When Good Setups Go Bad

One of the best setups I’ve seen in the currency markets was (note: past tense) the EURCHF.

After a multi-month uptrend, the currency pulled back into a picture-perfect bull flag. One of the few negatives arguing against a long trade was that the cross went a little parabolic in mid April, but that’s an acceptable and normal over-extension in a strong trend. At any rate, the length of the pullback was likely enough to work off any overextension, so this became one of the best buying opportunities I’ve seen in a long time.

A failed bull flag in the EURCHF

But… one glance at the chart above shows a strong (-3.3 sigma as I’m writing this) breakdown. What lessons can we extract from this:

  • First, this is one of the classic ways in which pullbacks fail, as highlighted in my first book: strong momentum against the anticipated trade direction. If you’re looking to buy, there’s nothing like a sharp collapse to tell you you’re wrong!
  • Second, we need to be responsive to information as the market gives it to us. If we are locked into a mindset that says “EURCHF will go up” then we might tend to rationalize or ignore a move like this. Seeing the market objectively tells us that this is probably not good for our anticipated long trade.
  • Third, no matter how great the setup looks, it’s still just a tilt in probabilities. In fact, I’ve come to believe that the “prettiness” of a pattern or the quality of the setup has little to do with trade outcomes. (That’s not a casual observation–that’s the result of analyzing hundreds of patterns and trade decisions made in real time.) I can find the best pattern possible, but I’m still just flipping a weighted coin. My results are only important over a large sample size, and the outcome of any trade is random.

In this case, most traders would have had no entry so there was no loss associated with this failed pattern. But if you did have a position, your task is simple and clear: follow your trading plan. Have your stop in place (mental or in the market) and get out of the trade when price movement proves you wrong.

A simple post, a simple pattern, but a lesson that can make the difference between success and failure.


Adam Grimes has over two decades of experience in the industry as a trader, analyst and system developer. The author of a best-selling trading book, he has traded for his own account, for a top prop firm, and spent several years at the New York Mercantile Exchange. He focuses on the intersection of quantitative analysis and discretionary trading, and has a talent for teaching and helping traders find their own way in the market.