Wednesday, October 15, 2014

Why is Volatility good for some systems and dangerous for others?

I'm often find myself reading popular blogs and forums which talk about volatility as a dangerous development in markets, and Forex in particular. Granted, no matter the system, when markets accelerate in their transactions there is always the possibility of errors, no matter how robust or automated the process. In the case of my own trading method, times of decreased volatility are a strong indicator of drawdowns.

So I asked myself, what is it about Meantrades that makes volatility a necessary and good thing? The answer surprised me a little, and makes me doubt what I discovered as it seems I am on to something that most retail traders are unaware of. And how can that be? I'm just a regular guy who happens to be a forex trader.

Volatility is a measure of uncertainty.

Meantrades signals are determined when a reversal is seen short term on a longer trend. For example, if the daily trend is long, Meantrades will only see a buy signal if there is a swift selloff and rapid reversal. The amount of time necessary for this reversal is usually around 12-48 hours, anything longer and the daily trend is at risk of reversing and  this prevents signals on smaller time frames to fail to appear. I should mention then, that the past few years I have traded nothing smaller than an hourly chart (and the range bar equivalent).

But, what exactly is being measured in Forex volatility? 

The term is often used interchangeably with acceleration and range. But, what is truly important from my perspective, is that it refers to uncertain direction in the market with an expanding price range (this requires an objective assessment which traders demarcate with options trading, most commonly used for commercial hedging rather than outright speculation). All other meanings are interesting but not very relevant for my needs as a directional trader.

I think it is worth delving into popular standard definitions as most people simply have an emotional or experiential reaction to the news of "volatility" in the markets. I too was vulnerable to this for years as I was glued to CNBC and then Bloomberg on the tv in the background. I've since gone dark and rarely, if ever, turn on the news when i am trading. I have even extended this to popular forums and chat rooms where trade signals are issued. I find that no matter how useful the information, it will eventually conflict with my own signals. Inevitably the signals I choose to ignore because of external information will be the screaming winners.

Investopedia defines volatility as either:

1)A statistical measure of the dispersion of returns for a given security or market index.


2)A variable in option pricing formulas showing the extent to which the return of the underlying asset will fluctuate between now and the option's expiration. 

The point is the press almost never refers to either of these definitions when they report on volatile markets. All the are reporting on is that a closely watched index has dropped a larger percentage than in previous sessions. In itself this is of course, important and newsworthy, but for traders it creates false assumptions.

Why do bloggers often talk about the dangers of volatility in trading?

Simple. Most trading systems are static in their application. They do not seek a dynamic pattern to determine entries and exits. Although meantrades uses no "feel"or artificial intelligence. It seeks a "nesting" pattern which only works well when volatility is present in the forex market. Perhaps this is the main differentiation between Meantrades and systems such as these. There have been popular systems over the years which attempt to tackle this but often their complexity extends far beyond the capacities of retail traders. Which frankly is a nice thought exercise but without vast economic resources, they are just not satisfactory solutions for the average trader. The buzzword associated with these "revolutionary" systems is: adaptive. Two of the more interesting are well presented in video format:

Summers Bars are very similar to constant range bars. However they perform one extra adaptive function which really caught my eye. They take into account the average volume in previous bars and begin to print as volatility increases. This smooths out indicators as well as gives you a unique technical perspective which standard charts cannot offer. The results are not necessarily an improvement but, like meantrades, it puts you in and takes you out of the market in less crowded junctures.

Adaptive Moving Averages were popularized by Perry Kaufman. According to Investopedia this approach would:
allow winners to run. As a trend comes to an end and prices consolidate, the moving average would move closer to the current market action and, in theory, allow the trader to keep most of the gains captured during the trend.

However just as static approaches to markets have proven, this very interesting attempt was nothing more in the end than intellectual stimulus for whipsawed traders everywhere. As the article mentions in conclusion from a great book on backtested technical indicators:

 "Although the adaptive moving average is an interesting newer idea with considerable intellectual appeal, our preliminary tests fail to show any real practical advantage to this more complex trend smoothing method."

Volatility, the most dynamic of indicators.

Trading static systems in a dynamic market will yield excellent results some of the time, and dreadful results the rest of the time. Using a crass simplification, mean reversion trading will yield tiny gains 70 percent of the time while breakout systems will get chopped to death during the same market conditions. While breakout systems will reap huge rewards during the other 30 percent of the time while mean reversion systems will lose all their gains in the same market environment. I have seen some try to create a barometer to transfer between each method with fairly effective results, and for this I think they alone get how retail trading is done. For the rest, there is just heartache without much education other than to learn how to admit defeat in the face of an unflinching forex market.

The trick for most traders is to learn to embrace volatility, not as a dangerous side effect but as a surfer would; acknowledge the force of nature which provides you with the waves to surf. It's best o remember that nobody ever got rich in a still marketplace.

Thursday, October 9, 2014

Drawbacks of my trend systems

Although no system is perfect, I think it is a healthy exercise to consider what are some weaknesses inherent in my approach to trend trading.

Signals sometimes reveal that a trend has ended a little too early. Or in yesterday's trade, a little too late.

The problem of the Hard Right Edge
world trade center mall chaos on display

  • A signal to go long is actually a signal to go short in a much more important price trend. The problem is you never know when or where than much more powerful price trend will begin. This is what you might refer to as the illusion of control. No matter how many technical indicators you place on your chart or how thorough your backtest reveals an edge, making each and every trade is an act of random faith that price will behave in the accustomed fashion. As we observed yesterday, things can go wrong all at the same time and there is little one can do to protect the downside than to keep risk to a minimum via position sizing.

  • Profitable signals are usually pared by periods of random drawdowns which have no discernible beginning or end. These signals can be seen in non-traditional trading markets such as pre-construction real estate buying trends, a colleague of mine has cataloged popular Miami condos that yield seeking traders are gravitating towards in Miami these days. Before reading on, check them out here: . Last week saw one of the best single day returns while this week saw all signals sucked into the false dollar bull run.

  • Profitable signals appear at random intervals and can continue for an indeterminate period.
A few golden rule lists I have found both counter-intuitive and true:

Gartman's 20 Rules of Trading

Tim Morge, Master Your Trading Master Yourself

8 Rules that Simplify Futures Trading

Today's Signals 10/9/14

Current positions:
Short EUR/JPY 137.46 or higher
Short GBP/JPY 174.37
Buy USD/CHF .9508 or lower
Short GBP/USD 1.6161 or higher
Buy USD/JPY 107.99 or lower
Buy USD/CAD 1.1116 or lower

Closed Positions:
Buy EUR/AUD 1.4344 +42
Short EUR/USD 1.2613 -72
Short XAU/USD 1204.34 -86
Long USD/CHF .9614 -63
Long USD/CAD 1.1167 stopped breakeven
Short AUD/USD .8792 stopped breakeven
Short GBP/USD 1.6059 stopped breakeven

*Stops are based on the previous swing high or low prior to the signal and require an hourly close above or below this swing high or low; they are not based on a strict price.

Wednesday, October 8, 2014

Today's Signals 10/8/14

Current Positions:

Buy EUR/AUD 1.4344 or lower
Short EUR/USD 1.2613 or higher
Short XAU/USD 1204.34 or higher
Long USD/CHF .9614 or lower
Long USD/CAD 1.1167 or lower
Short AUD/USD .8792 or higher
Short GBP/USD 1.6059 or higher

Closed Positions:

Short GBP/USD 1.6039 -69
Short AUD/USD .8738 -55

*Stops are based on the previous swing high or low prior to the signal and require an hourly close above or below this swing high or low; they are not based on a strict price.

Tuesday, October 7, 2014

Daily Signals 10/7/14

Current Positions:

Short EUR/USD 1.2613 or higher
Short GBP/USD 1.6039 or higher
Short AUD/USD .8738 or higher
Short XAU/USD 1204.34 or higher
Long USD/CHF .9614 or lower

Closed Positions:

Buy EUR/AUD 1.4400 stopped breakeven

*Stops are based on the previous swing high or low prior to the signal and require an hourly close above or below this swing high or low; they are not based on a strict price.

Monday, October 6, 2014

Today's Signals 10/6/14

Current Positions:
Buy EUR/AUD 1.4400 or lower

Closed Positions:
Buy USD/CAD 1.1107 +131
Short AUD/USD .8772 +78
Buy EUR/AUD 1.4418 stopped breakeven
Short EUR/USD +111
Short XAU/USD 1215.08 +218

*Stops are based on the previous swing high or low prior to the signal and require an hourly close above or below this swing high or low; they are not based on a strict price.

Friday, October 3, 2014

Today's Signals 10/3/14

Current Signals:

Buy USD/CAD 1.1107 +105 stop to breakeven
Short XAU/USD 1215.08 +155 stop to breakeven
Short AUD/USD .8772 +75 stop to breakeven
Buy EUR/AUD 1.4418 +8
Short EUR/USD 1.2642 +84 stop to breakeven

Closed Trades:

Short EUR/USD 1.2629 -45

*Stops are based on the previous swing high or low prior to the signal and require an hourly close above or below this swing high or low; they are not based on a strict price.