Using Your Trading System Part 2

Ingot54 · June 26, 2011

IS MY SYSTEM WORTHLESS?

In this second part of the topic, we begin to really address how to operate your trading system

Part ONE asked the question: “Is the Trading System I bought useless?” in the context of “Comparing “Hindsight with Reality.”

What I meant was this: It is very easy to throw together a few Moving Averages and a few Indicators, and call it a SYSTEM; and then it is just as easy to find a chart the demonstrates how good this system functions, in choosing winning trades. The scam system vendor from a nice, bright Internet site, is really coming up with great trades … in HINDSIGHT. He is NOT showing you the trades AS THEY HAPPEN.

What I am doing, is the reverse. I am “cherry picking” a section of a chart where the system worked nicely, purely to illustrate THE WAY TO OPERATE A SYSTEM, not to prove that the system actually works. My approach is to show you how to read the chart at the right hand edge of your screen, candle-by-candle as the price reveals itself. That is the contrast between “Hindsight Trading” and “Reality Trading.”

In the last paragraph of the last post, I said:

“But notice that the MACD histogram has crossed UNDER its signal line, and is falling. This tells us MOMENTUM is slowing … nothing else. Next, the RSI is still ABOVE 50, and parallel to the 50 line. No conclusions to be drawn there either. We need to wait another hour, to see what price is going to do.”

Refer to Chart 1 below

We don’t have that situation yet, so we need to wait until we do see the fast MA, the 5, cross the slowest MA, the 34. In fact it does not happen until 7 hours later, at the close of the candle illustrated below. There is a decisive move down, and after the candle closes, we can see that the MA’s have actually crossed. So, after waiting patiently – I call it “stalking” the trade – we finally have the alert AND the trigger.

Refer to Chart 2

Note: This MA crossing might not have been seen on the “entry candle” until the candle actually closed, and certainly had the following candle been a rallying candle, the MA cross may even have disappeared – thus triggering a whipsaw situation, but not necessarily negating the trade. These are the risks of trading. Had the 4H chart remained in a downtrend, we would not have been stopped out of the trade. That’s for another day.

We enter the trade immediately the new candle opens. We can expect some draw-down because as mentioned earlier, price is dynamic – it ebbs and flows like a living thing, as it progresses. There are two other things to take note of here: The MACD histogram has crossed DOWN through the zero line, and the RSI has not only crossed down through the 50 line, it has revisited the 50 line and then dropped sharply away again, in the direction of the possible new trend.

In this style of trading, you do not know where your take-profit level will be. You only know you are a part of a very good

trend, and you claimed your entry at an excellent point in a pullback. These trades can run for days, because they are based on the 4H charts, which are les susceptible to “noise” in lower TF.

It would be easy to say here that our trade made about 130 pips, based on the crossing of the medium MA – the 13EMA, by the fast, or 5EMA on the 1H chart. But this is not the case, unless you have enough experience to use skilled discretion in closing the trade. The trade actually closed out with around 70 pips, based on the system rules. I closed the trade at that point so as to illustrate two things:

The first is that we can have an arbitrary rules-based strategy to tell us the conditions under which we will close the trade, no questions asked! The second thing is that we can use our thinking (discretion) and experience, to remain in “good” trades long enough to extract the maximum pips, but not so long that we give back more pips than we really needed to.

Refer to chart 3 below, for an arbitrary closing signal … the crossing of the fast and the medium speed EMA’s:

Closing the trade here gave us around 70 pips, as we said, but had we managed the trade from the 1H chart, we would have made around 120 pips – far better it seems than the pips made following the 4H chart. Or so we think … we are not finished with this lesson yet.

Which is the best strategy for trade management, and why?

Refer to closing point on the 1H chart. chart 4 below.

The better action here is to remember to check ALL TF before making a decision about closing this trade. If we checked the DAILY chart, we would see that the DOWNTEND is still strongly intact, and we are experiencing a pullback on the 4H chart, but not a true signal to close the trade. The best situation is to remain with the 4H chart, and manage the trade from there. Why? Because the RSI has NOT crossed the 50 line, and the MACD has NOT crossed the zero line.

Further, on the 4H chart, the MACD is very flat – it does not look like it is really wanting to rise much further. You will notice we are not losing many pips in the pullback. Experience teaches us that if we follow rules in trading, we can come out of scary trades as a winner. In this case, we have the CONFIDENCE of a powerful DAILY trend backing us.

So what you may think is an error, in not using the lower TF – the 1H – to manage the trade, is actually just consistent application of the rules. Failing to do this, could well have cost us hundreds of pips at other times. By the way – by applying this same strategy to the DAILY chart, we could have scooped about 550 pips, and the trade was still running. Maybe we could have made more pis .. maybe fewer … we don’t know until our trades are closed out.

Refer to this nice DAILY Chart, chart 5 below.

There are 550 pips in that trend at the point we see it.

Trading is full of hypothetical situations. You can only make your rules and stick to them. The situation about the trend continuing down in the higher Daily TF, could have been written in your journal as a post-trade comment, and certainly an important case made for the future, to allow for such circumstances in the rules. There is no substitute for screen time … and more screen time.

One swallow does not make a summer, and one great trade that works out, by manipulating the rules, does not invalidate the rules. Rules should only be amended when a benefit to do so can be demonstrated consistently over time. If you can bend and break the rules so easily, then they are not rules at all … they are guidelines! I can tell you, good traders don’t have “guidelines” … they have iron-clad rules!

Finally, had we been trading the DAILY charts, through following what is going on in the WEEKLY TF, and taking entries from the 4H charts, we might have enjoyed a trade of between 1000 and 2000 pips … and the trend is still running. A bit better than 70 pips … or 120 pips! Longer trends have immeasurable benefits to us – the least of all is the stress-free method of trading.

I hope I have been able to show the benefits of a few things here:

1) Higher TF trades can be just as successful as scalping the very fast TF and with less stress

2) Trading decisions are made from the reality of the right-hand-edge of the screen, not hindsight, or setups 20 candles earlier

3) Using multiple TF can be of huge advantage to traders regardless of style

4) Following the rules strictly can actually have an enormous positive impact on your account

5) Rules can be amended based on consistent evidence from your trading journal

6) Following the rules strictly has an enormous reinforcing effect on the traders confidence in his method, and in his ability as a trader.

CONCLUSION

A traders failure to understand and apply a system consistently and accurately, speaks more about his lack of attention to detail and rules, than it does about the efficacy of the strategy employed.

Rather than blame the system for failing to deliver the profits promised on the website, traders should first of all be certain they are trading a simple system – one that they can easily understand, without too many indicators and filters. We have seen how a simply devised forex trading strategy DOES have the ability to make pips, without the need for more complications.Then it is easy to accept responsibility for our own trading decisions, and NOT blame a strategy that is over-size for our current skills.

Quite often it is the eagerness of traders to overtrade, that is at the root of their problems. There are many virtues successful traders need to have, and the chief amongst them would have to be patience, focus and discipline to follow simple rules.

A poor system in skilled hands can do as well or better, than a sophisticated system in unskilled hands. And how do you get the skills? Certainly not from a system purchased over the Internet!

Skill is developed, not purchased.

You acquire forex trading skills through screen time, practice, working under a successful mentor, engaging in forum conversation with quality contributors, learning about what drives the forex market, understanding your indicators through and through, watching what happens to price on different TF simultaneously, and of course the golden trio: focus, commitment and consistency. In one word, these three qualities add up to … discipline!

I hope you enjoyed this two-part series of posts. next post will be much shorter, but I will post something useful to your trading bottom line.

Posted in my blog: http://forexapplepie.com/