How To Turning Poor Trading Systems Into Good Trading System?

Here’s an interesting idea that I’ve never seen elsewhere. We can use good
risk management to improve the profitability of trading methods. Let me
show you how.


Although there are many reasons why trading systems look bad during
testing, one common problem is that a system has shown a few huge losses
during the testing period. Here is how risk management concepts can help.

Make a histogram of all the losses, making the left axis the size of the
loss and the bottom axis the number of times that the loss occurred. What
you will find is that most of the losses are moderate but there are several
whopping losses. Simply look at the histogram to see where you could put
a money management stop that would cut out most of the major losers but
only account for a few trades.

For example, assume that you have 100 losses in your test. Ninety-five
of the losses are $1,000, which you can financially (and psychologically)
handle. However, there are five that are greater than $1,000, including a
couple that are greater than $5,000. Change the rules for exiting positions
to either the signal of the trading system or $1,000, whichever shows the
least loss. You will find that you will reduce the total losses typically by
20 percent to 40 percent.

Once in a blue moon, a trade will show a big open loss only to turn
around and move to a profit position. However, that outcome is so rare that
this simple technique can turn many losing systems into profitable systems.
In addition, it may significantly enhance nearly all systems.

HOW BIG A POSITION
SHOULD I TAKE?
Here’s what I recommend for weighting on each position. Why not start
with 0.5 percent for each method/pair? In other words, let’s say that you are
trading trend analysis, channel breakout, and the Conqueror. You would
risk a maximum total of 1.5 percent for each pair. That means that you will
risk 0.5 percent for each method. Note that you could, at any given time,
be risking zero, 0.5 percent, 1.0 percent, or 1.5 percent. Note that you will
get to the maximum risk in only a few rare circumstances. I’ll come back
to this in a minute.

I recommend 0.5 percent in each position not because it is the best
amount of risk to take but because it is a good starting point for traders.
This amount is usually a small amount to lose for anyone.

A beginning trader should likely start with 0.25 percent for each technique/
instrument pair. That means that using four techniques on one given
pair will mean that the total risk could get as high as 1.0 percent (though
this is highly unlikely).

Then, start to increase the amount of risk as you feel more confident
about the techniques. Go to 0.3 percent, then 0.4 percent, and so on up to

the point that you feel comfortable. You probably don’t want to get to a
point where you have a total risk of over 5 percent in any given pair. But
the point is to develop the confidence to increase risk as you develop as
a trader.

Use the concept of changing the size from Kelly and apply to the fixed fractional.

THE BOTTOM LINE: DIVERSIFY
THROUGH TIME
What is the bad news of using strict risk management? Not much.
First, you have to be much more disciplined in your trading. You have
to do a little more work to figure out your risk on each position and the
total portfolio risk. Frankly, this is no big task.

Second, your return may go down, though this is not a given. For most
people, their returns will skyrocket. Generally, traders with powerful risk
management rules will not have years that put them in the top 10 percent
every year. It is difficult to have 100 percent years using these rules. It takes
a lot of risk to make a ton of money.

However, the risk-adjusted return (the return in a portfolio divided by
the standard deviation of the monthly returns) will shoot higher. You will
be producing lower returns but with sharply reduced risk.

In addition, although you will not be number one in any given year,
you will be number one for any given five years. It was largely using this
technique that got me a top ranking for my Macro hedge fund and for my
stock-picking letter. I was never top ranked for any given year but always
ended up in the top 25 percent. After a few years of being in the top 25 percent,
I ended up at or near the number one ranking. It was this pattern of
consistently high returns that did the trick.

This chapter has put you in a very elite group. You now know more
about risk management than probably 95 percent of investors. You now
know how to control risk at a level only the most sophisticated hedge funds
do. This is a huge advantage in the fight for forex profits.

Let me prove this. Most institutional investors are not allowed to have
less than 97 percent of their money under management to be in cash. They
certainly aren’t allowed to be short. This applies to mutual funds, segregated
funds, and union funds. The manager would be fired if they were
to go 50 percent into cash! The basic concept is that the investor wants
to invest in, say, natural resources, and then they buy a natural resources
mutual fund. The manager is supposed to stay fully invested in natural resources
stocks and not deviate from that mandate. So they have to stay

fully invested in natural resource stocks even in the midst of the bear
market.

Now, grab the next 100 retail investors on the street and ask them if
they use any risk management. The answer from only a few will be that
they use some protective stop orders. The rest will think you are nuts.
That leaves only some hedge funds that use proper money management.

Welcome to the risk management elite!
Sharply controlling the risk in your portfolio can keep you in the game
and even beat the game. Use the fixed fractional or Kelly method to calculate
how large your position should be, use some type of portfolio risk
management to control the total risk in your portfolio, and make sure that
you have the right attitude to keep trading. If you follow these rules, you
will find a sharp increase in both your profits and your confidence.
Source: How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life (Wiley Trading)

The Importance Of A Postmortem, Learn From Yourself !!

This is one of the truly great techniques for attaining greater self-discipline,
increasing your skills as a trader, and focusing more on educating yourself.
I am a big fan of postmortems and have written about them for more than
25 years.

A postmortem is taking each of your trades and tearing it apart from
the perspective of seeing what you can learn. This is easiest if you are using
a trading plan because the plan is a record of what you were thinking and
you will not have to rely on your faulty memory to figure out what you were
thinking.

The first thing to look at is the trading plan and see how your analysis
held up. When you said that the stochastics were bearish, did the market
go down? Were your milestones the correct milestones to consider? Did
you correctly identify the driving fundamentals?

As far as self-discipline is concerned, the key factor is the action section
of the trading plan. Did you follow your plan? Did you enter and exit
the trade when you said that you would and use the techniques that you
said you would? Grade yourself hard because it is here that your lack of
self-discipline will really show up. It is here that most traders fail. They
typically enter the trade correctly but fail to use the exit technique outline
in the plan. They either panic and jump out too soon or get stubborn and
don’t get out until it’s too late.


Take the trading plan and use a red pen to grade yourself. Mark on
the plan where you succeeded and where you failed. It’s important to see
where you succeeded because you want to promote good habits in your
trading. You want to see where you failed so that you can reduce the
propensity to do it again.

Take the initial trading plan and your postmortem and file them away.
Then, every several months, take them out and read through them. You will
find it fascinating to see a living record of your trading.

Look very closely for patterns of success and failure. For example, I
studied Elliott Wave analysis for months. I initiated many trades largely
based on my Elliott Wave analysis. I gave up on it when I studied my postmortems
and realized that I rarely had a winning trade using Elliott Wave.

That doesn’t mean that Elliott Wave is not a valid form of analysis but it
does mean that I couldn’t apply the concepts and make money.
You will start to see areas where your analysis is consistently leading
you to profitable trades or where your behavior is leading you to losing
trades and so on. Look to study the profitability of your techniques and,
more important, where you succeeded or failed from a self-discipline point
of view.

The postmortem is a key to becoming a better trader. You can continually
refine your abilities as a trader. Let’s say that you are trading five
different methods. You go out and start to trade a sixth method. After a
year, you sit down and throw out the worst of the techniques and trade the
top five for the coming year. Of course, you will want to now find a new
sixth system to test for the next year. Perhaps the new system is better
than one of the old ones. Perhaps not. You will gain incremental profit if
the new system is better than just one of the old ones. Multiply this concept
for the rest of your trading career and you can see that this can add
dramatically to your profits each year.

Now imagine that you have increased your annual profits by replacing
inferior systems with superior systems each year. Now compound those
gains.
Again.
And again.

Do you see how powerful this substitution technique is for building
serious wealth in your life?
Notice how the postmortem forces you to grade yourself and your techniques.
It forces you to learn more about trading. It forces you to become
more focused on education and self-discipline. You will feel less pressure
to make money and more pressure to become a better trader. You will either
unlock the key to becoming a successful trader or you will find the
reason why you cannot be a profitable trader.
Source: How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life

Sample Trading Plan

Sample trading plan has the following elements:

Method: Trading in the same direction as the higher time
frame trend.

Calendar: For trading intraday, always check the news
calendar at forexfactory.com or FXstreet.com for the
daily schedule of news releases. Always exit existing
short-term positions 5 to 10 minutes ahead of those
scheduled news releases.

Charts: Daily and weekly candlestick charts to select
market and direction; 15-minute and 60-minute
candlestick charts for the setup and signal.

Overlays: Horizontal support and resistance levels,
trendlines, and appropriate pivot points.

Indicators: Stochastic (14, 3, 3) and MACD (26–12–9).

Setup: Identify and record short-term trends on weekly
and daily charts for the markets covered on the basis of
the position of current trendlines and the stochastic.

Find markets in which the short-term trends on the
daily and weekly charts are pointing in the same
direction. Markets you need to be cautious about are
those in which the trends on the weekly and daily

charts are moving in the same direction but price is at
or near historical lows or highs (support or resistance)
and in which there is double divergence or more on the
daily chart as measured by the MACD. Once you’ve
selected the markets that fit these criteria, look for
setups and trade signals on the 15-minute chart at or
near support or resistance that are going in the same
direction as the charts with higher time frames. Once
you identify possible trade signals, filter or confirm
those signals with the 60-minute chart. If the trend on
the 60-minute chart already is pointing in the same
direction as the potential signal on the 15-minute chart,
take the trade. If the short-term trend on the 60-minute
chart is not moving in the same direction as the
potential signal on the 15-minute chart but there is an
indication of indecision such as a shooting star or a
hammer and then a price close beyond that candle that
is indicative of a possible reversal and a shift in
momentum such as a stochastic trigger line cross, take
the trade. If the short-term trend on the 60-minute chart
conflicts with the potential signal on the 15-minute
chart, meaning there is no indication of indecision or a
shift in momentum on the higher time frame, do not
take the trade. We also are cautious about entering
trades with multiple divergence shown by the MACD
on the intraday charts that are opposite to our position.

Signals: Trendline violation with stochastic confirmation
on a closing basis and/or a close beyond the high or
low of an appropriate doji (hammer for buy, shooting
star for sell) on support or resistance. The candle to

close below the high or low of the doji or inside candle
is most often by definition a change-of-direction candle.

Exit and Stop: Always place stop just beyond the last swing
high or swing low in the direction opposite to the
position you took. For a buy, or long, position, place a
sell stop below the last swing low, keeping within your
risk parameter: 1 to 3 percent of the account per trade.

For a sell, or short, position, place a buy stop above the
last swing high, again making sure to keep your risk at
an acceptable level. You also can use a 2-ATR stop as
long as the risk on the trade is acceptable to you. Once
you are in the trade, be mindful that you must start to
draw a new trendline that will provide support or
resistance for the trend you just entered. Our entry
signal is the same condition that marks a shift in the
short-term trend. A price close on a closing basis
beyond this new trendline, moving against our position,
also will serve as our signal to exit the trade. If the trade
goes in our direction by the same distance as the money
we’ve risked, we can move our stop to breakeven. For
taking a profit we key off existing trendlines and pivot
points. If you entered the position on a short-term
trendline violation, you should monitor price behavior
as it approaches and tests the intermediate-term
trendline or the next daily pivot point. If it looks to be
pausing—showing indecisive candles—on an area of
support or resistance, take the profit; if you are trading
multiple contracts, take a portion of the profit. If it
closes beyond the intermediate-term trendline, look for
it to trade to the long-term trendline. You can deploy

the same strategy by using pivot points. If the market
moves beyond a pivot level, look for it to move on to
the next pivot level. If the market moves beyond all
existing support or resistance on the chart, continue to
update the trendline created by the current move and
look for the order of operation of the technical
indicators to give you an exit signal. To exit a trade,
look for the same or a similar price action that
prompted you to enter the trade. If you are in a trade
and it does not go in the direction of the signal, you do
not need to wait for your stop to get hit. You can exit
the trade on the basis of a combination of a short-term
trendline penetration on a closing basis and a cross of
the MACD and its trigger line on a closing basis.

A change-of-direction candle, which often creates
trendline penetrations, also can be used to exit a trade.
Keep in mind that the longer you are in a trade that is
not going in the direction of the original signal, the
more your risk will increase. You can always come out
of a trade and go back in if you get another signal.
Source: Mastering the Currency Market: Forex Strategies for High and Low Volatility Markets

You Should Developing Your Trading Plan !!

Perhaps the most powerful technique for increasing self-discipline is the
use of a trading plan and the attendant postmortem technique. I am going
to go into detail about this technique and will show real examples of trading
plans.

Traders lose money mostly from making stupid mistakes. They forget
to put in the stop because they will do it tomorrow. They don’t know the
right contract size. They like the way the stochastics are acting but completely
ignore the breakdown on the chart. And so on. In other words,
they simply forget to take a look at something that they know they should
look at.

I think that the two main reasons for not looking at something that you
should are:
1. Not paying attention due to a busy schedule or not caring
2. Not wanting to confuse your opinion with facts

I firmly believe that the consistent use of a trading plan will overcome
these two problems. I further believe that the trading plan is the second
most important part of a trade, after money management. The actual entry
and exit techniques are secondary. Most traders will find this statement
hard to accept but most profitable traders, even if they do not use a trading
plan, will agree with me. There are several reasons why.

Without proper monitoring of information, you will drown in a flood
of information. With a trading plan, all the relevant fundamental and

technical indicators can be stored in one spot. It will allow you to outline a
scenario of the expectations for the future. In addition, it provides a place
for the exact entry and exit points to be delineated and necessary money
management principles to be applied.

One of the important features of the trading plan is that it is devised
before the money is risked. Traders are typically far less emotional about
a trade before the money is committed. Typically, traders lose their objectivity
when they are on the firing line and money is committed.

The trading plan also helps to educate you. After a trade, you can go
over your trading plans and evaluate what actually happened. This is called
the postmortem. You have an opportunity to examine how accurate the
pretrade analysis was and discover areas of weakness in your own education
or insights. Often, investors will realize that certain facets of their
trading technique have been over- or underestimated. They think that a particular
technique is doing well when, in fact, it is doing poorly. Traders can
refer back to the trading plan while in the trade to determine whether
things are going as planned and whether there have been significant
changes that will affect the analysis that led to initiating the position.

The trading plan thus becomes a rudder for the average speculator, who
tends to trade like a rudderless ship. When investors are forced to commit
thoughts to paper before initiating the trade, their thoughts must be
more logical and coherent. The record of the thoughts before the trade is
initiated provides a useful insight for future growth.

The use of a trading plan is also a viable way of reducing mental fatigue
and anxiety. The trading plan is a record of the thoughts of the trader
before the trade is initiated. It represents a calmer, detached state of mind
than will exist when money is on the line. Traders who have committed
money based on a rational trading plan will be able to refer back to that
trading plan and use it as a touchstone of calm.
Source: How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life (Wiley Trading)

Developing a Disciplined Trading Plan

No matter which trading style you decide to pursue, you need an organized trading plan, or you won’t get very far. The difference between making money and losing money in the forex market can be as simple as trading with a plan or trading without one. A trading plan is an organized approach to executing a trade strategy that you’ve developed based on your market analysis and outlook.
Here are the key components of any trading plan:

• Determining position size: How large a position will you take for each trade strategy? Position size is half the equation for determining how much money is at stake in each trade.
• Deciding where to enter the position: Exactly where will you try to open the desired position? What happens if your entry level is not reached?
• Setting stop-loss and take-profit levels: Exactly where will you exit the position, both if it’s a winning position (take profit) and if it’s a losing position (stop loss)? Stoploss and take-profit levels are the second half of the equation that determines how much money is at stake in each trade.

That’s it — just three simple components. But it’s amazing how many traders, experienced and beginner alike, open positions without ever having fully thought through exactly what their game plan is. Of course, you need to consider numerous finer points when constructing a trading plan, and we focus on them more in the full version of Currency Trading For Dummies. But for now, we just want to drive home the point that trading without an organized plan is like flying an airplane blindfolded — you may be able to get off the ground, but how will you land?

And no matter how good your trading plan is, it won’t work if you don’t follow it. Sometimes emotions bubble up and distract traders from their trade plans. Other times, an unexpected piece of news or price movement causes traders to abandon their trade strategy in midstream, or midtrade, as the case may be. Either way, when this happens, it’s the same as never having had a trade plan in the first place.

Developing a trade plan and sticking to it are the two main ingredients of trading discipline. If we were to name the one defining characteristic of successful traders, it wouldn’t be technical analysis skill, gut instinct, or aggressiveness — though they’re all important. Nope, it would be trading discipline.

Traders who follow a disciplined approach are the ones who survive year after year and market cycle after market cycle. They can even be wrong more often than right and still make money because they follow a disciplined approach.

Taking the Emotion Out of Trading
If the key to successful trading is a disciplined approach —developing a trading plan and sticking to it — why is it so hard for many traders to practice trading discipline? The answer is complex, but it usually boils down to a simple case of human emotions getting the better of them. Don’t underestimate the power of emotions to distract and disrupt.

So exactly how do you take the emotion out of trading? The simple answer is: You can’t. As long as your heart is pumping and your synapses are firing, emotions are going to be flowing. And truth be told, the emotional highs of trading are one of the reasons people are drawn to it in the first place. There’s no rush quite like putting on a successful trade and taking some money out of the market. So just accept that you’re going to experience some pretty intense emotions when you’re trading.

The longer answer is that because you can’t block out the emotions, the best you can hope to achieve is understanding where the emotions are coming from, recognizing them when they hit, and limiting their impact on your trading. It’s a lot easier said than done, but keep in mind some of the following to keep your emotions in check:

• Focus on the pips and not the dollars and cents. Don’t be distracted by the exact amount of money won or lost in a trade. Instead, focus on where prices are and how they’re behaving. The market has no idea what your trade size is and how much you’re making or losing, but it does know where the current price is.
• It’s not about being right or wrong; it’s about making money. The market doesn’t care if you were right or wrong, and neither should you. The only true way of measuring trading success is in dollars and cents.
• You’re going to lose in a fair number of trades. No trader is right all of the time. Taking losses is as much a part of the routine as taking profits. You can still be successful over time with a solid risk-management plan.

Source: Developing a Disciplined Trading Plan

Make Sure Your Trading Ways Fits With Your Lifestyle

One of the critical reasons for being a forex trader is the lifestyle that you
can lead. All it takes to be a pro forex trader is some capital, an Internet
connection, and 15 minutes a day. What you do the rest of the day is up
to you.

Trading can be enjoyable. Certainly. And that can be a great reason for
you to want to be a trader.

But most people are not interested in trading by itself. They want the
results of trading. They want to create a better retirement for themselves.
They want to help their parents, friends, and/or their children. They want
to pay for their children’s education. They want great vacations. They want
to travel around the world. They want to do what they want whenever they
want!

Stop. Take a few minutes. What lifestyle is your dream? Can you
achieve that dream doing what you are doing now? Can you achieve it
through forex trading? Few businesses or jobs have the flexibility or ability
to create such lifestyle power.

We all have the desire to change our lives. We want to live the life we
dream about. We have needs and desires. Forex trading is one of the few
ways that you can achieve all this with such little commitment.

I am fortunate enough to live this lifestyle. I wrote this book in the
United States, Belize, Singapore, Hong Kong, and Malaysia. I traveled to
other countries for pleasure. I traded in all of these countries. I never spent
over 15 minutes a day trading forex. That gave me the time to truly live my
life. I read a ton of books. I lost 20 pounds recently. I got a great tan. I had
a lot of amazing experiences. I saw a lot of unbelievable things. But the key
to that lifestyle is that I am a pro forex trader. I can be anywhere and still
make money.
You must trade to live, not live to trade. Trading is your tool. Use it.
Source: Make Sure Your Trading Ways Fits With Your Lifestyle