Carry Trade Strategy Ideas

Is it possible to earn some passive income while you hold certain currency positions
over a period of time? The spot forex market offers just that opportunity. The Carry
Trade Strategy is a popular way of trading the global forex market, and is a strategy
highly favoured by large financial institutions such as hedge funds, pension funds
and banks. What makes carry trades so desirable is the possibility of earning
interest, which is a unique aspect that traders – both big and small alike – can take
advantage of.

All currencies in the world have interest rates attached to them, and these rates are
decided by each country’s central bank. For example, the Federal Reserve Bank in
the US determines the country’s interest rates while the Bank of England sets the
United Kingdom’s interest rates. Since each country sets its own interest rate,
countries – or, rather, their currencies – are bound to have varying interest rates.

Some countries may have relatively higher interest rates while others may have
relatively lower rates. How can traders exploit the fact that some currencies have
much higher interest rates than others? Let me introduce you to the concept of a
carry trade.


What Is A Carry Trade?
A carry trade is a long-term fundamental trading strategy that involves the selling
of a certain currency with a relatively low interest rate, and using the funds to buy
a currency which gives a higher interest rate, with the hope that the high-interestrate
currency will appreciate against the low-interest-rate-currency. When these
positions are held overnight, carry traders are paid interest on the currency they are
long in, and must pay interest on the currency they are shorting. The interesting
aspect of this strategy is that the investor or trader is able to gain the difference
between these two interest rates, known as the interest rate differential or spread,
which can be a hefty amount when leveraged.

A Basic Carry Trade Strategy
1. Buy a currency with a high interest rate, and
2. Sell a currency with a low interest rate

Currencies and interest rates
• Currencies with typically high interest rates: GBP, NZD, AUD, CAD
• Currencies with typically low interest rates: JPY, CHF

The Japanese yen and the Swiss franc tend to be on the selling side of the carry
trade due to their traditionally low interest rates. Such low-interest-rate currencies
are known as funding currencies since they are used to fund the purchase of high
interest rate currencies such as the British pound, the New Zealand dollar or the
Australian dollar which tend to have high interest rates.


Example: carry trade
Here is an example of a carry trade. Let’s say the Japanese yen has
an interest rate of 0.25%, and the New Zealand dollar gives an
interest rate of 7.25%. Since the New Zealand dollar has a higher
interest rate than the Japanese yen, a trader who wishes to profit
from a carry trade may buy the New Zealand dollar and sell the
Japanese yen at the same time. An annualised profit of around 7%
(7.25% - 0.25%) may be reaped from the carry trade if no leverage is
used. This return is based on the assumption that the exchange rate
between the New Zealand dollar and Japanese yen remains
unchanged throughout the holding period of one year. If that carry
trade is carried out with a 10 times leverage, it will increase the
unleveraged 7% annualised return to a huge 70% annualised return.

The conventional notation of currency pairs is such that JPY and
CHF tend to be the counter currency while GBP, NZD and AUD tend
to be the base currency in a currency pair. Hence, traders who are
interested in carry trades will long currency pairs like GBP/JPY,
AUD/JPY or NZD/CHF, effectively buying the first currency in each
pair (which also tends to be the higher-yielding currency) and
simultaneously selling the second currency in the pair (which tends
to be the lower-yielding currency). Since they are trading these
currency pairs in the long direction, they will want the base or highyielding
currencies to strengthen in value against the counter or lowyielding
currencies.
Source: 7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets

Trading Style: Different Strokes for Different Folks

After you’ve given some thought to the time and resources you’re able to devote to currency trading and which approach you favor (technical, fundamental, or a blend), the next step is to settle on a trading style that best fits those choices.

There are as many different trading styles and market approaches in FX as there are individuals in the market. But most trading styles can be grouped into three main categories that boil down to varying degrees of exposure to market risk. The two main elements of market risk are time and relative price movements. The longer you hold a position, the more risk you’re exposed to. The more of a price change you’re anticipating, the more risk you’re exposed to.

In the next few sections we detail the three main trading styles and what they really mean for individual traders. Our aim here is not to advocate for any particular trading style, because styles frequently overlap, and you can adopt different styles for different trade opportunities or different market conditions. Instead, our goal is to give you an idea of the various approaches used by forex market professionals so you can understand the basis of each style.

Short-term, high-frequency day trading
Short-term trading in currencies is unlike short-term trading in most other markets. A short-term trade in stocks or commodities usually means holding a position for a day to several days at least. But because of the liquidity and narrow bid/offer spreads in currencies, prices are constantly fluctuating in small increments. The steady and fluid price action in currencies allows for extremely short-term trading by speculators intent on capturing just a few pips) on each trade.

Short-term forex trading typically involves holding a position for only a few seconds or minutes and rarely longer than an hour. But the time element is not the defining feature of shortterm currency trading. Instead, the pip fluctuations are what’s important. Traders who follow a short-term trading style are seeking to profit by repeatedly opening and closing positions after gaining just a few pips, frequently as little as 1 or 2 pips.

In the interbank market, extremely short-term, in-and-out trading is referred to as jobbing the market; online currency traders call it scalping. (We use the terms interchangeably.) Traders who follow this style have to be among the fastest and most disciplined of traders because they’re out to capture only a few pips on each trade. In terms of speed, rapid reaction and instantaneous decision-making are essential to successfully jobbing the market.

When it comes to discipline, scalpers must be absolutely ruthless in both taking profits and losses. If you’re in it to make only a few pips on each trade, you can’t afford to lose much more than a few pips on each trade.

Jobbing the market requires an intuitive feel for the market. (Some practitioners refer to it as rhythm trading.) Scalpers don’t worry about the fundamentals too much. If you were to ask a scalper for her opinion of a particular currency pair, she would be likely to respond along the lines of “It feels bid” or “It feels offered” (meaning, she senses an underlying buying or selling bias in the market — but only at that moment). If you ask her again a few minutes later, she may respond in the opposite direction.

Successful scalpers have absolutely no allegiance to any single position. They couldn’t care less if the currency pair goes up or down. They’re strictly focused on the next few pips. Their position is either working for them, or they’re out of it faster than you can blink an eye. All they need is volatility and liquidity.

Retail traders are typically faced with bid/offer spreads of between 2 and 5 pips. Although this makes jobbing slightly more difficult, it doesn’t mean you can’t still engage in shortterm trading — it just means you’ll need to adjust the risk parameters of the style. Instead of looking to make 1 to 2 pips on each trade, you need to aim for a pip gain at least as large as the spread you’re dealing with in each currency pair. The other basic rules of taking only minimal losses and not hanging on to a position for too long still apply.

Here are some other important guidelines to keep in mind
when following a short-term trading strategy:

• Trade only the most liquid currency pairs, such as EUR/USD, USD/JPY, EUR/GBP, EUR/JPY, and EUR/CHF. The most liquid pairs have the tightest trading spreads and fewer sudden price jumps.
• Trade only during times of peak liquidity and market interest. Consistent liquidity and fluid market interest are essential to short-term trading strategies. Market liquidity is deepest during the European session when Asian and North American trading centers overlap with European time zones — about 2 a.m. to noon Eastern time (ET). Trading in other sessions can leave you with far fewer and less predictable short-term price movements to take advantage of. 
• Focus your trading on only one pair at a time. If you’re aiming to capture second-by-second or minute-by-minute price movements, you’ll need to fully concentrate on one pair at a time. It’ll also improve your feel for the pair if that pair is all you’re watching. 
• Preset your default trade size so you don’t have to keep specifying it on each deal. 
• Look for a brokerage firm that offers click-and-deal trading so you’re not subject to execution delays or requotes. 
• Adjust your risk and reward expectations to reflect the dealing spread of the currency pair you’re trading. With 2- to 5-pip spreads on most major pairs, you probably need to capture 3 to 10 pips per trade to offset losses if the market moves against you.
• Avoid trading around data releases. Carrying a shortterm position into a data release is very risky because prices can gap sharply after the release, blowing a shortterm strategy out of the water. Markets are also prone to quick price adjustments in the 15 to 30 minutes ahead of major data releases as nearby orders are triggered. This can lead to a quick shift against your position that may not be resolved before the data comes out.

Medium-term directional trading
Medium-term positions are typically held for periods ranging anywhere from a few minutes to a few hours, but usually not much longer than a day. Just as with short-term trading, the key distinction for medium-term trading is not the length of time the position is open, but the amount of pips you’re seeking/risking.

Where short-term trading looks to profit from the routine noise of minor price fluctuations, almost without regard for the overall direction of the market, medium-term trading seeks to get the overall direction right and profit from more significant currency rate moves.

Almost as many currency speculators fall into the mediumterm category (sometimes referred to as momentum trading and swing trading) as fall into the short-term trading category. Medium-term trading requires many of the same skills as short-term trading, especially when it comes to entering/ exiting positions, but it also demands a broader perspective, greater analytical effort, and a lot more patience.

Capturing intraday price moves for maximum effect
The essence of medium-term trading is determining where a currency pair is likely to go over the next several hours or days and constructing a trading strategy to exploit that view.
Medium-term traders typically pursue one of the following overall approaches, with plenty of room to combine strategies:

• Trading a view: Having a fundamental-based opinion on which way a currency pair is likely to move. View trades are typically based on prevailing market themes, like interest rate expectations or economic growth trends.
• View traders still need to be aware of technical levels as part of an overall trading plan.
• Trading the technicals: Basing your market outlook on chart patterns, trend lines, support and resistance levels, and momentum studies. Technical traders typically spot a trade opportunity on their charts, but they still need to be aware of fundamental events, because they’re the catalysts for many breaks of technical levels.
• Trading events and data: Basing positions on expected outcomes of events, like a central bank rate decision or a G7 meeting, or individual data reports. Event/data traders typically open positions well in advance of events and close them when the outcome is known.
• Trading with the flow: Trading based on overall market direction (trend) or information of major buying and selling (flows). To trade on flow information, look for a broker that offers market flow commentary. Flow traders tend to stay out of shortterm range-bound markets and jump in only when a market move is under way. 

Big resource: Currency Trading For Dummies

Do We Only Need One Method ?

Which system should you use if you can only trade one? I guess I would
pick the channel breakout for the position trading and inside days for the
day trading. I think they are the best in terms of keeping risk tight yet having
a large profit potential.

A final comment on tying the various techniques together is what I call
the holistic or weight of evidence method. The basic idea is that you trade
according to the weight of the evidence. Let’s say you are using Conqueror,
channel breakout, and trend analysis. You will go long when the majority
of those techniques are bullish and short when the majority are bearish.
You will always use the tightest stop of the three.

Now note that it is possible that you will be flat the market on occasion.
Let’s assume that all systems are flat to start. The trend analysis then gives
a buy signal to go long and we enter a buy order that gets filled. We are
now long with a stop when the trend analysis tells us to get long. We then
get a sell signal from the channel breakout that gets filled before we are
stopped out on the trend analysis. You take that trade as well, which gets
you flat the market. Technically, you are now long and short with protective
stops in the market. Basically, you will get long again when the channel
breakout trades get stopped out or get short if the trend analysis gets
stopped out.

The market trades along for a while and the Conqueror gets long
on the same day that the channel breakout gets stopped out. You are now
long three contracts with three different stop losses. You continue doing
exactly this method so that your position will vary from three short to
three long and everything in between. You will therefore be the longest
or the shortest when the market is the strongest or the weakest. And that
is exactly what you want to be.

Smaller investors will also find the weight of evidence to be useful. In
this method, you don’t go long until, say, all three methods turn bullish. In
other words, you would wait until two methods are long and then you put
in an order to enter long on the signal for the third method. You then place
a protective stop at the point that the closest method would get stopped
out. In other words, you may be entering on a trend analysis entry stop
but exiting on a Conqueror exit stop. In other words, you will only be trading
one contract but you wouldn’t be entering until all three methods are
long and are exiting the position when just one of the methods exits. By

using these techniques, the smaller trader can gain exposure to the market
without entering very many trades.
Source: How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life

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)

Technical Execution Of The Strategy

To ride a trend successfully, you should get confirmation from the price action or technical signals that a trend is in place, and should avoid getting into trends which are already near the ending stage. There is no need for you to predict what the market is going to do, because you can never know that for sure, but the next best thing is perhaps to just go along with what the market is doing, and trend riding allows you to achieve that.

Trading a trendline bounce can be a very profitable, yet simple, strategy for joining an existing trend as it provides a relatively low-risk entry point for traders. Here are the steps of this strategy:

1. First determine how long you wish to ride the trend for because that will influence the time frame of the trend you will ride on.
2. Make sure that the current market sentiment agrees with the technicals. If not,
3. Note the gradient of the trendline in both time frames and the number of times it has been tested.
4. Confirm trend direction and trend strength with oscillators.
5. Enter a limit entry or market entry order based on the hourly or daily trendline, depending on your preferred time horizon.
6. Place stop-loss orders at least 20 pips on the other side of the trendline.

I will now go through these steps with you with a more detailed explanation of what to look out for when adopting this strategy.

1. Determine your holding period , Since many people like to day trade the forex market, I will highlight two suitable time frames for this trading horizon: the daily and hourly time frames. Even if you trade intraday, it is necessary for you to use at least the hourly chart to plan your trade even though you may be using the 5-minute or 15-minute chart to monitor your trade. In my opinion, it is essential for day traders to know the trend direction on the daily chart as this enables them to trade knowing the overall technical picture.
2. Make sure that the current market sentiment agrees with the technicals , The forex market is mainly driven by the players’ perceptions of fundamental news, and technicals usually follow the market sentiment. Hence, you should look for the market sentiment to be supportive of the trade, in the direction of the prevailing trend. If the market sentiment appears to be shifting, and the prevailing trend seems to be threatened, you should give the trendline bounce a miss. However, if the sentiment agrees, you can proceed with the rest of the strategy as outlined.
3. Note the gradient of the trendline on both time frames and the number of times it has been tested. As mentioned earlier, for the Trend Riding Strategy I prefer to stay out of joining a trend that is on a very steep trendline, but that really is up to you, depending on your own risk appetite and trading style.
4. Confirm trend direction and trend strength with oscillators , Ideally, either Stochastics or MACD histogram should be sloping upward when trading an upside bounce (off an up trendline), or sloping downward when trading a downside bounce (off a down trendline). However, this condition is not a prerequisite as these oscillators may lag if the momentum is not accelerating, but if you can get additional confirmation from the oscillators then the probability of success will be higher
5. Enter a limit entry or market entry order on the hourly or daily trendline, depending on your preferred time horizon.The problem with placing a limit entry order is that sometimes the price may not reach your limit to open your position, and you could end up with an “either my price or none” situation, missing out on the opportunity to trade a trendline bounce. One way of securing your place on the trend bounce is to initiate your trade a few pips before the price-trendline touch (see the following chart).
6. Place stop-loss orders at least 20 pips on the other side of the trendline. Having tight stops is the worst enemy of this strategy. It is very common for currency prices to exceed and pierce the trendline, even a daily one, by 10-15 pips or more in a very fast-paced move, and then just as quickly retreat back into the main price territory on the action side of the trendline. This move is often orchestrated by institutional players to hit the accumulation of stops beyond the trendline so as to sweep money off weak hands into their own pockets. Of course sometimes the prices may pierce 20 plus pips through the trendline, and then make a U-turn back into the old territory, resuming the underlying trend.

Note: There is no one-size-fits-all stop loss level that is the “best”, as that will depend on how long you intend to hold your position for and your lot size.
Source: Technical Execution Of The Strategy

THE NETLESS STRADDLE TECHNIQUE

What you do is yon place your two entry orders around the channel consolidation WITHOUT either stops or limits! Yes, you did read that statement correctly. Let me explain the benefits (and the downsides) of doing this and you’ll soon see how good it really is... and then later I’ll give you some specific AWESOME trading techniques to apply this concept with.

Lets continue using the above stated numbers for our example. You place two entry orders, one to go long at 1.2200 and the other to go short at 1.2150. You DO NOT place any stops, but more importantly YOU MUST NOT PLACE ANY LIMITS (it is ABSOLUTELY CRUCIAL that you don't use any limit orders as this can bum you bad. This is because if your first trade were to exit for profit by a limit order, then the market reverses, picks up your second trade, then reverses again before it hits your other limit order you can then have unlimited loss potential since you don't have a stop or the other trade to cancel this one. Obviously this would be bad if this rarer scenario would happen while you re sleeping or away from your computer for a long time).

Lets say that the price moves up (or down), your entry order gets triggered into a trade, and it continues trending in that direction profitably. Obviously this is a good scenario. At this point you would place a protective stop loss order to ensure that you've lock in some profit, letting your trade continue hoping that it continues to run for more profit (appropriately trailing your stop). You would ALSO cancel the other entry order that hasn't been triggered (very important).

" What about if the trade goes bad? Shouldn't I have a protective stop loss to prevent unlimited risk?" It is not necessary! If the market were to move sufficiently to trigger you into a trade then turn around to the other side of the channel picking up the second trade then you have nothing to worry about. When you have two active trades in the same currency pair each going in opposite directions (one long the other short) then they cancel each other out. Essentially the second trade IS a stop for the first. At this point no matter what happens it won’t cause you to loose any more money (except overnight interest if you leave it open through 5pm EST). Most brokers simply treat a trade (of equal lots for the same currency pair) going in opposite directions as simply a stop that cancels both trades out. Go ahead and try it in a demo account by entering a trade in one direction (since this is not for real money go ahead and make an arbitrary random trade since it doesn't matter if the result is for a profit or loss) then place an equal trade in the opposite direction. For most brokers doing this will result in both trades being canceled, leaving you with a net gain or loss.

Though I don't know of any broker that does keep both trades alive in this situation there might be some that. do. If your broker does this then simply put stops limit orders on both trades set at the same price about 10 pips away from the current market price and sooner or later the market will move to trigger the stop & limit orders to exit from the trade.

In the above stated example that resulted in a double 50 pip loss, totaling 100 pips lost, the result would have been different. In that example you would have only lost 50 pips rather than 100 because once the second trade is triggered it is "game over", locking in the 50 pip loss, and no matter what happens after that you cant loose any more. Once you are in a double trade you broker should just cancel out both trades, or if you have a weird broker then you might have to use a special technique to exit both trades (which was described above).

This "Netless Straddle" method can be used to straddle various types of "opportunities". Generally speaking, whenever you encounter times that the market can move in either direction, and at times you are somewhat uncertain about which direction the market might move then you may use this technique. It can be utilized in any time frame, like trading the day high/low breakouts, consolidation breakouts on your hourly charts, or for those ambiguous "Bi-Directional-In-Wave" you might encounter Surfing or Scalping.

Advantages

The advantage of using this method of straddling is that you can place a trade and leave (no baby sitting required) that is open ended for unlimited profits with only a fixed risk (your risk is only the distance between your two entry orders). Furthermore, your ultimate risk is only half of the ultimate risk of a standard straddle, thus you may engage in a full trade (based on your equity

management risk levels) for each trade. For example, if you can normally risk 2% then with a regular straddle you should place each entry order risking only 1% each (both totaling 2%), but with this technique each trade can be for sufficient lots that would amount to 2%, thus your potential wins can be twice as big.

Disadvantages

The disadvantage is that if you experience a fake-out (bull bear trap) then the market reverses and keeps going through the other breakout price then you might lose the opportunity to be in that successful trade.

Do the "Advantages" outweigh the "Disadvantages"? I think so, but I’ll leave the decision up to you. You'll find situations when doing this works, and situation when this doesn't work for you. Ultimately you are cutting your loss in half, or doubling your potential gains, which in my opinion leaves you with a net advantage overall (as not all breakouts result in bull/bear traps).

The bottom line is that I'm not suggesting that you exclusively adopt this method of straddling and divorce the standard straddle technique. I’ve simply presented you with an alternative method to add to your trading toolbox. There are some circumstances when you'll prefer the "Netless Straddle", and other times that you'll prefer to go with the standard straddle. There are a few opportunities in this "Sailing" eBook when the Netless Straddle is specifically appropriate, such as a variation of the "Forex Roulette" trading the high/low breakouts of day candles.
Source: Forex Sailing

Forex Roulette

The first trading tactic that we'll look at that is part of the Sailing concept is what we'll call "Forex Roulette". This concept can be applied from small trades (say 30 or 40 pips) to relatively larger trades (say 100 or 200 pips). In general this type of trade should be limited to a maximum of 300 pips so that it has a chance to be completed within a relatively short time frame (typically a couple of days to less than a week).

Though I usually cringe at the thought of comparing Forex to anything gambling related, sometimes it is easier to do so for conceptual purposes. Please remember that by following sound trading principles Forex IS NOT gambling, though for some traders (judging by the way that they do trade) the line between gambling and speculation is rather gray. I am using the popular casino game to help describe this trading tactic - hope you understand. Lets look at the casino game to compare it to Forex for the purpose of learning this technique.

There are many aspects of the game of Roulette, we won’t be looking at all its variables but one in particular - the red black part of the game. In Roulette you have the option to place a bet on either the red diamond or the black diamond. This only presents a choice between the two options. Once the ball goes around the wheel and lands on some number a color is determined to be the winner; either red or black. Basically, this is a 50/50 game (lets ignore the green 0 and 00 for now). Essentially it's a coin toss, and statistically you’ll be right betting on either of the two diamonds (red or black) 50% of the time. In this game if you were to place a $100 bet on "red" then there is a 50/50 chance of winning or loosing. If you were to win then you would win the same amount you risked thus walking away with $200 (your original $100 plus the $100 you won). If you were to loose then you would walk away with nothing (having lost your original $100). In this same the "risk to reward ration" would be 1:1.

Ok, so now lets look at Forex. As you already know the Forex market can only move in three directions; up, down, and sideways. In reality, if you think about it, a "sideways movement" is really a temporary non-event. It is inevitable that sooner or later it'll end up moving either up or down. The equivalence to this in Roulette is when nothing has yet happened (like the ball is still spinning in the wheel but hasn't yet landed). The solution to a "sideways movement" is to simply wait... sooner or later it WILL go up or down.

So in Forex you see what on the surface now resembles Roulette. Just as in Roulette the ball can land on either red or black, in Forex the market can move either up or down - both on the surface appear to be a 50/50 proposition. With either you could theoretically "play' 100 rounds but in the end come out more or less even (ignoring green 0 & 00, or in Forex the spread). So how do you turn the "odds" in your favor? By using clever strategies you can put the "odds" onto your side to "win" consistently.

In Roulette gamblers have strategies to win, but to make a long story short, the only sure fire way to win at Roulette is to be the owner of the casino, not the gambler. Ultimately the odds favor the casino over the gambler. Gamblers do have strategies applicable to the red black aspect of the game but in the end statistically they'll loose. The two most common strategies are to play the opposite colors from the prior winning color, especially after a streak or bunching of the same color (as statistically they should balance out but the "law of independent trials" dictates that each roulette play is completely random and has nothing to do with any previous plays), and the most common "equity management" principle they follow is what is known as the "Martingale System" of doubling up on loosing bets to chase their losses back into gains. Simply put this is a stupid strategy because sooner or later the gambler would face the statistically inevitable event of either running out of money to continue doubling up on the losses or that they would reach the table maximum (maximum amount of money permitted to bet).

In contrast to Roulette gamblers Forex speculators do have a definite advantage. What gives us our edge is that we are familiar with the behavior of the markets and we have technical analysis tools to be able to predict what the market will do with better than just guessing accuracy. By combining trading wisdom with a 50/50 opportunity we hope to increase our frequency of "wins" to have a net profitable effect.

Lets say you have found a "lucky coin" on the street with which you make your trading decisions. By flipping the coin you decide to go either long or short in the market from wherever the market happens to currently be. Let's say that each time you flip the coin you'll enter a trade with a 100 pip stop loss and a 100 pip limit.

Chances are that after a series of trades you should have a net result of nothing - your gains equal your losses - or you may have a statistically probable discrepancy between how many winners vs losers resulting in a marginal net gain (your coin is lucky indeed) or a net loss (better get rid of your UN-lucky coin).

As intelligent traders lets get rid of our oracles (lucky coins, tarot cards, spin-the-bottles, or whatever) and use our knowledge of the Forex markets to make our predictions. The simplest way to describe the "Forex Roulette" technique is to use ANY successful technical analysis methods to determine the probable direction the market will go in, determine the probable distance the market will go in that direction, and determine the probability of the market not going sufficiently far in the direction of your stop, then placing a trade with an equidistant stop and limit based on the above determined predictions. The preceding highlighted sentence adequately describes the "Forex Roulette" method, and if you were to ponder it for a while you could certainly come up with countless applications for it, but I’ll do you a favor by elaborating upon some specifics in this article.

Lets say I have a six-sided dice, and lets say I were to proposition you with the following bet - each time I roll the dice if it lands on 1, 2 or 3 I’ll pay you $100 but if it lands on 4, 5 or 6 you pay me $100. Essentially this is a straight 50/50 proposition to which you might decline playing because ultimately it's pointless because the expected net result should be nothing (or you might play with me simply out of boredom). But lets say that I propose the game that if the dice lands on 1, 2, 3 or 4 I’ll pay you $100, but if it lands on 5 or 6 you pay me $100 (representing a 66%, 66/33 odds, or 2 to 1 in your favor). After you've made certain that I didn't have loaded dice (I'm not cheating here) you would be very enthusiastic of playing this game with me, and you would want to play this game with me as often as you could. Why? Simply because you know that statistically out of every three times we play the game you’ll be winning $100 net profit. If we rolled the dice 30 times you should be up (statistically) $1,000..

This "dice game" example described above is what we are trying to accomplish with the "Forex Roulette" method. Your technical analysis tools help you to slant the odds away from 50/50 into your favor. How steeply you slant the odds into your favor will depend on how skillful you are at technical analysis methods, but even if you are very new to Forex and have just begun learning you should already have sufficient skills to at least have a slight advantage. Because of this fact I would recommend the "Forex Roulette" method to novices, but it is also quite valuable to even the most advanced traders.

Having a "Trading Journal" (a note book or electronic document) where you record all your trades (including screen captures of the chart, reasoning for your trade, entry/exit prices, and results) is a great idea for you to keep. In your journal you should also record each "Roulette" trade you ve done so you can keep score of your statistics, most importantly your ratio or percentage of winning trades vs losers (also keeping a running tally of your profit/loss). This will become a powerful document for you to learn from (analyzing what worked for you and where you can make improvements).

After engaging in a bunch of trades (10 minimum, but 30 or more is far better) you can start to calculate what your success ratios are. Remember, you won't "win" every trade, but the higher your percentage is over 50% the better you will do in the long run. If you can get your predictions up to 66% (same odds as our dice example above) or better after some practicing then you’ve accomplished for yourself a "Holy Grail" because you have now cultivated a skill that can rack up significant profits over time. Is this a realistic expectation to accomplish? Of course it is! With practice your skills to make appropriate predictions will improve, so keep practicing.
Source: Forex Sailing

SYSTEM TESTING

You must test each indicator, rule, and method before including them in your trading system. Many traders do this by dumping historical data into testing software and obtaining a printout of their system’s parameters. The profit-loss ratio, the biggest and the smallest profit or loss, the average profit and loss, the longest winning and losing streaks, the average profit, and the average or the maximum drawdowns give the appearance of objectivity and solidity.

Those printouts provide a false sense of security. You may have a very nice printout, but what if the system delivers five losses in a row, while you trade real money? Nothing in your testing has prepared you for that, but it happens all the time. You grit your teeth and put on another trade. Another loss. Your drawdown is getting deeper. Will you put on the next trade? Suddenly, an impressive printout looks like a very thin reed on which to hang your future, while your account is being whittled away.

The attraction of electronic testing is such that there is now a small cottage industry of programmers who test systems for a fee. Some traders spend months, if not years, learning to use testing software. A loser who cannot admit he’s afraid to trade has a wonderful excuse that he is learning new software. He’s like a swimmer who is afraid of water and keeps himself busy ironing his swimsuit.

Only one kind of system testing makes sense. It is slow, it is timeconsuming, and it does not lend itself to testing a hundred markets at once, but it’s the only method that prepares you for trading. It consists of going through historical data one day at a time, scrupulously writing down your trading signals for the day ahead, then clicking your chart forward and recording the trades and signals for the next day.

Begin by downloading your stock or futures data for a minimum of two years. Swing to the left side of the file, without looking at what happened next. Open your technical analysis program and a spreadsheet. The two most important keys for traders on a computer are Alt and Tab because they let you switch between two programs. Open two windows in your analytic program—one for your long-term chart with its indicators, the other for the short-term chart. Open a spreadsheet, write down your system’s rules at the top of the page and create columns for the date, entry date and price, and the exit date and price.

Turn to the weekly chart and note its signal, if any. If it gives you a buy or sell signal, go to the daily chart ending on the same date to see whether it gives you a buy or a sell signal as well. If it does, record the order you have to place in your spreadsheet. Now return to the daily chart and click one day forward. See whether your buy or sell order was triggered. If so, return to the spreadsheet and record the result. Track your trade day by day, calculating stops and deciding where to take profits.

Follow this process throughout your entire data file, advancing a week at a time on the weekly chart, a day at a time on the daily chart. At every click write down your system’s signals and your actions.

As you click forward, one day at a time, the market history will slowly unfold and challenge you. You click and a buy signal comes into view. Will you take it? Record your decision in a spreadsheet. Will you take profits at a set target, on a sell signal, or on the basis of price action? You are doing much more than testing a set of rigid rules. Moving ahead day by day, you develop your decision-making skills. This one-bar-at-a-time forward testing is vastly superior to what you get from backtesting software.

How will you deal with gap openings when prices open above your buy level or below your stop? What about limit moves in futures? Should the system be adjusted, changed, or scrapped? Clicking forward one day at a time gets you as close to the real experience of trading as you can ever get without putting on a trade. It puts you in touch with the raw edge of the market, which you can never experience through an orderly printout from a professional system tester.

Manual testing will improve your ability to think, recognize events, and act in the foggy environment of the market. Your trading plans must include certain absolute rules, most of them concerning money management. As long as you stay within those rules, you have much freedom in trading the markets. Your growing levels of knowledge, maturity, judgment, and skill are much more important assets than any computerized testing.
Read More : SYSTEM TESTING

Scalping Trading System

Scalping is one of the toughest types of trading. It means trying to capture profits of less than $0.50 per share as fast and as often as you can. There are several ways to scalp. This first is by capturing the spread. The scalper tries to buy at the bid and sell at the ask.

These days, spreads on stocks with large trading volumes have become smaller. Before the market converted to decimal pricing, the standard spread was 1⁄16 of a dollar or a “teenie.” A “teenie” equals 6.25 cents. A scalper who bought at the bid and sold immediately at the ask would make the spread of 6.25 cents per share.

If the commission was a penny per share, the scalper would still make money. The scalper must be right more often than not. Three things can happen: The stock can go against you, stay the same, or move in your favor. Two of the three possibilities are bad.

When the market went to decimal pricing, the spread on the high-volume stocks became a penny or less. This has made it impossible for scalpers to profit. Another scalping technique involves momentum trading. Scalpers try to ride on the back of institutional trading. They learn to spot opportunities on Level II, then jump in at the beginning of a move and get out before the momentum dies. On any given day, there will be short bursts of activity when buy or sell orders from large institutions reach the market. The sheer size of these orders tends to move the market in the direction of the order. A sell order tends to move the market down, whereas a buy order moves the market up. It takes effort to learn to spot these activities.

Rather than looking for specific stocks, momentum scalpers watch for news events, earnings reports, and business news that can set a particular stock in motion. They watch the various queues for signs of a potential burst of activity. Usually, this is done by watching the activities of the market makers.

Another method the scalper uses is “shadowing the ax.” The “ax” is a large institutional player that is actively participating in the movement of a stock. Usually, the institution has received a large buy or sell order. To get it delivered, the institution will employ different tactics to confuse the trading public about its true intentions.

To make money using this strategy, scalpers need to have a clear understanding of how each of the different market-making operations act. Otherwise, they can get on the wrong side of the trade. I do not discuss all the various scalping tactics here, but now you have the basic idea.

A scalper has to constantly watch the Level II screen and quickly react to the information it provides. Unfortunately, the screen does not slow down and allow the scalper to interpret the information. Decisions must be made in less than a second.

Once a decision has been made, scalpers must react before the price moves away from them. Execution skills come into play. Scalpers with less than optimum execution skills will not succeed. They will always be late, unable to get the shares they want. Scalping is not for everyone.



Read More : Scalping Trading System

The Value Of Adding The Fibonacci Numbers To Our Trading Systems

Let’s put everything you have learned so far together to increase your
percentage of finding a winning trade. The natural law of the Fibonacci
numerical sequence is not capricious, it works on every time frame and in
every market. It is just as valid in the Forex as it is in the stock or
commodity markets. As a matter of fact, anywhere you can pull up a
financial chart, on any time frame, you will see the Fibonaccis in action.

I will never forget one class I taught in Sydney, Australia, when I met an
older gentleman, named John, who introduced himself to the class by stating:
“I have come to take your course because three years ago, I bought $250,000
worth of Qantas stock at $2.00 a share. I told myself when it hits $5.00 a share,
I’m selling.” He proceeded, saying, “That #@*#@* stock went to $4.90 cents

a share, looked at all my sell orders, laughed in my face, then U-turned and is
now back around $2.00 a share. I came here to figure out what happened and
why I was so greedy and didn’t sell at $4.90 a share. That was my retirement
money.” This reminded me of a saying my dear friend and mentor Fred
Gronbacher taught me, it goes something like this: “The ignorant must suffer.”
I told John, and the class, “After I teach you how the markets work, on
the last day of the class, we will pull up a chart and look at Qantas stock.

Mark my words, and write this down right now.” Everyone grabbed a piece
of paper and started writing. “On Saturday, when we pull up the chart, at
$4.90 there will be a bearish candlestick formation at a D Fibonacci extension
level followed by an uptrend line break, the reversal will create a
bearish ‘king’s crown,’ and the market will begin to make down A, B, C, D
all the way down to $2.00 a share.” I would have showed all of them at that
moment what I was talking about, but it would have been of no value until
they finished the course.

After class on the third day, we pulled up a Qantas chart and, sure
enough, right before everyone’s eyes was one of the most beautiful evening
stars at a D Fibonacci extension level. This was followed by an uptrendline
break, a bearish king’s crown, and down A, B, C, D’s. John jumped up out
of his seat as he was sitting on the first row and, in front of 45 people,
grabbed me, gave me a bear hug, and kissed me on my cheek. The class
began to laugh, but as John pulled away, he looked at me with a tear in his
eye, whispering “Thank you, chief!”

It has been from countless moments like these, shared by great people
like John, that I have found my true destiny in life. I have learned we make
a living by what we get, but we make a life by what we give.

CONCLUSION
Knowing where to get into the market and where to get out, and why, is
about as close to the holy grail that you’ll ever get. Understanding that
nature exists in the market, and how it works, places the trader at a huge
advantage. It allows a trader to wait for the retracement bounce at a preprojected
retracement number, having the market move in their direction
from entry, which is every trader’s dream, then riding it to the preprojected
corresponding Fibonacci extension.

As you read the step-by-step rules of trading a trend, try to envision the
movement of the market and the trading process. This methodology works
on all time frames and in all markets.
Read More : The Value Of Adding The Fibonacci Numbers To Our Trading Systems

Always Pair Strong With Weak - Trading Secret

Every baseball fan has a favorite team that he knows well. The true fan knows who the team can easily beat, who they will probably lose against and who poses a big challenge. Placing a gentleman’s bet on the game, the baseball fan knows the best chance for success occurs against a much weaker opponent. Although we are talking about baseball, the logic holds true for any contest. When a strong army is positioned against a weak army, the odds are heavily skewed toward the strong army winning.

This is the way we have to approach trading.
When we trade currencies, we are always dealing in pairs - every trade involves buying one currency and shorting another. So the implicit bet is that one currency will beat out the other. If this is the way the FX market is structured, then the highest probability trade will be to pair a strong currency with a weak currency.

Fortunately, in the currency market we deal with countries whose economic outlooks do not change instantaneously. Economic data from the most actively traded currencies are released every single day, and they act as a scorecard for each country. The more positive the reports, the better or stronger a country is doing; on the flip side, the more negative reports, the weaker the country is performing.

Pairing a strong currency with a weak currency has much deeper ramifications than just the data itself. Each strong report gives a better reason for the central bank to increase interest rates, which in turn would increase the yield of the currency. In contrast, the weaker the economic data, the less flexibility a country’s central bank has in raising interest rates, and in some instances, if the data comes in extremely weak, the central bank may even consider lowering interest rates. The future path of interest rates is one of the biggest drivers of the currency market because it increases the yield and attractiveness of a country’s currency.

In addition to looking at how data is stacking up, an easier way to pair strong with weak may be to compare the current interest rate trajectory for a currency. For example, EUR/GBP - which is traditionally a very range-bound currency pair - broke out in the first quarter of 2006. The breakout occurred to the upside because Europe was just beginning to raise interest rates as economic growth was improving.

On the flip side, the U.K. raised interest rates throughout 2004 and the early part of 2005 and ended its tightening cycle long ago. In fact, U.K. officials lowered interest rates in August of 2005 and were looking to lower them again following weak economic data. The sharp contrasts in what each country was doing with interest rates forced the EUR/GBP materially higher and even turned the traditionally range-bound EUR/GBP into a mildly trending currency pair for a few months. The shift was easily anticipated, making EUR/GBP a clear trade based upon pairing a strong currency with a weak currency.

Because strength and weakness can last for some time as economic trends evolve, pairing the strong with the weak currency is one of the better ways for traders to gain an edge in the currency market
Read More : Always Pair Strong With Weak - Trading Secret

Trading Methods

Every one is eager to get hold of the Holy Grail, whether it truly exists or not. It is
indeed the elusive factor that courts the relentless determination of its seekers. A lot
of traders – both new and not so new – seek the perfect formula that is capable of
predicting with 100% accuracy the future price movements. Want to know where it
lies? It only exists in the creative part of the mind – together with fairies and gnomes.

There is no perfect formula or strategy that can achieve that unrealistic goal
because people who are involved in the financial markets evolve with changing
market circumstances, even though certain old habits die hard. Despite the nonexistence
of the magic formula, there are certainly high probability ways of trading
the forex market. While the bulk of this book is focused on the Method part, you
need to combine Method with both Money and Mind in order to attain success in
the trading business.

The old question: technicals or fundamentals?
There are generally three broad categories of forex traders pertaining to what they
base their trading decisions on:
1. the technical trader,
2. the fundamental trader,
3. the trader who combines both technicals and fundamentals.

Each type of trader has a distinctively different way of interpreting the currency
market based on his or her own opinions.
Technical trading
A technical trader believes that historical data has a big role in the forecasting of
future price action, and is thus devoted to currency price chart analysis, making use
of various charting tools such as support and resistance levels, trendlines and a
myriad of chart indicators to understand past price behaviour so as to predict what
the market will do next.

Most forex traders employ some kind of technical analysis to help them make
trading decisions. In fact, technical analysis of the forex market is so prevalent
among market players that self-fulfilling prophecies often occur at price levels
where people’s responses become quite predictable; that is, you will know if most
players will buy or sell at those levels due to their historical significance. Technical
traders assume that everything that is to be known about the market has already
been factored into the current price.


Fundamentals trading
The second category is the fundamental trader who weighs and analyzes the various
economic news and information relating to the country of a particular currency in
order to come up with a fair evaluation of the value of that currency relative to
another. Fundamental traders believe that the exchange rate of currencies are
largely driven by economic and geopolitical conditions, aside from central bank
interventions, and will keep track of economic data such as trade balances,
inflation, Gross Domestic Product (GDP), unemployment rates, interest rates and
so on. They are also concerned about what policymakers have to say regarding the
monetary policy of the country, and will keep on top of these when speeches
are scheduled.

Combing technicals and fundamentals
Since there are advantages of analyzing the forex market from these two different
fields, it would be too restrictive to just side with one area and ignore the other. The
most effective traders tend to make trading decisions based on a combination of
both technical and fundamental factors in order to get a feel of the overall market
sentiment, and then decide to either trade that sentiment or to trade against it taking
a contrarian approach.

The strategies taught in this book must always be combined with the prevailing
market sentiment, which is influenced mainly by fundamentals.


Method is malleable
I believe that an important factor of trading success lies in the matching of Method
with the trader’s own personality and trading style. Some strategies may work well
for some traders, but may not have the same results for others over a period of time.

This may seem puzzling for some people who are wondering that if something
works for someone, then it should work for other people as well. In trading, there
are so many other factors specific to each trader that can influence the overall
trading performance – his or her emotions, psychology, trading time frame, money
management rules, lifestyle, trading capital and so on.

The strategies included in this book are open to customisation according to your
own personal preference. While most of the strategies are meant for day or swing
trading, you have the freedom to adjust certain parameters to suit your own trading
time frame and/or other preferences.
Source:7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets

Practical Aspects Of Trading Systems

Let’s take a very brief look at some of the practical aspects of my approach to
trading. Remember, it’s mine, you can use it, but adapt it, personalize it to fit you.

Business Plan
Business plan - My trading system starts with proper goal setting and a
well-defined business plan. Understand that you have embarked on a
business venture. Unrealistic expectations can be one of your biggest
enemies. What is it that you want? Not what you think you want or think you
ought to want. What is it that you really want? You will be surprised how, after
a little examination, you may come up with goals that are different, even very
different from what you thought. I want to make money is not a goal. A goal is
I want to make money because….or I want to make money in order to….and
that ‘because’ or that ‘in order to’ is critical to your trading success. It is about
being realistic and honest with yourself.

Whatever your goals are, make sure you keep your feet on the ground.
Always ask yourself this simple question: Am I trying to achieve the
impossible? You cannot make returns of 100% on capital per month. Yet
there are service providers selling this absurdity to the public. You may be
lucky and do it once using high gearing but I guarantee you this: you will not
do it month after month. Unscrupulous service providers are after your
money. Don’t believe their promises or stories. “Open an account with
just $500.00. It gives you buying power of $100,000!” This is a business -
your business, don’t confuse it with buying a lottery ticket while running
errands.

Your business plan is an organized process to work towards those goals.
Both the setting of realistic long-term goals and the concept of a business
plan should place you in a frame of mind that will increase your chances of
making a success of your trading. The business plan should include certain
“what if” scenarios, the usual “S-W-O-T” (strengths-weaknessesopportunities-
threats) analysis, market research and several other aspects
peculiar to a trading business. Reading this book will contribute to your
general market research and the development of a profitable business plan
you can implement. It even gives some strategic guidelines and
methodological pointers. It is not a 1-2-3-you’re-a-millionaire-if-you-doexactly-
this-or-your-money-back-guaranteed-guide.

4x1 strategy

4x1 strategy - To implement my business plan, I have a 4x1 strategy, one
currency, one lot, one direction, one percent
One currency
Concentrate on one currency. Get to know it. Don’t jump back and forth.
One lot
Low gearing. Small position size.
One direction
Trade in the direction of the “fundamental” trend. Be disciplined and patient.
One Percent (1%)
Understand profit – what it is and when to take money off the table.

Median Trading
Median trading - The specific methodology I use to make the nitty-gritty
trading decisions I call “median trading”. Those of you who may have been
around the block a few times, will immediately recognise that the parameters
of this methodology are neither original nor new and are used by other
successful traders. It remains an interesting, and perhaps instructive fact, that
many successful traders use much the same basic principles. My 4x1
strategy is deployed within a comfort zone I get by ‘snapping’ a static picture
of the market and fixing it in my ‘median grid’ based on the principle that price
always reverts to a median. My median grid is divided into price levels. This is
an important concept. Exactly because intra day pricing is virtually random I
substitute fretting about entries and exits at specific prices with a
system of identifying ever changing buying and selling price levels of 20
– 50 pips, depending on relevant factors such as account size, gearing and
so on.

This provides a comfort zone because there is a high probability that
immediate future price action will occur within this demarcated zone. It
provides flexibility and room-for-error (another very important concept in
discretionary trading), in which both discretionary and non-discretionary
technical trading produces good results. Price levels, rather than specific
prices at specific moments in time are buying and selling zones. This also
determines the time frame I use. I use a time frame that I feel is
“manageable”. This means I can relate cause and effect (information
and resulting price action / price changes). When I can’t I can’t. I call it
noise and ignore it, rather than find a reason just in order to say I have one. I

accept it. The market moved. That’s it, let’s get on with things. No one can
tell you what is happening all the time.

I can also anticipate price changes based on known future events. I can
gauge the size of the price move based on the impact of the event. I can also
discern between noise (meaningless price changes), trend following /
supporting / enhancing price changes or trend changing price changes.

Relational analysis
Relational analysis - Unlike many other good, successful traders who rely
solely on technical analysis, I make a lot of use of fundamental analysis
(anything that is not technical or psychological). I believe in a holistic
approach, the more relevant analysis you include in your trading decisionmaking
the better the decision-making is going to be. Relational analysis is
what brings it all together, the meaningful relating, one to the other, and
all to one, of Price, Event, and Time (PET). You must learn to ‘see’
connections which are not obvious. This applies especially to major
fundamental trends. What are the factors at play today that will cause us to
look back in three months’ time and with the perfect science of hindsight see
the obvious trend. If you can see the trend developing with that type of
foresight today you are 90% of the way there.


SIMPLIFICATION
There is a temptation, when faced with complexity, to reduce and simplify. That is
sometimes necessary, even good, but how much simplification does this complex
market allow before it punishes you, not for simplifying, but for being simple? That is
the question all traders face everyday. There is no easy answer but finding an
acceptable, workable answer will make you a winning trader. It will require you to
grapple with this complexity and find your own way through the maze. If I am making
it sound difficult then let me say that it really isn’t. It’s not a stroll, but most people will
manage if they apply the basic rules. There are buyers and there are sellers.

Sometimes the buyers are in charge and the market moves up. Other times it is the
sellers and the market moves down. And sometimes the buyers and the sellers are
slugging it out with neither gaining the ascendancy and the market moves side-ways.
But within this seemingly simple ‘battle’ a lot is going on behind the scenes.

What Is a Trading System?

Throughout the book, a number of trading systems are explored as ex-amples of the art of designing and testing trading systems. This is not a recommendation that you trade these systems. I do not claim that these systems will be profitable in the future, nor that profits or losses will be similar to those shown in the calculations. In fact, there is no guarantee that these calculations are defect free. I urge you to review the section in chapter 3 called a reality check. That section points out the inherent limitations of developing systems with the benefit of hindsight. You should use the examples in this book as an inspiration to develop your own trading systems. Do not forget that there is risk of loss in futures trading.

What Is a Trading System?
A trading system is a set of rules that defines conditions required to in-itiate and exit a trade. Usually, most trading systems have many parts, such as entry, exit, risk control, and money management rules.

The rules of a trading system can be implicit or explicit, simple or complex. A system can be as simple as "buy sweaters in summer," or "buy when she sells." By definition, the system must be feasible. Ideally, the system accounts for "all" trading issues, from signal generation, to order placement, to risk control. A good way to visualize effective system design is to stipulate that someone who is not a trader must be able to implement the system.

In practice, every trader uses a system. For most traders, a system could really be many systems. It could be discretionary, partly discretionary, or folly mechanical. The systems could use different types of data, such as 5-minute bars or weekly data. The systems may be neither consistent nor easy to test; the rules could have many exceptions. A system could have many variables and parameters. You can trade different combinations of parameters on the same market. You can trade different parameter sets on different markets. You can even trade the same parameter set on all markets.

It should be clear by now that there is no single universal trading system. Every trader adapts a "system" to his or her style of trading. However, it is possible to draw a distinction between a discretionary trader and a 100% mechanical system trader, as compared in the next section.
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Why Should You Use a Trading System?

The most important reason to use a trading system is to gain a "statisti-cal edge." This often-used term simply means that you have tested the system, and the profit of the average trade—including all losing and winning trades—is a positive number. This average trade profit is large enough to make this system worth trading—it covers trading costs, slippage, and is, on average, likely to perform better than competing systems. Later in the book, I discuss all of these criteria in greater detail.

The statistical edge is relevant to another statistical quantity called the probability of ruin. The smaller this number, the more likely you are, on paper, to survive and prosper. For example, if you have a probability of ruin less than, say, 1 percent, your risk control measures and other measures of system performance are typically sufficient to prevent instant destruction of your account equity.


My biggest source of concern about these statistical numbers is they assume you will trade the system exactly as you have tested it, with not one deviation. This is difficult to achieve in practice. Thus, your risk of ruin—and it is only a risk until it becomes a fact—could be higher than your calculations. Despite this concern, you should develop systems that meet sound statistical criteria, for that greatly enhances your odds of success. As usual, there are no guarantees, but at least the odds, if not the gods, will be on your side.

Another reason to use a trading system is to gain objectivity. If you are steadfastly objective, you can resist the siren call of news events, hot tips, gossip, or boredom. Suppose you are a chart trader and you enjoy some flexibility in interpreting a given chart formation. It is very easy to identify a pattern after the fact, but it is rather difficult to do so as the pattern evolves in real time. Hence, analysis can paralyze you, and you may never make an executable trading decision. Being objective frees you to follow the dictates of your analysis.

Consistency is another vital reason to use a trading system. Since the few rules in a trading system are applied in precisely the same way each time, you are assured of a rare consistency in your trading. In many ways, objectivity and consistency go together. Although consistency is known as the hobgoblin of little minds, it is certainly a useful trait when you are not quite a champion trader.

A trading system gives another crucial advantage: diversification, particularly across trading models, markets, and time frames. No one can be certain when the markets will have their big move, and diversification is another way to increase your odds of being in the right place at the right time.

In summary, you can use a trading system to gain a statistical edge, objectivity, consistency, and diversification across models and markets. A key assumption underlying this section is that the system you are using is well designed and robust. The next section discusses examples of a robust trading system.
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How Do You Implement a Trading System?

Begin with a trading system you trust. After sufficient testing, you can determine the risk control strategy necessary for that system. The risk control strategy specifies the number of contracts per signal and the in-itial dollar amount of the risk per contract. The risk control strategy may also specify how the initial stop changes after prices move favorably for many days.

The system must clarify portfolio issues such as the number and type of markets suitable for this account. The trading system must also specify when and how to put on initial positions in markets in which it has signaled a trade before commencement of trading for a particular account.


A trade plan is at the heart of system implementation. The trade plan specifies entry, exit, and risk control rules along with the statistical edge. You should record a diary of your feelings and the quality of your implementation, plus any deviations from the plan and the reasons for those deviations. You should monitor position risk and the status of all exit rules.

Last, take the long view: Imagine you are going to implement 100 trades with this plan, not just one. Thus, you can ignore the perform-ance of any one trade, whether profitable or not, and focus on executing the trade plan.

Who Wins? Who Loses?
Tewles, Harlow, and Stone (1974) report a study by Blair Stewart of the complete trading accounts of 8,922 customers in the 1930s. That may seem like a long time ago, but the human psychology of fear, hope, and greed has changed little in the last 60 or so years. The results of the study are worth considering seriously.
Stewart reported three mistakes made by these customers. (1) Speculators showed a clear tendency to cut profits short, while letting their losses run. (2) Speculators were more likely to be long than short, even though prices generally declined during the nine years of the study. (3) Longs bought on weakness and shorts sold on strength, indicating they were price-level rather than price-movement traders.

I should contrast this experience with the TOPS COLA philoso-phy discussed earlier. By taking profits slowly and cutting off losers at once, you will avoid the first mistake reported by Stewart. Second, by being a trend follower, you will avoid the next two mistakes. If you follow trends, you will be long or short per the intermediate trend, and avoid any tendency to be generally long. Third, if you follow trends, you will follow price movement, rather than being a price-level trader.

You will win in the trading business if you have a specific trade plan that contains all the necessary details. You should focus much of your effort and energy on implementing the trade plan as accurately and consistently as possible. Thus, you must go beyond technical analysis, deep into trade management and organized trading, to win.

The usual advice for technical traders is a collection of rules with many exceptions and exceptions to the exceptions. The trading rules are difficult to test and the observations are hard to quantify. I want you to go beyond technical analysis by converting an art form into a concrete trading system, and then focusing on implementing the system to the best of your ability. Trading is analysis in action. Thus, this book is an attempt to bridge the gap between the development and the implementation of a trading system.
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