Wednesday, November 23, 2011

Meantrades Exit Strategies; taking huge swings with zero risk

In the past few years I have observed some of the debates which spring up regarding how to take a profit in intraday trading. There are 2 basic strategies.

  1. Take profits at a pre-determined level and go flat.
  2. Exit half a position at a predetermined level and move stop to break-even (or break-even plus enough to cover commissions).
There might be a slightly better way to achieve ideal profitability. It will require that you know the strengths and weaknesses of your system.

With regards to meantrades, there are two basic exit strategies when combined, are quite effective at maximizing profits.

The two basic techniques are as follows:

  1. When price reaches the opposite keltner band from entry, we can take our profits, go flat entirely.
  2. When price reaches the opposite keltner band from entry, we can move our stop to break even and begin using the supertrend stop as our trailing exit. 
The second option creates far more profits but it is not a smooth process. Perhaps 70% of all trades will be stopped out for zero gains. That's not an easy way to trade intra-day and can lead to overriding the rules of the system.

One solution to this is to work with a very rudimentary wave structure to determine which exit method to use.

One of the more effective structures is a double top or a double bottom. When taking the initial topping short trade take the keltner touch as the profit exit. However if price trades back up to the original top area and either stops you out for a loss and creates a fresh signal OR price simply tests the top, the second touch of keltner should be considered an opportunity to trail the trade and shoot for the moon.

Here is an example of the double top trade scenario:

As you can see the second short trade went much further and allowed us to benefit in several ways. By already having a nice profit for the day we could take our chances on a huge run with our stop at break even. This is what we should always strive for: take huge chances with zero risk.

A second technique, which I am toying with is to use a uniform exit strategy until the weekly target objective is met and then to switch over to the opposite one. In other words, if your goal is 100 pips a week and you started off the week using supertrend exits, once you reached the 100 pips you would then switch over to keltner exits for the remaining trades for that week. This allows you to trade with much less indecision and fear that you will miss potential profits. 

Something else in the back of my mind, although not yet tested, is to take some average of the MPE (Maximum Positive Excursion) and use that as the absolute exit for trades. I never really thought this was an ideal method to exit as it does not adjust according to volatility the same way that the Keltner bands do but I still remain curious as to the relative performance of applying keltner exits versus fixed exits. In order to create this exit strategy I would need to record the MPE as well as the MAE (Maximum Adverse Excursion) in my trade journal (which I don't do at the moment.)

Sunday, November 20, 2011

OHLC is just a line in the sand for Support and Resistance

In spite of my interest in OHLC, there are plenty of other ways to create very clear and potent daily levels of support and resistance within the meantrades method.

Let's compare several of them and see the results from last week.

Using 10 pip CRB's we can track the progress of each method of Support and Resistance. It's starting to become fairly obvious that no matter how to create your "line in the sand" on your chart, every day the results will vary. Thus, for posterity's sake, let's compare the results. Keep in mind when we look at historical trades, we are very mechanical in our entry, although in real-time you can be less so, taking into account the velocity of the markets (the rate of bar change) to help you decide if one of the primary rules of meantrade could be overlooked for the sake of a great risk to reward setup. For example, perhaps price has already violated the keltner midpoint and you still want to take the reversal from the S/R level. There are so many good trades which don't set up perfectly. This requires a traders vision and resourcefulness and is the reason most great mechanical systems cannot be hardcoded into a black box to ride off into the sunset and make us all millionaires in a month.

Traditional Pivot points (using the daily close at 5pm as the starting point for daily calculation):

11/14-11/19, Keltner touch exit: +30
11/14-11/19, Supertrend exit (note: when using the supertrend exit, we move stops to break even once we touch the opposite keltner band from entry, it creates a high percentage of break even stop outs, but allows for a few really big wins throughout the trading week): +31

Fibonacci Levels based on the first High Low close of the day:
(One of the true benefits of this method of creating intra-day S/R is that it does not have levels after the market breaks out, in a sense, it only looks for reversals within the expected daily range)
11/14-11/19, keltner touch exit: -28
11/14-11/19, supertrend exit: +102

With this method we also have the option of trading with the trend only after price has broken the last fib extension level. As you can see in the screenshot above, this creates some very high probability setups.

ORB Fib levels based on Asian session range:
11/14-11/19, keltner touch exit: +87
11/14-11/19, supertrend exit: +114

Finally, OHLC levels:

11/14-11/19, keltner touch exit: +51
11/14-11/19, supertrend exit: +114

Quite interesting that the OHLC S/R levels performed exactly the same as the ORB Fib levels. Fine with me, it proves Meantrades was ok the way it is originally. I like having that validation. Most people in back-testing circles refer to that mental condition as positive expectancy. With positive expectancy we can take every signal without trepidation.

One more method for creating S/R levels I learned from a guy on elite trader a long time ago who claimed, with about 5 years of trading futures under his belt by this time, that if you adjusted your fib ratios to 3.77, 5.12 and 7.80 instead of the standard, 1.618, 2.618 and 4.236, you would have more accurate targets for the daily range. I tested it a while back and it was true...sometimes!

If we take the opening range and use these ratios, as well as high low and 50% of the ORB and then applied these ratios for last weeks trading this is what happens:

11/14-11/19, keltner touch exit: +113
11/14-11/19, supertrend exit: +206

Looks like a winner.

Keep in mind that this is based on a single brokers data. Your results will certainly vary. In fact, I invite anyone to get in touch with me on yahoo at "mezarashii" and I would be happy to teach you how to set up your charts to get you going on meantrades..., well, I'm not sure what we should call the last method of creating S/R levels. I'm open for suggestions.

So what did I discover here in the end. Almost certainly pivots are a waste of time when trading horizontal support and resistance levels. But then, this I knew for years. I'm not sure why it does not work in forex but I'm assuming it has a lot to do from what time you plot them and the end of trading for one market is not the end for another. Perhaps re-plotting based on the opening price of each market would yield more active S/R lines but at this point I will leave that discovery to someone else. I prefer ratios and you can see why with the results from last week. Imagine getting a yield like that week in and week out. Most of these winning trades came on 2 or 3 days only. The beginning of the week was a real dud and sitting on a negative balance was quite challenging. But with positive expectancy, you can continue to pull the trigger with total confidence. That is what I took from this weekend analysis.

Wednesday, November 16, 2011

Meantrades OHLC a deeper understanding...

My objective with altering the Support and Resistance levels to OHLC with Meantrades is to refine an already useful concept. The less trade points we have an opportunity to trade, the more likely we are to execute according to plan. Of course the assumed premise is that the system has a positive expectancy.

Meantrades, regardless of how the support and resistance lines are formed, no matter what the time frame, has a positive expectancy. The only question in my mind has always been drawdowns. OHLC seems to create a more significant way to enter the market and reduce risk.

Yesterday there was 3 trades in 4 markets I follow. EURUSD went for a loss, Oil had a break even stop, as did YM index. With intervention both Oil went for 40 points as did the YM. The EURUSD loss was -37 pips. In the previous stop method of meantrades, the EURUSD trade would still be short and sitting on a drawdown of about 150 pips this morning. Nothing to panic about, but with volatility at an all time high, there will come a day in the not too distant future where the maximum negative excursion will be so large, no account size can handle it. I hate hard stops, but I hate margin calls even more.

OHLC will always be used with modified price bars. Originally I saw the value of constant range bars with their ability to remain in trends longer. These days, it is more about reducing risk. If you were to compare a stop loss on a time based price candle, there is no way to know truly how large it will get before its close. Fast markets create larger candles. With constant range bars, fast candles are always the same size. Compare these two losing trades to see what I mean:

I am using the 15 minute time frame in comparison. There is no exact way to compare the two charts. In my eyes 15 minutes seems to be the smallest time frame you can trade without seeing false signals all over the place. But then, some people see the market crystal clear on 5 minute charts. It doesn't really matter to me anymore, CRBs have eliminated any lack of clarity for me in the markets.

Here we can see with CRBs we reduced the stop loss not only in amount of pips but we were able to see that the market had violated its stop level much earlier than with the conventional time based chart.

To recap what Meantrades actually comprises:

  • Keltner bands: 

We must have a Keltner band touch of the outer band in the opposite direction of the trend. We don't want to be trading support and resistance without a healthy amount of momentum in either direction. If a market is simply climbing the wall of worry, there is no place to be looking for reversals. It is much better to be with the trend at that point as it will eventually climax and present a better reversal trade opportunity at some later point.

2 possible Keltner band setups:

  1. Market has a strong breakout outside the Keltner bands and then reverses.

2. Market trades outside the Keltner but has no thrust higher. This is a slightly lower percentage scenario than #1 but nonetheless still a statistically significant trade setup. Often this trade can turn into a creeping market where it never has any thrust higher but still takes out stops.

Sunday, November 13, 2011

Meantrades Redux V

Taking my lesson from the Perfection Trap, a bold look at what works and does not in Meantrades trading. After accepting that horizontal lines based on some secret Fibonacci on Gann type formula are at best random and accurate less than 40% of the time, I took a second look at what is important in support and resistance trading: where were there buyers and where were there sellers. There are 4 undeniable price points everyday, all else is anathema.





With that in mind we can take these price points and potential support and resistance lines for each day. Meantrades have always been about finding price points for entry where one would consider the market at a disequilibrium. If we are to trade at previous closing prices which printed on the chart, we can assume there is some intrinsic value at these price points.

From Friday's London session we saw two ideal setups.

These price points are not guaranteed levels of reversals but they are relevant almost every day. Markets push and pull, give and take, they never break out without retracement. We just need to catch a single wave each day to become rich.

Applying our traditional mean trade setup(with one small adjustment, we only take the reversal after price crosses the supertrend level*), testing of the preset levels for the day, there are very nice trades coming out with these OHLC levels.

How simple, how elegant.

One added bonus of shifting this method of creating support and resistance lines is that the first trade of the day happens MUCH earlier than all previous versions of meantrade. Most days there is a very powerful signal during the Asian session, which is quite convenient.

Here are the results on GBPUSD from last week:

Monday: -1
Tuesday:  +55
Wednesday: +11
Thursday: +20
Friday: +19

*the benefit of using the supertrend "crossover" (basically just the price reversing strong enough to crossover the supertrend stop line) as opposed to previous methods of stopping is the use of leverage more effectively. Taking small losses allows trading in multiple markets simultaneously without any additional account risks. Bad trades are exited efficiently. There is no overnight exposure. All the typical benefits of an intraday system are now employed, another positive effect of refining systems and the mental escape from The Perfection Trap.

Saturday, November 5, 2011

Filtering trades on XAU via time analysis

Yesterday was a really tough day on XAU. Until friday I was averaging more than 40 pips per trade on the XAU market. I decided to take a look at what was going wrong. The obvious was it was the first Friday of the month--this is usually an extremely low volume time to trade. It is often mistaken to be high volume but in fact the volatility skew on NFP days is due to a LACK of volume not a surplus of participants.

What I discovered over the past 30 days is that XAU has a very strong tendency to whipsaw at 3 intervals during the day. Note, all times are GMT +2.

The first, and perhaps most obvious was 12:00. This is when London is at lunch and NY is still in bed. Nobody should be trading signals at this time of the day. The second was the beginning of the afternoon session in London and NY is just waking up at 14:00. The consistency of the whipsaws was quite interesting. It's been common knowledge that market makers adjust prices rather violently when there is no news and their order books seem imbalanced. Best thing to do is to avoid signals which are created from this activity.

Avoiding these transitional periods in the XAU spot market added quite a return to the past performance for the last 30 days. Perhaps you too could benefit from observing what time of the day bad trades are coming in.

The other side of this coin is that the all time biggest winners will invariably come at the times most commonly creating bad trades. This is what the Black Swan theorists are always harping on about. Very low frequency returns will always outpace steady small profits. As a intraday trader, I cannot grab all of a move but I can take  what is obvious to me here and now. Once in a while I will nail those fat tail returns but it is best not to hunt for them like a hidden giant in the forest.

Thursday, November 3, 2011

The Perfection Trap

I'm reading an excellent book on improving trader mental states at the moment. Thus far the biggest impact on my state of mind is what the author Adrienne Toghraie calls "The Perfection Trap." This is what happens when you grow up in a highly critical environment where nothing you do is the best and no praise is bestowed on your actions as a child. No action goes un-analysed. You are critical others and they are critical of you. In the best case scenario, this creates highly creative and hard working young adults, in the worst case it creates neurotic children who resent their upbringing.

The first time I noticed this as a liability in my trading was when I began to have problems honoring my predetermined stops. It was as if the market moving against was a personal affront to my entire being. Just a single trade in a series of hundreds had become my defining moment as a trader, and consequently a human. How absurd when I look back on it, but it continues to haunt me when I introduce trading to a new person interested in the markets. The idea that I allow them to watch me trade and have that trade turn into a loss is somehow humiliating. I am a trader and yet I cannot make money with this person watching me? I become a fool watching them watching me.

VS Naipaul has a line in one of his old books which basically says something along the lines that a ruined North African trader was a fatally flawed businessman because he was so in love with selling his goods at a price which represented beauty in math. As his business began to sour it was obvious to those around him that he loved the precision of numbers more than earning a profit.

That in itself is an enormous lesson to take away and apply to the forex markets. No system works as a perfect  entity in the present or even the future. In the past, for sure, this is how we create systems to begin with. We look for patterns which repeat as often and as precise as possible. But the market doesn't care. And if we think about it for a moment, neither does mathematics. We are still discovering new possibilities in number theory. This is only possible because previous notions are in fact wrong.

A profitable trader is lucky though, if they can overcome the Perfection Trap, they can succeed where the mathematician will fail. Somehow I feel fortunate to have chosen this path as I can measure my success with the most linear of numbers: my profit.

Here are a few questions to consider from Trading on Target and decide if you should address this as a weakness in your mental trading arsenal.

How long have you been in the perfection trap?

What is the origin of the need to have perfection in your life?

How do you apply perfection to yourself and in your trading? Do you also apply the same standard of perfection to others in your life?

What are you trying to accomplish in your quest for perfection? What is the ultimate payoff? Is there a need for a sense of control? Of being more worthy of love and admiration? of reducing fear of loss and pain?

These are just some of the relevant questions I asked myself. Now that I am vigilant in my desire to create profits over personal emotional needs while I am in a trade, these deep emotional issues are no longer sabotaging my trading as they once did. This is not to say I have beaten my demons dead, far from it. But by being aware of this weakness within, I am a better trader.