There are a number of variations of how traders use a common technique known as “straddle trading”, but here is a common scenario. Let’s say you have found a sideways moving consolidation (a.k.a. sideways channel). You have learned from me that the best way to trade a consolidation is to jump on a surfable wave after it breaks out of the channel, but sometimes you can’t sit around your computer waiting for that to happen so you use a traditional straddle. With a traditional straddle you simply place an entry order on both sides of the channel (one to go long at the top of the channel, the other to go
short at the bottom of the channel). Typically your stop loss is set at the
opposite side of the channel. What should happen, in theory, is that the price
should eventually break out of the channel consolidation (which inevitably it
does) and (hopefully) the price should continue trending for a while in that
direction.
Using this basic straddle method as described above will often yield you some
nice profits, however there is a downside to that technique. Sometimes (often
enough to become rather annoying) the price will move up enough through the
horizontal channel line to trigger you into a trade, then it either continues to
move up but not sufficiently to trigger your limit exit order or it just comes
back down immediately back into the range of the consolidation. Then the
price continues to move down through the consolidation to the other side of it
until it exits your first trade for a loss AND simultaneously enters you into the
second trade going in the opposite direction. If it continues trending in this
new direction then hopefully you could simply exit the trade when it moves
profitably far enough to at least break even with your first trade, or preferably
even further so that you at least have some profit at the end of this
experience. The real kick in the pants happens when the second trade also
turns around, goes through the consolidation channel range and reaches the
other side triggering your stop loss. When this happens you become a twotime
looser (this is what happened to me in that loosing trade I mentioned
above).
To help you to understand let’s give a numerical example of this. Let’s say
you have a consolidation of 50 pips (let’s use round easy numbers for this
example). You find that the top of the channel is at 1.2200 and the bottom is
at 1.2150. You then place two entry orders. The first order has an entry of
1.2200 to go long, a stop at 1.2150, and a limit at 1.2250. The second order
has an entry of 1.2150 to go short, a stop at 1.2200, and a limit at
1.2100. Then you wait for something to happen. Let’s say the price moves up
through the channel and hits 1.2200. Your trade is now entered and you have
a long position. The price inches up to 1.2240 (oh so very close to your profit
limit) but unfortunately turns around and plunges down. Quickly it moves
through the channel zone until it arrives at the other side. Simultaneously two
things happen (1) your original trade now exits for a 50 pip loss and (2) you
are now entered into a new trade going in the other direction. It goes down a
bit more until it too turns around racing back upwards. Shortly it crosses over
1.2200 again resulting in your second trade exiting for a loss of 50 pips. So
your net result is two loosing trades totaling 100 pips lost.
(Note: The above example shows using limit exit orders but many
traders don’t use them to allow profits to run. Whether you’d have used
them or not in the above example wouldn’t affect the end result.)
In all fairness the above worst-case scenario doesn’t always happen. Many
traders do use straddles profitably (as have I), but what if there was a way to
minimize that potential downside described above while simultaneously
allowing you to let profits run even further without limits?
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