This is an email I received yesterday. I thought it might be helpful to others too if I made an article out of the answers.
Question 1: How do we actually determine if it will be trending or just whipsaw?
Let me start by saying that there’s no way to know for sure at any time where the price is going and how exactly it will get there (whether it will be a straight 400 pips UP day or an entire month of back and forth movement to cover the same distance). If there was a way, then there would be no need for risk management. Traders would just wait for the ‘sure thing’ to come and then put their whole account into that long or short position. It is very important to understand that no matter what sophisticated statistics or analyses we use, we can’t predict the future. All we can do is to take calculated risks. If one can’t handle uncertainty, trading might not be the best option for him.
Hopefully having succeeded in getting readers in the right frame of mind – probabilities, not certainties – we will now revisit the question. I can only speak for myself on how I go about determining whether a trend is more likely to occur than a whipsaw. Please bear in mind that these are just general guidelines:
- On what time-frame does the setup appear ? The best chance for success is when a setup is visible on several time-frames (let’s say 15min, 1h, 4h) and is congruent with the price trend on higher time frames – in other words, if there’s a double-bottom on the 5min chart, but on the higher time-frames all you see are big red bars, I wouldn’t try to catch the falling knife.
- The more complex the setup is – for instance, a significant chart pattern comprised of several small ones that failed to materialize – the higher the chance the breakout will have a follow through.
- When does the breakout occur ? All things being equal, I prefer them to happen during the London session, or early Tokyo for yen pairs, when the liquidity is the deepest. If it takes much more money to move the price, then there’s a higher probability the move is authentic and not just noise.
- Are there any big news scheduled after the breakout ? (like NFP, Central Bank Rate statements) These events can really speed up a trend, and not only on a short-term basis.
Question 2: What would you suggest a part time trader do to become better at trading?
You mean besides reading my site ? Check out the books and videos I mentioned. I would suggest anyone to take trading seriously and don’t view it as a get-rich-quick scheme. Treat it like a business not a hobby – businesses pay you money, hobbies cost you money.
Question 3: How do you set your stops and take profits? Is it by looking at recent support and resistance?
I set a stop-loss in such a place that if the price gets there, it means the idea behind the trade is no longer valid. For instance, if I buy at support, and then the price smashes through it, I get out. See here, here or here for examples. I don’t set take profits. Why impose artificial limits on upside potential ? Every profitable trade closes either by hitting a trailing stop loss or when I consider that the risk/reward picture is no longer favorable.