IF YOU WANT SOMETHING GOOD OUT OF LIFE, you’re probably going to have to take a risk. Life (and trading) is just plain risky business. So what’s the difference between a novice risk taker and a professional? It’s all in the preparation. Let’s say I’ve decided to climb Mount Everest— with no training or previous experience, my expedition would basically be a suicide mission.

At 29,002 feet, Mount Everest is the highest peak on our planet and it attracts thousands of adventure seekers every year. However, out of the 4,102 people who attempted to climb Mount Everest between 2008 and 2009, 216 did not survive. That’s a 5 percent fatality rate for semi-professionals, but if the average person on the street were to attempt the climb, their potential fatality rate would be closer to 90 percent.

It is an understatement to say that conditions on the mountain are extreme. Most guide companies aren’t willing to take their chances on the people who can’t meet a strict set of guidelines. Alpine Ascents, one of the top guide companies, requires potential climbers to participate in a weeklong training course. In addition, they need to have climbed a series of other high-altitude mountains and prove they are in excellent physical condition (after all, they must be able to carry a 30-pound backpack for multiple days). Lastly, they must be mentally prepared to deal with strenuous situations at high altitudes.

The company only has one expedition per year in April or May, when the weather is the most cooperative. Why does Alpine Ascents have so many rules? Because they know that no matter how many times they have taken groups to the summit, it will still be risky.

Although you may not be planning an expedition up Mount Everest, being as prepared as possible and taking all the right precautions is something that everyone has experience with. For example, if you have children you will try to give them the best preparation for adult life that you possibly can. Some parents are so ambitious that certain preschools or kindergartens have waiting lists, requiring that you sign up your child before he or she is even born; usually these are the schools that charge steep tuition fees! Then as they get older, parents may send their kids to science camp, weekend prep classes, and tutoring sessions to help them with their homework. By the time they are ready to take the SATs for college admission, they will have taken a course from Kaplan or Princeton to get them prepared for the actual tests. After all, a good SAT score significantly improves their chances of getting into an Ivy League university. Getting into a good school is important because it can land them a good job and secure a good future. This is not to say that every child who goes to private kindergarten and takes Kaplan SAT prep classes will have a great career, or that those who don’t will flounder, but as parents, we look to do the most that we can to give them their best chance of success.

Our children are far more important than trading or investing, but the reason Alpine Ascents takes such great precautions with their climbers and we do the same with our kids is that everyone wants to succeed and not fail. The same thought process needs to be applied to trading and investing because we want to succeed and not fail. Therefore, we want to find trading opportunities that have low risk.

Sticking with High-Probability Trades

What professional traders look for are the “high-probability” trades, or the ones with the most variables aligned in their favor. Here are some secrets to determining whether a trade is high probability or not. Let’s say that the EUR/USD is in an uptrend and you see an opportunity to buy the currency pair on a retracement or dip. If you were trading purely on what you saw in a single chart or setup, you would most likely just dive right in and buy. Unfortunately, that is akin to driving down the road with blinders on! At minimum, it is important to take a look at the general trend in the market because being unaware of your environment can lead to unnecessary risks. Fundamental and technical indicators as well as market sentiment are three factors that can affect every trade. If you can wait for those factors to line up in your favor, you have a far greater chance of reducing your risk and landing a potential profit. Ask yourself these questions to help decide whether a trade is worth the risk or not:

1. How deep is the retracement or dip? Imagine that you accidently cut your finger with a knife while chopping vegetables. The deeper the cut, the longer it will take for your finger to heal. If it is just a shallow slice, then a band-aid will do the trick but if you accidently chopped off part of your finger, then it is far more complicated and a hospital visit would be necessary. In trading, a very strong retracement or dip is much more difficult to recover from than a shallow decline. Therefore, buying after a deep correction in an overall uptrend is generally a lower probability trade than buying after only a small retracement. Just as a deep cut increases the risk of losing a finger, a deep correction increases the risk of the currency pair breaking its uptrend.
2. Is there a good fundamental reason behind the decline in the currency pair? If the decline in the currency pair was triggered by a very disappointing economic data such as an abysmal report on consumer spending, then it is a lower probability trade that you may want to reconsider because short-term fundamentals are not on your side. However, if there is no major reason to explain the dip, then the coast is clear and there’s a greater chance that the uptrend will resume.
3. Could tomorrow’s news release hurt the trade? When trading the EUR/USD, it is also important to check to see if there is a piece of Eurozone or
   U.S. economic data scheduled for release over the next 24 hours that could affect your trade. For example, if German retail sales are on the calendar and the market believes the data could be strong, it creates the backdrop for a higher probability trade. This would also be true if there is U.S. economic data on the calendar that the market expects to be weak. However, if there is reason to believe that the German data will surprise to the downside or U.S. data will surprise to the upside, then it may be better to pass on the trade.
4. What is the general sentiment in the market? Does it support the trade? Considering the general sentiment in the market, known as its “risk appetite,” is also very important. For example, if the Dow plunged 300 points, there is a good chance that the Asian markets will trade lower in the next session because if American traders are nervous, there is a good chance that Asian traders will be as well. Therefore, it may not be such a good idea to buy the EUR/USD on a dip after a sharp sell-off in stocks because the dip could turn into further losses if Asian traders join in on the selling. However, if risk appetite is steady and equities ended up, flat, or only slightly lower, then the coast is clear. If the risk appetite is actually
   positive with traders optimistic enough to rally stocks, then there is a greater chance that the rally in the EUR/USD will resume.
5. Which key levels could affect the trade? Key levels on a chart, or technical indicators, are also important. If the dip in the EUR/USD stopped just above a significant support level like 1.3000, assuming the support level continues to hold, going long EUR/USD would be a higher probability trade. However, if it broke below the support level, then there is scope for additional losses if support turns into resistance. In this case, it may be better to pass on the trade.

These five questions are guidelines that can be applied to both trading and investing but they are not rules that are set in stone. Oftentimes the answers to these questions will conflict and that is when our judgment should be used to determine which factors are more and less important.

If You’re a Short-Term Trader . . .

For short-term traders, there are two additional points that can be considered to create even higher probability trades.

One year when I was at a traders’ conference in Florida, I met a tall middle-aged trader named Dave who said he was having a difficult time turning a profit in his forex trading. I asked him tell me a little about his trading strategy. He responded by saying he likes to look for breakouts. I pressed for more details and he described his trading day.

Dave is married with two children and works as a fulltime accountant during the day—a typical American lifestyle. He comes home from work, has dinner with his wife and kids, watches TV for about an hour, goes into his home office, turns on the computer, and begins trading. He starts by drawing trendlines on 5-minute charts to capture the range over the past few hours and then looks for breakouts. What is wrong with this picture?

The problem is that when Dave gets around to trading, it is approximately 8 P.M. East Coast time, which is the beginning of the Asian trading session. Unfortunately, this is the time when more “fake-outs” than breakouts occur because the beginning of the Asian session is typically one of the quietest times in the currency market. Most of the major currencies usually trade in very tight ranges between the end of the New York trading session (around 4 P.M. Eastern Time) and the beginning of the European trading session (around 2 A.M. Eastern Time). This means Dave is looking for breakouts at the worst time possible. Therefore, when it comes to short-term trading, two other points need to be considered:

1. Is it the right time of day for my trading strategy? It is important to realize that certain times of the day are more suitable to certain trading strategies. Very often currencies may fluctuate in a range before an important U.S. economic release, but the worst thing to do would be to try to pick shortterm tops and bottoms at that time because of the high risk of a breakout. If a breakout or trendfollowing strategy sets up when the European and U.S. markets are both open, then it creates a higher probability trade because there are enough participants in the market to fuel continuation. If a breakout or trend-following opportunity presents itself at any other time, we need to be a bit more skeptical about the quality of the trade.
2. Is this the best currency pair to trade? Picking the right currency pair to trade can mean the difference between successful and unsuccessful trades. In fast and furious news trading (Chapter 9), we only traded the majors, but that may not always be the best option. For example, there are many cases where U.S. and Canadian economic data are released at the same time. If the Canadian data is very weak, one would assume that the best currency pair to buy after the news is released is USD/ CAD. This is true if the U.S. economic data is stronger than expected, but if it is weak, then the U.S. dollar and the Canadian dollar could both decline, leading to no major continuation in USD/ CAD. In that case, it may be better to consider expressing the Canadian news trade through another currency pair such as AUD/CAD or CAD/JPY, which will be less affected by the U.S. economic data. The same is true if you have a good piece of European data but the market is bullish toward the dollar for one reason or another. Then perhaps buying euros against the pound is the higher probability trade.

These are judgment calls that short-term traders must make at the time of the trade, but they can mean the difference between a successful and an unsuccessful trade. It’s worth the extra minute you’ll take before diving into a trade.

The Key Is Yours

You can never be 100 percent certain about whether a trade will be successful or not, but you can increase the probability of it being successful by looking for only highquality trades. This extra effort is important if you value your hard-earned money (and I think you should!). I am a big believer in high-probability trading and the questions in this chapter are the ones that I ask myself before every single trade.

The point is to have as many stars aligned in your favor as possible on your trades and not to expose it to unnecessary and amateur risks. Trading will always be risky business, but making sure the fundamentals, technicals, and market sentiment support your trade every time will give you the highest probability of success. The keys to successful trading are to have an edge, minimize the risks, and not be greedy!

Get It? Got It? Good!

• Shallow retracements are a sign of higher probability trades.

• A trend is more likely to continue if there is no fundamental reason for the dip.

• Seek out trades that are supported by upcoming economic data.

• Trades that are in line with the general sentiment in the market are a better choice.

• Make sure key levels will not stall the trade.

• Short-term traders should know what time of day is suitable for their trading strategy and to pick the right currency pairs.