Day 1: Buy at Sell day 5 at Day 2: Buy at Day 3: Buy at Day 4: Buy at By stepping into the trade in units rather than entering all in one go, you have managed to turn a loss-making trade into a winning one. Note: To stress again, you always set your maximum risk level in advance of a trade being placed and never exceed it. If the trade had continued to lose, you would NOT have added more units once you had reached your maximum exposure. The simple strategy uses the DVB indicator mentioned earlier.
Going long on a reading below 50 and short on a reading above I have performed similar tests on intraday day trading systems for stock markets and forex markets and while they do vary depending on the system, the general conclusions remain the same. Units: The number of units the trade is divided into when stepping in stages. The higher the number, the better the ratio. Anything better than 1. Ideally, you want your biggest loss to be less than your annual growth rate, which would give you a MAR greater than 1.
The Compound Annual Growth Rate is 2. In raw Compound Annual Growth Rate terms, simply using one unit for your trades has historically provided the best returns. However, this does come at a cost. You are fully exposed to any trades that move against you over multiple days.
Using two units instead of one does decrease the CAGR, but because the Max Draw also decreases by a greater magnitude, it does appear that using two units may represent a greater risk-reward. The benefits of scaling are not exponential though as the MAR remains fairly set at around 1. As you divide your trade into ever greater chunks, you reduce your drawdown risk, but your annual returns reduce as well. One thing you may have noticed though is how scaling increases your strike rate.
As you spread your risk across an increasing number of units, you increase your chance of making a profit overall from the first signal to the last. Beyond raw numbers, there are other potential benefits to using a stepping strategy — managing trading psychology.
Related Ideas
Some of the best returns from counter-trend trading strategies have come at points where the market is highly volatile. At these points it would be more difficult to implement your trading signals in practice unless you have learned to manage your trading fears in the face of large potential losses, or have implemented an environment filter as discussed in the previous article.
This is where trading theory meets trading reality. There are always two aspects to any trading system:. Stepping into your trades may reduce the personal impact of entering a trade that could run away from you right away and mitigate possible early losses that may otherwise shake you out of your trade. In addition to reducing the size of potential drawdown, sequencing may reduce expected losing sequences, which may just help you stay the course during an especially choppy period for your trading strategy.
Stepping into your trades is not a magic bullet that will transform a poor system into a highly profitable one. What it may do is help you spread the risk on that trade by reducing your cost of entry. It is also a good way to keep your trading discipline on trading signals in volatile trading environments.
Position size and stop loss are used to manage risk
The major downside of stepping is the increased cost per trade either in brokerage fees or increased spread, but the peace of mind and experience gained from remaining in the market may more than make up for it. The exact number of units to apply is up to you and will depend on the characteristics of the system you are trading. As a general rule of thumb, the quicker it finds winners, the less scaling you may want to apply and vice versa. While most people will have heard of legendary investors such as Warren Buffett or George Soros, there is another financial billionaire who has a track record on a par with these giants, yet few have ever heard of him.
The trader is Jim Simsons, head of the highly secretive Renaissance Technologies. Over the years small snippets of information have emerged though. Another hint that has emerged over the years is the flexibility that Renaissance applies to their trading systems. Renaissance scours the market for repeatable patterns that could be translated into profitable trading systems.
This is only the tip of the iceberg though. Their real genius is reportedly not their systems, but their ability to know what systems to apply in different market conditions and when something has gone off the boil. Financial markets are constantly evolving, with trading patterns shifting from slow and steady upwards grinds pre to wild thrashings that made financial markets appear to be acting at the behest of a baby randomly pounding the keyboard.
Repeatable patterns appear within financial markets, offering substantial rewards for those who can spot them early enough. The real skill is not in spotting them, but understanding them well enough to know when and how to apply them in context. Specifically, this means, the ability to know:. In the many years that I have been trading and during the time I have been writing What Really Profits, I have seen many trading systems come and go. In that time I have been able to spot a pattern in how well particular products might fare.
The worst kind of systems are those where a vendor appears to offer little understanding of the context in which a system best flourishes. So if you intend to trade a systematic trading strategy with fairly rigid rules and you know that every trading system has a shelf life to some degree or another, what are you to do? Does the system perform especially well when markets are choppy and relatively poorly when markets are more trend following?
Some trading systems are consistent with steady winners, while some equally profitable systems can be more volatile. Sometimes tracking the progress of your trading account can tell you more about the health of your trading system than the performance of the system itself.
Trading with the Trend - 6 Ways To Identify The Direction Of The Trend -
When you better understand your trading system you have the ability to be flexible in your application of it. If you have access to back-testing software, I thoroughly recommend testing a trading strategy not on the basis of performance, but to spot what else is going on around any particular times of under or over performance.
Even if you have access to back-testing software, this only goes so far though. The best results come from seeing how your trading strategy performs live day in, day out.
Think of a trading strategy as being like a good friend or relative. For example, you might know when someone is best left to themselves or if they have some good news they are trying to hide. By getting to know a market and getting to know a trading system, you can spot the subtle signals that will help you switch on or switch off a system.
Horizontal vs Trend Lines in Forex, differences you need to know
To put some of these ideas into practice, one filter I have been applying lately is to identify when markets are behaving abnormally. My favoured short-term indicator when day trading financial markets has been the DVB indicator, but in early August I noticed that it was entering dangerous territory. As with the article on Stepping In, I have performed similar research on shorter-term day trading systems on a variety of markets including The DVB indicator performs best in choppy, counter-trend trading conditions, but there are times when markets become too choppy with violent moves that are so big they do not reverse.
You only have to look at charts of most stock market indices in August to see what I mean. Thankfully, I have been applying an abnormal market filter, an idea first mooted by Michael of Marketsci. When price breaks this steeper trend line, it almost always extends toward the major trend line. The more distance there is between the two trend lines, the higher the profit potential.
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By using this counter trend trading techniques, traders can employ a strategy as simple as using two trend lines to trade with this method. The first step, if to identify a trend on the price chart. You can do this by quickly scanning the securities of your interest. Typically, we use a one-hour chart time frame. This is more suited if you are a short term trader. The first step is to observe the chart where the trend is clearly bullish or bearish.
You can do this by observing the highs and the lows in price. Once a trend is identified, the next step is to connect the two consecutive lows to form a rising or a bullish trend line, or to connect the two consecutive highs to form a bearish trend line. Typically, this is the major trend line and we anticipate that when price changes course, it will move to this major trend line. Pay attention to the slope of the trend line as well.