Strong dollar pressures FX, but short-sellers need caution
The US dollar is trading near a seven-month high. Treasuries dropped after U.S. retail sales data increased the likelihood of an interest rate hike by December. That dollar strength has pushed many currencies down, but before you jump into a short or countertrend swing trade, plan how you'll limit your risk.
By Vikram Rangala
Friday, October 14, 2016 - 00:00
On October 12, the US dollar index touched a seven-month high, with a broad-based show of strength against virtually the entire basket of major currencies.
The dollar has showed particular dominance versus the Japanese yen, rallying for much of the week with a 0.5 percent gain Friday morning to 104.25 yen.
The bull run for the dollar is steady but not dramatic. By contrast, some of its rival currencies have been volatile. For example, the euro has been in a steady slide since late August, following a post-Brexit rally. That downtrend has been anything but gentle.
Nadex spreads, as well as binary options, offer several strategies for traders, whether they are looking for countertrend plays or straightforward trend-following. A spread, for example, lets you take one segment of a larger price move, put a floor and ceiling on it to cap the risk and reward, and then trade the range that it defines.
In a choppy market like the EURUSD, the real challenge for traders is finding the upper and lower ends of each price swing. Let's say you've decided to go long for one of the countertrend moves. You don't want to buy at what appears to be the bottom only to watch the market drop further. Traders call that "trying to catch a falling knife."
What if you could ensure that no matter how much further the market dropped, you could only lose a certain fixed amount, an amount you chose in advance? A spread or binary option, because of the built-in limited risk, rescues you from the losing game of trying to pick tops and bottoms. Instead you can focus on blending with the trend.
For the same reason, the ceiling (or floor if you are going short) offers a natural profit target. Once the spread gets close to or reaches the ceiling (or the binary gets close to the $100 maximum), it's a good time to consider just taking profits.
How many times have you been in a profitable trade but decided to hang on in the hopes of squeezing out just a little more profit. Greed is a sneaky emotion and it can sneak in and spoil a perfectly good trade. Many people hear the words "limited profit" or "capped profit" and think of it as a negative. In fact, the capped risk and reward of binary options and spreads are both positive advantages.
How so? We hold onto winners in the hopes of getting more, because we think we can get more. What if you knew you had gotten all you could get from that particular trade? Hanging on won't bring you much more profit. It might not bring any. But it will bring you the risk of the trade going against you. Once you can see that, it's a no-brainer to take profits.
After that, you can look for the next trade if you want. Or you could take a break and go get a sandwich.
The bottom line in any trade, particularly in the kind of choppy markets we're seeing in forex right now, is to manage risk. Keeping your losses small and within limits allows you to capitalize on the profitable runs with confidence. When the risk limits are built in, as they are for Nadex traders, it can be a real advantage.
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