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.

  • Supertrend Indicator:
This is the newest addition to the meantrades setup arsenal. For many years I never considered the position of the moving averages in my trading to determine my entry. It was obvious, at least to me, that moving averages were just not statistically significant in short term trading to warrant their inclusion in my system. Once I discovered the supertrend algorithm, that changed in a hurry. Finally an average of price which takes into account the maximum excursion from the current bar to determine trend. By applying the average true range metric, we now have a statistically significant discovery of price persistence in one direction over another.  

We use the supertrend indicator for two purposes.

1. To enter on crossovers of the supertrend stop line. This acts as a huge filtering process of potential trades. It eliminates a great deal of false signals created by the keltner channels (the strength of the keltners are also its weakness) that simply resume their trend. Drawdowns on the account are greatly reduced with the addition of the supertrend crossover to determine entry.

2. To keep us in a profitable trade longer than ever before. In the past we would take half our profits at the successful touch of the keltner band on our exits and move the stop to breakeven. Now, with the use of the supertrend we can remain fully invested in the market even after the market has traversed the entire length of the keltner channel. We simply move stops to breakeven once we get there rather than exiting half. These select few trades which trend once they have reached the intial price target are so profitable that results of the meantrade method have seen two and threefold improvements in the monthly results.

  • Pure price bar action:

A lot of people talk about "naked trading" and think they are in fact trading without tools. The price bar itself is a tool. You have, at minimum, 4 price points of information: open, high, low and close. With this we can determine an enormous amount of information about the market. We can tell if it is trending, consolidating, the speed of the trend as well as the stalling of a trend. In meantrades we are always looking for the opportunity to enter just as the market turns. We use OHLC price bars to help us see this. 

In simple terms, we are looking for a price bar which closes in the direction of the reversal. 

A bearish reversal bar closes lower than it opens.

A bullish bar is one which closes higher than it opens. Here are two examples:

  • OHLC levels:
Simple as can be. Our action levels are based upon only 4 price levels. There are some nuances to keep in mind but for the most part, these are the only levels we will look for to enter the market on meantrades setups.

Our stops will be placed at the swing high or low of the level we are trading from. This takes a little practice to see from sight but it is not that hard.

As you can see Meantrades OHLC is a more detailed apporach than ever before. Tommorrow I will cover account equity, risk management, range bar size, expectancy as well as some clever tools which will minimize execution errors.

No comments: