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A Classic "Trade Off " Scenario

A Classic "Trade Off " Scenario

2011-07-05 22:27:00
Richard Krivo, Trading Instructor

In our Trading Room webinars we offer a variety of trading plans each week. One of our key rules in trading (if not THE key rule) is that we only want to take trades in the direction of the trend on the Daily chart as they will have the higher probability of success.

That being said, there are two ways represented on the 4 hour GBPCHF chart below to enter the trade in the direction of the trend: 1) on a break of support at the previous low; and, 2) as an indicator signals that momentum has shifted in the direction of the trend.

The inevitable question that is asked then is…which way is the best?

Take a look at the chart below for a visual…

A_Classic_Trade_Off_body_Picture_1.png, A Classic "Trade Off " Scenario

Either entry would be considered a technically valid entry. As far as which is the BEST one will depend on the perspective of the trader in question.

While a break below the previous low is a compelling reason to enter a short position, the placement of the stop above the previous high, can entail taking on a significant amount of risk.

On the other hand, when the RSI moves below 70 signaling that momentum has shifted to the downside on a pair that is in a downtrend on the Daily chart, that can be an equally compelling reason to short the pair. Also, with the stop placed above the previous high on this trade as well, we are taking on significantly less risk since our stop is closer to our entry.

So, in one instance (the break of support) we enter later with more risk but a greater probability of success. With the other, (the RSI breaking below 70) we enter earlier with less risk but with a lower probability of success. No pun intended, but the trader is definitely presented with a classic “trade off”.

Which strategy suits your trading style and personality the best? It is up to you…

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.