The Footnote Rules©

Rockefeller Treasury Services, Inc.

The footnote rules, or contingent trades, arise from our observation of actual professional traders in a big-bank trading room. The central question is how to continue trading when your first idea has been proven wrong.

Note that the contingency trades described below are very hard to enter on many electronic trading systems. Unless you can stay at your machine night and day, you may not be able to place the contingency trades. This is unfair to smaller traders but there is nothing we can do about it. If you master the concepts behind the contingency trade, I can pretty much guarantee you that you will become a better trader within one year.  Do the best you can with the order-entry system you’ve got or consider switching to a different broker. Please don’t ask me which brokers allow such trades! I do not keep up with each broker’s technology, the technology changes all the time, and I never recommend brokers, anyway.

We have four footnote or contingency rules. They all pertain to avoiding missed opportunities when you already know the direction.

Before embarking on the Footnote Rules, note one common-sense rule we apply that does not really arise from changing your trade but rather from the opening price differing by a large amount from the closing price. We often advise readers to “enter at the open” and since obviously we don’t yet know what price the open will be, we use the close as a proxy for it. But what if the open is a large number of points or more under/over the close?  The stop and target will be dead wrong. Sometimes the stop or target  will be only a few points away–and get hit repeatedly when re-entry rule 3 is also applied.

Here we apply “proportionality:” if the open is 15 points or more under/over the close, take the number of points from the original stop and target and apply them to the new actual entry. Note that we changed this rule from 22 points to 15 points in February 2012.

Example: We advise buying the pound at the open when the close is 1.5500. The stop is 1.5460 (40 points) and the target is 1.5560 (60 points). But by the time the open occurs, the price is 1.5430, which is under the stop and renders it useless.  Since the original stop was 40 points, using proportionality you would subtract 40 points from the true open entry and your new stop is 1.5390. Similarly, with an open and entry at 1.5430, your target of 60 points has now become 1.5490.

Even if the actual entry differs from the close by less than 15 points, if the stop and target would be stupid numbers–too small or too large a distance from the actual entry–you are free to use proportionality at any level. Just be aware that your track record will diverge accordingly from ours.

Footnote Rule 1–Trading a Corrective Pullback

This rule is currently disabled, but here is the principle: If we are square with an interest in re-entering long, we can name a re-entry at the current close or some other level. If we name a level that is lower than the current close, it means we expect a dip before the upmove continues. Clearly, as buyers, we want to buy at a cheaper price. But to guess how much a price will dip has very little basis in technical analysis, and it’s high risk–if we name a dip that is too big, we will miss the move altogether. Therefore, the footnote rule says

Re-enter at the lower price as shown in the re-entry box but if the level is not reached, re-enter at the close or as near to it as you can get if the price has corrected at least 20 points from the close in the first 2-3 hours after the close.

Sometimes the re-entry level is higher than the close (in the case of a buy recommendation) or lower than the close (in the case of a sell). This is what we call a “prove it” level, meaning we want the higher level to prove that the move really is still in place. The higher level will usually be something like the last highest high or the highest high of the past x number of bars.

Footnote Rule 1 entries are always in bold and italics so you can see the recommended re-entry price is different from the close.

Footnote Rule 2: Continuation, or Not Letting an Opportunity Pass You By

Let’s say you have met a profit target and exited the trade with a nice gain, but now the price keeps rising in a strong rally (or falling in a rout if you have been short). You are experiencing remorse for having exited and being left behind. Footnote Rule 2 is the remedy. Re-enter in the swing direction at 40 points over your exit (which was the target on the previous trade). Place a stop at 40 points. Take profit at 60 points (revised as of Feb 2012). This is obviously arbitrary… but we sometimes get moves so big that you can re-enter three or four times on Footnote Rule 2 for a total gain of 300-400 points. The last trade is almost always a loss of 40 points as traders retreat and cover at the end of a session. But if you have just made 60 points (or more), it’s small price to pay. Every once in a while Footnote Rule 2 results in a loss but this happens seldom. Because the FX market is prone to frenzies and panics, Footnote Rule 2 can be your best friend.

There are some tricky aspects to Footnote Rule 2. Let’s say the re-entry is NPR, or “no position recommended.” But the price has now moved 40 points beyond the last close. You should use Footnote Rule 2 to enter.

Or consider the situation when you have hit the stop and re-enter on  Footnote Rule 3 below. If you hit the profit target on this trade, Footnote Rule 2 applies as though the stop had never happened.

Footnote Rule 3: Trading After a Stop is Hit

If you are stopped on a re-entry but then the  price goes back to the re-entry level, do it again, i.e., re-enter again at the same re-entry level as shown in the original entry or the  Re-entry Box.  The reversal could be temporary. The point is that the re-entry levels are selected (usually) to be significant levels, generally two-thirds of the distance of the last big bar, a support or resistance line, the 10 or 20-period moving average, or some other technical indicator… sometimes a Fibonacci number.  If it is hit once and then reverses but gets hit again, the second hit only reinforces that it was indeed a significant level. The reversal off the level the first time was probably bears fighting a bull move or vice versa.

Sometimes we apply Rule 3 when we went into the session with an existing position and thus the stop and target were set for that exact situation. We need to adjust the stop or target if the old stop or target is a stupid number, either delivering the opposite outcome (e.g. loss on a target) or a small number of 15 points or less. Therefore, if the difference between entry and stop or target is negative or 15 points or less, adjust the stop to 38 points from entry and target to 44 points.

Footnote Rule 3 can be hard to apply unless you are paying attention. We sometimes miss it ourselves.

Footnote Rule 4–Reversal Rule

Rule 4 was introduced in August 2011. The purpose of Rule 4 is to address the situation where a major event occurs and direction reverses abruptly, as when a central bank intervenes or some other big news comes out. If you cannot reverse during the session, you have to wait for the next session, missing a big part of the move. Here’s the rule: if your stop is hit AND ALSO  the price moves against your direction by another 80-120 points, reverse direction. Place the new stop 44 points from entry and the target 48 points from entry.  This makes the hurdle for reversal fairly large, not only the existing stop (say 44 points) but also the 80 point waiting region and another 48 points to the profit target, or a total of 128 points from reversal entry  to profit level. This is a full Average True Range for most currencies.

Note that you should use Reversal Rule 4 even in cases where a stop is not hit. Let’s say you took profit but then the price moves 80 points away. Chances are this is a reversal and you should use Rule 4 in this case, too. Of about a dozen cases in which reverse-after-gain was applied over the past 6 months, all were profitable.

We change Rule 4 to 80 points or 120 points periodically, depending on average ranges. The exact number is always noted in the Text Box on the recommendations page.

Example 1: We are square in yen in futures. Re-entry is to BUY/go LONG at 12990 with a stop at 12947. Stop is hit for a loss of 43 points.  Yen continues to fall another 80 points to 12867 and we enter SHORT on Reversal Rule 4. Target is -48 points = 12819 and this is hit for a gain of 48 points.  In this case, as BoJ intervened, yen fell another 50 points, triggering Footnote Rule 2. We enter short at 12819 – 50 points = 12769. Target is hit at 12669 for a gain of 100 points.  Without the Reversal Rule 4, we would have a loss of 43 points. With Reversal Rule 4, we have a gain of 148 points.

Special case: If you have no position and the Globex or Spot open is 120 points from CME or 4 pm spot close, enter in the opposite direction to the recommendation with the same stop (44 points) and target (48 points) as in Reversal Rule 4 above. This will be very rare–we have only two hours between the close and the open and prices hardly ever move that much in those particular two hours (end of the US session). For example, if the close in the pound is 1.6300 and our recommended re-entry is to BUY at the open but the open is 1.6180 (close minus 120 points), do not buy but instead SELL at 1.6180 with a stop at 1.6224 (44 points) and target at 1.6132 (48 points).

Note that we say sometimes Rule 4 uses 80 points and sometimes 120 points. This should not be a surprise since average daily trading ranges widen and contract all the time. The current number of points is always noted in the text box on the first page of the report.

Suspension of the Footnote Rule

We often advise “Do not use this or that footnote rule.” This is because we see something tricky on the chart or smell something fishy in the environment that could cause the rules to generate multiple whipsaw losses. Suspending a footnote rule is experience talking and you should feel free to disregard it.

Track Record

Realistically, the only people who can actually trade the footnote rules are those with a great electronic platform or those who are sitting at the screen all day. This is probably fewer than 5% of our subscribers. That means our track record will ALWAYS be better than yours. We hope you understand that this not an effort to exaggerate our track record. You really could get these results if you were willing and able to spend the time and do the work. One of the key reasons to publish the track record with footnote rule trades included is to show how some professionals, who really do sit at their terminals all day, achieve exceptional returns. It’s also a lesson in technicals, and finally, it’s a vindication of the adage that you really can make a great deal of money trading FX because sometimes moves are huge and sufficiently consistent to be predictable. This is not to say you can get “rich quick” trading foreign exchange. You can’t. But you can take advantage of the very large moves in FX that are magnified by the use of leverage—without betting the ranch. We have stops and profit targets to be conservative and prudent. The footnote rules release our  opportunistic side, but still without taking excessive risk.

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