It’s OK to sell high and buy low, but don’t start catching knives

On November 8, 2012 | By | In Forex tips

If you have been trading stocks or currencies long enough you must have heard the famous saying: “sell high and buy low”. I won’t try to explain what it means, just Google it, there’s plenty of information in the internet. I use this kind of strategy quite frequently in my forex signal service. However, there’s some potential danger when trying to apply this kind of rule in a rashly manner without taking into account certain fundamental and technical factors in financial markets.

Let’s take a look at a one descriptive example which explains it better than a thousand words.

The picture describes the huge downside assets’ trend (in this case – major EURO currency depreciation against the US dollar) that occurred during the infamous credit crunch and financial crisis of 2008. The super bad news in the stock and housing market influenced other related assets’ markets which led to extremely volatile movements of currency pairs, extending for hundreds of pips overnight.

If we look closer at EUR/USD weekly chart of 2008 period, we can identify some strong support levels within the 2008 July – October time frame which were broken without much resistance.

The first level at 1.5274 was broken without any resistance, the price just slid down to the nearest November 2007 – January 2008 resistance, present support level at 1.4960. It even broke the line further down for about 50 pips and eventually bounced back to 1.5080 on August. The price went up from the 1.4960 support level only for 120 pips and then plunged into new lows that some traders might have anticipated. The question remains, was it possible to trade in the market using the classical buying low selling high technique without losing your capital. In my opinion it was possible, to a certain extent and here is why…

  1. I almost doubled my forex account during those few months of downtrend simply by selling almost everything against the dollar and keeping away from entering the trades against the trend. My decision was based purely on the fundamental factors. The news about the financial crisis and the stock market crash was coming up every hour, one just had to wait for a bounce and sell it once more. Markets were not bouncing like they should have in a swinging or ranging market conditions and after a little consolidation there was another breakout further down. That’s what happened the second week of August. After a minor rebound the price cut into the last week 1.4902 low and stopped only at 1.4637.
    So, a golden rule to remember is that it’s news that often drives the market, and when the news is devastating on a worldwide scale (like credit crunch), technical factors lose their importance and become irrelevant in making trading decisions.
  2. If it was a ranging or swinging market – I would have definitely gone for it with selling and buying orders, but the fundamental trend indicators were too obvious to ignore, that’s why buying low rule would have meant too much of a risk in this case.
  3. Another classical rule is “trend is your friend”, which means trading only in the direction of a trend is much more likely to be profitable than trading against the trend when the odds are against you. Selling high when the price is going downwards in a downtrend diminishes your risks to a minimum and increases profitability chances. In the 2008 downtrend it wasn’t easy to catch the trending EUR/USD train, because sometimes the price bounced back for 800 pips (from 1.4000 to 1.4800 in September). Still, if you managed your stops correctly and used the pair retracements, it was possible to make some easy pips without risking too much.
  4. Managing stops was another crucial thing in order to survive the financial hurricane during that fatal period. The golden rule that I use is moving my stop losses to a break even point after the price moves in the direction that I predicted. If I wanted to trade against the trend, I would only trade near important support levels with tight stops, which had to be reduced to a minimum after a positive movement.

Making trades based on predictions of average daily price movements could work, if there was no news, spikes and manipulations which happen from time to time. In this particular example the assurance that the price will never make 400 pips in one day wouldn’t have worked. Moreover if you were certain about the retracement on the next week, you would have been knocked out again, because the price went the double distance the next week.

Finally we have the most recent example with the same EUR/USD pair.

If we take a closer look at the October 31st – November 5th movement on a daily chart, we can see the same pattern in a smaller scale. The price went down 1.3018 to 1.2762 covering the distance of almost 256 pips, but this time let’s focus on the support levels. The first stronger support was at 1.2880 and it was easily broken. The second support level at 1.2824 was just a temporary stop with a 40 pips bounce back after a weekend. On Monday the price broke the third support level at 1.2800 and even made it 40 pips lower before bouncing back. Three levels taken out without much resistance and looks like this is only the beginning of a greater trend. If that’s where the market is going, it’s high time to jump in the early train.

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