Forex Strategies and Tips

Open Leg Cost Average Trades

How often have you heard "The Trend Is Your Friend" and catch a trend as it  pulls back?

This is great advice, but the trick is knowing how to catch those pullbacks without suffering loss after loss after loss as you try to time it right.

This entry method, which we call OPEN LEG COST AVERAGING will save you a lot of stop losses because it spreads out the entry to increase your odds.

Chopsticks or a Fly Swatter?

Trying to exactly determine where the pullback will end and the trend will resume – then placing one good trade there – is like trying to catch a fly with chopsticks.  It's fun if you can do it, but you're going to miss a lot as you try.

And in trading... each miss means a stop out and money you've lost, plus broker commissions you may have had to pay.

Nailing the turn is like trying to catch a fly with chopsticks
Instead of the chopstick approach, you could place a series of trades over a range of prices, and use a wide and broad net to catch the turn of the pullback, which is a lot like using a nice big fly swatter to catch that fly.

Define Your Valid Zone

Rather than give each entry a tight stop and praying that it works out before it stops out, you instead define a broader zone in which you will place 1, 2, 3 or even more trades.  You can let them all have the same stop loss level.

In an uptrend define a  BUY ZONE.  
In a downtrend define a SELL ZONE.

How do you define this zone?  Look for significant features in your chart, such as strong support or resistance levels, big number price levels or significant Fibonacci retracement levels. It's not set in stone for all trades - draw it as you see fit.

It's wherever you look and say to yourself:
"If price breaks that level then the trend is probably over".

What Does Open Leg Mean?

We use the term LEGS when we talk about a group of trades that you think of as though they are one trade. Each individual trade within the group is one leg.

'Open' refers to the fact that each leg, each individual trade, is still open and alive when the other trades are placed in the group of trades that make up your overall position.

By the way, there are cost averaging calculations we'll show you how to do when the earlier legs of a trade have closed at a loss before the new position is placed, but that's a different trading approach that we call closed-leg cost averaging.

What Does Cost Average Mean?

When you put on several trades on the same currency pair – all going in the same direction – your broker averages together the cost of all the trades and reports one price to you.

Some brokers display this average price on their platform; some broker's platforms (like MT4) do not display this.  If your broker doesn't show it to you, you can always use the Advanced Calculator's OPEN CA tab to see the aggregate net price of your cost averaged trades.

It's very useful to know this net price, because then you can see at a glance where price needs to move to give you break even or profit.   It may be at a level where some of your trades are still negative, but the profit of other trades has pulled the group into profit.  Knowing this price lets you set take profit and manage your position better.

Is This A Dangerous Way To Trade?

No - in fact in many ways it's safer because you are not defining a tight area in which you are right or wrong.  You won't get stopped out as often.

But remember... All trading is dangerous if you don't position size correctly. Position Sizing saves you from losing more on any one trade – or group of trades – than you define as your risk profile.

An entire tab of the Advanced Calculator is dedicated to setting up these kind of trades so you can make sure you don't lose more on the whole group than you can afford to lose.

An Example Trade

An example of an open legged cost average trade set

Discussion:

In the trade shown above we see a nice uptrend in place.  Knowing that price generally moves in a step-like fashion we want to buy into this trend  after it has pulled back, and traders have regrouped, ready for a new push up.

In this case we have chosen to look for previous resistance to define the lower edge of our valid buy zone (shown in red above).

We can place our trades by either of two methods:

Ⓐ We divide our vertical distance into even increments and enter trades along a fixed grid.  For example, we could divide the trade we see above into fourths (or more) and place a Buy Limit or Buy Stop along that grid.

In the trade above, the top of our Buy Zone is 137.20 and the bottom is 135.20, a 200 pip span. Assume they all use a stop at the bottom or the Buy Zone box (135.20). Dividing by four we get a grid level every 50 pips.  We could put buy orders at:

    • 136.70
    • 136.20
    • 135.70

If price is currently below a grid point, we use a Buy Stop order to catch the trade as it goes up; if price is currently above a grid point, we use a Buy Limit order to catch the trade if price goes down and touches that lower price.

Ⓑ We manually enter buy trades as we see price action that we feel indicates an entry, such as the breaking of a certain candle formation.

In the trade shown above, 2 of our 3 trades are picked up so we have 2/3rds of our position moving into profit as the trade advances.

Why Not Just Use Bigger Stops?

In the above trade, you could make the argument for just using a 200 pip stop.  Yes, it's simpler.  You'd have all that room to let the trade work out plus you'd have your full lot size on the line if the trade goes fully to profit.  But check this out... it might blow your mind!

Try to answer these 3 questions right:

Of course the outcome will vary depending on whether 1, 2 or all 3 of your legs were picked up. The profit will be less if only 1 or 2 legs are activated, but the potential if all 3 are picked up is pretty impressive.

You will also get different outcomes based on how you proportion your budget.  You might not want to use the same lot size for all your trades.  Maybe you go in with a larger position for your first entry, then a medium for your second and a smaller position for your third.

You'll be able to test different options and see the results of all these variations in advance on the Advanced Calculator's Open CA tab.

Using The Advanced Calculator

This powerful style of trading is a great example of how the Advanced Calculator can work for you.  A simple, free position calculator on your broker's platform will not serve this purpose at all. In fact you would need to be quite proficient with a spreadsheet to work it out for yourself.  Yet the Advanced Calculator makes it easy.

You can use this tab with either entry mode we talked about above, Ⓐ  - hit the Configure button to have the Calculator automatically lay out a grid for you, or Ⓑ - manually put in the entry prices and lot sizes yourself.

Screenshot from the Advanced Calculator's Open Leg Cost Average tab

In the above screenshot from the Advanced Calculator we see the 3 legs of the trade we have been discussing.  If you wanted to add additional legs, the Calculator is set up to compute 12 legs at a time for you; just click Add a leg.

You can put in any price and lot size you want in each leg. The red box at the bottom of the tab gives you instant feedback on what your risk or potential loss will be.

The green box also gives you the option to explore what profit you will make if you close all the legs at better-than break even; you can test various prices.  In the above screenshot we show the price we'd need to get a 2% gain (137.20) on the trade we illustrated.

As another example, if you put in an exit price of 138.20 you see your potential profit show up as 4.15% percent:

Notice also the blue box that shows your Break Even price. This is what some brokers show as the cost-average net price.

Any Downside to this Method?

The only downside to trading like this is that sometimes when a trade works right away in your favor, not all of your positions have been picked up, so your profit may be a bit less than it would have been if you'd just gone fully into one position.

Wouldn't it be great to have a crystal ball to know which trades were going to linger and retrace further before working out, and which trades were going to work right away and just take off?  Trading is like this – it's always a trade off.

You have to look at your own emotions and psychology to know which method is best for you: One trade fully in at one place? -  or spread your risk over a range?  Which pain hurts you the most? Taking a lot of losses?  Or missing out on not maximizing profit sometimes? Pick whichever approach you think will cause you less pain when it fails.

No Trading Strategy Will Work Every Time

We have found this to be a very solid strategy for Forex trading; but remember, there is no such thing as a strategy that works every time.  Please read our Risk Disclosure.

Losses are part of trading, but if you are using the Advanced Calculator, you can make sure you are not taking any loss bigger than you intend to or have budgeted for.  Read more about using a risk profile.