+1 Risk/Money Management Technique

August 4, 2008 at 8:41 am Leave a comment

By FX Insights

+1 Risk/Money Management Technique

This post is going to explain what the +1 risk management technique is, why I use it, how it works, and specifically how I use it to manage risk, manage my money, and prevent my trades from going into drawdown and sucking the life out of my equity and usable margin. 

The +1 technique means this – it’s placing a take-profit limit on a trade or several trades that have a much higher probability and potential of going against me… trades that are contrarian to what the market is showing me it wants to do… trades that could easily go into 100 or more pips of drawdown… trades that are counter to what all of my indicators are telling me. 

The +1 take-profit order simply closes out a trade if the market moves against that trade. The trade gets closed out for 1 pip and my margin and equity is protected from drawdown. 

Take-profit limit – this is what I call an order that I place on my trade station to automatically close out a trade at an exact price point. Some people call these stops or stop orders. I don’t like to use the term stop because it carries a negative connotation. Other people simply call them limit orders. I call it a take-profit limit because that’s how I see it in my mind and that’s what it does, it takes profit. 

Now, I’m going to explain the rest of how this works and what the parameters are in a FAQ style because these are the most common questions I get…

Why do you use this +1 limit if you really don’t care about drawdowns?

Generally, I could careless about drawdowns. When I have a trade that goes into drawdown that is in the direction of where I know the market wants to go, it makes no difference to me. For example, if I’m forecasting the EUR/USD to go up and to continue an upward directional move in the near-term and I take a euro long that goes into drawdown, it doesn’t matter because I know where the market is going and I know it’s just a matter of time before my negative entry turns into a positive entry, so it’s no worries. 

I almost never use the +1 on a trade that is taken with the prevailing trend of the market. Again, if I think the euro’s going up and I take a long, I’m not going to put the +1 limit on it. There’s only one case where I will use this on a trade taken with the prevailing trend – if I am forecasting the euro to go up in the near-term but I see something within the real-time price action to indicate we may see some temporary drawdown, and I take a long, I may use the +1 to close me out but only so I can buy again at a lower level. In that case, yes, I will use the +1 so that I can simply enhance my entries for better ROI. 

When do you most often use the +1 technique?

I most often will use the +1 limit-order technique when I take a trade that is in direct opposition to everything I see in the market. If the fundamentals and the market correlated variables and the price action is telling me to go long on the EUR/USD and I decide to add a euro short, there’s a good chance I’m going to throw on the +1. 

For example: if gold and oil are moving up, the USD fundamentals are all negative, the price action is showing momentum to move the euro up, and my overall bias is to be euro long, yet I decide to take a short, I’m likely going to use the +1 on that euro short. Plus, if I’m biased euro long and I know the tech traders are shorting and I discover where their stoplosses are set at, 100% of the time I’m using the +1 technique. 

Why do you take trades that go against your market analysis and forecasting?

First of all, the EUR/USD does not move in a straight line. If my general bias and forecasting says that I should be euro long and we make a 220+ pip move in a trade day, I’m taking a short. Yes, that trade is counter what my forecasting tells me, but I also know the patterns of the EUR/USD and based on those predictable patterns, the smart trade is a short, not a long because taking a long after a 220+ pip would be a really dumb trade and a trade taken at the top of a range. 

One of the main reasons I take trades counter to what the market is telling me is because I want to take a trade on a position basis or a swing basis. For example, I’m net euro long and my market forecasting is telling me to stay euro long and the price action is telling me we have a greater probability of continuing to move up. Let’s say the EUR/USD has moved up 1200 pips over a 3-week trade period, so I decide to add a EUR/USD short. 

That would be a position trade, a short taken on a swing basis. It’s not a hedge, it’s simply a position trade. The trade gives me a position in the market and should the market want to top out after making an extended 1200 pip move, I’ve got a short in and can ride that short down during the time of correction. 

In this scenario I may use the +1 or I may not and simply let the trade go into drawdown or even take a loss on it and re-short at a higher price level. If I take a position trade or a swing trade what dictates whether or not I use the +1 largely rest with the real-time factors in the market, mainly whatever the price action is telling me. 

Again, let me be clear, hedging and position trading are two totally different things and two totally different concepts of trading. I do not hedge and do not ever recommend anyone to hedge. Hedging is an exact science, and no offense, but it’s an exact science most retail traders never get the grasp of and will cause a margin call. 

In the past I’ve hedged but only out of necessity because I’ve overleveraged or overtraded an account and my hedges were pure protection measures. This is a situation you never want to get yourself in because you then have to trade your account like a skilled surgeon performing a life-threatening operation on a dying patient. 

If you don’t over leverage your account and you learn how to use the +1 technique on trades that have a higher degree of falling into drawdown, you will never need to hedge your account… very simple. 

And now for the biggest question…

Exactly when do you put on the +1?

As soon as you take a position in this market obviously you automatically go into drawdown until your trade at least moves to cover the spread. This might sound like a no-brainer, but let me be clear – I do not put on the +1 as soon as I take the trade. That would just be stupid. 

Typically, under most circumstances, I wait for the trade to go 10 or more pips in the positive before I put on the +1. If the trade never goes into the positive but stays in drawdown, at that point I either have to decide to ride it out or determine how much I want to give back to the market and cut my loss. 

The reason why I wait for the trade to go 10 pips into the positive is because if I took a euro short, which was counterintuitive to what the market was telling me, and we jump down 10 pips, which would put me in the positive by 10 pips, that jump down could just be the markets natural reactionary drop to more euro longs being taken. 

So, my euro short is up by 10 pips, I put on the +1 take-profit limit, and then the market starts moving back up, it hits my limit and keeps going, I get closed out, I make a pip, and I’m not stuck with a negative entry… very easy. 

What do you consider when trying to decide whether or not to put on the +1?

Really, the exact same factors are always considered whenever I take any trades… what is the price action telling me? How many pips have we moved today, this week, and the past 3-4 weeks… what is gold and oil doing? How have the fundamentals been printing? What kind of momentum is the price action showing based on how much liquidity is in the market? All of things we talk about every day in the chat and in the daily updates… 

Some traders will laugh at this technique… they will mock and ignorantly think that I’m “only making a pip on a trade, big deal…” That’s fine, I really don’t care. They are missing the point of this style of trading, which is to protect my account from unneeded drawdowns and from the market sucking up my usable margin and equity. 

Again, this +1 is more of an exact science and will take some fine-tuning if you are new to using it. Now, this technique will never work for you if you don’t have the ability to do some basic market forecasting and you can’t get a nominal read on where the market is going. If you have no clue what the market’s doing or what it might do, using this technique will just keep closing you out of trades that would likely be profitable. And then you’ll blame me for constantly stopping you out… I’m already prepped for the hate mail… 

But, if you have even a halfway decent ability at reading the price action and you are more fundamental in your approach to seeing the market, I really believe this is a great tool that can be used to protect your account and protect your money. 

If this doesn’t make sense to you, read this post 50 times if you have to. I’ve explained it to the best of my ability, but of course, questions are certainly welcomed. If your stuck on something or you need more clarification, please let me know. 

-FX Insights

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