I fully embrace the philosophy of simplicity in trading as a mean to success and as a goal in my personal development. On the other hand I strongly believe that tactical trading decision are all but simple. The root of complexity in this realm, I believe, is in the nature of the homo sapiens  and there isnt any mechanical system, algorithm or top-notch newsletter that can help traders with that. Last week I presented here some setups that brought these concepts back to my desk and that is what I want to share with you today.

3 Classical Examples of Pattern Retest

Lets dive in and spend some words to review some nerve wrenching reversals on a few pairs that I have been trading lately. 1) In the last 2 weeks the EUR-AUD cross rate had a perfect retest of the Neckline of a 46-week Head and Shoulder. Both pattern and pattern retest were perfect examples of classical chart pattern action and reaction. 2) AUD-CHF offers a case similar to the one analyzed above and even if pattern completion was not so clear and decisive as the one of EUR-AUD so far both the formation and the retest of the Neckline played out nicely without negate the pattern. 3) GBP-AUD is the perfect  example of a frustrating price behavior for a chartist. First of all, this setup had a sloping Neckline and sloping Necklines always make entries and stop-loss placement difficult to be assessed. Secondly, the market had a reversal that put into doubt the correctness of the “Horizontal” Neckline, BUT not of the “Orthodox” Neckline. So one could have been wondering: what is the best trendline to follow, what could I have done?, if I would have done that. All this BS that in an ideal world should not even get close to a traders mind. If you have been following me over the past weeks (here and here ) you know what my strategy was and in which market I still hold positions (If you have not: Im still short EUR-AUD and long AUD-CHF, but I got stopped out from GPB-AUD).

There is nothing spectacular in this, you may say. But it is tough when the price action first completed a pattern, then reversed back, go behind the initial entry level and finally, suddenly, reverse again to its original direction. This is what I refer to as the boomerang effect. in the sense that a trader decides to risk all his profit and part of his bank-roll to purposely  allow a trade the maximum room to develop itself, but then the trade fails! So here are the questions that are likely to come to your mind in a rational tentative to improve your trading:

• How a drawdown of unrealized profits shall be handled?
• Shall a trader use trailing stops in order to protect unrealized profits?
• Shall a trader move its stop to B/E as the market advance toward its target (as I did in GBP-AUD) or shall he give to the market full room to develop a movement with the risk to get a boomerang effect?

Well, it depends (I told you that it is not simple!). It depends on your actual portfolio composition and on your money management strategy. Here is where at chart trader shall put in the back-sit its charts for a while a think exclusively as a money manager .

In general, in trading you have to find the right balance between returns and risk: once you have chosen your way to  analyze the market (with volume profile, classical pattern, EW, etc) then it all boils down to find and implement a trade-off between returns and drawdowns (risk). Money management alone cannot increase the absolute returns on your system. But It can optimize your risk-adjusted returns.

It is extremely important for a trader to do not improvise during the execution phase. A trader is more a composer than a jazz musician. There are two good reasons for that: firstly once you are in a trade you are more prone to bad decisions; secondly, you should be able to test you strategy and collect statistics on what it works and how it works. If you improvise or trade based on your instinct you cannot collect statistic (and, anyway, the sooner than the later you go broke!).

4 Money Management Ideas

Lets get back to the three markets we talk above and use them as example to see what are the tactical decision that a trader could have been taken to manage his money after he entered his positions. Again, we are talking about positions taken on completed patterns that are already in the green. Lets start our review from the money management concepts that potentially offer the higher absolute return:

1) Give the trade full room to develop up to the final target or back to the initial stop loss level. 

Provided that you are not over-leveraged, this is the method that, based on my experience, provides the higher return. The bad news is that account volatility gets relatively high. This strategy also may be not appropriate if in your portfolio you have correlated positions or you are experiencing a drawdown.

2) Give the trade limited room for corrections

This is based on the fact that a good breakout shall bring to a shift move to the measured target without indecision. In such case the initial stop can be moved manually or automatically to trail the price action. The problem with this method is that the win ratio would drop a lot and commissions could get an issue.

3) Move stops to break-even as soon as possible

2-3 bars after the entry bar move the initial stops to B/E; then proceed as per the first case, without managing further the position.

4) Scale out half  position or so after the first thrust of the breakout

Exit from part of the position after a few % move of the market. The scalp trade would reduce the risk, lower the volatility of the position and the one of your trading account. The negative is that by scaling out your would leave also some profits on the table.

5) Micro-manage the position or part of it based on shorter time frame pattern that may develop after the breakout

Lets say that we were in the GBP-AUD trade illustrated above. we could have been:

1) Enter short 100% of the position at the breakout

2) Scaled out part of the position or the whole position after the completion of small inverse head and shoulder that formed when the market reversed

3) Reestablish the whole position when the blue trend line got broken on the downside.

This is a tactic that personally i do not like, because it force me to stay too close to the markets and involve too much activity.

These are all tactical dilemmas that traders face all along their journey. There is no short cuts. Note: chart traders shall strive to choose only optimal setups when selecting candidates for a trade, this substantially reduce the number of retests and pattern failures. This is the most effective way to skew possibilities of success. Creative charting has more to do with visual art than professional trading.