A whipsaw is a price reversal leading to a trading loss that occurs soon after your trading system gives you a buy signal. Forex positions tend to trend strongly in one direction just 30 percent of the time. The rest of the time prices generally bounce around randomly in a trading range. Whipsaw risk is highest when the price is in a trading range, rendering trading signals unreliable no matter what trading system you are using.
Instructions:
1) Measure trend strength before you buy. Add the ADX indicator to your Forex price chart -- this indicator can be found in your chart indicator list. An ADX reading of 30 or higher indicates a strong price trend.
2) Buy near strong price support. Support is the price level where demand is strongest. Using the drawing tool on your chart software, draw a line connecting recent price bottoms. This line represents price support.
3) Place a protective sell stop order below price support. A sell stop order is an order you place with your broker to sell at the price you indicate. This protects you from further loss if the price breaks through support.
4) Measure volume. When your trading system gives you a buy signal, did trading volume increase? Increased trading volume indicates broad investor participation in the price move. If volume is low, a whipsaw may be more likely to occur, so avoid taking the trade.
5) Check the news. Is the government meeting to decide on interest rates? Is there an election? Are there other potential market-moving events taking place? Whipsaws often occur in response to news events.
6) Use a wider stop order percentage. It is not possible to find the perfect price to buy. Give yourself some room for error by placing your protective stop order at least 3 percent below your buy price.
Tips and Warnings:
Many traders believe that the more complicated their trading system is, the better. Nine times out of ten, this is not true. Simple trading systems usually work best. Discipline is what separates successful traders from the unsuccessful. Find a good trading system and follow the system's rules religiously.
No trading system can be designed to avoid all whipsaws. Whipsaws are part of trading. It is important to not let this frustrate you. Oftentimes traders will avoid using protective stop orders because they notice sometimes the price whipsaws higher again after their stop order sold their position. A small loss can often lead to a big loss, so it is important to always use stop orders.
Source - eHow
