April Fool’s – Navigating the Sovereign Debt Storm

Last month (April) was one of the most challenging months of trading for me in a while. Unfortunately, it took me most of last month and part of this month to figure out that I had to re-tool my approach in order for it to start working again. The grueling experience last month was due to bad timing – my decision to get aggressive with trading in April and the unfortunate change of market behavior getting weird.

Sovereign Debt “Crisis” = Markets Getting Weird

What changed about the market last month that caused my tried and true trading approach to become less effective? No conviction (no follow through) and lots of head-fake moves as the markets tried to digest / sort-out what was going to happen with Greece. As of today, the markets are still trying to figure it out since no one knows how deep the issue goes beyond Greece (ie. Spain, Portugal, etc.). Meaning that if the issue goes beyond Greece’s borders then the “bailout” package planned for Greece only addresses just one problem cog in the Euro machinery. With that said, last month was when I cut myself off from most social contact and other non-trading related activities so that I could figure out how to get back in-tune with the market.

For those not familiar with how I trade, I use the 4-hour chart time frame to look for my trade setups. And on this time frame I wasn’t seeing the same kinds of setups and or follow through that I was used to getting up until April. Instead, most of the action was very abrupt, wishy-washy and didn’t present the same kinds of smooth price action that I would normally have targeted. This meant testing different aspects of my approach and finding out how to adjust. So began my forward testing.

I’m not a fan of back testing…I’m all about forward testing. This means putting real money experimental trades at risk in order to learn what works and what doesn’t in the heat of battle (none of this hypothetical “it would have done this” back testing stuff). The downside with forward testing is that you will tend to lose money until you figure it out. The huge upside to forward testing is that you tend to learn very quickly (or risk going broke) and once you’ve found a solution you know it will work in the real-world and not some virtual world based on historical data.

The solution I discovered for me: trade a time frame one-magnitude smaller than what I was trading. I consider one-magnitude as a time frame multiple roughly 5 times bigger or smaller than a particular time frame (I thank Dr. Alexander Elder for introducing me to this concept via his writings many years ago). So in my case, one-magnitude smaller would mean the 45-minute chart time frame (my charting software allows for this custom time frame). Nothing else, for the most part, needed to be changed with my approach – trade setups and money management essentially remains the same (a testament to a simple but robust approach I’ve built over the years). Now, all I do is look for the same kinds of trades but on a different time frame chart and I’m back in business with the market.

Since moves in the market were not as long-lived as usual (due high levels of risk aversion the markets were not as willing to make a strong bet one way or the other – exception, EUR selling off) and moves suddenly happened without forewarning or any technical reasoning, it only made sense that I look for smaller moves that would be clearer to see on a smaller time frame. After some getting used to, I was finally able to time my entries and exits on the smaller time frame and returned to a normal level of successful trading. I suspect that at some point in the future I should be able to bump back up to the 4-hour time frame again once the market reverts back to some kind of “normal” rhythm. But until then, I will be staying put with my newly re-tooled approach until the sovereign debt storm blows over.

Moral of the story, be constantly aware of what is working and not working for your trading approach and adjust when necessary. Because one day it might just save the health of your trading account.

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