Tuesday, 18 June 2013
I often refer to my system in my posts and the aim of my trading is to follow the system rules as closely as I can and so get results as close to the system results as possible. Let me preface this by stating emphatically that there are dozens, if not hundreds of methods that will work successfully in forex markets. Even a simple moving average crossover system will produce a profit of 15-30% per year if followed rigidly. The problem is always in following the method rigorously.
My system rules are the result of the insights I have gained over many years of trading culminating in extensive research I did back in late 2011 to mid 2012. Many of you must have wondered what my system is. It consists of time-tested, well proven technical analysis basics – trendlines, Fibos, Support/Resistance and chart patterns. The magic happens when these are combined with insights of time-cycles I gained when I did my research. I am reluctant to disclose on this blog the timing insights that are the key to my method. The results of following the system rules mechanically are fantastic. Below are the system trade logs I have kept in parallel with my actual trade logs. Before that, I need to explain my money management strategy for the system.
Financial markets are the finest example of crowd psychology in action that we can find in the modern world. The bigger the crowd, i.e. the greater the number of participants in a market, the more applicable insights into crowd psychology will be. In statistics this is referred to as the sample size: the larger the sample size, the more reliable the results of the statistical analysis. Therefore the most reliable markets to trade will be those that have the most participants, i.e. the most liquid markets. Therefore, I decided to trade only the most liquid markets. In forex these are the EURUSD, USDJPY, EURJPY and in the second tier GBPUSD, AUDUSD; i.e. 4 or 5 pairs at most.
With this settled, I divide my trading capital into 4 equal parts to start with, and assign 1/4 capital to each pair. Each trade in the system risks 10% of the capital available to that pair. This might seem like a lot, but 10% out of the 25% allocated to the pair works out to 2.5% of total capital risked in each trade. This happens to be the sweet spot for capital to risk as advocated by many successful traders over the years.
As the trades accumulate profits and losses, this method of allocating capital automatically allocates more to the pairs which are more successful, and less to the less successful. This also fits well with trading advice from experienced traders throughout history – Do more of what works and cut back on what doesn’t work.
One key aspect of my system is that it is always in the market. When one long trade is closed, it is immediately flipped to short. Similarly when a short trade is closed, it is immediately flipped to long. The criteria for closing a long trade is the same as the criteria for going short, and vice-versa. This is emotionally difficult because usually the close is after a good profit or a stop loss. But I’ve found that the best trades are those flipped just after a loss. Makes sense – being stopped out is the markets way of telling us that we were wrong. If being bullish is wrong then one must go short!
Here are the system results for January to June (up to 18 June): one sheet each for EURUSD, USDJPY, EURJPY, GBPUSD, AUDUSD.
At the moment the system is short EURUSD and almost -100 pips in the red, as this pair is bumping up against tough resistance at 1.34 which is also the stop level. This is a situation where in live trading I would have closed this trade now, but the system stays in until it is stopped out.
The system is long USDJPY since last Friday, and I closed my live trade near the bottom at a big loss, although the stop loss had not been exceeded. The pair has now recovered all the loss and looks like it will go higher.
GBPUSD is short since this morning, after having been whipsawed by the tiny break of 1.5750 and reversal down. In hindsight the stop should have been at least 10 pips from the key 5750 level. Still, the policy of immediately flipping trades is at work here, the short from 1.5680 helping recover some of the earlier loss.
System is short AUDUSD from yesterday, the trade is approx 100 pips in profit.
Some readers may question the results logged here – they seem too fantastic. One has to remember that these are trades without emotion, and emotion is the key problem that blocks us from succeeding. Sure, the results will not be identical in real life unless executed by a machine. It is too hard for a person to take trades at all hours of the day, not get affected by news events, etc. But if I could get a mechanical system to trade this, the results will be close to what the mechanical system achieves.
The question many of you will ask is why not program this system and automate it? The short answer is that the rules are not indicator based, and all the ‘programmable’ platforms (mainly MT4 and NinjaTrader) are only good for developing systems using indicators. I don’t use any of those indicators, except Fibos. From what I’ve seen of MT4 and Ninja, it is not possible to program trendline breaks and recognizing chart patterns like support, resistance, etc. I’m sure it is possible to program this using advanced AI techniques but that is beyond my resources at the moment.
In the next post I’ll explore the lessons I’ve learned about myself, why I am unable to execute my system rules and what I can do about it.
By the way, if any of you are thinking that my results are bulls#^t and are tempted to make any derogatory comment, save your energy. I don’t care if you don’t believe me. I am not selling anything, and if you think this is nonsense, move on.