1 Chapter 4.4 Exotic Options 0
Exotic Options Explore each of the following exotic options, and see if you can identify opportunities in your trading to use an exotic option: Exotic options are highly specialised Forex tools that enable you to tailor your trading strategies for specific situations. You should feel extremely confident in your fundamental and technical analysis skills before you begin trading exotic options for while they can be quite lucrative for experienced traders, they can be too risky for brand-new traders. Vanilla option traders often use exotic options to compliment their vanilla option trades or in situations when a vanilla option just isn t feasible. Oftentimes, Forex traders find that premiums for exotic options are cheaper than premiums for vanilla options (see document for Forex Options) because they can customise exotic options more precisely, with more variables. Knock-In Call Knock-In Put Knock-Out Call Knock-Out Put Double Knock-In Call Double Knock-In Put Double Knock-Out Call Double Knock-Out Put One Touch No Touch Double No Touch Exotic options are not available on every currency pair. Only those currency pairs that are traded actively enough qualify. 1
Knock-In Call Options A knock-in call option is an option that automatically becomes a normal vanilla call option when the underlying currency pair trades at or beyond a specified price level (barrier) before expiry. In other words, you get knocked into a vanilla call option if the currency pair touches a certain price. 1.4150. If the EUR/USD currency pair drops down to the barrier at 1.4000, knocks you into the vanilla call option and then turns around and moves back up above the breakeven point at 1.4150, you will be profitable on your knock-in call option trade. You can see a risk graph for a knock-in call option below. Remember that the risk graph only looks like this if the currency pair drops down to the barrier and knocks you into the vanilla call option. Otherwise, the risk graph would be blank because you would never have been knocked in. Traders use knock-in call options when they believe a currency pair is going to go up before the option expires but not before it experiences some volatility and goes down before it goes up again. Here s how it works. You will be profitable with a knock-in call option if the currency pair drops down to and touches the barrier, knocks you into the vanilla call option and then turns around and rises up past the strike price and the breakeven price before the option expires. For example, imagine you buy a knock-in call option on the EUR/USD with a strike price of 1.4100, a barrier of 1.4000 and a breakeven point of 2
Maximum gain the currency pair drops down to the barrier, knocks you into the vanilla call option and then turns around and rises up past the strike price and the breakeven price before the option expires. Minimised losses the currency pair drops down to the barrier, knocks you into the vanilla call option and then turns around and rises up past the strike price but not above the breakeven price before the option expires. Maximised losses the currency pair drops down to the barrier, knocks you into the vanilla call option and then never turns around and rises up past the strike price before the option expires. EXTRA MATERIAL: CLEAR DESCRIPTION OF HOW TO READ A HOCKEY STICK CHART Maximised losses without being knocked in the currency pair never drops down to the barrier to knock you into the vanilla call option before the option expires. When you trade a knock-in call option, one of the following four things will happen: 3
Knock-In Put Options A knock-in put option is an option that automatically becomes a normal vanilla put option when the underlying currency pair trades at or beyond a specified price level (barrier) before expiry. In other words, you get knocked into a vanilla put option if the currency pair touches a certain price. below the breakeven point at 1.1250, you will be profitable on your knockin put option trade. You can see a risk graph for a knock-in put option below. Remember that the risk graph only looks like this if the currency pair rises up to the barrier and knocks you into the vanilla put option. Otherwise, the risk graph would be blank because you would never have been knocked in. Traders use knock-in put options when they believe a currency pair is going to go down before the option expires but not before it experiences some volatility and goes up before it goes down again. Here s how it works. You will be profitable with a knock-in put option if the currency pair rises up to and touches the barrier, knocks you into the vanilla put option and then turns around and falls down past the strike price and the breakeven price before the option expires. For example, imagine you buy a knock-in put option on the USD/CHF with a strike price of 1.1300, a barrier of 1.1400 and a breakeven point of 1.1250. If the USD/CHF currency pair rises up to the barrier at 1.1400, knocks you into the vanilla put option and then turns around and moves back down 4
When you trade a knock-in put option, one of the following four things will happen: Maximum gain the currency pair rises up to the barrier, knocks you into the vanilla put option and then turns around and falls down past the strike price and the breakeven price before the option expires. Minimised losses the currency pair rises up to the barrier, knocks you into the vanilla put option and then turns around and falls down past the strike price but not below the breakeven price before the option expires. Maximised losses the currency pair rises up to the barrier, knocks you into the vanilla put option and then never turns around and falls down past the strike price before the option expires. Maximised losses without being knocked in the currency pair never rises up to the barrier to knock you into the vanilla put option before the option expires. Knock-Out Call Options A knock-out call option is an option that automatically expires worthless when the underlying currency pair trades at or beyond a specified price level (barrier) before expiry. In other words, you get knocked out of a vanilla call option if the currency pair touches a certain price. Traders use knock-out call options when they believe a currency pair is going to go up and that it is going to remain above a fixed level of support until the option expires. You will be profitable with a knock-out call option if the currency pair stays above the barrier, leaves you in the vanilla call option and rises up past the strike price and the breakeven price before the option expires. For example, imagine you buy a knock-out call option on the EUR/USD with a strike price of 1.4100, a barrier of 1.4000 and a breakeven point of 1.4150. If the EUR/USD currency pair remains above the barrier at 1.4000, 5
keeps you in the vanilla call option and moves up above the breakeven point at 1.4150, you will be profitable on your knock-out call option trade. You can see a risk graph for a knock-out call option below. Remember that the risk graph only looks like this if the currency pair remains above the barrier and keeps you in the vanilla call option. Otherwise, the risk graph would be blank because you would have been knocked out of the vanilla call option. When you trade a knock-out call option, one of the following four things will happen: Maximum gain the currency pair remains above the barrier, keeps you in the vanilla call option and rises up past the strike price and the breakeven price before the option expires. 6
Minimised losses the currency pair remains above the barrier, keeps you in the vanilla call option and rises up past the strike price but not above the breakeven price before the option expires. Maximised losses the currency pair remains above the barrier, keeps you in the vanilla call option and then never rises up past the strike price before the option expires. Maximised losses by being knocked out the currency pair drops down to the barrier and knocks you out of the vanilla call option before the option expires. Knock-Out Put Options Traders use knock-out put options when they believe a currency pair is going to go down and that it is going to remain below a fixed level of resistance until the option expires. You will be profitable with a knock-out put option if the currency pair stays below the barrier, leaves you in the vanilla put option and falls down past the strike price and the breakeven price before the option expires. For example, imagine you buy a knock-out put option on the USD/CHF with a strike price of 1.1300, a barrier of 1.1400 and a breakeven point of 1.1250. If the USD/CHF currency pair remains below the barrier at 1.1400, keeps you in the vanilla put option and moves down below the breakeven point at 1.1250, you will be profitable on your knock-out put option trade. A knock-out put option is an option that automatically expires worthless when the underlying currency pair trades at or beyond a specified price level (barrier) before expiry. In other words, you get knocked out of a vanilla put option if the currency pair touches a certain price. You can see a risk graph for a knock-out put option below. Remember that the risk graph only looks like this if the currency pair remains below the barrier and keeps you in the vanilla put option. Otherwise, the risk graph would be blank because you would have been knocked out of the vanilla put option. 7
Minimised losses the currency pair remains below the barrier, keeps you in the vanilla put option and falls down past the strike price but not below the breakeven price before the option expires. Maximised losses the currency pair remains below the barrier, keeps you in the vanilla put option and then never falls down past the strike price before the option expires. Maximised losses by being knocked out the currency pair rises up to the barrier and knocks you out of the vanilla put option before the option expires. Double Knock-In Call Options When you trade a knock-out put option, one of the following four things will happen: Maximum gain the currency pair remains below the barrier, keeps you in the vanilla put option and falls down past the strike price and the breakeven price before the option expires. A double knock-in call option is an option that automatically becomes a normal vanilla call option when the underlying currency pair trades at or beyond one of two specified price levels (barriers) before expiry. In other words, you get knocked into a vanilla call option if the currency pair touches either one of two predetermined prices. 8
Traders use double knock-in call options when they believe a currency pair is going to go up before the option expires but not before it experiences some volatility and either goes down before it goes up again or goes up dramatically. Here s how it works. You will be profitable with a double knock-in call option if one of the following two things happens: The currency pair drops down to and touches the lower barrier, knocks you into the vanilla call option and then turns around and rises up past the strike price and the breakeven price before the option expires. You will also be profitable if the EUR/USD currency pair rises up to the upper barrier at 1.4200, knocks you into the vanilla call option and then remains above the breakeven point at 1.4150 until expiration. You can see a risk graph for a double knock-in call option below. Remember that the risk graph only looks like this if the currency pair either drops down to the lower barrier and knocks you into the vanilla call option or if it rises up to the upper barrier and knocks you into the vanilla call option. Otherwise, the risk graph would be blank because you would never have been knocked in. The currency pair rises dramatically and touches the upper barrier, knocks you into the vanilla call option and then remains above the breakeven price until the option expires. For example, imagine you buy a double knock-in call option on the EUR/USD with a strike price of 1.4100, a lower barrier of 1.4000, an upper barrier of 1.4200 and a breakeven point of 1.4150. If the EUR/USD currency pair drops down to the lower barrier at 1.4000, knocks you into the vanilla call option and then turns around and moves back up above the breakeven point at 1.4150, you will be profitable on your knock-in call option trade. 9
When you trade a double knock-in call option, one of the following four things will happen: Maximum gain one of the following two things happens: 1. The currency pair drops down to the lower barrier, knocks you into the vanilla call option and then turns around and rises up past the strike price and the breakeven price before the option expires. 2. The currency pair rises up to the upper barrier, knocks you into the vanilla call option and then remains above the breakeven price before the option expires. Minimised losses one of the following two things happens: 1. The currency pair drops down to the lower barrier, knocks you into the vanilla call option and then never turns around to rise up past the strike price before the option expires. 2. The currency pair rises up to the upper barrier, knocks you into the vanilla call option and then drops below the breakeven price and the strike price before the option expires. Maximised losses without being knocked in one of the following two things happens: 1. The currency pair never drops down to the lower barrier to knock you into the vanilla call option before the option expires. 2. The currency pair never rises up to the upper barrier to knock you into the vanilla call option before the option expires. 1. The currency pair drops down to the lower barrier, knocks you into the vanilla call option and then turns around and rises up past the strike price but not above the breakeven price before the option expires. 2. The currency pair rises up to the upper barrier, knocks you into the vanilla call option and then drops below the breakeven price but remains above the strike price before the option expires. Maximised losses one of the following two things happens: 10
Double Knock-In Put Options A double knock-in put option is an option that automatically becomes a normal vanilla put option when the underlying currency pair trades at or beyond one of two specified price levels (barriers) before expiry. In other words, you get knocked into a vanilla put option if the currency pair touches either one of two predetermined prices. Traders use double knock-in put options when they believe a currency pair is going to go down before the option expires but not before it experiences some volatility and either goes up before it goes down again or goes down dramatically. Here s how it works. You will be profitable with a double knock-in put option if one of the following two things happens: The currency pair rises up to and touches the upper barrier, knocks you into the vanilla put option and then turns around and falls down past the strike price and the breakeven price before the option expires. The currency pair falls dramatically and touches the lower barrier, knocks you into the vanilla put option and then remains below the breakeven price until the option expires. For example, imagine you buy a double knock-in put option on the USD/CHF with a strike price of 1.1300, an upper barrier of 1.1400, a lower barrier of 1.1200 and a breakeven point of 1.1250. If the USD/CHF currency pair rises up to the upper barrier at 1.1400, knocks you into the vanilla put option and then turns around and moves back down below the breakeven point at 1.1250, you will be profitable on your knock-in put option trade. You will also be profitable if the USD/CHF currency pair falls down to the lower barrier at 1.1200, knocks you into the vanilla put option and then remains below the breakeven point at 1.1250 until expiration. You can see a risk graph for a double knock-in put option below. Remember that the risk graph only looks like this if the currency pair either drops down to the lower barrier and knocks you into the vanilla put option or if it rises up to the upper barrier and knocks you into the vanilla put option. Otherwise, the risk graph would be blank because you would never have been knocked in. 11
When you trade a double knock-in put option, one of the following four things will happen: Maximum gain one of the following two things happens: 1. The currency pair rises up to the upper barrier, knocks you into the vanilla put option and then turns around and falls down past the strike price and the breakeven price before the option expires. 2. The currency pair falls down to the lower barrier, knocks you into the vanilla put option and then remains below the breakeven price before the option expires. Minimised losses one of the following two things happens: 1. The currency pair rises up to the upper barrier, knocks you into the vanilla put option and then turns around and falls down past the strike price but not below the breakeven price before the option expires. 2. The currency pair falls down to the lower barrier, knocks you into the vanilla put option and then rises above the breakeven price but remains below the strike price before the option expires. Maximised losses one of the following two things happens: 1. The currency pair rises up to the upper barrier, knocks you into the vanilla put option and then never turns around to fall down past the strike price before the option expires. 2. The currency pair falls down to the lower barrier, knocks you into the vanilla put option and then rises above the breakeven price and the strike price before the option expires. Maximised losses without being knocked in one of the following two things happens: 1. The currency pair never rises up to the upper barrier to knock you into the vanilla put option before the option expires. 2. The currency pair never falls down to the lower barrier to knock you into the vanilla put option before the option expires. Double Knock-Out Call Options A double knock-out call option is an option that automatically expires worthless when the underlying currency pair trades at or beyond one of two specified price levels (barriers) before expiry. In other words, you get knocked out of a vanilla call option if the currency pair touches either one of two predetermined prices. 12
Traders use double knock-out call options when they believe a currency pair is going to go up before the option expires but that it is not going to go up or down too far. Here s how it works. You will be profitable with a double knock-out call option if the currency pair rises above the breakeven price but does not touch the upper barrier before the option expires. For example, imagine you buy a double knock-out call option on the EUR/USD with a strike price of 1.4100, a lower barrier of 1.4000, an upper barrier of 1.4200 and a breakeven point of 1.4150. If the EUR/USD currency pair rises above the breakeven price at 1.4150 while remaining below the upper barrier at 1.4200, you will be profitable. You can see a risk graph for a double knock-out call option below. Remember that the risk graph only looks like this if the currency pair remains above the lower barrier and below the upper barrier. Otherwise, the risk graph would be blank because you would have been knocked out of the option. When you trade a double knock-out call option, one of the following five things will happen: Maximum gain the currency pair rises above the breakeven price but remains below the upper barrier, keeping you in the option until it expires. Minimised losses the currency pair rises above the strike price but remains below the breakeven price, keeping you unprofitably in the option until it expires. Maximised losses the currency pair falls below the strike price but remains above the lower barrier, keeping you unprofitably in the option until it expires. Maximised losses by being knocked out the currency pair falls down to the lower barrier and knocks you out of the vanilla call option before the option expires. Maximised losses by being knocked out the currency pair rises up to the upper barrier and knocks you out of the vanilla call option before the option expires. 13
Double Knock-Out Put Options pair falls below the breakeven price at 1.1250 while remaining above the lower barrier at 1.1200, you will be profitable. A double knock-out put option is an option that automatically expires worthless when the underlying currency pair trades at or beyond one of two specified price levels (barriers) before expiry. In other words, you get knocked out of a vanilla put option if the currency pair touches either one of two predetermined prices. You can see a risk graph for a double knock-out put option below. Remember that the risk graph only looks like this if the currency pair remains above the lower barrier and below the upper barrier. Otherwise, the risk graph would be blank because you would have been knocked out of the option. Traders use double knock-out put options when they believe a currency pair is going to go down before the option expires but that it is not going to go up or down too far. Here s how it works. You will be profitable with a double knock-out put option if the currency pair falls below the breakeven price but does not touch the lower barrier before the option expires. For example, imagine you buy a double knock-out put option on the USD/CHF with a strike price of 1.1300, a lower barrier of 1.1200, an upper barrier of 1.1400 and a breakeven point of 1.1250. If the USD/CHF currency When you trade a double knock-out put option, one of the following five things will happen: Maximum gain the currency pair falls below the breakeven price but remains above the lower barrier, keeping you in the option until it expires. 14
Minimised losses the currency pair falls below the strike price but remains above the breakeven price, keeping you unprofitably in the option until it expires. Maximised losses the currency pair rises above the strike price but remains below the upper barrier, keeping you unprofitably in the option until it expires. Maximised losses by being knocked out the currency pair rises up to the upper barrier and knocks you out of the vanilla put option before the option expires. Maximised losses by being knocked out the currency pair falls down to the lower barrier and knocks you out of the vanilla put option before the option expires. Traders use one-touch options when they believe a currency pair is going to reach a certain price before the option expires. Here s how it works. If you choose a barrier above the current price of the currency pair, you will be profitable with a one-touch option if the currency pair rises up to, and touches, the barrier before the option expires. If you choose a barrier below the current price of the currency pair, you will be profitable with a one-touch option if the currency pair falls down to, and touches, the barrier before the option expires. For example, imagine you buy a one-touch option on the EUR/USD with a barrier of 1.4200. If the EUR/USD currency pair moves to touch that barrier at 1.4200, you will be profitable. One-Touch Options A one-touch option is an option that automatically pays a set amount when the underlying currency pair trades at or beyond a specified price level (barrier) before expiry. In other words, you make money on a onetouch option if the currency pair touches a predetermined price. You can see two risk graphs for a one touch option below. Looking at both of the risk graphs, you can see that you only make a profit if the currency price touches a certain price either above or below the current price of the currency pair. 15
16
When you trade a one-touch option, one of the following two things will happen: Maximum gain the currency pair rises or falls to the barrier before the option expires. Maximum loss the currency pair does not rise or fall to the barrier before the option expires. works. If you choose a barrier above the current price of the currency pair, you will be profitable with a no-touch option if the currency pair never rises up to, and touches, the barrier before the option expires. If you choose a barrier below the current price of the currency pair, you will be profitable with a no-touch option if the currency pair never falls down to, and touches, the barrier before the option expires. For example, imagine you buy a no-touch option on the EUR/USD with a barrier of 1.4200. If the EUR/USD currency pair never moves to touch that barrier at 1.4200, you will be profitable. No-Touch Options A no-touch option is an option that automatically pays a set amount if the underlying currency pair never trades at or beyond a specified price level (barrier) before expiry. In other words, you make money on a no-touch option if the currency pair never touches a predetermined price. You can see two risk graphs for a no-touch option below. Looking at both of the risk graphs, you can see that you only make a profit if the currency price never touches a certain price either above or below the current price of the currency pair. Traders use no-touch options when they believe a currency pair is not going to reach a certain price before the option expires. Here s how it 17
When you trade a no-touch option, one of the following two things will happen: Maximum gain the currency pair never rises or falls to the barrier before the option expires. Maximum loss the currency pair rises or falls to the barrier before the option expires. Double No-Touch Options Traders use double no-touch options when they believe a currency pair is not going to reach either of two prices one above the current price of the currency pair and one below before the option expires. Here s how it works. You will be profitable with a double no-touch option if the currency pair never rises up to, and touches, or falls down to, and touches, either one of the barriers you have chosen before the option expires. For example, imagine you buy a double no-touch option on the EUR/USD with one barrier of 1.4200 and another barrier of 1.4000. If the EUR/USD currency pair never moves up to touch the barrier at 1.4200, or down to touch the barrier at 1.4000, you will be profitable. A double no-touch option is an option that automatically pays a set amount if the underlying currency pair never trades at or beyond either of two specified price levels (barriers) before expiry. In other words, you make money on a double no-touch option if the currency pair never touches either one of two predetermined prices. You can see the risk graph for a double no-touch option below. Looking at the risk graph, you can see that you only make a profit if the currency price never touches either one of two barriers either above or below the current price of the currency pair. 18
When you trade a double no-touch option, one of the following two things will happen: Maximum gain the currency pair never rises to the upper barrier or falls to the lower barrier before the option expires. Maximum loss the currency pair rises to the upper barrier or falls to the lower barrier before the option expires. 19
Contents TRADING PSYCHOLOGY Forex traders have to not only compete with other traders in the forex market but also with themselves. Oftentimes as a Forex trader, you will be your own worst enemy. We, as humans, are naturally emotional. Our egos want to be validated we want to prove to ourselves that we know what we are doing and we are capable of taking care of ourselves. We also have a natural instinct to survive. All of these emotions and instincts can combine to provide us with trading successes every now and then. Most of the time, however, our emotions get the best of us and lead us to trading losses unless we learn to control them. In this section, you will learn about the following four psychological biases that may be affecting your trading results and what you can do to overcome them: Overconfidence bias Anchoring bias Confirmation bias Loss aversion bias Many Forex traders believe it would be ideal if you could completely divorce yourself from your emotions. Unfortunately, that is next to impossible, and some of your emotions may actually help improve your trading success. The best thing you can do for yourself is learn to understand yourself as a trader. Identify your strengths and your weakness and pick a trading style that is right for you. 20
Overconfidence Bias Overconfidence bias is an over-inflated belief in your skills as a Forex trader. If you ever find yourself thinking to yourself that you have got everything figured out, that you have nothing more to learn and money is yours for the taking in the forex market, you probably suffer from an overconfidence bias. stopped out of not because I saw another entry opportunity but because I couldn t believe I was wrong? You can also ask yourself, Have I ever put more on a trade than I normally would because I was just sure this trade was going to be the one? If you have, you need to be aware of those tendencies. Dangers of Overconfidence Overconfident traders tend to get themselves into trouble by trading too frequently or by placing extremely large trades as they go for the home run. Inevitably, an overconfident trader will end up either trading in and out and in and out of trades churning the trader s account or risking too much on the one trade that goes bad and wipes out most of the trader s account. Are You Overconfident? If you want to know if you have any overconfidence tendencies, ask yourself, Have I ever jumped right back into a trade I had just been Overcoming Overconfidence The best way to overcome an overconfidence bias is to establish a strict set of risk-management rules. These rules should at least cover how many trades you will allow yourself to be in at one time, how much of your account you are willing to risk on any one trade and how much of your account are you willing to lose before you take a break from trading and re-evaluate your trading strategy. By limiting the number of trades you are willing to be in and the amount of risk you are willing to take, you can spread your risk out evenly over your portfolio. 21
Anchoring Bias Anchoring bias is a propensity to believe that the future is going to look extremely similar to the status quo. When you anchor yourself too closely to the present, you fail to see the dramatic changes that are possible as currency pairs fluctuate and the underlying fundamentals shift. Are You Anchoring? If you want to know if you have any anchoring tendencies, ask yourself, Have I ever lost money because I couldn t accept that the trend had ended? If you have, you need to be aware of that tendency. Dangers of Anchoring Anchored traders tend to get themselves into trouble by convincing themselves that the current trend will never end and a reversal in the economic strength of a particular country is next to impossible. Alas, they become emotionally attached to the previous trend of a currency pair, and they continue to place trades that go against the new, current trend. With each trade, they lose more and more money because they are bucking the trend. Overcoming Anchoring The best way to overcome anchoring is to look at multiple time frames on your charts. If you usually trade on the hourly charts, take a look at the daily and weekly charts every now and then to see where some of the longer-term levels of support and resistance are and what the longer-term trends look like. You should also take a look at the shorter-term charts to see when the shorter-term trends are reversing. Broadening your perspective will help you avoid anchoring yourself to any one point. 22
Confirmation Bias Confirmation bias is a propensity to look only for the information that confirms the beliefs that you already have. For instance, if you believe the EUR/USD is going to go up, you will look for the news, the technical indicators and the fundamental factors that support your belief. Dangers of Seeking Confirmation Traders who over-actively pursue confirmation of their beliefs tend to miss key warning signs that would normally have protected them from unnecessary losses. In an attempt to build a case for their beliefs, traders miss the facts. Ultimately, this leads to them fighting the trend and losing money with each ill-conceived trade. Do You Seek Confirmation? If you want to know if you have any confirmation bias tendencies, ask yourself, How often do I look for signs that I may be wrong in my analysis? If your answer is rarely or never, you may be a confirmation seeker, and you need to be aware of those tendencies. Overcoming Confirmation Bias The best way to overcome confirmation bias is to find someone, or a group of people, you can talk to about your trading. Hopefully the person, or people, you talk about your trading with will not always agree with you. Talking with traders with diverse perspectives and ideas will help you look at your trades from multiple angles. Sometimes you will strengthen your convictions by talking with other traders. Other times, talking with your trading partner will cause you to change your mind. Keeping an open mind will help you catch new moves and avoid holding on too long to past beliefs. Loss Aversion Bias Loss aversion bias is based on the theory that the pain that is caused by losing $1,000 is greater than the joy that comes from gaining $1,000. In other words, fear is a more powerful motivator than greed. 23
Dangers of Loss Aversion Traders who fear losses are much more likely to hold onto losing positions than traders who are able to accept short-term losses and move onto other, more-profitable trades. Holding onto losing positions jeopardizes the stability of your portfolio by not only incurring losses but also keeping you out of better trades. often, however, traders fail to act on their mental stop losses. They let their emotions get in the way, and they start rationalizing their choice to stay in the trade until it turns around. As soon as you enter a trade, you should set your stop loss order. Take your emotions out of the picture. Do You Fear Losses? If you want to know if you have any loss aversion tendencies, ask yourself, Have I ever held onto a losing trade past the point where I knew I should have gotten out because I hoped the currency pair would turn around and wipe out my losses? If you have, you need to be aware of those tendencies. Overcoming Loss Aversion The best way to overcome a loss aversion bias is to trade with physically set stop loss orders. Many traders tell themselves that they will trade with a mental stop loss a stop loss level that they think about and promise themselves they will act on if the currency pair ever reaches it. All too 24
25
Disclaimer None of the information contained herein constitutes an offer to purchase or sell a financial instrument or to make any investments. Norne Securities do not take into account your personal investment objectives or financial situation and make no representation, and assume no liability to the accuracy or completeness of the information provided, nor for any loss arising from any investment based on a recommendation, forecast or other information supplied from any employee of Norne Securities, third party, or otherwise. Trades in accordance with the recommendations in an analysis, especially, but not limited to, leveraged investments such as foreign exchange trading and investment in derivatives, can be very speculative and may result in losses as well as profits. You should carefully consider your financial situation and consult your financial advisor(s) in order to understand the risks involved and ensure the suitability of your situation prior to making any investment or entering into any transactions. All expressions of opinion are subject to change without notice. Any opinions made may be personal to the author and may not reflect the opinions of Norne Securities. Risk Warning Trading in the products and services of the Norne Securities may, even if made in accordance with a Recommendation, result in losses as well as profits. In particular trading in leveraged products, such as but not limited to, foreign exchange, derivatives and commodities can be very speculative and losses and profits may fluctuate both violently and rapidly. 26