Absolute simplest KISS method. Also, how should we measure risk/reward?

[permanentjaun]

Howdy all,

I'm sorry but I like open discussions around theories of trading. I'm not going to give you a system saying when X currency is above this MA with RSI here then buy 3 lots, blah blah blah. Here is the latest theory that's been mulling around my head.

How KISS can a trading system get? How about if I told you all you had to do was place on order at the open of a new candle without consideration of any past price movement? What if I told you the system was at the very least 80% correct? You'd say get out of town right? Maybe its not that easy, but it can be!

It all hit me when d3vil posted a thread about a strategy he was considering. You can read about it here:

http://www.strategybuilderfx.com/showthread.php?t=17439

My idea is nearly exactly the same except on one thing. d3vil's system requires that a currency move 50 pips to trigger a trade in that direction. My idea is, why wait for the 50 pips? I say, at the open of a new candle on a daily or weekly chart open a trade in any direction with a take profit of only 10 pips or so. No thought required, just enter a trade.

Look at a daily and weekly chart. There is a lot of movement in those candles. This system doesn't care about all that movement though. This system cares only about a few pips, 10 perhaps. What do you see in each candle on those charts? Rarely, very rarely do you see a candle open and go in one direction without any form of shadow in the opposite direction. Meaning, if a candle is a long white candle, there is still usually a shadow of a few pips below the open.

That's what got me thinking. What if when a new candle on a weekly or daily chart is formed you enter a long or short trade for only 10 pips profit. Why do I mind only taking 10 pips? Well look at the chart. How many times did a new candle form where you would have entered a position and not made the 10 pips? (I should note I'm looking at GBP/USD, EUR/USD, and USD/JPY) I'd say the win/loss ratio is 80/20. That's a very conservative number I'd say.

Also note the problem with the 80/20 number. Out of the trades that would have gone wrong, how many of those would you have been on the bad side of? If the trades were picked at random we can assume you would have been on the right side in those losing situations 50% of the time and 50% of the time on the wrong side. So the win loss ratio would probably actually be 90/10. Not sure how much better actual judgement could help, but then consider if you were able to use some chart reading experience to place yourself in the winning position of the possible losing trades better then 50% of the time. Win/loss then becomes upwards of 95/5.

I just got back from a trip to the SEMA convention in Las Vegas so I haven't looked at the charts to confirm those win/loss numbers. I'd say on a weekly chart those numbers will stand up pretty well though.

Here is another thought that came from this. What is risk/reward? Why do most of us measure our reward in pips rather than by how risky the play actually is? I see the above strategy as very safe considering the extremely low pip goals and high frequency of being correct. It is up for discussion, but I would feel very safe placing much more than just 2% of my account towards such a trade. Thus, when you're making $100 a pip consistently do you mind only taking 10 pips a week? $52K a year is probably a lot more than most make here trading. The idea is to just keep reinvesting and adding more funds to slowly build the value of your pips. When we try to take more pips, in any strategy, our probability of success begins to drop dramatically.

Right now I am having difficulty determining an exit strategy for a stop loss system though. With such long time frames we allow plenty of movement and don't want to wipe out our 10 pip profits with one long candle of 100+ pips. There are plenty of times when a currency will retrace 60 pips to give us our profits as well though. This makes me wonder how many of those 80% good trades did this and would be eliminated by a stop loss to reduce our chance of success to only 80% overall or less.

The take profits and losing exit strategy still need to be worked out. I've been thinking about taking only 5 pips from a daily candle to average 25 pips a week. The success rate would be increased on a daily candle while still giving us more pips than taking just 10 on a weekly chart. The system could also be applied to many different currencies at once to give a possible 100 pips per week if just 4 currencies are used that work well. The more volitile with low spreads the better. Isn't that cool? A system that works well with volatility. EUR/USD would work well too. We need currencies with many shadows in their candles.

This thread was also to get people thinking about different forms of trading. Many systems try to be successful based on how many times the thought process is correct. This system is based off of how many times in a time period currencies actually do something. I'm having trouble putting it into words, but do you understand what I'm saying? It's like, when a candle first opens on a long time frame chart it is 100% certain that it will move from the open in one direction or the other. What other certainties can we base a system off of? I'm going to look at a similar strategy, but with entries near the very end of a candle to see if the candles after it tend to overlap the previous close by a few pips. Could we increase the probability of success with that?

I'll finish by saying the last benefit of this system. It's so easy even an EA could do it! (Thinking of the geico caveman commercials, haha) Seriously though. No indicators. No thought process. Trades for long/short could be completely random and still be in situations where it wouldn't matter which position you take and still be upwards of 80% correct. Simple strategies could be entered though. For example, when the previous candle was red then enter a short on the open for the next candle. If it was green enter a long trade. This would add some decision making to the strategy and might help eliminate those losing trades better than 50% such that the win loss is 95/5 right off the bat.

What do you all think? The beginning would be slow, but once you start earning $50 or more a pip, the profits will add up quickly. Matt

[permanentjaun]

For anyone not reading other forums that I've posted this on, right now I'm thinking the success of this system relies in helping an EA or us make an educated guess to help us to determine if we should enter long or short in a trade. If out of 80% of the candles it doesn't matter if we're long or short then we need to focus on the 20% where it does matter. How do we predict more correctly those candles? My suggestions to get the thinking juices going was for an EA to look at a 4 hour chart and see where there 5 and 20 Hull MA's were. If the 5 HMA is above the 20 then the position is entered long and short if their positions are reversed. The positions are entered on the open of a daily or weekly chart but direction chosen on the momentum on a 30 minute to 4 hour chart. It could help tremendously. I'm trying to figure out how much more that actually helps in winning more than 50% of the losing 20%. Matt

[RavenMM]

Matt, I would like to say good luck with your system. Instead, I have to say that your " simple" system has left me confused.

It started off with just place a trade on the open of a candle. By the time the 2nd post has finished, we're using moving averages to determine long or short.... hang on, is that on a 30 min chart, a 4hr chart or what?

Don't get me wrong, I'm all for discussion on simple systems. But this already looks complicated. Furthermore, while you can look historically at any time frame and say that trades would be 80% successful with this system, I believe the reality would be different.

If you're only going for 10 pips, how big is your stoploss? To make this system worthwhile, I assume it's got to be 10 minus the spread or less???

Sorry, perhaps don't really understand your simple system??

[permanentjaun]

Hey RavenMM,

Excellent questions. I probably didn't explain myself clearly enough.

The system is still based off of opening a long or short position when a new candle forms. What I noticed is that 80% of the time the candle that forms has large enough pip movements that it doesn't matter if you went long or short, you would have still hit your pip targets. On the remaining 20% we have the opportunity to make the right trade and still exit with a profit. Using a 50/50 chance at making that happen leaves us with 90% success and 10% of the trades still ending up as losers.

In my second post I mentioned moving averages because the success of the system depends on 2 issues. The first issue, which the moving averages tries to address, is to give ourselves a chance greater than 50/50 on the 20% of the trades that aren't guaranteed profits. The idea is that on a daily chart, perhaps if we base the decision to go long or short on short term momentum, say on moving averages on a 30 minute chart, then it will give us that edge to be better than 50/50 on those 20% trades.

For example, we want to know if we should go long or short for our 5-10 pips when a new daily candle opens. We look at the current momentum on a shorter time frame chart, perhaps 2 hour, to get a direction to take. We could use something like if a 5 MA is above the 20 MA then we assume the current short term trend to be bullish and we enter long on the daily candle. if the 5 MA is below the 20 MA then current short term trend is bearish and we enter short. We base our long or short decision on the daily chart from the indicators on a shorter chart.

Would you enter a trade on a daily chart based off of an indicator on a weekly chart? Probably not because the weekly chart is too slow to make decisions for a daily chart. Conversely, I believe if we were to use indicators on a 30 minute to 4 hour chart to make decisions on a daily chart, it could give us a better idea of how to enter the trade on the daily chart.

The second issue that needs to be solved is what you already mentioned; stop loss. If we are only looking for 10 pips, how do we place a stop loss against it to protect profits, but not allow a currency to swing enough such that if it goes 10 pips against us we give it enough room to swing back and give us our 10 pips? This I haven't solved yet.

Right now what I am more concerned with is trying to find a way to make our entries more accurate and successful. It is my belief that when creating a system you should focus on doing that. Then when you think you can not make it any more successful then place a stop loss system that does not affect your success rate.

I manually looked at a daily chart of GBP/USD last night. I started on February 8th, 2004 and went to June 27th, 2005. I believe that is about 357 trading days. Out of those 357 days there were 56 times that the candles didn't have enough movement to guarantee profits. When I mentioned 80% in my previous posts, this is that number. 56/357 = .156. Meaning out of those trades it was 84% guaranteed successful. If we entered 50/50 on those 56 trades then the system would have been 92% successful hypothetically.

Here is an odd finding however. If we entered a long or short decision based on the previous candle it would actually have hurt us in those 56 trades. Meaning if the previous candle was up then we enter long on the next candle and if the previous candle was down we enter short. If we did that it would have only saved 21 of the 56 trades or about 37.5% of them. This may be too close to 50% to use it as a system. This is why I believe something like using shorter time frame chart MA's or other indicators may be more useful at giving us a more accurate short/long decision. Until I learn how to write EA's I won't be able to test that in the long term however.

I also noticed that by lowering the pip targets from 5 to only 2 or 3 pips on a daily chart that it didn't really help much. It seems when a candle doesn't give us enough pips to make profit it usually is because it had such a strong trend that it never bothered to swing a few pips at the open. I believe this strengthens my belief that if we found the trend on a short term chart it could help us with the remaining 20% losing situation tremendously.

Hope I cleared some things up for you. Matt

P.S. - BTW, 2-3 pips may not seem like much at all. Even 10 pips isn't much. The point of the strategy is for the long run and to use compounding. Also, what if you play 5 currencies and get 2 pips from each a day. That's 10 pips a day total and 50 pips a week. It will add up quicker than you think.

[Trevman]

your post was very long so lets see if i've got this right, each day you place a order at open and profit of 10pips and let it run. (see attachment) the arrows highlight when the market did not move enough for a 10pip shadow - the ones i could be bothered to check (according to metatrader at least) as you can see these are at the peaks of movements and so would have left you gravely out of pocket but worse that this is

Originally Posted by permanentjaun

Thus, when you're making $100 a pip consistently do you mind only taking 10 pips a week? $52K a year is probably a lot more than most make here trading.

...or loosing $100 a pip the drawdown on this kind of strategy would be immense even on a mini

[permanentjaun]

Sorry I don't see your attachment. I will discuss your post though.

I have evolved the idea to try different avenues. I mentioned earlier that a good key to the success of this system was finding a way to put yourself on the winning side of the trades more than 50% of the time. Right now that key is in the form of a filter. Apparently I came back to the idea of the thread I referenced in my first post. If we wait for 50 pips, on GBP/USD, then it gives us a very good indication of how to place our trade.

Just last night I placed a trade in this matter and banked the 5 pips I wanted. I lowered my TP to 5 since I'm looking at a daily chart. It opened at 1.9020. I straddled that price 50 pips away with my entry orders. A buy at 1.9070 and a sell at 1.8970. They were parent and contingent orders so I could place my exit orders too.

Price moved south to hit 1.8970, and continued in that direction to bank my 5 pips. I could have left the buy order open but decided to cancel it as I had to leave the computer for several hours.

This filter needs some tuning for GBP/USD as well as other currencies it is applied to. We need to calculate the average shadow/wick length of a candle in its opposite direction. For example, what is the length of the bottom shadow when the candle is up? What is the average length of the upper shadow when the candle is down?

We want to find the window that most shadows do not go into yet the bodies do. This way we enter trades in the direction of the real body and not the counter trend shadow. I'm sure I could make it much easier to see in a video presentation.

I'm having trouble convincing myself to move the filter from 50 pips away. I think when we start to increase it to say 70 pips, then we place ourselves in a situation where the TP may not be hit even if we're on the right side of the trade. This happens quite a bit in a ranging market. Also, many times the entry order may not be hit.

Another problem that still needs to be addressed is the stop loss. We can institute a stop loss much easier in this system. Still don't know how much room we should give it though. Would a 50 pip SL save us from one bad trade wiping out the many small profits? Is it too far? Is it too close and we get stopped out even on winning trades? Anyone have any suggestions? Matt

[Trevman]

apologies, heres the attachment i was reffering to in my post
http://www.moneytec.com/forums/213124-post6.html

i'd also like to point out that the daily candles you see on your chart may or may not be the same as mine, due to time zone differences and "days" occuring at different times

[permanentjaun]

Yes that is exactly how the system would work. It's also a good example of why I'm interested in it. Out of the 96 candles I counted there were only 4 instances of failure. On that chart it was 95.8% successful. I found that its actually successful more along the lines of 80-85% of the time. That is not counting the times when you would have been on the right side of the possible losing trades.

Like you mentioned however, when it fails it's going to fail hard. This is why I want to explore the idea of waiting for the price to move 50 pips off of the open to get us into the body of the candle more often. Since we're only interested in getting X amount of pips per candle, what does it matter if we get them in the beginning or 20 minutes before it closes? Waiting for substantial movement will help us that much more in our decisions.

I'm thinking an entry 51 pips away might be more useful. 50 might fall victim to the brokers stop hunting and such. Matt