As the result of the poll in our Telegram Channel showed, with 65% of the answers, traders worry about those errors which are stopping us from being more profitable. This is our top 5 list and how to avoid them.
ERROR #1: TRADING CORRELATED INSTRUMENTS.
If you have already spent some time reading the markets, or you are in our free Telegram channel, you may have realized by now, that correlations can be used in our everyday trading.
This is a double edge sword that allows us to diversify and protect our trades. Yet those correlations are, at the same time, very dangerous for those who don’t apply that knowledge to their advantage.
What is correlation?
According to Investopedia, correlation is a statistical term describing the degree to which two variables move in coordination with one another.
In our field, correlation means that two different currency pairs, indices, commodities… move in the same direction (posivite correlation) or in the opposite direction (negative correlation).
In the Advanced Technical Analysis course, correlations are very important to understand how markets are moving. We hate complicated things, so we apply some basic truths. Here are some of them:
- In Forex, we consider these big groups of currencies:
- EUROPEANS: EUR, GBP, CHF (with exceptions).
- OCEANICS: AUD, NZD, CAD.
- AMERICAN: USD
- SAFE HAVEN: JPY, CHF.
- As you can see, we are not adding any exotic currencies (MXN, ZAR…), or those directly related to the main ones (SEK, NOK,…) They are dangerous for new traders, so I will avoid including them in this post.
- General Thermometer of the market is given by Risk ON-OFF tone at a certain moment.
- RISK ON: Oceanics show strength, traders are taking more risks investing on these currencies, which are directly related to Commodities (AUD-Iron, CAD- Oil, NZD- Milk). Very brief explanation, I know, but hope it makes sense.
- RISK OFF: Uncertainty and panic scare investors, who move their investments to safe assets like Gold, JPY, USD or CHF.
- Indices and DXY (dollar index) are also great tools to measure Risk tone. Basically, weak DXY (weak dollar) allows investors to buy cheaper stocks and S&P500, DowJones, Nasdaq… can move upwards. In times of uncertainty, money move our from Indices and Stock market to safer assets like Gold, or those currencies mentioned above.
We could continue much longer talking about correlations, but the reason of this post is to avoid trading correlated instruments in a wrong way.
Many traders believe that correlations will help them profit from the markets, by diversifying and reducing their risk. For this to be true, they should at least reduce their trade size accordingly. If someone will buy EURCAD, EURNZD and EURAUD, because market is alligning against Oceanics, no matters what is the trader’s normal trade size (for example 0.15), it needs to be split to keep the same risk. (0.05 x3).
Let me ask you something. Can you analyze those 3 charts and predict which one is the best to trade? This would save you from needing to check three charts instead of only one. Simplicity works, doing your homework, pay.
Needless to say, those trading negatively correlated pairs, like buying EURUSD and selling GBPUSD will struggle big time. This could be done only with a low spread broker, a right mindset and a lot of knowledge. Traders’ mind feel much more sadness of seeing -5% drawdown than happiness seeing +5% profit. That’s how our brain works.
We use these negative or positive correlations to lock our trades sometimes. You can find in our Telegram channel how we locked +700pips in AUDUSD sells with AUDJPY buys in the summer of 2021.
So, wrongly understood, correlations can lead traders to overtrade more than needed, and be overexposed in the markets.
If you understand that once you open a trade, it is your responsibility to manage it until the trade is closed, you will agree with me that the lower the number of open trades, the better for your account, your mind, your family and your health.
To resume, correlations are great. When you understand them, they help you make money and not to lose it. Here’s how we can this concept to our benefit:
- Identify how market is positioning, treating Europeans, Oceanics, Safe Havens and American currencies as a whole.
- Once you understand the general mood of the market, select those pairs that should move faster.
- Analyse those charts and mark levels or zones for Take Profit or possible reversals.
- Most of the times, correlated pairs will wait for the rest to get to their levels, before any significant move.
- As always, PATIENCE is a must, if you are in a hurry to trade a pair, and you are not using correlations to wait for the proper moment, you may be stopped out over and over until the rest of the pairs arrive to their zones. When the market finally moves, your account has already suffered a 2-3% loss and your mind tents to use wrong trade size (revenge trading) trying to recover from those wrong operations.
- Once all the pairs alligned, you can check the crosses to select your favourite trade. For example, if you see Oceanics are alligned to start a big move against the dollar, you have to analyze AUDCAD, AUDNZD, NZDCAD in the correct timeframe to choose which of the pairs will move faster: AUDUSD, USDCAD or NZDUSD. That’s applying correlations to your benefit!
This is just a quick explanation of how we avoid this #1 Error. Trading is never easy, we knew that. No job interviews, free schedule, work-from-home, in pyjamas… too good to be true. In fact, trading is one of the hardest jobs you can have. Requires study and sacrifrices. Once we master the right tools, the right mindset will just be the result of your hard work. Stay tuned next week for the next common Error #2 and how to avoid it.
Remember we are here to help, you can contact @Chusssss or @chuslaptop in Telegram for any doubt.
Our next edition of the ATA Course will start in July 2022, you can book your seat now by registering in the website, once the enrolment starts, we will send an email to inform you about it. We love privacy, so we will never share your email with any company, or spam you with emails. In fact, we don’t have any subscriber or newsletter option, so ensure to read our Telegram channel to be updated regarding new posts.
Thanks for all the support. Have a great Sunday!