ready to act onthis information.Disregarding marketinformation is stubborntrading.Ifyoujointhegroup

of stubborn traderswhoholdonto beliefs despitecontradictory marketinformation,youtoomayfindthem to be very expensivebeliefs (see Chapter 16 formoreonexpensivebeliefs).The third and final part of

the trade is the exit. Now,your style of exit strategy isobviously something that isunique and special to yourpersonality.Yousimplymust

trade and exit in a way thatmake sense to you, and fitswith your view of themarkets.Theexitiswherethemoneyismade.Exitsliterallydiscriminate traders; traderswho consistently makemoney know how to applyexits. Those traders whoconsistently lose moneyusually have great difficultywithexits.If you doubt that exits

control your trading destiny,then consider this: Have youtaken the exit challenge?(Learnhow to test thepowerof exits atwww.fxjake.com/book). Ifyou have, you have seen thepowerofexit.Byapplyinganexit strategy, you are able toconsistently pull profits,regardless of why you haveentered.Ifyouhavedonetheexit strategy challenge, then

you know how powerful aproperexitstrategy,ifappliedconsistently,will bring homemoney consistently. It is nottoolatetodotheexitstrategychallenge, so if youhavenottried it, please do it. It is agreat way to put the exit inperspective.As a trade specialist you

will become familiar witheach phase of the trade foryour chosen strategy. You

willlearnhowtodiscriminategood set-ups from poor set-ups, you will learn how todiscern if a trade is goingwell,orifitisnotgoingwell,and you will learn how toapply your chosen exitstrategy consistently. (Notethatalltradesmayexperiencea drawdown, but theexperienced trader, a traderwho understands MarketBiofeedback,willknowwhen

topulltheplugonatradethatispoorlyperforming)You will have to back-test

your chosen specialty, tobuild your confidence, andbecome an expert with yourtrading system. Experiencetrading your system across abroad range of markets isimportant if youare to applythis system confidently andconsistently. You may find,for example, that, as a

specialist trading the last-kisstrade,itworksextremelywellon the four-hour charts andthedailycharts,butwhenyouapply it to the one-hourcharts,thewinrateplummetsfor you. This is valuableknowledge, and instead oftrying to fight the system,knowing how you trade it,and which timeframes areeffectiveareimportantpiecesof information that you can

use to improve your tradingandaidyoursuccess.

ChoosingYourTimeframe

Choosing your market isimportant—just as importantas choosing your timeframe.There are three questions toanswerwhen considering thetimeframe you are willing totrade. First, what type of

personareyou?Yourtradingpersonality will go a longway to determine thetimeframe that you will feelcomfortable trading. Second,howmuch time do you haveduring your day? Traderswho have considerable timeto trademaybeable to tradelower time frames (such asthe five-minute or fifteen-minute charts), but peoplewithverybusydaysmaynot

be able to trade anythingother than the highertimeframe. Third, are you apatient trader?Patient traderswill be able to endure theinevitable fluctuations inlonger-term trades, butimpatient traders find it verydifficult, and end up tradingshorter timeframes. In fact,impatient traders make verygoodscalpers.Before you decide on your

chosen timeframe, rememberthesetwoprinciples:First,theshorter the timeframe youdecide to trade, the moreintenseconcentrationyouwillneed to sustain to beconsistently profitable.Second,asarule,traderswhostart out trading longertimeframes and trade thosetimeframes successfully formonths (or years) have amuchhighersuccessratethan

those traders who jumpstraight into the five-minutecharts. So choose yourtimeframecarefully.

RISKRULESTrading is simply a game ofmanaging risk. How manytrades will you take at anyone time? How large willyour trading positions be?When thinking about risk,

there are three key aspectsyoushouldconsider:(1)yourrisk appetite, (2) maximumdrawdowns, and (3)correlatedtrades.

RiskAppetiteThe simplest rule to apply isto think about your sleep. Ifyouareabletoputatradeon,place the orders in yourplatform, and then go to

sleep, this is the trade sizethat fits your risk profile. If,however, when you place atrade you find it difficult tosleep, you find that you arealways thinking about thetrade while away from yourcomputer, then the trade istoo big. You need to reduceyour trading to the sleepingpoint, thepoint atwhichyoucan place a trade, accept therisk, and get a good night of

sleep.

SLEEPINGPOINT

Thepointatwhichyoucanplace a trade, accept therisk associated with thetrade, andget agoodnightof sleep. If a trade isconstantlyonyourmindorif you find yourselfchecking a trade at oddhours in the night, there istoo much risk associatedwiththetrade,anditshould

be reduced to the sleepingpoint.

MaximumDrawdown

Your appetite for risk willhelp determine the size ofyour trade, but so will yourmaximum drawdown. Themaximum drawdown is theamount you are willing toloseoveraperiodoftime.An

easy way to track themaximum drawdown is tolook at it from the point ofviewofonetradingweek.Forexample, you may risk1percentofyour accountoneach trade. If you set yourweekly maximum drawdownto 5 percent, you canwithstandfivelosingtradesina row. After five losingtrades, you have hit yourmaximum drawdown for the

week. You may decide tostop trading once yourmaximumdrawdownishit.How you decide to apply

themaximumdrawdownrulemaydependonthetimeframeyoudecidetotrade.Youmaydecide to have a maximumdrawdown per month if youtrade a longer timeframe. Ifyou tradeshorter timeframes,you may decide to have amaximum drawdown amount

foroneday.Itisuptoyoutodecide. Note that yourmaximum drawdown willaffect how many trades youare able to take at any giventime.For example, you may

decide to have a maximumdrawdown of 5 percent foreach trading week. If youhavesixdailytradesignalsonthe first trading day of theweek, andyou risk1percent

on each of these trades, youcould have a drawdown of6 percent should all thosetrades go bad at once. Theimplication,ofcourse, is thatyou should reduce your riskso you are unable to reachyour weekly drawdown onthefirstdayoftheweekifallof the trades end up losers.So, if you have a 5 percentdrawdown rule per tradingweek, and you have six

trading signals in one day,perhaps instead of risking1 percent per trade you risk0.65 percent per trade for anoverall risk of 3.9 percent.This way, you have another1.1percent to risk therestofthe tradingweekshouldall6tradesbecomelosers.Another critical question

you must ask about yourtrading system is this: Howwill you deal with

drawdowns? Will you use astop-trading rule? How willyou recharge your batteriesand jump back into tradingafter a drawdown? Perhapsyoubelievethata“drawdownretreat” is a good idea. Youmaydecidetogetawayfromthe charts, and, if possible,get away from your tradingstation and take a trip out oftown after experiencing adrawdown.Thetheorybehind

this is if you get away fromtrading for a while you will(1) avoid revenge trading (aquick way to blow up youraccount), and (2) come backto the charts with a freshperspective.Thebestwaytocomeback

tothechartsfreshistosimplyfollow a planned sequencewhenever you experience amaximum drawdown. Forexample, you may decide to

follow this five-stepsequence: (1)Go away. Youwill get away from yourtradingstationandawayfromyour home or trading office.Evenifonlyfor theweekendor couple of days. It isimportant to remove yourselffrom the place where youhave experienced thedrawdown.(2)Back-testyoursystem. This should be apredetermined number of

trades (e.g., 200 trades) or aset time period (e.g.,EUR/USD daily chart from2009 through 2011). (3)Evaluate your tradingstatement. What has beenworking well? What has notbeen working well? Is thedrawdown due to bad luck?Or is thedrawdowndue to alack of discipline; are youfollowing your trading rules?Perhaps there are a few

currencies that account for85 percent of your losses?Take a good look at yourtradingstatement toseewhatseems to be working andwhat needs improvement.Make sure that you go backfar enough with yourstatement to see what wasworking for you before thedrawdown.(4)Decideifyoursystem still works. You haveback-tested and you have

examined your tradingstatement. If your tradingstatement reveals nothingmore than bad luck, andback-testing suggests yourtrading system still works, itis time for another test. Testyourtradingsystemonrecentmarket data. This way youcan be sure that your tradingsystem no longer works. Ifyour drawdown has occurredover the past three weeks,

take a close look at recentmarket data from the pastthree months to see if thesystem is profitable. If youhavefoundthat thesystemisno longer profitable, itmightbe best to stick to a demoaccount when you begintradingagain.

DEMOACCOUNT

Short for “demonstrationaccount”—many forexbrokers offer free practiceaccounts, also called demoaccounts. These accountsallow forex traders tobecome comfortable withthe trading platform (thebroker's trading software),and they also allow traderstotesttradingsystemswithreal markets. Theseaccountswillkeep trackofwinning and losing tradesbecause they are fundedwith an amount ofsimulated money such as

$50,000.

Demo trading will ensurethatyoudonotlosemoneyifthe trading system no longerfinds consistent profits. Youmust be careful of jumpingback into the cycle of doomwhen doing this. If yourtrading system no longerturns a profit (and you areapplying the rulesconsistently),itistimetofind

another system. (5)Work onyou.Youarethemostcriticalaspectofyourtradingsystem.When your confidence isshaken after a seriousdrawdown you shouldtransition back into tradingcarefully.Thegoalshouldbeto build up confidence. Thetwo easiest ways to buildconfidence are to back-testyour system (see it workingover historical data) and to

create a positive mindset.(Specific tools for improvingyour trading psychology arecoveredinChapter16.)Decide and plan for your

approach to a drawdown.Nearlyeverytraderwillhaveto sit through one of thesedifficult times. Professionalforex trader Ashkan Boloursuggests that there is alwaystimeformakingmoneyinthemarkets. He says, “If

something is not working,step away, re-analyze yourtrades,andthencomebacktothe markets. Stepping awayfrom the markets will giveyour mind and your bodytime to rest, and youwill bemuch better for it when youcomebacktothemarkets.”Comingoutofanextended

drawdown your goal shouldbe to slowly build up yourconfidence. It is necessary to

havearegimentedroutineforgetting through thesedrawdowns.Withoutastrongstructure, without rulesdesigned to keep you fromemotional revenge tradingafter a drawdown, you'realmost certain to fall intoundisciplined trading and totakeonexcessiverisk.Designa plan today so that if adrawdown appears, you arereadyforit,becauseyouwill

not feel like designing adrawdown plan in the midstofadrawdown.

CorrelatedTradesCorrelated trades are perhapsthe most obvious threats toyour trading account. Forexample, from time to timethe markets may print dailykangarootailsonmanyoftheyen pairs. If I decide to take

thedailykangarootailontheUSD/JPY, AUD/JPY,NZD/JPY, CAD/JPY,EUR/JPY, and GBP/JPY, Imust be careful. What willhappenifeachofthesetradesareavailableonthesameday,and I have a maximumdrawdown limit of 5 percentfor theweek?With a risk of1percentper trade, Iquicklyreach my weekly drawdownlimit simply by taking these

trades should theyall endupaslosingtrades.One obvious solution is to

reduce the per-trade riskwhen several correlatedcurrency pairs offer tradingset-ups. If you have abackground in statistics, youunderstandwhatacorrelationis, but if you do notunderstand correlation verywell, take a look at thecorrelation video at

www.fxjake.com/book. Youwilllearnhowtomeasurethecorrelation between any twocurrency pairs. Once youhave determined that twocurrency pairs are correlated,thenextstepistoreduceyouroverall risk for correlatedtrades.Here is an example of a

planformanagingcorrelated,simultaneoustrades.

Bullish kangaroo tails

print on the daily chartsforthefollowingpairs:USD/JPY, AUD/JPY,NZD/JPY, CAD/JPY,EUR/JPY,andGBP/JPY.The standard risk pertradeis1percent.The maximum weeklydrawdownis5percent.For simultaneous tradeswith a correlation of 0.65and above, the risk isreducedto0.5percentper

trade.The correlations are runon the six currency pairsand all are correlatedabove the 0.65 level, sotheoverallriskpertradeisset to 0.5 percent, for anoverall risk of 3 percentontheday.Even if all six trades endup as losers, thedrawdown will only be3percent,sotherewillbe

2 percent of additionalriskavailablefortheweek(two standard trades at1percentriskeach).

Decide how you willmanagetheriskoncorrelatedpairs. As with every otheraspectofyourtradingplan,ifyoudecideonaplanofactionbeforeyouareinthemidstofa high-pressure tradingdecision, you and yourtradingaccountwillbemuch

betteroff.

MANAGINGYOURTRADESThe way you manage yourtrades is completely apersonal decision. There aretwo parts to managing thetrade. The first part ismanagingtheentryprice.Thesecond is managing the exit.

Both decisions may bepersonalized depending onthe way you decide toapproachyourtrading.Asfortheentryprice,there

are several possible methodsof entering a trade.Youmaytake a market order(executing the trade at thecurrent market price). Youmay take a limit order(executing the trade after themarket retraces, or moves in

the “wrong” direction). Oryou may decide to use therecommended buy stops (orsell stops for sell trades),executingthetradeentryonlyoncethemarketmovesintheexpected direction.Additionally, you may alsodecide to use an alternativeentrystrategy:Youmaywaitforthemarkettoofferaclue.In other words, you enteryour trade once you receive

market feedback, once themarket suggests it willmoveintheexpecteddirection.Managing the exit is also

critical. There are many exitstrategies available to you,many of them listed inChapter 11. However, youmay also decide to manageyour exit based on marketactivity.Some traders believe that

all trading decisions should

be made before the trade istriggered. Inotherwords, theentry price, the stop-lossplacement, and the profittargets are all determined inthe beginning, before thetrade is initiated. This way,there is no thinking after thetrade is triggered. Traderswhoadheretothisphilosophyattempttogetoutoftheway,and allow the market to ratethetradeasawinnerorloser.

Some traders take thisapproach because they havejobs outside of trading. Thisrestricts their availability formanaging the trade. Thislimitedexposuretochartscanbe a good thing. Sometimestradersgetintheway.Tradersmaygetintheway

during the analysis of themarkets, when decisions aremade concerning whichtrades to take. Many traders

have found that too muchmarket analysis iscounterproductive. It is ofteneasier and more efficient tohave a quick look at themarkets, decide on a courseof action, and then to simplysetthetradesandforgetthem.Abe Cofnas, a renowned

traderwhodeals inbothspotforex and forex options, hasthis to say about marketanalysis: “It is so fascinating

to see—but for me I oftenfind my best trading resultsoccur when I do minimalanalysis, and let my visualsense of price action let mereact to and not anticipateconditions.”Cofnas is certainly not

alone.Therearemanytraderswho follow this samephilosophy. Sometimestraders can simply out-thinkthemselves, and it may also

comeduringtheexitphaseofthe trade. Colin Jessup, anaked forex trader inCanadahas this to say aboutmanaginghistrades:“Ifpriceaction retraces more that61.8percenttowardsmystop,I will close the trade tominimize the loss. Usuallythe70percentlevelismylinein the sand if I'mwatching atrade live. That said, due tomy schedule, my trades

usuallyeitherhitmytargetorstopmeout.”Decide for yourself how

much management you willdo when trading. Stick tothese rules. Try to duplicateyourback-testinginyourlivetrading. Thiswill ensure thatyour live trading results willresemble your back-testingresults.

ManagingStopsand

ProfitsHow will you take losses?Will youwait for themarketto hit your stop loss or willyou close out the trademanually before your stop ishit? Will your profit targetsbeachievedautomatically,orwill you wait to see if themarket can push through azonebeforeexiting?Are you a runner or a

gunner? If you are a runner,yourstoplossandyourprofittarget may be one and thesame(forexample,ifyouareusing the three-bar exit). Ifyou are a gunner, will youleave your profit targets inyour trading platform andwalkaway?Your disposition and your

lifestylewillprobablyanswerthese questions for you. Ifyou are at work during the

dayandareunabletomanageyourtrades,youmayneedtolet your trading platform dothe managing for you. If,however, you are a full-timetraderorhave access toyourchartsnearlyallday long,becareful. It may seem like agoodideatobeabletowatchthechartsallthetime;itmayseemlikeagoodideatohaveyour tradesavailableonyourphoneatalltimes.Sometimes

watching your trades unfoldmay mean you exit a tradeprematurely. The rule ofthumb here is to trade yoursystem just as you back-testit. You must make sure thatyour back-testing duplicateshow you will trade in youreverydaylife.Ifyougetverynervouswatchingyourtrades,then it is probably best thatyou walk away. It may bebest for you to let your

tradingplatformmanageyourtrade if you find yourselfmaking poor decisions whenwatchingthelivemarkets.Theforextradingplatforms

today are brilliant, and theyoffer many opportunities fortrailing exits, the ability tomove a stop loss based onmarket action, and so forth.Know who you are as atrader, and what yourweaknesses are. If you find

yourself doing better,capturing more profits whenyou step away to allow yourtrades to either hit the takeprofitorthestoploss,withoutyour intervention, perhapsyou should stick to thishands-off approach tomanaging your trades.Perhaps you are able tomanage your tradessuccessfully and cut yourlossesbeforetheyhitthestop

loss. The important thing toremember is that a few poortrades do not mean youshould redesign your tradingsystem (beware the cycle ofdoom).

UsingMarketInformation

The market is constantlysending information tomarket participants. What

will you do with thatinformation? Will you takemarket data and use it toadjust your entry strategy?Willmarket informationhelpyoutomanageyourexits?For example, if you're

looking at taking a bullishkangarootail,youmaydecidetoplaceyourbuystopabovethehighof thekangaroo tail.Butwhat if themarket tradesdown to the stop loss level

before the buy stop entry istriggered? Does this meanthat you will disregard thistrade and remove yourpending buy stop order? SeeFigure13.1foranexampleofthis scenario on a one-hourGBP/USD kangaroo tail set-up.

Figure13.1TheGBP/USDprintsakangarootailontheone-hourchart.However,insteadofpushingthrough

thebuystoporder,themarketfallslowerthanwherethestoplosswouldbe.Mostnakedtraderswillcancelthebuystopinthissituation.©2000–2011,MetaQuotesSoftwareCorp.

If the market pushesthrough where the stop losswouldbe, itmaymakesense

to cancel the trade. This isusing market information tomanage your trades, evenbefore they occur. You mayalso use market informationtomanageyourexits.Ifyouareinatradeandthe

market prints a reversalsignal,howwillyoureact?Ifyouareinaselltradeandthemarket prints a buy signal,will you exit a trade?Will itdependonwherethereversal

signal prints? Some nakedtraderswillonlycloseatradeifthemarketprintsareversalsignalonazone.Othernakedtraders will simply close atrade as soon as price actionoffers a counter signal, asignal in the oppositedirectionof the trade.Decidehow you will manage areversalsignal.Ifyouareinabuy trade and the marketgives a sell signal, will you

exit?Take a look at the daily

NZD/USD chart in Figure13.2. This is a sell signal, abearish kangaroo tail on the0.7590 zone. The markettriggersthetradeandfalls,asexpected. However, once themarket reaches the zone at0.7430, an interestingcandlestickprints.Thisisnota bullish kangaroo tailbecausetheopenisnotinside

of the previous candlestick'srange. Nevertheless, thecandlestick does suggest thatthemarkethas foundsupportdownhereat0.7430,andthusthe naked trader may decidetocloseouttheposition.

Figure13.2ThedailyNZD/USDchartprintsabearishkangarootail,suggestingthemarketmayfall.Themarketdoesfall,butonceitreachesthenextzone

at0.7430,abullish“almostkangarootail”prints,suggestingthemarketmaymovehigher.©2000–2011,MetaQuotesSoftwareCorp.

Decide how you will usemarket information. If youare very comfortable

interpreting price action,perhaps you will use marketinformation to adjust yourtradeasthecandlestickprintsonthechart.Formanytradersand those new to nakedtrading, it may be easier tosimplystickwithyourtradingplan and let your trade reachthe profit target or the stoploss.

KNOWINGYOUR

TRADINGPERSONALITYThemost important factor indetermining how you willtrade is your tradingpersonality. What is yourtrading personality? How doyou knowwhat you do best,

andhowdoyouknowwhatisuncomfortable for you? Thebasic distinction amongtraders is the one thatdistinguishes short-termscalpers from longer-termswing traders. You probablyalready know which campyou belong to. If you find itdifficult to go to sleep orwalk away from your chartsknowing that you havemoneyatrisk,thenyoueither

(1)have toomuchat risk foryour tradeor (2) you are notfit for trading longer-termcharts.Likewise,ifyoufinditnearly impossible to sitthrough a trade on the five-minute charts,watching yourequityseesawbackandforth,you are probably best suitedto the longer-timeframecharts. What makes sense toyou?Do you like to take trades

with the flow of the market,ordoyouliketofindreversalpoints? Take the TradingPersonality Quiz to find outwhich trading systems fityour view of the markets atwww.fxjake.com/book.Typically traders fall into

oneoftwocategories:(1)“gowith the flow” trend tradersand (2) reversal traders. Thetrendtradersaredrawntotherunners’ exits in Chapter 11,

and the reversal tradersoftenenjoy trading for profittargets. You may rememberthisgroupfromChapter11—the gunners. Remember thatyou may not have thepatience to stick with thetrade and ride out a long-lasting trend if you are areversal trader, quick profittargets may be more yourstyle.Ifyouareatrendtraderyouwillhavetolearntodeal

with those trades that fallbackandendupasbreakevenor losing trades, even aftertheystartoutinprofit.Tradewhatmakes sense to

you.Ifyouthinkitiseasiertofind turning points, tradereversals. If you think it iseasier toridethetrend,makesure you get good atidentifying and riding strongtrends.

YourLife,YourTrading

How often you trade is anabsolutely critical decision,Trading can deplete yourpsychological andphysiological energy. If youdon't believe this, thenconsider this: The next timeyou have an exceptionaltrade, a trade that bagsseveral hundred pips, once

you close the trade try toimmediately make anothertrade.Willyoufinditeasytomake another trade? Ofcoursenot!Thereasonisthattrading is draining, and youmusttakecareofyourself.As a trader, you must be

physicallyfit.Ahealthybodyequals a healthy mind. Tostay healthy, you must getmore than adequate sleep,you must take good care of

your body. You must try tolimit your time in front of acomputer screen. If you failto do these things, yourtrading will suffer. You canevenmake a game out of it.Perhaps you decide that youare only able to trade if youdo some exercise that day.Or,perhapsyoudecidethatifyoudonot get at least sevenhours of sleep, you are notallowedtotradethefollowing

day. The idea here is to setgoals to encourage goodhabits.One habit to avoid as a

traderisdrinkingandtrading.It may seem like an obviouspitfall, but if you do drink,avoid trading under theinfluence. Just as you wouldnotwanttodrinkalcoholandgo for a drive, you certainlydonotwant to drink a bottleof wine and then decide to

scalptheGBP/USDforafewhours.As a forex trader, youarewellawareofthefactthatthe market is nearly alwaysopen.Formanytradersitcanbe tempting to trade into theweehoursofthenight.Ifyouare under the influence, it isbest to avoid making anytradingdecisions.Good habits should extend

into the psychological realm.Ifyouenjoyself-hypnosisor

meditation,youmayfindthatyour trading improvesdrastically when youconsistently find time eachday to practice self-hypnosisor meditation. (There aremore resources for you atwww.fxjake.com/book if youwould like to learn moreabout meditation or self-hypnosis.) Perhaps youdecidetotakesometimeeachday to mentally recharge

beforeyoumakeyourtradingdecisions, before you sitdownandanalyzethecharts.If you are thinking right

now “I do not need to spendanytimebeingquiet;Ijustdonothavetimeforthat,”pleaseat least consider a newapproachtoyourtrading.Forone month try using self-hypnosis, meditation, or justsomesimplequiet timealonebefore you jump into your

tradingroutine.Youmayfindyour trading results improve.Somethingassimpleassomequiettimealonecanrechargeyour psychological batteries,andbetterbatterieswillmeanbettertradingresults.Trading will suck the

psychological energy fromyouifyouallowittohappen,so be careful. Trading sixplushoursperdayispossible,but probably only for those

people who are full-timetraders. If you are trying toworka jobandtradesixplushours each day, you areprobably going to be aninefficient trader. You maymake mistakes, find itdifficult to concentrate, andfind it difficult to stayconsistently profitable if youare working a full-time jobandworking as a trader full-time. It may seem as though

trading is a wonderful,carefreelife,butitiswork.

HowSubjectiveIsYourTrading?

The last important facet ofyour trading system is howmuch room for interpretationyou are allowing in yourtrading system. Do youdecide to take only thosetrade set-ups that look right?

Or do you take only thosetradesthatarestrictlydefinedbyyourtradingsystem?Eachtradertakesadifferent

approachtotheapplicationofthe trading system. Forexample, perhaps traderElliott decides to trade thebig-shadow set-ups on thedaily charts. Elliottwill onlytakethosebig-shadowset-upsthat look to be very high-probability set-ups. The

bearish big-shadow set-upsmusthaveaclosedownnearthe low, and the bullish big-shadow set-ups must have aclose near the high.The big-shadow candlesticksmust beverylargeandElliottdecidestoonlytakethosebig-shadowset-ups that trigger the entrypriceon thenextcandlestick,and he takes profit at thenearest zone. Elliott maybelievethatheisusingavery

strict, well-defined tradingsystem,butifyouaskMolly,shemightdisagree.Trader Molly decides to

also trade only daily big-shadow trades. Trader Mollytakes a different approach.Trader Molly will only takebig shadows that are largerthan the previous fivecandlesticks by at least15percent.TraderMollyalsodecidestoonlytakethosebig

shadows with the closingprice within 15 pips of thelow(forbearishbigshadows)or the high (for bullish bigshadows).Molly consistentlyapplies the three-bar exit toherstrategy,knowingthatshemay have some losing tradesand small winners, but shewill also have a few largewinners.Where do you fall on the

continuum? Are you more

likeElliott?Doyouprefer totrade with a little bit ofsubjective analysis? Or areyou more like Molly?Perhaps you share her desiretohaveclearconcretetradingrules so it is very clearwhatyou should be doing whenfollowing your tradingsystem.

ChoosingYour

PlayingFieldInmanyways, the timeframeyou choose to trade isdetermined by your lifestyle.Ifyoudon'thavefourorfivehours a day to sit down andwatch the charts, it will bedifficult foryou tobea five-minute chart scalper. Unlessyou have an automated exitfor your shorter-timeframetrading,itisunlikelythatyou

will be able to trade theshorter-timeframe chartswithout several hours ofscreentime. Even if you dohave an extra four or fivehours each day, you may bebetteroffavoidingtradingtheshorter-timeframe charts.Manytradershavefounditismuch easier to simply take alookatthechartsonceaday,put in your trading orders,and then walk away.

Sometimes, after a fewyearsof this sort of trading,successful traders will movedown to shorter timeframes.A general rule of thumb isthis: Trading shortertimeframes means a smallermarginforerror.Trading the shorter

timeframe means that youmust be precise and decisivewhen executing your trades.An example will best

illustratewhythisisthecase.If you decide to trade thefive-minute EUR/USD chartin the hopes of pulling10 pips of profit from themarkets, thenyou are payinga high price to trade. Thespread (the differencebetween the price for buyingthe EUR/USD and the priceforselling theEUR/USD)ontheEUR/USD is likely to bequite tight,perhaps twopips,

soyoumustmake12pips tobag10pipsofprofit.Thisisacommission of 16 percent(2 pips divided by 12 pips =16 percent). This is a heftycommission.If, instead, you are trading

the daily EUR/USD chart,you may be looking to gain100 pips and will need tocapture102pips tocover thespread, so this is an overallcommissionof1.9percent—a

significant reduction in thecommission cost. Longer-term trading is not onlycheaper,itiseasiertoexecutesuccessfully. If you initiate adaily chart trade and enteryour trade at a poor price,perhaps you miss your entryprice by 3 pips, you may,instead,make 97 pips, ratherthanthefull100pips.Thisisa reduction of profits by3 percent; not great, but

certainly something yourtrading account can probablywithstand. If this same typeof poor execution isassociated with a short-termtrade,a3pipslipupbecomesa reduction in profits by30percent(3pipsoutof10is30 percent). A consistentreduction in profits by30percentmaytipthetradingsystemoverintotheabyssofunprofitablesystems.

It is your choice, youmustdecideifyouhavethetradingexperience, the time, and themental toughness toconsistently execute short-timeframe trades. If you donot have all three, it may bebest to stick to the longer-timeframecharts.

YourTradingLifestyle

Asyoucansee,thereismuchmore to your trading systemthat simply deciding onwhether you prefer to tradethe last kiss or trendykangaroos, whether you liketotradetheone-hourchartorthe weekly chart. It isimportant for you to decidenotonlywhatyouwill trade,butalsohowyouwilltradeit,andtodefinethepreciserulesyou will use to trade your

system. Defining all thesevariables for your system upfrontwill help youdown thetrack when you have toendure difficult times.Drawdowns, losing streaks,and bad luck are all moremanageablewhenyouhaveawell-defined trading systeminfrontofyou.One last note should be

made about your successes.When thinking about your

tradingsystem,muchofyourplanning may involvereducing exposure to risk.However, you should alsothink about your successes.What will you do when youhaveanexceptionalrun?Willyou take time off tocelebrate?Willyoupullsomeof your profits out to buysomething nice for yourself?Remember to celebrate yourwins.

DEFININGYOUR

TRADINGSYSTEM

In summary, creating yourtrading system involvesseveral aspects. Thefollowinglistwillhelpyoutorefine your trading systemand define the rules so that

you are ready for anysituation before it arises. Ifyour trading system answersall these questions, you havedone well, and you have atruetradingsystem.

Are you a marketspecialist or a tradespecialist?Howmanyhoursofdailyscreentimedoyouallowyourself?Which trading

session (European,Asian, or NorthAmerican) do youtrade?Which timeframeswillyoutrade?Which trading set-upsdoyoutrade?Which exitstrategies do youuse?How muchinterpretation do

you have whenplacingtrades?How muchinterpretation doyou have whenexitingtrades?What is yourmaximum risk pertrade?What is yourmaximum weeklydrawdown?What is you

maximum monthlydrawdown?How do you dealwithdrawdowns?Howwillyouregainconfidence after amaximumdrawdown?Whatwillyoudotoensure you arephysically fit totrade?Whatwillyoudoto

ensure you arepsychologically fittotrade?

CHAPTER14

BecominganExpert

Far too many people—especially people withgreatexpertiseinonearea—are contemptuous of

knowledge in other areasor believe that beingbright is a substitute forknowledge.

—PeterDruckerForex traders around theworld are making moneyeveryday.Thesetradershaveone thing in common—asecret. This secret maysurprise you. If you are likeme, when you first startedlearning about trading you

thought all the traders whowere making money werecomputer science,mathematics, or physicswizards with lightning-fastcomputers deploying secretalgorithms. Trading was thedomain of the well educatedthathadthecomputingpowerto crack the market code. Iwas convinced that only byduplicating these effortswould I be able to

consistently rackupprofits. Iknew that trading had to becomplex, and perhaps youfeelthinksameway.Thisisnottrue.Some of the very best

traders in the world share asimple secret: They useextremely simple and yetpowerful, trading systems.Thebest traders in theworld—hedge fund traders, banktraders, private millionaire

traders you will never hearfrom—all have one thing incommon: These people areexperts.Theydoonething.

WHYDOYOUWANTTOTRADE?

This may seem like a funnyquestion, but why do you

want to trade?Ifyouwant totrade because you want tomakemoney,perhapstradingis for you. If, however, youwant to trade because youwantexcitement,oryouwantto be able to tell people thatyou are a trader, or becauseyou love the excitement ofhaving money at risk, thenperhapstradingisnotforyou.If you want excitement tryskydiving, or hunting wild

boars. If you want to tellpeople that you are a trader,youcandothat,butifyouarenotquiteconsistentwithyourtrading, just trade a verysmall account, that way youcan get the recognition ofbeingatraderforasmallfee.Ifyou love theexcitementofhaving money at risk, youshould try gambling.Gamblers are honest. Theyrisk their money, and they

recognize the inherent risk intheir occupation, they are upfront about it. This is anhonorable approach togambling because gamblersadmit that their money is atrisk and admit that luck willguide theirwinnings.Traderscanbegamblersindisguiseiftheyaretradingforthewrongreasons.You probably know a

gamblerortwodisguisedasa

trader. This is the differencebetween a trader and agambler: A gambler has norisk management, and agambler is willing to loselarge amounts of moneyquickly. A trader treats eachtradeasacalculated riskandmanageseachtradeaccordingtohissystemrules.Gamblerscan lose all the money atonce,andtradersloseonlyasmuch money as their system

willallow.Thedistinguishingfactor is that a gambler doesnot follow risk managementrules, whereas a traderfollows strict riskmanagementcontrols.Experttradersdomorethan

simply follow strict riskmanagement controls; theyalso concentrate on onetrading technique.This is thereal secret of expert traders:They focus on one market,

onetradingsystem,oneedge,andtheyusethisedgeintheirtrading repeatedly. Profitabletrading is boring. Profitabletraders are experts, and theseexpert traders do one thingoverandoveragain.

THESECRETOFTHEEXPERTS

Why do profitable traderslimitthemselves?Theansweris simple: Profitable tradersknow what makes money.Profitable traders trade tomake money. If you wouldlike to make money as atrader, do what the expertsdo. Become good at tradingone system. You know howtodo thisnow.Allyouneedis in this book. You simplyneed to put the work in,

practice, and become anexpert with a trading systemthatmakes sense to you, andthentradethattradingsystem.Trade your system over andover again until tradingbecomes boring (and veryprofitable).All the very successful

traders are doing one thing.Thismay seemunbelievable,but entire hedge funds arebuiltononeidea.Hedge-fund

traders often have one edge,andtheyusethisedgeintheirtrading. Now, some hedgefunds may have severaltraders, each with his ownedge, but to be a successfultrader you simply have tohave one thing that you areverygoodat,andthenyoudothis one thing over and overagain.Themostsuccessfultraders

I know follow this rule. The

traders that struggle, thetraders who have difficultyfindingconsistentprofits, arethe ones who repeatedlychange their systems,reanalyzing and reorganizingtheir trading rules. In otherwords, they are still stuck inthecycleofdoom.Thekeytobreakingthecycleofdoomistodecidewhatmakessensetoyou, which of the tradingsystemsinthisbookresonate

with you. Once you havechosenone, you simplyneedtotestitoverandoveragain.Then apply this system,concentrateonfollowingyoursystemrules, andwatchyourconfidencegrow.Youcando the same thing

hedge fund traders do. Youcanbejustlikeabanktrader.You can be a professionaltrader.Butbeforeyougopro,youmustdecidehowyouwill

make your money in themarkets. What is yourexpertise? Which tradingsystem fits your beliefs?Once you align your beliefswith a trading system, yousimply need to gainexperience and confidence inthe trading system, and youwill never look back. Yourexciting journey is ahead ofyou;soonyouwillbecomeanexperttrader.

SIXSTEPSTOBECOMINGANEXPERT

Although it may seem thatbecominganexpert isaverydifficult thing to do, it isreally rather simple. As withmanythingsinlife,ifyouputthework into it, youwill beabletoreaptherewards.Hereare six steps to becoming an

expert.

StepOne:GetintheComfortZone

The first step is to becomecomfortable drawing zoneson your chart. Zones are thebasis for your tradingdecisions.As a naked trader,allyourtradingdecisionswillbe based on zones, so it isvery important that you have

these zones drawn correctlyonthechart.Itismucheasierto draw fewer zones,providedthosezonesareverystrongandwelldefined, thanit is to draw toomany zonesonyourchart.Ifindoubt,erron the side of using fewerzonesonyourchart.Asanakedtrader,youwill

spend a lot of time waitingfor the market to hit yourzones.Thisisfine;thisispart

of what it means to be anaked trader. If you findyourself feeling as thoughyou need to take action,perhaps you should back-testyour trading. Test one year'sworth of data (on a shortertimeframe), and then test alower frequency tradingsystem on longer-timeframecharts. Compare theprofitabilityofeachback-test.Areyousurprisedatwhatyou

find? Sometimes makingmoneyiseasierwhenyoudonot trade. Sometimesavoiding trades is just asimportant as taking tradeopportunitieswhentheyarise.

Goal: Learn to quicklyidentify zones on anychart.

StepTwo:DecideonaCatalyst

The second step towardexpertise is foryou todecideon which catalyst you willuseinyourtrading.Youhavelearned about severalcatalysts (and there aremoreat www.fxjake.com/book),and hopefully by now youhave back-tested some ofthem.Sowhichoneresonateswith you?Do you prefer thesimplicity of the kangarootail?Ordoyouliketheadded

confirmationof the lastkiss?Perhaps you find the trendykangaroo to be an excellentmethodforcapturingtrendingmarkets. It does not matterwhich catalyst you havechosen. What does matter isthat you trade a catalyst thatfits with your view of themarkets.You must trade a catalyst

that fits with your beliefs.Choosing a catalyst that fits

with your beliefs will helpyou to rideoutanybumps inyour equity curve and avoidthecycleofdoom.

Goal: Choose the onetrading catalyst that youwant to build yourexpertiseon.

StepThree:Back-Test

Bynowyouprobablyhavea

goodunderstandingofall thebenefitsassociatedwithback-testing your trading system.Back-testing will verify thatyourtradingsystemworks.Itwill help to build yourconfidence in your tradingsystem.Itwillhelpyouwhenyou are experiencingdrawdowns, it will help saveyoufromfallingbackintothecycleofdoom.Inshort,back-testingiswhatseparatesthose

consistentlyprofitable tradersfrom those traders who areforever stuck in the cycle ofdoom.Ifthereisoneideathatyou

take from this book let it bethis: Back-testing yourtrading system is the onething that you can do toaccelerate your trading. Thisone thing is the mostimportant habit that you candevelop in an effort to

becomeaprofessional trader.Back-testing is thatimportant.You should have a clear

goalinmindwhenyouback-test your trading system.Tryto tripleyour tradingaccountwith a small percentage atrisk for each trade (e.g. 1percent or 2 percent at risk).Triplingyour tradingaccountwill help you to believe inyourtradingskills.

Goal:Risking2percentorless, triple your back-testingaccount.

StepFour:ForwardTest

If you have back-tested yourtrading system, and you arehappywiththeresults,you'reready for the next step. Thenext step is to employ yourtrading system in real time.

Unfortunately, this is a veryslow stage. You will beunable to speed up time asyou can when you are back-testing, but you will closelymirrorthelivemarkettradingexperience.Create a goal for your

forward testing. Try to tripleyour demo account. Becauseyou will be trading in realtime, it will probably takelonger to triple your account

than it did when you tripledyour back-testing account.However, in some ways,demo trading much moreclosely resembles “real”trading because you cannotquicklyadvance thecharts tosee if you have made thecorrect trading decisions.Embrace the time it takes toaccumulate expertise withyourforwardtesting.Toforwardtest,yousimply

need to open up a demoaccount. These accounts areofferedbyanyforexbroker.

Goal:Risking2percentorless on each trade, tripleyourdemoaccount.

StepFive:TradeaSmallAccount

Afteryouhavefoundsuccessback-testing and found

success forward testing, it istime to start trading a liveaccount. Live trading cannever really be duplicated.Back-testingiswonderfulandadds to your confidence;forward-testing is also greatbecause it closely resembleslive trading. However, theonlythingthatmattersislivetrading profits. Begin with avery small trading account.Whatissmalltoyoumaynot

be small for someone else.The size of your accountshould be made up of 100-percent risk money. This ismoneythatyouarewillingtorisk for this exercise. Neverrisk more money than youcanaffordtolose.Once you triple this small

account, you are ready. Youhavebuiltyourconfidencebytrading (back-testing withhistorical data, livedatawith

your demo account, and,finally,youhave tripledyoursmall live account). At thisstage, you probably cannotwait to begin trading yourstandardliveaccount.

Goal:Risking2percentorless on each trade, tripleyoursmallaccount.

StepSix:TradeaLiveAccount

Most traders do not do whatyouhavejustdone.Youhavebuiltyourconfidenceoverthepreviousfivesteps.Nowyouare ready. It is time to putintopracticewhatyouknow,andby this stageyouwillbeexcited. Make sure that youmaintain your discipline andcontinuetodothesamethingthat you have been doing.Theimportantthinghereistofollow your system, without

regard to whether you are inthemidstofaluckystreakoran unlucky streak.)Remember, you have thepower of your trading, andyou understand that youwillsuccessfullypullprofits fromthemarket.Themostimportantthingat

thisstageistoduplicatewhatyou have been doing. Justbecause you are trading astandard account does not

mean anything changes.Concentratingonyourtradingsystem rules will yieldpositive results. Thinkingabout themoney involved ineach trade will probably bedistracting and will likelythrow you off track. Keepdoingwhat you dowell, andyouwillbecomeanexpert.

Goal:Risking2percentorlessoneachtrade,stick toyour trading rules. Focus

solely on following yourtradingsystemrules.

DOINGITAGAIN

Is it possible to duplicatethese steps with anothertrading system? If you havedecided to follow thepathofthe market expert, youprobably will add more

systems to your repertoire. Itis not necessary that you doso.Itmaybeeasierforyoutotradeonesystemcomfortablyfor at least eight monthsbefore attempting to becomean expert with anothersystem.Eventually,youmaydecide

to do what many profitabletradersdecidetodo.Youmaywanttogainexpertisewithanadditional trading system. It

isnotnecessarytodoso,andit may be tempting to jumpheadfirstintoanothersystem,but you should first giveyourself time to get boredwithyour first system.Thereare at least two reasons forbecoming an expert with anewtradingsystem.Thefirstis that trading the profitablesystem is boring. Perhaps itseems crazy to you that youmay one day become bored

with consistent tradingprofits, but it may happen.You may want to expandyour horizons, and addanother tool to your tradingtoolchest.Thesecondreasonforbecominganexpertwithanew trading system is basedon risk management. Bydiversifying your tradingstrategy, youmay reduce thelikelihood of an extendeddrawdown. All trading

systems have drawdown, butifyouhaveacomplementarytrading system, one that islikely to make profits whilethe other is struggling, thenyou have the makings of asolid trading strategy. Manyprofessional traderseventually get to the stagewhere trading diversifiedtrading strategies makessense. It is not necessary, ofcourse, but it is possible for

you to become an expert alloveragainwithanewtradingstrategy. This is a great waytoreduceyourrisk.

BORINGTRADINGISEXPERTTRADING

If you find yourself bored

with your trading, you areprobably consistentlyprofitable. The desire forchangeoranewchallenge isoften the biggest threat toprofitabletrading.Exciting trading is often a

signofoneof twoproblems.Either the trading system isnewandunproven(notback-tested) or there is too muchrisk on each trade. If thesystem is unproven, the

excitement is due to theunknown.This is not a goodthing. Exciting trading isexciting because it is akin togambling. Gambling isexciting. This is preciselywhyriskingtoomuchonanygiven trade is exciting.Trading shouldbe fun,but ifit isexciting. It isa sign thatthesystemisunprovenoryouareriskingtoomuch.Remember the story about

Miguel? He is an experttrader, and by his ownadmission, his trading isboring.Embrace theday thatyour tradingbecomesboring.It may still be very fun tomakemoneyconsistently,butit does not have to beexciting.

ASIMPLE

TRICKRight nowyouknowhow tobecomeanexpert.Youknowwhat you can do to get toexpertise, it involves work,but if you choose to take thepath of the expert, it is nowavailabletoyou.Theproblemwith the steps to expertise isjust that; there are steps, andit takes time to achieve thisexpertise.Obviouslypatience

is needed to get there. Theworkandeffortiswellworthit, but the fact remains, itdoes take time to get there.What if you could use asimple trick to gaininvaluable experience?Wouldyou like tobeable tolearntoseethemarketsasanexpertoverthecourseofonlyafewhours?Thatiswhatthistrick will give you, this isanother means of gaining

expertise. This is a truefavorite of mine, a way foryou to “see” the markets forwhat they are, an ebb andflowofbuyersandsellers.Set aside several hours for

thisexercise.It isgreat todothis over four hours, but youcandoitwithlesstimeifyouwish. The length of theexercise isdeterminedby thetimeframeofthecharts.Soifyou are looking at the 30-

minutechartsthiswilltake30minutes, if you're looking atfour-hourchartsthiswilltakefour hours. The four-hourchartsaremy favoritecharts,so I love to do this exerciseoverfourhours.Openachart,andwaitfora

new candlestick to appear. Ifyou are watching a shortertimeframe chart, such as the30-minute chart, after a fewminutes, about three minutes

orso,takeascreenshotofthecandlestick. The idea is thatyou are taking snapshots ofthecandlestickasitiscomingto life. While you are doingthis, you should considerwhat you think is going tohappen. It does notmatter ifyouarecorrectornot,itonlymatters that you make aguess.Youshouldtakeatleastsix

snapshotsofyourcandlestick

atequaltimeintervals.Ifyouare watching a 30-minutecandlestick, you should takesix snapshots at five-minuteintervals.If,however,youarewatching a four-hourcandlestick,youshouldtakeasnapshot at 40-minuteintervals,andsoforth.Aftereachsnapshot,answer

thefollowingquestions:Is the candlesticknow trading higher

or lower than theopeningprice?Do you think thecandlestickwillstarttrading higher orlower between nowand the nextsnapshot?Willthiscandlestickclose as an up(bullish) or as adown (bearish)candlestick?

Do this for all of thesnapshots. Watching thecandlestickprintlikethisisalot like watching your childgrow up. Maybe in someways you may be able toanticipatethefuture,buttherewillbeturningpointsthatarecritical, and by recording thecandlestick at regularintervals you will be able tosee how well you cananticipate the market. The

pointofthisexerciseisnottoshow you how unpredictablethe markets are, or toencourageyoutogetintouchwith your inner psychic. Thepoint of this exercise is that,by watching themarket, youearnvaluableexperience.Justas working in a forex testerwillhelpyoutogettradesonyour belt, it is also true thatwatchingacandlestickunfoldina livemarket is invaluable

experience.At the end of the exercise

youwill have a slow-motionrecord of the lifespan of acandlestick. Once thecandlestick has finishedprinting, answer thesequestions.

How does thesecondscreenshotofthe candlestickdiffer from the lastscreenshot of the

candlestick?Did the candlestickstart moving up ordown?Did the candlestickclose in that samedirection, or did itendupclosingintheoppositedirection?During whichtrading session(Asian,European,orNorth American)

didyouchoosetodothisexercise?Do you think theresults may havebeendifferentifyouhad chosen adifferent tradingsession?Did the candlestickafter the one youobserved close inthe same directionas the candlestick

youobserved?Based on the firsttwo screenshots ofthe candlestickwould you havebeen able to predictwhatthecandlestickended up lookinglike?

If you are interested inreally accelerating yourtrading, do this exerciseoften. It is quite different to

the back-testing in that youare watching the marketunfold in real time, just asyou would during a livetrading session. The mostimportantthingyoucanlearnfromdoingthisexerciseistheimportance of the closingprice.Theclosingpriceisactually

critical to the expert nakedtrader.Thinkaboutthis:Iftheclosing price is not in the

right spot, do you get akangaroo tail? If the closingpriceisnotintheprecisespotfor a bullish big shadow, doyouhave a valid buy signal?If the closing price for abearishbigbeltisnotnearthelow, but rather near themiddleofthecandlestick,isita valid sell signal? Theclosing price is absolutelycriticaltothenakedtrader.The real secret to this

simple trick is that theopening price of thecandlestickdoesnotmatterasmuch as the closing price.Where the candlestick printsduring the first two or threesnapshots is not as importantaswherethecandlestickendsup,wheretheclosingpriceis.A slight difference in theclosing price can drasticallychange the look of a pricepattern,andis,therefore,why

this exercise is so critical,why you can watch acandlestick and see that thebeginning of the candlestickis not nearly as important astheclosingprice.Thinkabouthowmuchyou

learned since you beganreading this book. Now youshould be able to look at achart and immediately knowwhether you can take a buytrade,aselltrade,ornotrade.

Now, you know how tobecomeanexpert trader.Notonlythat,butyouknowwhatto focus on to become anexperttrader.Now,youknowhow important the closingpriceistoyournakedtradingsetups.Youshouldbefeelingmore confident now. Youknowprecisely the steps youneed to take to beginfollowing the path to experttrading. In the next chapter,

wewillexploreconfidenceinyourself, confidence in yoursystem,whattodowhenyouexperience confidenceproblems, and why losingtradesshouldhavenothingtodowithyourconfidence.

CHAPTER15

GainingConfidence

Inactionbreedsdoubtandfear. Action breedsconfidence and courage.If you want to conquer

fear,donot sithomeandthinkaboutit.Gooutandgetbusy.

—DaleCarnegieImagine you have thefollowing:

A trading systemyou are comfortabletrading.A trading systemwithaveryhighwinrate.

An incredibleamountofmoneytotradeyoursystem.All the time youneedtotrade.The best computerand a fast internetconnection.

Is this all that you need totrade successfully? Will youfind consistent profits withonly these things? Theanswerisno.Youneedmuch

more than this to tradesuccessfully. To findconsistentprofitsyouneedtohave confidence. In fact,confidence is the mostimportant ingredient fortrading success. Confidencewill help you profit with anaverage trading system, butwithout confidence you willbe unable to find success,even with a brilliant tradingsystem.

Youwillfindthattherearetwo different types ofconfidence problems forforex traders: (1) a lack ofconfidence in the tradingsystem, or (2) a lack ofconfidenceinyourself.

THEORIGINOF

CONFIDENCE

ISSUESAll traders will have losingstreaks. Losing streaks mayleadtofeelingsofinadequacyanddisparity.However,ifthetrading system is a validwinningtradingsystem,ithasbeen tested, and is profitableover the long run, there isprobably nothingwrongwiththesystem.Mostof thetime,a losing streak is due to the

wrong application of thetrading system. In otherwords,mostlosingstreaksaredue to the misapplication ofthe system (caused by thetrader), and not the systemitself.There are several common

issuesthatmanytradershave,all of which may lead tolosingstreaksandconfidenceissues.

Risk-ManagementIssues

The next chapter willexamine risk in detail. Fornow, it is important only tonote that without properapplication of riskmanagement rules, a tradingdrawdown may beexacerbated and, therefore,may be very difficult tohandle for many traders.

Traderswhohaveissueswithriskmanagementwillusuallymultiply their drawdown andfind it difficult to makemoney consistently. Normal,everyday losing streaks areunfortunate and difficult formany traders to endure, butwhen these drawdowns areaccentuated by poor riskmanagement, the results areoftendisastrous.

ProblemswithDiscipline

Discipline problems arecommon. Many traders atbanksarenotbrilliant traders(in fact, many retail forextraders are much bettertraders than bank traders).Bank traders do not have asixth sense for the markets.These traders do not haveaccesstosecretalgorithmsor

indicators. Many traders areconsistently profitablebecause there is a built-indisciplinesystematthebank.Bank traders have a risk

manager. The risk managerensures that the bank tradertrades with discipline. Thebankhires intelligent traineestobecomedisciplined traderson the forex desk. The riskmanager ensures that thebank traders do not risk too

muchontheirtrades.All the bank traders must

followone simple rule:Theymust not takemore risk thanthey are allowed. Each banktrader knows how much hemay risk, every bank traderhas a number, and his riskcannot exceed this number.Theriskmanagerontheforexdesk oversees the riskassociated with each of thetradestakenbythetraders.If

a trader takes on too muchrisk, the trader is warnedonce. If a trader makes thismistakeagain,thetraderloseshis job. These are the rules.Eachbank traderunderstandsthis, and the forex tradingdesk is set up to tightlymanagerisk.The interesting thing about

thissystemis thateventhosetraderswhoareexceptionallyprofitable—the traders who

makemillionsforthebank—even these traders are shownthe door if they take on toomuch risk. Banks understandtrading isagameof risk.Allthe bank traders must bedisciplined traders. Anytraderwhostepsoutoflineisasevereconcernforthebank.Retail forex traderssuchas

you and I do not have a riskmanager. However, it ispossibletore-createthebank

system. This is how you cando this: become accountableto someone. Find a tradingbuddy, your partner, arelative, anyone you respect.Offer them your tradingstatement eachweek. This isyour report card. Report therisk for each trade. Beaccountable to this person. Ifyou take on too much risk(win or lose), your riskmanager should reprimand

you. Perhaps your “riskmanager” will change yourtrading platformpassword soyou are unable to trade foroneweek if you take on toomuchrisk.Youmustlearntokeep risk manageable if youwant to consistently extractprofitsfromforextrading.

ChangingSystemsIf you have a losing streak,

you may become too carefulor too reckless with yourtrading system. This is acommon reaction to adrawdown. This often leadsto a downward spiral. It isimportant to keep track ofwhatyouaredoing.Therearemanyways todo this,butbemostcommonwayistokeeptrack of your trading. Tomake sure that you are notchanging your trading rules,

dooneofthefollowing:Takescreenshots of your tradesbeforeyoutakethetrade(thesetup), during the trade, andafterthetradeisclosed.You may also want to

create a trading journal. Thisjournal should includeinformation suchaswhyyoudecided to take the trade, thesystemyouemployed for thetrade,your feelingsabout thetrade, the result of the trade,

andaratingonhowwellyouapplied the rules of yourtrading system to thatparticulartrade.Alternatively, you may set

up a video journal; there aremany software options forthis, some of them freelyavailable on the Internet, buta popular one is called Jing,whichwill allowyou to takea quick recording of yourtrade.Afinaloptionwouldbe

to look over your tradingprintouts—in other words,your trading record. This isanotherplacewhereyoumaynotice what is happening,why you are changing yourtrading,andwhatexactlyyouare doing that is different toyoursystem.The key to combating this

problem is to become aware,more self-aware ofwhat youaredoingasatrader.Justasa

professional gardener doesnot mow the lawn the sameway every single week, youmaynotbetakingyourtradesthe same way even thoughyou are trading the samesystem. Taking records ofwhat you are doing isinvaluable for self-assessments later, in order tolook at exactly how you areexecuting your trades andwhat changes you might be

making.

MissingOutTraders may end up with alosing streak simply becausetheymissoutonsometrades.Thisisaparticularlydifficultproblemforthosetraderswhohave a low win rate. It isobviously possible to be asuccessful and profitabletrader—in fact to be a

professional trader—with atradingsystemthathasaverylowwin rate.Theproblem isthat if winning trades do notoccur that often, it isimperative that all trades aretaken to make sure thewinnersarecaptured.If you trade a system that

has a low win rate, and youmiss out on some of thetrades, and these trades endupbeinglargewinners,itcan

be disheartening. Obviously,if you trade a system with avery low win rate, you needlarge winning trades tomaintain profits.Missing outon these winners can bepsychologicallydemoralizing; it can bedifficult to maintain yourconfidence in a tradingsystem with a low win rate.There is an easy solution,however.

If you want to make surethat you do not miss out ontrades,ormissoutontradinginformation so that you canmanage trades, technologymay be your answer. Today,there are many technicalsolutionsforthenakedtrader.Technology today allowstraderstobealmostanywhereandstillmanagethetrades.Thekeyistobeprepared.It

is possible for the naked

trader to simply trade fromaphone. With well-equippedphones,nakedtradersareabletonotonlytoplacetradesandmanage trades, keeping tabson live market charts, theycan also set alerts. If themarket goes to apredetermined price level,traderswillreceivee-mailsoralertsontheirphones.On the Internet, there are

services thatallowyou toset

price alerts, so that once themarket crosses a price levelyou receiveane-mail. Ifyoureceive e-mails on yourphone, you should knownearly immediately if themarket reaches apredetermined price. Formore information aboutsetting alerts about yourchartsonyourphone,seethevideo on creating automatedalerts at

www.fxjake.com/book.

CONFIDENCEINYOU

Yourconfidencemayebbandflow; this is part of trading.There are some easy tricksyou can do to keep a steadystream of confidence in yourtradinglife.Youcandothreethings, and if you practice

these consistently they willhelp to maintain yourconfidence.

StepOne:TheReasonsforYour

SuccessIn order to be confident as atrader, you must consistentlyexecute your trading systemas it was outlined in yoursystem rules. More

importantly, youmust know,without a doubt, the reasonwhy you have chosen toexecute your trading system.In other words, your beliefsmust align with your tradinggoals.Thisisaforeignconceptto

most traders. Many tradersassume that they want tomakemoney, and if they arenotmakingmoney,thereasonis that they have not found

the trading system that willallow them to make moneyconsistently. Notice how theemphasis for most traders ison the system. The systemyieldsthereward.Thesystemis responsible for profits.Unfortunately this emphasisonthesystemisincorrect.Theonlytraderswhodonot

have to concern themselveswith the psychology oftradingare those traderswho

use automated tradingsystems.You are influencingyourtradingresultsregardlessof whether you acknowledgethis fact. Unless you aretrading a purely mechanicalsystem—a pure automatedtrading system, you areinfluencing each and everyoneofyourtrades.(Hereisatesttoseeifyoursystemisapurely automated system. Ifyou can be away from the

Internetforamonthandyoursystem will still trade andmakemoney for you, then itis a purely automatedsystem.)Your thoughts, yourbeliefs, and whether youbelieve you are deserving ofprofit all influence how youtradeyourtradingsystem.Think about and write

down your answers to thefollowing:

How many wealthy

peopledoyouspendtimewith?Do you think thatyou will one dayhave a lot ofmoney?When somethinggoes wrong withmoney,doyouthinkthatthisis“justyourluck?”When you see awealthy person,

whatdoyouthink?Do you think thatwealthy people aregoodpeople?If you becomeextremely wealthy,areyouworriedthatyour personalitymaychange?

To learn more about youranswers to these questionsand your attitudes towardmaking money, go to

www.fxjake.com/book.Aligningyourtradinggoals

with your financialpersonality is important andsomething that will occurregardlessofwhetheryouareconsciouslyawareofthis.

StepTwo:TheRewardsofRoutineThe trading system youemploydependsonyou.You

must identify and executetrades. You must apply therisk management rules toeachofyourtrades.Youmustremain vigilant and ensurethat you take all the tradesthatyoursystemidentifiesashigh probability trades. Inorder to achieve all this, youmust have an establishedroutine.This routinemust bewritten down, and it mustinclude all the important

variables for your tradingsystem.The rules for your trading

system must include yourtrading routine. Define whatyou will do, and what youwill not do regularly. Thiswill be your trading routine.Adherence to your tradingroutine is the closest thingyouhavetoinsuranceagainstsloppy trading. Sloppytrading involves missing

trades, trading the wrong lotsize, placing the stop loss atthe wrong price, or poorexecution when entering atrade.Ataminimum,thisiswhat

you should have writtendownforyourtradingroutinerules:

Whenwillyou lookfortrades?How will youcalculate your trade

size? (There is arisk-free calculationspreadsheet, a greattool for calculatingyour trade size, atwww.fxjake.com/book.)How often will youcheckthecharts?How will you bealerted to tradingopportunities?How will you bealerted when you

need to manageyourtrades?

Defining your tradingroutine is important because,over time, as you begin toconsistently capture profits,you will gain confidence inwhat you do. The simple actofenteringyourtradeintotherisk calculation spreadsheetwill often bring ananticipation of profits tocome.Thereisgreatpowerin

routine.

StepThree:TheMachine

If you have aligned yourpersonal beliefs with yourtradinggoals,andifyouhavedesigned a well-plannedtrading routine that you canadhereto,youarenowreadyto put into place fail-saferules and tools so you may

quickly regain yourconfidencewhenitwavers.The fastest way to regain

your confidence is to back-testinaforextester.Alosingstreak can be put into properperspective after you havetraded the GBP/USD overthree years and foundconsistent profits in a forextester using the very samesystem that has you in adrawdown. Back-testing in

general is a one-size-fits-allremedy.Not onlydoesback-testing help your confidenceduring a losing streak, but italsohelpsyou toconcentrateonwhat is important in yourtrading system. The simpleact of taking 50 trades in aforex tester (or your chosenback-testing software) addsanother 50 trades under yourbelt. You will have honedyour skills to identify valid

trade set-ups and executevalid trades within theconfinesofyoursystem.Spreadsheets can also help

you. If you can, make somespreadsheets with the datafrom your back-testingsessions.Thesedatawillhelpput drawdowns intoperspective. There is a greattemplate for you atwww.fxjake.com/book.Download the spreadsheet

there and enter your back-testing data into thespreadsheet. The spreadsheetwill calculate for you thestatistics of your tradingsystem. Having the statisticsin front of you is evidencethat your trading systemworks, and youmay need totrot these data out when youare experiencing a losingstreak,toremindyourselfthatwhat you are doing is

successfultrading.Inthenextchapteryouwill

see how confidence and riskare related. For now, it isimportant to note that if youarenotfollowingyourtradingsystem, that is, if your riskmanagementdoesnotfitwiththe rules of your tradingsystem, you may find itextremelydifficult toexecuteyoursystemproperly.

REASONSFORLOSINGSTREAKS

Therearemanyreasonsthatatrade may not make money.These reasons include thefollowing:

Poor systemexecution(mistakes,sloppy trade entry,humanerror,etc.).

Changing market(trading system nolongerworks).Bad technology(slow computer,poor Internetconnection,etc.).Dishonest broker(marketmanipulation, baddata feed, frozentrading platform,etc.).

Trading system notflexible enough(unusual marketactivity, newsreport,etc.).

All these reasons have onething in common: They areincorrect. These are notreasons for a losing trade;they are excuses. Confidentnaked tradersunderstand thatthese excuses will not aid inthe collection of profits from

the markets. These reasonsforfailedtradingareexcuses;each offers a reason forfailure. If you find yourselfusingthesereasonsforlosingtrades,pleasereconsideryourthinking. Changing yourthinking about what ispossible and what is underyour control will helpimproveyourconfidence.Losingtradesarereallydue

toonething—badluck.Luck

will come and go, as youknow, so the drawdown youare experiencing will betemporary,andaslongasyoudonotchangeyourrules,youwillgetitbackontracksoon.Bad luck is thereasonwhyatrade ends up a loser. Badluck is the reason you neverknow if a trade will makemoney or if it will losemoney.Thepossibilityofbadluck is the reason why

responsible traders place thesameamountofriskoneverytrade.If you follow your trading

system and all your tradingrules, you will have theconfidence of knowing thatonly one thing can lead to alosing trade—bad luck.Luckcan neither be accounted fornor can you anticipate yourluck. Armed with back-testing data and your trading

record (from your liveaccount), you may have averygoodideaofthechancesthatyournexttradewillbeanunluckyone.The probability that any

giventradeisalosingtradeiscalculatedasfollows:

Ifyourtradingsystemhasa59percentwinrate,thenyouhavea41percentchancethatyour very next trade will be

anunlucky(losing)trade.

Thinking about your nexttradeintermsofprobabilitiesmay help you to re-focus onwhat is important: followingyour trading system.Worryingaboutanyonetradeor emphasizing reasons whyyour trade lost money is notimportant. The big picture isimportant, the overallprobabilityofawinningtrade

is important.Aspecific tradeisnotthatimportant.

THEBADMARKETTHEORY

Some traders are concernedthat very good tradingsystems will change themarket. The theory goes

somethinglikethis:Ifalargeproportion of traders startusingthekangarootailonthedaily forex charts, eventuallythe daily forex charts willstop printing reliablekangaroo tails because toomany traders are usingkangaroo tails to find high-probability trades. Althoughthe story sounds good, it isincorrect.Even if all the retail forex

traders (traders like you andme)tradedthedailykangarootails,wewouldnotaffect themarket.Therearetworeasonswhy this is true. First, everytrader views the marketdifferently, so what is aworthwhile kangaroo tail tomemaynot be aworthwhilekangarootail toyou.Second,retail forex traders make upsuchasmallproportionoftheforexmarketthatevenatruly

coordinatedtradeexecutedbyall retail forex traders wouldnot have an effect on themarket. The majority of thevolume in forex is from thebanks and private funds, notthe retail traders. The retailtraders make up about1 percent of all the forextradingvolumeeachday.The great thing for the

naked trader is that nakedtrading systems are based on

market psychology. Thenaked trading systems youhave learned in thisbookarebased on the psychology ofthemarketparticipants.Theyare likely to hold for as longas humans participate in themarkets. Any downturn inperformance is likely due tobad luck if you have beenfollowing your system rules.This means that the profitswill likely return to normal

again, after the bad-luckstreakisover.Finally, the possibility

remains that your tradingsystem completely falls apartand stops working. The wayto test this is to takea recentsample of all the trades forthat system and compare thewin rate to thehistoricalwinrate. If you are concernedabout a recent losing streakfor your trading system,

compare your historical winratetothewinrateofthepast50trades.Ifthehistoricalwinrate differs greatly from thecurrent win rate, the tradingsystem may be losing itspotency.

CHAPTER16

ManagingRisk

Yes, risk taking isinherently failure-prone.Otherwise, it would becalledsure-thing-taking.

—JimMcMahon

As you progress as a traderyouwill become involved inthinkingandprobablyreadingabout trading psychology.Trading psychology is abroad term that encompassesthe studyof traders and theiremotional issues abouttrading. Trading-psychologyliterature takes its cues fromscientific study ofpsychology, common sense,and the experience of traders

and trading gurus. If you areinterested in tradingpsychology, it probablymeans that you are furtheralong in your tradingeducation.Ifyouareoneofthetraders

with an interest in tradingpsychology,youhavemovedbeyond looking for theperfect trading system. Younowunderstandtheimportantrole emotions play in trading

results. One thing that manytradersfailtorecognizeistheintricate relationshipbetweenwhat you risk and theemotions you experienceduring trading. In fact, riskand trading psychology aretwosidesofthesamecoin.

YOURRISKPROFILE

Everybattleiswonbeforeitiseverfought.

—Sun-TzuSome would say your lot inlife has been decided. Theending balance of youraccount is already known. Ifthiswerethecase,wouldyoulike toknowwhoknows thisnumber? Why not ask thispersonnowtofindoutifyoushouldspendsomuchofyourtime trading? Who knows

what your final balance willbe? Who is this person whocan tell you what the futureholds? Who knows howmuch money you will make(orlose)duetoyourtrading?You!Thispersonisyou!Youaretheonewhoknows

whether you will makemoney or not, even thoughyou may not have consciousaccess to this information.Most traders do not

acknowledge this fact: Yourbeliefs drive your behaviors.This includes your tradingbehaviors. Ifyoubelieveyouareworthyof tradingprofits,you will be able to makemoney. Ifyoudonotbelieveyour trading will lead toprofits,youwillnotbeabletoconsistently make money. Itdoesn'tmatterifyoudecidetowork in business or intrading.Yourbeliefs,whether

they are accessible to youconsciously, will drive yourbehaviors.This is exactlywhy people

who win the lottery end upbroke a few years later. Thisis a very common story.Perhaps you heard aboutthese people. Once they winthe lottery, things shouldchange for these luckywinners, but, in fact, it justdelays the inevitable result.

The end result is, of course,no money. (See the featuredstory “The Man WhoAuctions off His LotteryWinnings.”)

TheManWhoAuctionedoffHisLotteryWinnings

WilliamBudPost,IIIhadadifficult life. His mother

died when William waseight, and his fatherabandoned him and latersent him to an orphanage.As an adult, he driftedbetween meaningless jobs,workingas a spraypainter,laborer, cook, and truckdriver for the circus. Hewas unable to afford ahome and even spent 28days in jail forwritingbadchecks. Even his love lifewascursed.Hewasmarriedanddivorcedsixtimes.Then, his luck took a turnfor the worse. He won the

lottery.One day, in 1988, he hadno jobandwas receivingapaltry monthly disabilitycheck.Hehadonly$2.46inthe bank, so he sold a ringto apawnshop for$40andasked his landlady (whowas also his on-again-off-again girlfriend, AnnKarpik), to buy 40 lotterytickets with the cash. Oneof the tickets she boughtwas thewinning ticket.Hewon$16.2million.The lottery payments wereto be made over 26 years,

and totaled $497,953.47each year. He spent over$300,000 after receivingthe first payment. Budbought a liquor license, atwin-engine plane (he didnothaveapilot'slicense),arestaurant for his brotherand sister, andhebought aused-car lot for his otherbrother. He was $500,000in debt three months afterhisfirstlotterypayment.In quick succession, thingsgotworse forMr.Post.Heused his second annualpayment to purchase a

mansion for $395,000 inOil City, Pennsylvania,with the hopes ofrefurbishing it. But hisformer landlady, AnnKarpik, suedhim,claimingthattheyagreedtosplitanywinnings, a claim thatBuddenied.ThecourtruledthatBudowedAnnone-thirdofhis winnings. Bud wasunable to pay, so the courtorderedhimtogiveAnnhis1992 annual payment. Herefused, so the judge frozehis future payments.Understandably, visitors to

his Pennsylvania mansionnoticed that the estate wasin disarray, showers weremissing, the securitymalfunctioned(andchirpedevery60seconds),thepoolwas filled with garbage,there was an old car onblocks in the weedy yard,and the windows werecoveredwithplywood.Mr. Post was quicklyfalling into debt, so hehatchedaplan.Hedecidedto sell the ailing mansionfor$65,000andauctionoffhis 17 remaining lottery

payments in the hopes ofscratching out of debt. Hehoped that this planwouldallow him to hold ontosomecash.His plan failed.Within theyear, he had bought acouple of large screentelevisions, two homes,three cars, a truck, twomotorcycles, somecomputers,acamper,anda$260,000sailboatheleftinBiloxi,Mississippi.(Hehadhoped to start a charterfishing business with theboat.)

He was tracked down andarrested on that boat forrefusing to serve a prisonsentence.Hewasconvictedof assault. Apparently,Mr.Post fired a shotgun at amanwho tried to collect acar-repair debt back inPennsylvania.Post was quoted as saying“Once I'm no longer alottery winner, people willleavemealone.That'sall Iwant. Just peace ofmind.”He said, “I was muchhappierwhenIwasbroke.”Post got his wish: After

serving his sentence forassault, he was back toliving on his $450-per-monthdisabilitycheck.

WhyYouWin(orLose)

Youwin(or lose)becauseofyour beliefs. Specifically, ofcourse I am talking aboutyourwinningor losinginthefinancial game. It does not

matter if you are anentrepreneur, looking atestablishing a new business,or if you are a salesman,looking to cultivate a streamof customers, or, perhapsmore likely, if you are aburgeoning trader, looking toestablish reliable tradingmethod to pull profits fromthe market. The sameprinciplesapply toallpeoplelookingtomakemoney.Your

beliefsaboutmoney,andhowworthyyoubelieveyouareofmoney will determinewhether or not you makemoneytrading.Perhaps you don't agree.

Perhaps you believe that youonly need a good tradingsystem in order to find atrading success. If that is thecase, then why is it that oneprofitabletradingsystemmaybe offered to 10 people, and

those 10 people will havevarying degrees of success?There are some excellenttrading systems in this book.However, not everyonereading this book will takethese trading systems and goforward and make money.Whyisthisthecase?If you believe you are

worthyof tradingprofitsyouwill find they come muchmoreeasily.If,however,you

believe you do not deservetrading profits, you maynever find a trading systemthatworksforyou.Themostcriticalaspectofyourtradingsystemisyou.

YourMoneyAttitudes

Before you do anything else,do this.Get a piece of paperand a pen. Answer these

questions quickly and astruthfully as possible. Theimportant thing here is thatyou do this now. Be honestand be quick; use your gutreaction to answer in everycase.

True or False?Richpeople are goodpeople.True or False?Moneyistherootofallevil.

True or False?Money comes tothose who helpothers.Money is a_______.Mostrichpeoplearemore _______ thanmostpoorpeople.Those with moneyalsohave_______.Poor people arebetter _______ than

richpeople.If I had moremoney, I mightbecome more_______.

Your beliefs about moneycan determine how muchmoney comes your way. Ifyou believe money is goodandyouareworthyofwealth,moneyismorelikelytocomeyour way. However, perhapsyou believe something

different;perhapsyoubelievethat rich people are selfish.Maybe you think that mostwealthy people found wealththroughimmoralbehaviors.Ifyou thinkwealthypeopleareunethical,youareunlikely todesiretobecomewealthy.Some traders believe

wealthypeoplearenefarious,and thus these traders areunlikely to ever achieve realwealth. Why should they

become wealthy if wealthypeople are despicable. Othertraders think that rich peoplesimplymake loads ofmoneybecause rich people are verymotivatedto…makemoney.These tradersaremuchmorelikely to join the wealthycrowd.Seeing yourself making

money is the first step totrading success. If youbelieve wealthy people are

moralandgood,youaremorelikelytobecomeoneofthesepeople.Likewise,ifyouknowthat you will be makingmoney, if you are confidentthat you have the skills toachieve wealth, you are onyour way to becomingwealthy.

TRADING

PSYCHOLOGYANDRISK

MANAGEMENTThere are very few laws fortrading, but this is one ofthem: Improper riskmanagement leads toemotional trading problems.Win or lose, if you risk toomuch on a trade, you willendureemotionalproblems.It

is not only with the losingtrades that improper riskmanagement rears its head.Improper riskmanagement—riskingtoomuchonatrade—leads to emotional issues,evenifthetradeissuccessful.Iftoomuchriskisplacedinatradeanditendsupawinner,overconfidence, irrationalexuberance, and sloppy tradeexecution may be the result.Iftoomuchriskisplacedina

trade that ends up being aloser, any number of resultsmayoccur: tradingrulesmaybe ignored, psychologicaldespair may result, and themanagementofthetradewillalmost always beexceptionally poor. There isno way around this law oftrading.

EmotionalTrading

Emotional issues are alwaysrelated to your confidence intrading, the current trade inplay, or your confidence inthetradingsystem.Emotionalissues will creep into yourtrading regardless ofwhetheryoulikeit.Youthinkthatyoukeep your emotions out ofyour trading, but, for mosttraders, this is not true.Mosttraders get extremely upsetafter a losing streak, or a

losing trade, or missing outon a great trade opportunity.Under most circumstancestraders have a very difficulttime removing emotion fromtradingdecisions.However, is it important to

remove all emotions fromyour trading? Is it abad ideatotradeunemotionally?Afterall, if it is impossible toremove emotions fromtrading, perhaps you should

embrace your emotions. Thestandard opinion aboutemotionaltradingtoday,mostgurustellus,isthatemotionaltrading is destructive.This isnottrue.Theonlydestructivetrading is trading that is notaccording to your rules. Sowhether it is emotionaltrading or logical trading, ifyou trade in amanner that isnotconsistentwithyourules,you are trading in a

destructivematter.Emotional trading is the

result of improper riskmanagement. When the riskbecomes too much, rationalreaction to the market isimpossible. If you have everhadatradeinwhichyoutooka large position—too large aposition—and the trade wentagainstyou,youknowwhatitis like to try and thinkwhenyour emotions are running

wild.The antidote to this is to

apply proper riskmanagement to your trades,use a well-rehearsed set oftradingrules,andapplytheseover and over again in yourtrading.

Worst-CasePlanningWorst-case planning meansplanning for the maximum

lossoneach trade.Thisway,the maximum loss cannothurt you. Over time, byplanning for the same loss(your maximum loss, whereyourstoplossisplaced),youwillbecomemoreefficientinexecutingyourtrades.Thisisthe magic of consistent riskmanagement. If each tradehas the same risk associatedwith it, over time you willbuild up valuable experience

withthisrisklevel.If you keep your risk the

same,theworst-casescenarioforeachandeverytradeisthesame. If you walk outsidebarefoot on a hot day on theasphalt, your feet may burn.However,ifyouwalkoutsideevery day when it's hot, theasphalt slowly becomesbearable. The same principleapplies to drug addicts; overtime, drug addicts must take

more and more of the samedrug to get the same high.This principle of tolerancealsoappliestotraders.It'sthetendency for tradingexecution to become moreprecise over time when thesame amount of money is atrisk on every trade. Byrisking the same percentageof your trading account onevery trade,youwillbecomeusedtotheamountofmoney

at risk. You will becomeimmune, over time, to theequityswingsinyouraccountwith each losing trade, oreachwinningtrade.Whatwillhappen,overtime,isthatyouwillbegintofocusonwhatisimportant—executing yourtrades, and you will notconcentrate on the moneygainedorlostoneachtrade.

TRADINGTOLERANCETrading tolerance is thetendency for tradingexecution to become morepreciseover timewhen thesameamountofmoneyisatriskoneverytrade.

EncourageTradingTolerance

This is how you mayencourage trading tolerance.First, calculate your worst-casescenario.Thisshouldbethe dollar loss if your stoploss is hit. Second, add 20percenttothisamount.Third,use this figure whencalculating the risk for yourtrades. You should assumethis (percentage) risk for allof your trades. Finally, usethisformulatocalculateyour

risk for each trade. Beforelong, you will becomeaccustomed to risking thisamount. Be prepared to losethis amount. Be prepared forthese losing trades, and beprepared for a sequence oflosingtrades.Before long, the amount of

money will not seemsignificant, and you willbegin to focus on tradeexecution. This is where the

moneyistobemade.

RISKYMONEYTRAPS

Why do most traders fail?Why is trading forconsistentprofits so difficult? Tradersare simply people who lookto buy something when it ischeap, and look to sellsomething when it is

expensive.Tradersgetpaidtobe bargain hunters and agilemarket participants.However, there are so manypeople in the markets whofind extreme difficultyattempting to extract profitsfromthemarkets.Aclose lookat the reasons

that traders fail—the riskymoney traps—and how toovercomeeachof these trapswillprepareyouforentryinto

the markets. Remember toconsider the other marketparticipants. Many of thesepeople are well capitalized,and they have intelligentpeople behind theconstructionandexecutionoftheirtradingstrategies.Ifyoufind it difficult to overcomeyour own issues, if you fallinto one of the risky moneytrapsbeforeyouhaveenteredthe markets, you are at a

significantdisadvantage.

YourAccountIsUnprotected

The number-one trading skillyou need to succeed as atrader is theabilitytoprotectyour tradingaccount.This isparamount to all other goals,protecting your accountmeans survival. Traders whoare unable tomake the jump

from novice trader toprofessional trader fail torecognize the importance ofplaying defense. Professionaltraders are very good atplaying defense. Watch the“TaleofThreeTrades”videoat www.fxjake.com/book forarealmarketexampleofhowthis concept may be appliedto live trades. If you can getinto the habit of playingdefense, you can become a

successfulprofessionaltrader.Learn to recognize theimportance of playingdefence. Without this youhavenochance.Traders who are unable to

protect their money havedifficulties with beliefs.These traders may believethey are unworthy of largeamountsofmoney.Theymayalsoconfuse theirbeliefwiththefacts.Beliefsmaybecome

facts, but traders deal withoddswhenitmattersmost.I may believe the

USD/CAD is headed downbecause the market prints abearish kangaroo tail on thedaily chart. I may decide torisk money based on mybeliefthattheUSD/CADwillstart trading lower soon.However, thisdoesnotmakemybelieffact.Imustwaitforthemarkettotellmewhether

mybelief isgoing tobecomemarketfact.Ifthemarketinsteadbegins

totradehigherandhigherandhigher, I come to acrossroads. Perhaps I decideononeof thefollowingthreecourses of action: (1) I maydecide to dump the tradebecausemybeliefseemstobeincorrect.(2)Imaydecidetomovemystop losshigher, togive the trade a little more

breathing room because Iknow the market willeventually fall. (3) I mayeven decide to walk awayfrommycomputer, to let themarket decide whether mybeliefiscorrect,knowingthateither my stop loss or myprofit targetwill be hit. Twoof these reactions (1 and 3)are acceptable means ofdealingwithmybelief,basedonthecurrentmarketactivity.

The other reaction, 2, isdetrimental to my tradingaccount. I have decided torewrite my trading plan(initial stop loss moved, thetradenowhasmorerisk thanoriginally planned for), and Ihavedecidedthatmybeliefismarket fact, even when themarket provides informationtothecontrary.Think about that. The

markethastoldmethatafair

price is higher, not lower. Ithink the market is headedlower.Thisismybeliefbasedonthedailybearishkangarootail. However, the markettrades higher. I ignore themarket information, themarket freely provides mewith information about theUSD/CAD (the fair marketprice is higher), and I decidetoassumetheoppositeisfact.The market goes up and I

decidethemarketiswrong.Whodoyouthinkwillwin

thisbattleofwits?WillIwinorwillthemarketwin?Remember to keep your

beliefs in perspective. Thereare no beliefs worth morethan your entire tradingaccount. You work hard foryour money, so defend it.Throw away your beliefswhen the market tells youtheyare incorrect.Keepyour

moneyinstead.There are many other

beliefs that stand in the wayof trading success. Perhapsyou are familiar with theseriskyideas,suchastheI-will-make-it-big-once-I-get-a-big-accountidea.

YouNeedMoreScreenTime

At times it may seem as

though you do not have thetime to trade. Among thedaily commitments of work,family,andhobbies,itcanbedifficulttofindtimetotrade.Those missed opportunitiescan be awful. Simplywatching the market marchon without you can be moredifficult todealwiththanthestandard-issuelosingtrade.Maybe more time in front

of the computer will mean

more profits? Maybe youthink that trading shorter-timeframe charts mightmultiply your tradingopportunities and accelerateyour equity curve? Perhapsthisistrue;ifyouareabletotrade the shorter timeframesyou may find moreopportunities, if you are abletoschedulemorescreentime,more time in front of yourcharts.

Please beware that “I needmorescreen time to trade” isnot an excuse for avoidingback-testing. All of yoursystemsshouldbevettedwithback-testing results, forward-testing results, and thesmallerlive-tradingaccount.Most traders will use this

excuse to create a case forleaving a job, and thisthinking isadangerousplaceto be. Many traders are not

quite ready to start tradingfull-time, but they think thatby leaving their full-timepermanent jobs, the addedscreen time will push themover the top and make iteasier for them to achievetradingsuccess.Sadly, thisisoftennottrue.

YourJobIsHoldingYouBack

Related to the I-need-more-screen-timetrapistheI-gotta-dump-my-job trap. Tradersfantasize that more time,specificallymorescreentime,will help them to achieveconsistent profits. A littlemore focus will bring theresultstheyarelookingforintheirtrading.This seems logical, but it

rarelyworks.Puttingyourselfin a situation in which you

need to make moneyconsistently from yourtrading account, before youhave learned how toconsistently make moneyfrom your trading, is a badidea.Youwouldnotexpectastuttering game showcontestant tobeable to rattleoff quiz answers with thepressure of the clock tickingdown, would you? This iswhyitmakessenseforyouto

takethepropersteps,startingwith back testing, moving toforward testing, then on tosmall account trading, beforeyou ever begin trading for aliving, trading your largetradingaccount.Unrealistic expectations

may also affect your trading.It may be tempting tobackward engineer yourtrading profits. Perhaps youdecide to trade the daily

charts,andyouwouldliketomake $15,000 per monthfrom your trading. Youdecidethatyouneedtomake500 pips each month andtradefor$30perpip.$30perpip × 500 pips = $15,000;simple math provides youwithyourtradinggoal.What if your trading

account contains only$35,000?Youmayhavetobevery careful. If you are

trading at $30 per pip andyour stop loss is 100 pipsaway from your entry price(certainly possible with adaily chart trade), you arerisking$3,000onyour trade,that is 8.5 percent of yourtradingaccountatrisk.Threelosingtradessuchasthisoneandyouwouldbedownover30 percent on your tradingaccount. This is why manytraders have a difficult time

making the jump from part-time to full-time trader, yournice-to-have-profits turn intomust-haveprofits;thefocusison the money and not thetradingresults.Thinking about trading in

terms of money is preciselywhy many part-time traderswant to leave their full-timejobs. It is also the reasonmany part-time traders findconsistentlyprofitabletrading

so elusive once they leavetheir jobs. Remember toconcentrate on your trading,executeeachtradeasbestyoucan.Themoneywill come ifyouconcentrateonbecomingabettertrader.

YouNeedaBiggerAccount

Some traders insist onholding to the idea that only

larger trading accounts willallowforsuccess.Theideaisthat thegiant tradingaccountin the sky will bring somesort of nirvana.Unfortunately, for many ofthe reasons listed earlier inthischapter(namely,attitudestoward money and wealthypeople), the opposite isactuallytrue.The great majority of

traders around the world do

much better trading whenplacing trades in very smallaccounts. Once traders moveuptolargeraccounts,inmostcircumstances these tradersend up thinking too muchaboutthemoneyandtoolittleabout managing tradesaccording to their systemrules.It is possible to do

exceptionally well, even ifyoustartoffwithaverysmall

trading account. The focusshould be on trading yoursystem.Youreffortshouldbeplaced on executing andmanaging your trades asclosely as possible to therules of your system. If youmoveawayfromtradingyoursystem and instead focus onthe dollar amounts, you willlikely see your performancesuffer.Ifyouhaveissueswithmoney and wealthy people,

you are sure to see yourperformancesuffer.Theideathatalargetrading

accountwillhelpyouachieveyour financial goals may becomforting, but until youhave been able tosuccessfully manage yoursmaller trading account, anduntil you deal with yourbeliefs about wealthy peopleand money, trading a largetradingaccountwillprobably

belittlemorethanfrustrating.Large is, of course, a

relative word. For sometradersalargeaccountwouldbeanaccountof$10,000,andfor other traders an accountsize of $150,000 is small.Thinkaboutthis:theideathata few traders may see anaccount and think that it isvery small and other tradersmayseethesameaccountandthink that it is a very large

account.The fact that traderscan view the same accountvery differently is moreevidence for the idea thattraders’ attitudes and beliefstowardmoneywilldrasticallyeffecthowwell tradersmakemoney and sound tradingdecisions.So if you find yourself

thinking, “I need a biggertrading account so I willreally be able to make some

serious money,” make surethat you are making seriousmoney with your smalleraccounts first. A largeraccount may simply maketrading more difficult if youare not prepared for thechallenge.

ThinkingThatTradingIsEasy

Maybe you think that

consistentlyprofitabletradingis easy. Perhaps you havescrolled back on some chartsand identified the wonderfulopportunities staring back atyou.Theseopportunitiesmaycomeintheformofkangarootails and big shadows atmarket turning points, thoseplaces where the marketoffers a clue aboutwhatwillhappen next. You maybecome confident that

successful trading can beyours. Maybe you begin tothink that profitable tradingcanbeeasy.Be careful of this

overconfidence that oftenappears as the successful-trading-is-easy idea. Tradingsuccessfully can be simple,but that does not make iteasy. Trading successfullywillmeanputting in the timeback testing your system,

developing a trading plan tocover all of the what-ifscenarios you can come upwith, and creating a methodfor overcoming the doldrumsof the inevitable drawdowns.Planningiscriticalforyoutosucceed in the long term,butit is not the only ingredientforsuccess.Tosucceedyouwillneeda

healthy dose ofdetermination. History is

litteredwithstoriesoffamouspeople who overcameadversity, people whoaccepted success becausefailure was not an option.Determinationisthecommonthread among these stories.WaltDisney took threeyears(double the anticipated 18months) to produce a moviethatwentoverbudgetby400percent.Allthewhile,peoplesurrounding him questioned

whether his full-lengthcartoon movie would haveany mass appeal. The moviewasanoverwhelmingsuccess—you may have heard ofSnow White. Another manhad an altogether differentlife experience. His motherdied when he was nine. Hisfriend lenthimmoney to runabusiness,andayearlaterhelost the business and wentbankrupt. He ran for public

office on five occasions andlosteachtime.Theloveofhislife died before he couldmarry her. He suffered anervous breakdown. Hissecond son died at a youngage. You may know him asAbraham Lincoln, thesixteenth president of theUnited States. Anotherfamouspersonbeganlifeasachild in a poor household.She was the result of a one-

night stand. Her motherworkedasamaid.Herfatherwas in themilitarywhen shewas born. As a young child,she lived with hergrandmotherinpoverty,oftenwearing dresses made ofpotato sacks. She wassexually abused by hercousin, her uncle, and afamilyfriendfromtheageofnine. She ran away fromhome, became pregnant, and

her child died soon after hisbirth. Despite this dubiousstart in life, Oprah Winfreybecame a millionaire at age32 and is considered therichest woman inentertainment. She has actedin movies, co-authored fivebooks, and inspires millionswho watch her televisionshows and read hermagazines.Each of these people share

one thing in common:determination. You simplymust have determination tosucceed in trading (or anyother endeavor). Allsuccessful people sharedetermination. Yourdetermination will guide youto trading expertise in theformofallthehoursspentinfront of charts, back-testing.Yourdeterminationwillyieldresourcefulness when it is

needed most, duringdrawdowns and when yourconfidence is shaken. Yourdetermination will help aidyou to see your successbefore it appears.Determination isyour ride tosuccess. Let it carry you towhereyouwanttobe.Youknowwhattodonow.

The question remains: Areyoudeterminedtosucceedasanakedtrader?

AbouttheTradingSoftware

andVideoTutorial

In order to improve yourtrading, a special members’area is available on the webto supplement the concepts

laid out in this book.At thisspecial link you'll findinteractive tutorials and aFREE software tool,including:

Support andResistanceInteractive VideoTutorial: Gainconfidence whentrading withSupport/Resistancebyimplementingmy

proprietary rules aslaid out in thistutorial.Big ShadowInteractiveTutorial: Masterthe step-by-steprules to trading myfavorite andsimplest yet mostsuccessful strategyby watching thisinteractivetutorial.

Support andResistanceSoftware: Tradeside by side withme, using thiscutting-edgesoftware that sendsmy S&R lines rightto your tradingcharts,inrealtime.

Go towww.fxjake.com/book tocreate an account and access

the FREE Naked Tradingmembers’areatoday!

AbouttheAuthors

AlexNekritinAlex Nekritin has been aprofessional trader for morethan 10 years and is thefounder and president ofTradersChoiceFX.com.TradersChoiceFX is a forex-

introducing brokerage firmthat is able to enhance itsclients' forex trading successbymatchingthemupwiththebestfitforexdealerforthem.Alex's specialties include

riskmanagement and systemdevelopment.Hehasadegreewith a concentration ininvestment banking andderivative instruments fromBabson College inMassachusetts.

WalterPeters,PhDBefore becoming aprofessional trader, WalterPeters worked as a clown,magician, online marketresearcher, and juryconsultant. Dr. Peters has aPhD in experimentalpsychology and an extensivebackgroundinstatistics.Asanakedforextrader,Dr.

Peters enjoys trading simple

trading systems. He has akeen interest in tradingpsychology and how tradingbeliefs yield trading results.He trades with forex tradersaround the world on hiswebsite www.fxjake.com aplacefornakedtraders.Whenhe is not trading, Dr. Petersenjoys spending time in theocean and talking abouttrading.

Index

Action(cycleofdoomphase)AustralianDollar(AUD)four-hour wammie trade,triggeringline chart, price actionclarityone-hourtrendykangaroo

stoplosstrade,survival

reversalsRSIbuysignalRSIsellsignaltrade,stoplossplacementtrendykangarootradeweekly chart, kangaroo tail(printing)zones, pip distancedifference

Australian Dollar (AUD)dailychartbearishbigbelt

bearishbigshadowstoplossplacementthree-barexittrade, stop lossplacement

bearish big shadow, stoplossplacementbearishcandlestickbearish kangaroo tail,printingbearishtrendykangarootail,characteristics

candlestickfake-outkangarootailtrendykangaroo

appearancecandlestick,consolidationrange

uptrend,marketpausewammietrade

Australian Dollar (AUD)four-hourchartbearishkangarootail

bullishkangarootailprofittargetplacement

kangarootail,lengthwammie,printing

AustralianDollar(AUD)one-hourchartbearishkangarootail

printingcandlestickthree-barexit,applicationtrades, three-bar exit stoploss

trendy kangaroo trade,three-barexit(application)

Automatedback-testingadvantagedisadvantagesdiscretionary traderavoidanceForextraderavoidancepostdictiveerror

Back-testing, See alsoAutomated back-testing;Manualback-testing

advicedata,usefulnessdefinitionForextestergoalsmistakes,acceptancesoftware,usagestyle,considerationtime,usageusage

BadmarkettheoryBad-markettraders

fundamentalanalysis,usageterrible-system traders,contrast

Bad-markettraders,approachBankofJapan,interventionBank traders, risk manager(presence)BarchartBearishbigbeltcandlestickprintingcharacteristicsoccurrence

openingpriceprofittargetsellstop,placementstoploss

placementtradeset-up

Bearishbigshadowexamplesroomtotheleftset-ups, bearish big shadowcandlestick(importance)stoplossplacement

BearishbreakoutsBearishcandlestickBearishkangarootailscandlestickrangeclose,rangefailureopen/closeprinting

Bearishlast-kisstradesBearishtrendykangaroocharacteristicstail,characteristics

tradesBigbeltbearishbigbeltdefinitiontrading,advicezoneprinting

Bigshadowsappearancebearishbigshadowbullishbigshadowcandlestick,successprofit

rangerulestrade,entry

Blame(cycleofdoomphase)Bolour,AshkanBreakoutsfailurestrategytrading

Breakouttradeconceptexample

fake-out,relationshipBullishbelt,stoplosspositionBullishbigbeltadvantagecandlestick,printingcharacteristicsentrypriceopeningpricerewardtoriskratio

Bullishbigshadowscandlestickclosingprices

trade,buystopentryBullishcandlestickBullishkangarootailslengthopen/close, candlestickpositionproblemtail,shortnesstrade

entrytriggering

Bullish last-kiss trades, buy

stopplacementBullish trendy kangaroocharacteristicsBullish trendy kangaroocandlestickBullishtrendykangarootailsBuystopentryBuystopplacement

CanadianDollar(CAD)one-hour chart, bullish bigshadowresistance

presencesupport,presence

CanadianDollar(CAD)dailychartbearishbigshadowbearish last-kiss trades, sellstopplacementbullishbigbelt

entrypricebullishkangarootailbullish trendy kangaroo,stoplossplacement

double-bottom formation,creationdowntrendsupport/resistancezonetrendy kangaroo,appearance

CanadianDollar(CAD)four-hourchartdouble-top formation,printinglast-kiss trade, emergencystoploss

calculationCandlestick. See Kangarootailbearishkangarootailchartclosuredefinitiongiant candlesticks,avoidanceone-hour candlestick,supportprinting

stoplossplacementrestrictionstoplossplacementsuccessiontrades,stoploss(usage)

Catalystsdecisionkangarootail,relationship

CHF.SeeSwissFrancChoppy market, tradingsystemexploitationClosingprices

connection, line chart(usage)Europeantraders,reactionimportance

Cofnas,AbeCognitivepsychologyConfidence. See Self-confidencegainingissues,originmeaningpractice,comparison

regainingrelaxation,impact

Consolidationphasezone

exampleidentification

Countries, Forex traderpurchases/salesCurrenciescodelesson

listCurrentmarketpriceCycleofdoomactionphaseblamephasedefeatfamiliarityphasesrelationshipsearchphase

Decision-making process,verbalization(difficulty)

Demonstration account(demoaccount),definitionDiscipline,problemsDiscretionary traders,automated back-testingdiscouragementDiscretionary tradingsystems,traderusageDouble-bottomformationscreationdefinitionexample

indicationproblemreversalformationswammie formation,relationship

Double-topformationscreationmoolah,relationshiptrading

Downtrend, trendy kangarooappearanceDrawdowns

extensionDriftingmarketphase, price actioncontainment

Emergency stop loss,calculationEmotionaltradingEntryprice,markettradesEntrysignals,mistimingEURchartminorzone,clarityzones, pip distance

differenceEUR currency, purchasedecisionEURdailychartbearishbigshadowbearish kangaroo tail,printingbullishbigbelt

entrypricedeclinedouble-bottomformationfake-outs

kangarootail,uptrendlastkiss

trade,signaltrending

MACDbuysignalsupport/resistance zone,exampleszone,importance

EURfour-hourchartbearish big shadow, profittargetconsolidationphase

minorzone,presencetransitiontrendingphase,increasezone,identification

EURone-hourchartbearishbigshadowbuysignalnakedbuysignal,stochasticbuysignal(contrast)

EURresistancepresence

EURsupport

presenceEUR trades, MACD buysignalEURweeklychartbearishbigshadowbullishbigbeltbullishkangarootailkangarootail,printing

EURzone,clarityExit. See Ladder exit; Splitexit;Three-barexit;Zonesmanagement

signal,triggerstrategies

Expertise,acquisition/statusExpertsback-testingbecoming,stepscatalysts,decisioncomfortzoneforwardtestliveaccounts,tradingsecretsmallaccounts,trading

statustricks

Experttrading

Fake-outbreakouttrade,relationshipfour-hourchartexamplekiss,relationship

First touch, low (wammietradeplacement)Foreignexchange(Forex)back-testingcycle

machinemarket

interbank market,contrasttraders/players

trades,toolstrading

fundamentalsplatforms,usageprofit

Foreign exchange (Forex)traders

automated back-testingavoidanceeffort,expertstatusindicator-basedapproachpurchase/salerole

Forex Tester, manual back-testingsoftwareForwardtestFundamentalanalysis,usageFundamental indicators,technicalindicators(contrast)

Giantcandlesticks,avoidance

GreatBritainPound(GBP)one-hourtrendykangaroo

stoplosstrade,survival

trendy kangaroo trade, stoploss

Great Britain Pound (GBP)dailychartbearishbigbelt

sellstop,placementbearishbigshadowbullishbigshadow

double-bottomformationindication

last-kisstradewammietradeset-upzoneidentification

Great Britain Pound (GBP)four-hourchartbearishbigbeltbigshadowbullishkangarootailbullish trendy kangaroocandlestick

downtrendmarketrecovery

Great Britain Pound (GBP)one-hourchartcandlestickkangarootail,printingthree-barexittrades, three-bar exit stoplosstrendy kangaroo trade,three-barexitapplicationzoneassumption

Great Britain Pound (GBP)weeklychartbearishbigshadow,roomtotheleftbullishkangarootaillast-kisstrade

Gunnersexits

HighwinrateHindsightbiasdefinitionimpact

Indicator-based trader,advantagesIndicator-based tradingsystemsIndicatorscreation,pricedata(usage)definitionimprovementlag,definitionpricedatabasisslowness

Information, interpretation

processInterbank market, Forexmarket(contrast)

JapaneseYen(JPY)chart,minorzone(clarity)line chart, price actionclarityone-hourchart

bearishbigshadowbearishkangarootailbullishbigshadow

reversals

trade,stoplossplacementweekly chart, bearish bigshadow(roomtotheleft)

Japanese Yen (JPY) dailychartbearishbigshadow

stoplossplacementthree-barexittrade, stop lossplacement

bearish last-kiss trades, sellstopplacement

bearishtrendykangarootail,characteristicsbullishcandlestickcandlestickmoolahtradetrendy kangaroos,candlestick (consolidationrange)wammietrade

Japanese Yen (JPY) four-hourchartbullishkangarootail

consolidationzonedriftingmarket phase, priceactioncontainmentlast-kiss trade, emergencystoploss

calculationminorzone,presencezone,identification

Kangarootailadvicebearishkangarootails

open/close

printingbullishkangarootails

candlestickpositionlengthproblemtail,shortness

candlestickcatalystclosedefinitionexampleexitstrategy

failureformationlength

importancemarketbehavioropenplacementprinting,examplesprofittargetsretailForextradingshortness,problemsingle candlestick

formationsstoploss

placementtradinguptrendzonepenetration

Ladderexitfunctionstoploss,placementusage,patience

Lastkissconcept

markettrendingtrading

Last-kisstradesbearishlast-kisstradesbullish last-kiss trades, buystopplacementemergencystoploss

calculationplacement

profit,findingsignaltriggering,absence

Learningcurve(acceleration),back-testing(usage)Lien,KathyLinechartclosingprices,connectionusage,SeealsoZones.usefulness

Liveaccounts,tradingLong-tailed kangaroo tail,marketprintingLosing,reasonsLosingtrades,impact

Lotterywinnings,auctioning

MACD.SeeMovingAverageConvergenceDivergenceManualback-testingavoidanceexperience,accumulationlabor/timesoftware

problemsusage

Marketbuying/sellingexperience

consolidation,anticipationhistory,involvementinformation,usagemoodsscars,zones(comparison)specialist,definingtheory,badmarkettheorytrading,level(increase)turnaround

assumptiondoublebottom,initiation

turningpoint,capture

Marketbiofeedbackdefinitiondomainslearningoccurrencerecordation,issues

Maximumdrawdownexperience

Meta Trader™, F12 keyusageMillionaire Traders(Lien/Schlossberg)

Minorzonesavoidanceclaritydefinitionpresence

Moneytraps,risk

Money,attitudesMoolahsadvicecharacteristicsdoubletop,relationship

identificationtrade

characteristicstradingprocess

Moving AverageConvergence Divergence(MACD)appearancebuysignals,exampleslagmovingaverages,increasesignals

trader,profit

Naked buy signal, stochasticbuysignal(contrast)NakedForex,definitionNakedtradersadvantageexpertiseprofittrades,marketmovementszones,importance

Nakedtradingmarkethistoryinvolvement

set-upssignal,processstrategies

adoptionimpact

NewZealandDollar(NZD)chart,zonecontactdailychart

bearishcandlestickbearish kangaroo tail,printing

New Zealand Dollar (NZD)

four-hourchartbearishkangarootailcandlestick, bearishkangarootailprices,choppinesszone,clarity

One-hourcandlestick,supportOversold stochastic, buysignal

Personalbeliefs,tradinggoals(alignment)

Pipsdefinitiondistance,difference

Playingdefense,importancePostdictiveerrorPractice, confidence(comparison)Priceimpactimportance

PriceactionsignalPricedata

change,indicators(impact)metric

ProfitmanagementProfittargetsplacement

Range,definitionRelativeStrengthIndex(RSI)buysignal,exampleindicator

lagusage

sellsignal,example

Resistanceline,conceptResistancezonesEUR/CAD daily chart,examplesidentificationmarket,relationshipprice,relationship

RestingspotsRetail Forex traders, riskmanager(absence)Retouchdefinition

principle,basistrading

Retracements,tradeentryRetrading,problemReversalsexampleset-ups,tradingsignal,printing

Riskappetitemanagers

absence

presenceprofilerules

Riskmanagementcontrolsissuesproblems

Roomtotheleftexamples

RSI. See Relative StrengthIndexRunners

exits

Schlossberg,BorisSearch(cycleofdoomphase)Secondary thinking,encouragementSelf-confidenceSellstopplacementSingle candlestick formation,definitionSleepingpoint,definitionSmallaccounts,tradingSmall-tailed kangaroo tail,

downtrendSpecialty,back-testingSplitexitexecutionpatienceprofitusage

Spreadsheets,usefulnessStochastic buy signal, nakedbuysignal(contrast)StochasticmovementStoploss

highlevelmanagementplacement

AUD/JPYtradecandlestick,printingthree-barexit,usage

positiontriggering, candlestick(usage)wammietrade

Success,reasonsSupportline,concept

SupportzonesEUR/CAD daily chart,examplesidentificationmarket,relationshippips,additionprice,relationship

SwissFranc(CHF)monthly chart, bullishkangarootailone-hour chart, trendykangaroo tail (market

decline)supportweekly chart, bullish belt(stoplossposition)zonecontact

Swiss Franc (CHF) dailychartbullishbigshadow

trade,buystopentrydoublebottom,indicationzoneidentificationzonepresence

SwissFranc(CHF)four-hourchartbearishkangarootail,failurebreakouttradebullish trendy kangaroocandlestickdouble-top formation,creationdowntrendfake-outtouches

Technical Forex traders,

technicalindicatorusageTechnicalindicatorsdefinitionfundamental indicators,contrast

Terrible-systemtradersbad-markettrader,contrastblame

Three-barexitapplicationcandlesticks,printingstop loss (triggering),

candlestick(usage)successusage

Timeframecharts,usage

adjustmentinitiation

selectiontrading

TouchesTradersapproaches

back-testingblameexpectationsexpertiseexpertstatus,effortForexbrokerdivisionsjob,impositionlosingstreaks

reasonslossesmarketbiofeedback,usageroutine,rewards

screentime,increasesuccess,reasonswinning/losing,reasons

Tradescorrelationdecisions,basisentryexecutionexit

profitgunnersinitiation

loss,responsibilitymanagementmarketmovementbasisrunnerssignal

drawdown, naked traderavoidance

specialist,definingstagestools

Trading. See Emotionaltrading

accountlevelprotection,absencesize,increase

beliefscomputers,usageconsistencyeaseexpertisegoals, personal beliefs(alignment)habits

journal,creationlifestylepatterns (determination),back-testingdata(usage)personality,knowledgeplayingfield,selectionpractice,importanceproblems,avoidancepsychologyreasonsresponsibilitiesroutine,rewards

screentime,increasestatement,evaluationstyle,considerationsubjectivitytolerance

definitionencouragement

tricksvideojournal,setupwinning/losing,reasons

Tradingsystemapplication,traderapproach

back-testingchangeconfidencecreationdefiningdiscipline,problemsduplicationfitnesslifestyle,impactmakeup,impactquestionrules

suitabilitytestingtrustwinrate

TrailingexitsTransitionexampleidentification

TrendindicatorsTrendingmarkettradingsystemexploitation

Trendingphase,increase

Trendykangaroocandlestick,appearancecharacteristicsconsolidationrangedailychartappearancemanagementone-hour trendy kangaroo,stoplosspriceactionset-uptail,printingtrade,stoploss

tradingset-up,characteristic

traps,avoidanceTurningpointsTwo-candlestick big-shadowformationTwo-candlestickformationdefinition

Two-candlestick reversalformation

Uptrends,marketpauseU.S.Dollar(USD)

currency,purchasedecisionfour-hour wammie trade,triggeringmonthly chart, bullishkangarootailRSIbuysignalRSIsellsignalsupport

declinetrades,MACDbuysignalzone,clarity

U.S.Dollar(USD)dailychart

bearishbigbeltprofittargetsellstop,placement

bearish kangaroo tail,printingbullish big-shadow trade,buystopentrybullishcandlestickbullishkangarootailbullish trendy kangaroo,stoplossplacementdecline

double-bottom formation,creationdowntrendfake-outkangarootail

uptrendlastkiss,markettrendingMACDbuysignalmoolahtradetrendykangaroo

appearancecandlestick,appearance

uptrend,marketpausewammietradeset-upzone

importancepresence

U.S. Dollar (USD) four-hourchartbearishbigbeltbearish big shadow, profittargetbearishkangarootail,failurebigshadow

breakouttradebullish kangaroo tail, profittargetplacementcandlestick, bearishkangarootailconsolidationphaseconsolidationzonedouble-topformation

creationprinting

driftingmarket phase, priceactioncontainment

fake-outkangarootailmarketrecoveryprice,choppinesstouchestransitiontrendingphase,increasewammie,printingzone,clarity

U.S. Dollar (USD) one-hourchartbearishkangarootail

buysignalkangarootail,printingnakedbuysignal,stochasticbuysignal(contrast)trendykangarootail,marketdeclinezoneassumption

U.S. Dollar (USD) weeklychartbearishbigshadowbullish belt, stop lossposition

bullishbigbeltkangarootail,printinglast-kisstrade

Videojournal,setup

Wammiesadvicecharacteristicsentrystrategyformation, double bottom(relationship)identification

printingtradingprocess

Wammietradecharacteristicsprofitset-upstoplosstriggeringzone,touching

Winning,reasonsWorldcurrencies,listWorst-caseplanning

Zones. See Minor zones;Resistance zones; Supportzonesagecharacteristicsclaritydiscoveryadvicediscoveryprocess

linechart,usageshortcut

exitpatience

identificationdifficultylinechart,usage

importancemarket

approachscars,comparison

misconceptionsobviousness,absenceprice

impactrespect,absence

scattering