.
299
The Sample Analysis
each month’s performance from the three-year test period that really showsthe poor seasonal performance made in the month of April for those yearsback-tested.
DOES THIS WORK FOR FOREX?Since currency trading is a large component of my trading, I wanted to optimize a system for forex. The Defcon model was tested to stand up againsta noncorrelated investment vehicle to the equity markets. I chose the eurocurrency market to run a performance test. As we discussed in Chapter 7,due to the computers’ inability to test the forex markets’ data because thereis no centralized market and prices are quoted in bid/ask form, we ran thetest using the euro currency futures, which trades parallel to forex markets.The test period was conducted using 15-minute intervals during the U.S.open outcry trading session from 8:20 A.M. (ET) until 3 P.M. (ET).The winning percentages were not as great as in the S&P; but, boy, thebottom-line results showed a healthier profit! Table 11.5 shows the rate ofreturn with 365 percent, but it was based off a recommended starting balance of $16,770. The overall gross profit was $61,275, based on a test periodthat went back three years. We had 310 trades—the system generatedslightly more trades here than in the S&P. This may indicate that the mar-
TABLE 11.5
Euro Currency—All Trades from 01/03/2003 to 01/09/2006
Total net profit:Total trades:Average trade:Average # of bars in trade:Average # of trades per year:Max closed-out drawdown:Account size required:Open equity:Total winners:Gross profit:Average win:Largest win:Largest drawdown in win:Average drawdown in win:Average run-up in win:Average run-down in win:Most consecutive wins:Average number ofconsecutive wins:Average number of bars in wins:
$61,2758310$19864.24102.7–$13,163$16,770$825187$186,625$998$6,038–$2,713–$405$1,450–$405102.6359.78
Profit factor ($wins/$losses):Winning percentage:Payout ratio (average win/loss):Z–score (W/L predictability):Percent in the market:Maximum intraday drawdown:Return percent:Kelly ratio:Total losers:Gross loss:Average loss:Largest loss:Largest peak in loss:Average peak in loss:Average run-up in loss:Average run-down in loss:Most consecutive losses:Average number ofconsecutive losses:Average number of bars in losses:
1.4960.3%0.98–0.974.0%–$14,475365.4%0.1981123–$125,350–$1,019–$4,313$2,113$397$397–$1,63071.7671.03
300
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
ket is more volatile, not less, as some people believe. As for the test period,I believe this was a good time frame because it represents a great samplingof various market conditions, considering that we had several market conditions exist: bull trend, to a consolidation phase, and then a trend reversalor downtrend.In January 2003, the euro was valued at 1.0500 to the U.S. dollar. Itwent as high as 1.3660 in December 2004; and as of February 2006, the eurowas back at 119.00. During that time, the market conditions changed frombullish to bearish and went into a consolidation phase as well. We want tosee how a trading system performs in various market conditions. Notice thethree market conditions as indicated by the trend lines drawn in the weeklyeuro currency chart in Figure 11.8. According to the test results, the systemfared pretty well.Let’s examine both the volatility and the margin requirements. As ofFebruary 15, 2006, the daily initial margin requirement to trade one eurocurrency with a 125,000 contract value (margin requirements are set by theexchanges and are subject to change without notice) was $2,835.00. As youcan see, we are trading a highly leveraged market that has an average daily
FIGURE 11.8Used with permission of esignal.com.
The Sample Analysis
301
range of approximately 86 PIPs (percentage in points) per day. In the futures, each PIP is $12.50. That computes to a daily trading range of $1,075per day. In using strict money management guidelines, we are using only 28percent of our investment capital. So in the spirit of being a great trader, Iwant to ask why I would trade only one contract with a starting account of$10,000. The answer is clear, and another great example of why it is important to know what you are doing before you do it. By back-testing a system,I can determine what the worst to expect is. Granted, we did not implementany means for risk management. The Defcon system solely generates atrade triggered by the pivot point moving average approach. You will seethat by going back and validating the methodology, we had a single loss inthe amount of $4,313. That is the bad news; and more than likely, as withany severe and sudden market loss, it was generated by a shocking newsevent. The monthly unemployment report on August 6, 2004, was one suchevent where the euro currency moved almost 260 points in a single day.This was a good definition of a news-driven price shock. As the data inTable 11.3 shows, the profits were bigger in the euro than they were in thee-mini–S&P; but so were the risks. So we have a bigger profit; but alongwith that greater profit came greater risks. How many times have you heardthat before? The bigger the risk, the bigger the rewards. I have heard that abunch of times, but it is great to see it put in front of me based on a definedset of rules. So if I get the feeling one day to go “all in” like a poker playerand use 100 percent of my margin, in the euro currency I could easily dothree contracts. In one bad day, not only would I wipe my account, but Icould be deficit, meaning I could actually lose every penny in my accountand owe money.Using the back-tested results of a system allows me to see my program’s strengths and weaknesses. That is the edge I have against the market—knowing when to raise my positions and when not to. Besideslearning that my system can make money, I also found out that I need todouble my account if I want to double my positions. Using a computerproduct like Genesis allows me to identify and validate the methods employed. As we look at the equity curve in Figure 11.9, we can see a solid performance; and that should help maintain your confidence to stick withtrades generated by the signals. Figure 11.9 also highlights a negative$13,162.50 maximum drawdown from peak profits. Imagine increastingyour lot or contract size prematurely during that negative phase. It wouldcertainly ruin your trading day, year, or even career!In the stacked bar graph in Figure 11.10, we see the results of peak performance; and more important, we see the kink in our armor, the weakestpoint in our system from a seasonal perspective. By back-testing the system, our diagnosis shows a seasonal weakness in the markets that occursin January and February and continues into March. We know from the table
302
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
FIGURE 11.9Used with permission of www.GenesisFT.com.
By Month
Profit
by Profit
FIGURE 11.10Used with permission of www.GenesisFT.com.
The Sample Analysis
303
FIGURE 11.11Used with permission of www.GenesisFT.com.
in Figure 11.1 that we have a string of winners that last on average 10 in arow. Therefore, if at the end of October I have 10 winners in a row, I thinkI will be more selective in my trade signals in November! As you can see,the statistics show small drawdowns in November. According to the threeyear test period, April through August is the most profitable trading timeperiod (Table 11.6). We can enhance our performance by not trading inApril, though, as that was one of the worst-performing months as indicatedin Figure 11.6 on page 297.As you break down the numbers by the statistical results, it is by thatdata that you can determine the validity of your methods (Figures 11.11 andTable 11.7). When we look at a month-to-month breakdown of the eurocurrency, we see January 2004 was a whale of a disaster, as shown in Figure 11.11! With this information, we can determine if the cause of the disaster was the system, the methods, or one heck of a wild trading period.The answer should not surprise you: It was the last. There were only twodays that had daily trading ranges over 250 points. On January 16, 2004, themarket dropped like a hot sack of potatoes, with a high of 1.2610 and a lowof 1.2351, for a range of 259 points. Then two days later, it reversed higher,with a low of 1.2345 and a high of 1.2599, for a 254-point range. The marketgained back what it lost; but overall, it was simply a very violent trading period, as Figure 11.12 shows. Without some type of intraday risk management method, such as a trailing stop, all traders at some point will be
304TABLE 11.6
By Month Report
Jan 28, 2006 21:34:14Name: John Person Defcon III euroSymbol: EU-067Statistic to chart Profit, Position selection All trades, From date 01/03/2003, To date 01/09/2006.
Month
Trades
JanuaryFebruaryMarchAprilMayJuneJulyAugustSeptemberOctoberNovemberDecember
221928242631293430191830
WinPct
WinAvg
LossAvg
RunUp
RunDown
P/L
P/F
AverageTradeC/L
59.09 %57.89 %42.86 %66.67 %53.85 %64.52 %72.41 %73.53 %56.67 %57.89 %50.00 %60.00 %
$601$1,048$1,033$1,053$1,702$747$698$977$1,038$808$1,082$1,330
–$1,481–$1,791–$1,245–$858–$798–$520–$1,030–$958–$809–$941–$1,242–$795
$1,054$1,547$1,460$1,502$2,339$1,240$1,007$1,294$1,557$1,478$1,790$1,617
–$2,383–$2,486–$1,899–$1,597–$1,451–$883–$1,795–$1,347–$1,297–$1,584–$1,931–$1,294
0.410.590.831.232.131.440.681.021.280.860.871.67
0.590.800.622.462.492.611.782.831.681.180.872.51
–$251–$147–$269$416$548$297$221$464$238$72–$80$480
434257244323
MaxLoss
Profit
AverageBars
–$3,350–$3,800–$3,375–$1,975–$3,288–$2,550–$2,838–$3,138–$4,313–$1,838–$3,763–$2,738
–$5,513–$2,800–$7,525$9,988$14,250$9,213$6,413$15,788$7,138$1,363–$1,438$14,400
71.4581.3765.3663.2566.6252.0658.0750.3557.1083.9584.0062.90
TABLE 11.7
Monthly History Report
305
Used with permission of www.GenesisFT.com.
306
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
FIGURE 11.12Used with permission of esignal.com.
subjected to news-driven price-shock market environments. No one is immune to them. The good news is that they do not occur frequently, as thisdata shows.To summarize, the essence of back-testing is validating your methodsand showing the strengths and the weaknesses of your system. Moreover,it will help you define your goals and expectations for performance. Therefore, it can help you achieve the highest trading profits with the lowestrisks in most trading market conditions. I want to elaborate that by studying a system, in all market conditions, you at least will be better preparedand less shocked when an eventual negative situation develops in yourtrading career. The main goal in trading is consistency and staying in thegame. Statistics show this!
CHAPTER 12
Confidence to Pullthe Trigger Comesfrom Within
uccessful trading is all about diligence and hard work and having awinning attitude! Great traders take the trades that were developedwith thought and with keen observations that were based on predefined trading signals. This mentality will help you develop the confidence toexecute when a trading opportunity presents itself. Lack of confidence andfear are your enemies. Trading on a rule-based system will help you overcome most emotional issues as long as you are trading based on a signal ortrigger. Never take action on anticipating the signal. If the rule states tobuy when X crosses over Y, you have to wait for the cross rather than anticipating that the cross is about to occur. That is what trigger means: It isa call to action based on a conditional change.Many experienced losing traders who have come to me for help have acommon problem—they try to jump the gun and try to outguess the market.They have this feeling that they will miss the opportunity if they don’t act.By now, you know what a candle chart is; and you have read many timesthat it is imperative that you wait for the close of the time period for whichyou are trading to close before acting on a buy or a sell signal. Look at Figure 12.1—the candle on the left may have given an impression that a bullish breakout would materialize. However, keep in mind that unless youwaited for the close, it really formed a doji. Imagine getting all wrapped upemotionally, thinking you were missing a great buying opportunity only toexperience buying the high of the time period because you failed to be patient and disciplined in waiting for the time period to conclude, assuringyou of the buy signal, or of the higher close.
S
307
308
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
FIGURE 12.1
If you anticipate a signal, you might be right; and there are times whenyou can anticipate taking a trade based on a formulated, educated guess.One such scenario would be to make a buying decision based on what I calla “gap band” play. That is when the market departs too far from the pivotpoint moving average, which for a buying opportunity would be defined asa potentially overstretched price extreme or oversold market condition.Armed with the longer-term numbers, such as a monthly second support (S2) target, I would look to go long but with partial positions; or I would simply scale into a position with from one-quarter up to one-third of my normallot size or positions.Here is where it might seem like I would be playing the “catch thefalling knife” game, which I am. But when the market has the capacity tomake a major price reversal, especially when several indicators line up,such as stochastics warning of bullish convergence, the Commodity Futures Trading Commission (CFTC) Commitment of Traders (COT) reportshows a major imbalance, as discussed. Then if the market has been in along-term downtrend and shows that prices have departed too far from themean, that is what spotting a buying opportunity is about. That is alsowhen, under these certain conditions, it is apropriate to anticipate a trade.You should cut back on your initial position size and set a risk factor suchas a conditional setup if the market, for instance, makes a lower closinglow. You can also add a time element, such as “If the market does not reverse in X amount of periods, then get out.” In a situation like this, youcould implement a longer-term option strategy, such as buying call options.(I did not go into options in this book because that subject matter was covered in my first book on page 217.) Options are a great investment vehiclethat offers traders peace of mind and confidence to pull the trigger in highlyvolatile and precarious situations, such as picking longer-term tops andbottoms, especially in the bullish scenario just described. Remember, Ihave stated many times that as traders, we “look for opportunity and thenapply a strategy.” That is how we capture potential profits on big reversals.
Confidence to Pull the Trigger Comes from Within
309
Anticipating trades is a dangerous game, so you need to take that into consideration. If you ask yourself the right questions, then you can develop asolid trading plan. One such question is, “Is the risk worth the reward?” If itis, take the opportunity.
WAIT FOR THE TRADE SIGNALSFor day, short-term, or swing trading, you need to wait for signals and tradeby those signals. That seems easier said than done. But it is a common mistake that I have helped traders with, especially when they have jumped thegun, anticipating a buy signal from an indicator such as stochastics. Wewent over the stochastics %K and %D 20-level line-cross signal. Figure 12.2shows a detailed description of how to apply the 20 percent line closing signal properly, using the market’s price action while waiting for the close ofa time period to keep you from anticipating a trade. It also demonstrateswhen it is more apropriate to enter a long. If you learn what a true signal is,based on the close of a time period, and if you repeat that successful action,then you will develop the skills needed to have the confidence to consis-
FIGURE 12.2Used with permission of www.GenesisFT.com.
310
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
tently apply this method. Ultimately, your performance and trading resultswill improve.We discussed in Chapter 3 how to use the stochastics oscillator properly. It is so important. Let’s review: If you anticipated a buy signal based onthe stochastics %K and %D hook crossover the first time, you should noticehow either of the two closed above the 20 percent line in Figure 12.2. In addition, you did not see a higher closing high collaborate a buy signal. Anticipating without confirming factors or misreading a signal can and usuallydoes result in losses. Notice that the second signal where both %K and %Dcross and close above the 20 percent level is confirmed with a higher closing high. This is a confirming signal and will put you in a better mindset andmore often than not on the profitable side of the ledger. Remember, yourmind can and does play tricks on you when you are trading. That little subconscious voice will tell you to just hang in there, to just keep holding on tothe loser, because the market will bounce back. Odds are that fear takesover and you sell out of a long, right on the low of the move. You cannot acton emotional impulse. If you act on impulse and you are wrong, you needto get out immediately once and if the market breaks further against you,because the emotional state of greed got you into the trade and the emotional state of fear will get you out. Usually it is on the low. If you wait fora true buy signal based on the closing price action, you are trading with thecurrent flow of the market. This method of trading, once you see consistentresults, will increase your confidence; and that will give you what it takesto become a successful trader consistently over time.
THE RIGHT FRAME OF MINDMany times traders subconsciously sabotage themselves inadvertently.Avoid putting yourself in a situation that will cause you to be skeptical orafraid before you trade. A better way to state it is, do not trade while undergoing a major personal setback. This would include stressful events likebuying or selling a house, moving, sickness, a change in careers or a loss ofa job, a death in the family, or loss of a friend. A breakup in a relationshipor a divorce can also cause undue stress. Try to make educated decisions,and make sure you have the time to invest in your work before putting onany trades. Remember that it is alright to be wrong; just don’t be wrong allthe time, making the same mistakes over and over again. If you follow aproven strategy, you are already aware that there will be losses. We discussed this in Chapter 11. If you are trading on the edge, not in the rightframe of mind, angry, or upset, then you have lost the emotional edge thatis needed to stay focused and disciplined.
Confidence to Pull the Trigger Comes from Within
311
If you are not trading with an indicator, a plan, or a software program,then write your rules down on your computer screen. This is one methodthat can help keep you on track when you start trading out of impulse orfrom an emotional state of mind.
TRACK AND CHART YOUR TRADESA trading diary is a great way to check and confirm your trading executionentries and exits. In fact, most charting software has the capability to goback to see when you executed a trade. Think what this can do for a trader.If it is followed properly, it can and most likely will help you to improveto a new level of self-discipline and ultimately lead to increasing your selfconfidence. How? If you execute when the signals call for action, you canvalidate whether you responded when called to do so. You can check yourwork. You will find out if you hesitated when your methods called for youto exit and if you timed it per the system or not. One lesson we teach ourstudents at Trading Triggers University is to save a chart and print it outwith the entry scale-out and exit. Printing the chart out helps you to seeclearly how you respond or react to the trade signals. It will reinforce thevalidity of your system or any system, including my Defcon program withGenesis Software. By printing out and cataloging your trades by a chart,you will gain more experience in identifying the patterns that drive yourtrading signals. It also keeps track of or “inventories” what went right orwhat went wrong with a trading plan. It will allow you to study and examine the results in black and white. On successful trading days, it will begood to capitalize on your successes so that they can be repeated. Ofcourse, on bad days, it can allow you to focus on what went wrong so thatyou can understand and improve on it so that you stop repeating the samemistakes over and over again.
TWO CASES IN POINTIf you map out a game plan, trade off the “numbers,” or have a trading system, when you print out your chart and examine your trades, you are grading your own homework. I have posted on my web site a daily Dow Reportto which the Chicago Board of Trade links. Every day after the marketcloses, I post two numbers based on my teachings and on what we wentover in this book. Those numbers are what I believe the high and/or low ofthe session will be; and then, based on the market direction number, I willpost a trade recommendation. Figure 12.3 shows a direct quote that was for
312
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
FIGURE 12.3Used with permission of esignal.com.
Monday, February 13, 2006. The initial resistance level was 10983, and mytarget support was 10865. The exact low was 10865, and a high close dojipattern formed.This is not rocket science. Why would I state the day before what typeof pattern to look for and at what price? We know the reasons why I selecta high close doji trigger based on the statistical findings in Chapter 7. WhenI introduce two other dimensional market analysis approaches, such as amoving average and pivot point analysis, all you need is the patience to waitfor the signal to materialize. It is a high-probability setup; and in this case,the trade resulted in a 38-point gain, or $190 per contract, in less than anhour. The only drawback on this trade was that you had to wait until theend of the day for it to materialize. No pressure, no worries, just profits. Anice trade. And if you print out a chart and plot your entries and exits, youwill begin to see more clearly how a trade develops; and you will reinforceyour subconscious mind on what to look for in the next trade and improveyour confidence from within to win.There are many who visit my site just to see my numbers selection forthe market. I also include what the projections are for the week. For day
Confidence to Pull the Trigger Comes from Within
313
traders and swing traders, it helps them also identify a potential confluencesupport level based on pivot point analysis. Feel free to visit and check thenumbers yourself at www.nationalfutures.com; just click on the link thatsays Daily Dow Report. Even better: You now have your own Pivot PointCalculator, provided on the accompanying CD to this book.Another case in point as to why it is helpful to print out and cataloguecharts that track your trades is that it will help you to visually back-test themethods. The more you see the patterns recur, the more assurance you willhave in the methodology.The topic I covered in Chapter 5, demonstrating how to filter the pivotpoint price projections, based on the moving average approach, gives mean edge by reducing the noise or eliminating excess information. It helpsme to narrow the field to what the potential range might be of a given market for a specific time frame. If I have a predetermined point of view thatthe market might see a low of 1257 and a high of 1273, once I identify a pattern and conditional change in the price action, I can enter a position. InFigure 12.4, I have a trade example in the e-mini–S&P (Standard & Poor’s)that demonstrates how the market was contained within the bearish target
FIGURE 12.4Used with permission of esignal.com.
314
CANDLESTICK AND PIVOT POINT TRADING TRIGGERS
selected pivot point numbers based on the system. Remember, if bearish,then the target low will be near S-2 and the high will be near the first resistance level (R-1). If you stick to the rules and look for buy signals nearsupport and sell signals near resistance, follow the game plan, add theother two dimensional factors such as a high close doji or hammer pattern,with the moving average indicating a conditional change, then you enter aposition. As the market starts to show momentum loss as indicated byshadows, scale out of half of your positions, place a hard stop at breakeven, and then wait to see the flow of the market. If you print out yourchart and plot your entry price, your scale-out price, and then the pricewhere you exited on the balance of your positions, you will not only gradethe trading system but also your performance and how you react to market conditions.
SIMULATED TRADINGIt goes without saying that the more practice you have, the better you willperform. But if you practice the wrong thing over and over, then there is little hope for improvement. That is not a line for a trader—that was a linefrom a golf pro to a bad golfer. It just so happens that it applies to trading.Almost any brokerage firm will give you a free trial to a simulated tradingaccount for you to bang around on. With no real money on the line, you really are not putting your time to good use. It is extremely advisable if younever traded or if you switch to a new company to get accustomed to thetrading platform that may be unique to that company. That makes all thesense in the world.A trader needs to take action when a trigger is generated, rather thantaking a wait-and-see attitude and then reacting to the market long after themarket has moved. As a trader, you need to be quick. A sudden brain spasmspawned by fear, doubt, or greed will most likely not bring consistentlygood results. Hesitation is a trader’s enemy; that is why I say, “Plan yourtrade, and then trade your plan.”Simulated trading can help you test a trading method, but what abouttesting your emotional response to market conditions? How will you develop the confidence from within to win? What will seriously help thetrader who enters too early or too late and can’t hold on to the winner?What can help the trader who hesitates and can’t pull the trigger?For starters, you need to not trade with what we call “scared money.”That’s the money that you are afraid of losing, that you protect so well thatyou end up losing it. Remember in Chapter 11 that we went over the performance sheet on the trading system results. The payout ratio is the
Confidence to Pull the Trigger Comes from Within
315
amount of the average winner versus the loser. If you cut out of a winningtrade too early and do so randomly because you need to make a profit, thenyou are possibly setting yourself up for a financial meltdown because youare not letting your winners ride.One question that new investors ask me is why they did better at papertrading than they did when they traded with real money. The answer iseasy. They let their emotions such as fear, doubt, complacency, greed, anxiety, excitement, and false pride interfere with their rational and intellectualthoughts. When dealing with real money, you are faced with the realizationthat you and your money can part.Simulated trading is good to understand the mechanics of a trading execution platform. However, putting real money on the line is what will testyour trading skills. Here is a suggestion: If you want to really see if you havewhat it takes to be a professional trader who can execute a testable tradingsystem, then trade with the smallest lot or position size for a period of sixweeks or two months. You may not make lots of money if you are consistently right, but you will develop the confidence to act on your signals whenyour self-imposed training session is completed. If you trade stocks, instead of trading 200 shares of an $80 or $100 stock, trade 50 shares. Thiswill help you feel more at ease, and it will also put your emotions to the testas you are trading with real money.Here is another suggestion: Open an ultra-mini-s