The Professional vs. Amateur’s Reaction to a Losing Trade

How can a professional take the same trade as an amateur yet end the trade at a profit or be in a better position psychologically after taking a loss? Every trader experiences losing trades. Professionals and amateurs may have similar outlooks on a market, but oftentimes they end up with different results. This article will review the main difference between a professional and amateur’s perspective including a current trading example.

Focus on your system’s effectiveness and not individual trade outcomes.

If you plan to become a successful trader, you will need more than one trade to make a career. Lessen the impact that each individual trade has. That way, you can accept losing trades without losing sleep.

Do not be afraid to exit when you notice the market moving against your trade outside of your accepted risk. Amateurs often become emotionally married to a losing trade when the market moves against them and they’re not ready to accept the loss. They keep the trade open and try to propose to themself why it’s a good idea to stay in as the market continually rejects their idea.

Being attached to the outcome of every trade is emotionally and mentally draining so take a broader view so you can relax.

The professional mindset when approaching the market on the front end (pre-trade) and back end (post-trade) is calm and mechanical in nature. A state of Zen-like focus is present at all times because the professional accepts the risk and is ready to exit if the market tells them they were incorrect.

What surprised me from the start was how calmly the professional accepted wins and losses well within their money management system. I remember watching a fund manager steadily exit an oil trade that went against him 3% of his account equity. His ego didn’t get in the way. He quickly exited the trade because it was clear to him the market didn’t agree with the reason he got into the trade. Had he stayed in the trade, the market reversal would have eaten over 10% of his account equity which is unacceptable to a professional and weakens the sustainability of his trading career.

What was more important to this fund manager than being right and trying to force a winning trade?

He was focused on honoring the system that gives him an edge over the long run and never puts all his eggs in one basket by allowing a single trade to make or break his day, week, or month.

This is difference in the professional vs. the amateur mindset. The amateur is only focused on the trade at hand. The professional focuses on the system and keeps it super simple.

A system consists of the pairs you’ll be focusing on, the money management you use and the indicators that you have a unique ability for reading and acting on. This is how you will create an edge over the long run.

To see these diverging mindsets play out, let’s look at a current set up on AUD/USD on my favorite chart, the 4H:

(Created using FXCM’s Marketscope 2.0 charts)

We’ve identified three plausible entries based on a 21 period moving average and candle stick analysis (View our Candle Stick Course here). The problem for the amateur occurs when he sees the market is no longer trending as per the moving average and he stays in the trade after entry #3. By focusing on the trade alone, the amateur often fears booking the loss now more than using a poor system. Their “system” becomes one of hope and doesn’t allow the edge of a strong risk: reward ratio and high probability set ups to play out over time.

The professional mindset is mysterious to an amateur in their ability to seemingly not care about the money at risk because they accept the risk of the trade within their money management system. With 100% acceptance of the risk, they can flow freely and never be angry with what the market does next. I call this remaining fluid, which is common among the professionals approach to a market like FX.

---Written by Tyler Yell, Trading Instructor

You can take our Moving Average course to identify high probability set ups if you REGISTER HERE.

To be added to Tyler’s e-mail distribution list, send an email with the subject line “Distribution List” to TYell@FXCM.com .

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
Learn forex trading with a free practice account and trading charts from FXCM.

http://www.dailyfx.com/forex/education/trading_tips/daily_trading_lesson/2012/09/27/The_Professional_vs._Amateur_Reaction_to_a_Losing_Trade.html

Finding the Right Trade Size for You

Trade size is an important aspect of every trading plan. Traders quickly forget this to their own peril. Many traders are not reaching their trading goals because their trade size was too large for their account equity which leads to reluctance of letting go of losing trades.

This article will present an easy way to determine what trade size is appropriate for your account.

When trade size gets out of hand and too large, all the analysis in the world is worthless. The risk can quickly outweigh the benefits. Because of this, having a formula to manage your risk is of extreme value for your trading career. If you’re not a math major, no worries at all. A simple formula is provided at the end of the article for you apply moving forward.

Here is a visualization of the risk you take based on your trade size from Mark Douglas’ Trading in the Zone. To borrow his analogy on trade size, imagine there is a large valley much like the Grand Canyon that you are about to cross. The width of the bridge you will cross is directly related to the number of lots you will trade. As you can imagine, if you’re about to cross the Grand Canyon on a 10 lane highway bridge, you’re not going to fear walking across. You know the potential of pain is small because the bridge below you is steady. Now, the larger trade size you open in relation to your account, the smaller the road below you shrinks. Using the utmost leverage available, you’re essentially walking a tight rope. As you can imagine, the smallest fluctuation in the market can throw you over board.

Now, let’s walk through the application in finding the right trade size for you.

*Examples below will be filtered through the eyes of a $10,000 account with 2% max trade risk rule to determine trade size.

Here are the two aspects you’ll need to answer before determining appropriate trade size:

• Percent risk you’re willing to accept per trade –We recommend less than 2%
• Where do you want your stop in terms of pips

Percent risk you’re willing to accept

This will have nothing to do with the market and everything to do with your account balance. You determine your risk, not the market. Your money management system will tell you where to get out of every trade. We recommend you limit your risk per trade to less than 2% of your account equity. Noting this before you enter a trade is being proactive and will prevent you from increasing your exposure based on how good a set up looks to you. All good traders look to limit risk and most poor traders neglect this.

Many good traders will keep a trade journal that will have their current account equity updated and how much they should risk on any one trade. Our $10,000 account example with the 2% max trade risk tells us that before we look at the charts, we are only willing to lose $200 on a single trade. For most traders, this relieves stress by itself.

Converting that risk into Trade Size

Now that we know how much is at risk, we next decide the best trade size for us based on our pip based exit. Here is a simple formula to use to determine your trade size:

Proper Trade Size Formula:

Your three inputs will be your account balance, what percentage you want to risk, and the number of pips you are willing to allow the market to go against you before you exit the trade.

Account balanceX% risked / stop loss distance in pips = maximum value per pip

Using our example above and plugging into the formula, here are the three inputs.

Account balance = $10,000

Percent Risk = 2%

Stop loss distance = 100 pips

Plugging them into the formula:

$10,000 X 2% / 100 pips = $2 per pip

You can find dollar per pip value on the FXCM Trading Station 2.0 platform located below the trade size field. By manually adjusting the trade size, you can adjust your pip value to be equal to or less than the output of the proper trade size formula.

(Created using FXCM’s Trading Station 2.0)

If you want a larger trade size, we recommend you find another trade that better suits your account size or add more funds to your account.

Why do we advise limiting your trade size?

DailyFX recently went through 12 million live trades to find the common traits of our successful clients. Leverage was a main focus because many traders know what amount of leverage is available but few knew what was amount was best. Many new and inexperienced traders over expose themselves and when the market went against them, a large percentage of their account dissipated. Successful traders in our study consistently stayed under 10 X effective leverage and were often closer to 5 times effective leverage.

Here is a graph from the study to show you profitability percentage and it’s correlation to lower effective leverage.

(Graph courtesy of DailyFX, Traits of Successful Trader: How Much Capital Should I Trade Forex With?)

We encourage you to always define risk specific to your account and limit your leverage to assist in the longevity and success of your trading business.

---Written by Tyler Yell, Trading Instructor

 

http://www.dailyfx.com/forex/education/trading_tips/post_of_the_day/2012/10/12/Finding_the_Right_Trade_Size_for_You_.html 

Trading Against the Forex Crowd in Volatile Currency Markets

In our guide to FXCM Speculative Sentiment Index-based trading strategies, we discussed the “why trade against the crowd?” with a specific look to our SSI. This article covers the “how can we trade against the crowd?” with a closer look at the Breakout2 channel breakout strategy.

The Breakout2 trading system has been one of our more successful trading strategies in past years. We need to emphasize that past performance is not indicative of future results, but the strategy has historically done well in fast-moving markets with strong volatility.

Trading Rules for the FXCM Speculative Sentiment Index-Based Breakout2 Strategy

Automate the Breakout2 trading system via the FXCM Apps store

Buy Rule: Buy 5 lots when the currency breaks above its highest high of the past 24 hours.

Sell Rule: Sell 5 lots when the currency breaks below its lowest low of the past 24 hours.

Trade Filter: Breakout2 may only take short positions if the SSI ratio is at 1.22 or greater (55% of orders are long). It may only go long if the SSI ratio is at -1.22 or below (55% of open orders are short).

Profit Targets: Measure the 90-day Average True Range of the Pair. Place 4 limit orders every 0.5 ATR away from entry price.

Stop Losses: Measure the 90-day Average True Range of the Pair. Place 4 stop loss orders every 0.5 ATR away from entry price.

If long, place a trailing stop loss order at the 24-hour range low. If short, place a trailing stop loss order at the 24-hour range high. Note: the trailing stop will close the entire position if triggered regardless of whether any of the 4 ATR-based stops or limits are triggered.

Reviewing and Understanding the Logic of the Breakout2 System

Entries: Buys 5 lots when currency breaks its 24-hour high, sells 5 lots when it breaks 24-hour low: This is a high volatility strategy similar to our volatility-filtered Donchian channel breakout system. It does multiples of 5 lots so that it may scale out of orders. Like most breakout systems, it will more often do well when prices are breaking significantly higher or lower.

These are also the market conditions in which the trading crowd will most often be buying into weakness or selling into strength.

Thus the trades often have a stronger chance of success if they occur within larger market trends. i.e. we buy breakouts in an uptrend, sell breakdowns in a downtrend.

Filter: Can only buy if SSI at -1.22 or below (55% of traders are short), can only sell if SSI is at 1.22 or above (55% of traders are long): Breakout trades will often work best when they are in the direction of the larger trend. In other words, buying a topside breakout likely has a greater chance of success if done in an uptrend. Selling a breakdown is more likely to succeed in a downtrend.

SSI can tell us whether or not a currency pair is in an uptrend or in a downtrend—remember, most traders buy weakness and sell strength. If price is very volatile, we are more likely to see major breaks of support and resistance. Volatility likewise improves the performance of our benchmark channel breakout strategy.

Exits: Take the daily Average True Range of the currency pair for the past 90 days. Breakout2 places 4 stops and limits 0.5 ATR away from entry price. It places a fifth stop at the trailing 24-hour high or low. A trigger of the trailing stop will close the entire position.

Breakout2 uses a mix of fixed profit targets and stop losses that in our opinion improves its chances of overall success. Why a combination of both fixed and trailing profit losses/targets?

Breakout trading is often a lower-probability mode of trading. We offset the fact that positions are often unprofitable by employing a positive reward-to-risk profile and locking in a certain amount in profits without undue risk. That explains the fixed profit targets and stop losses.

The trailing stop is our way to allow the position to move in our favor without being closed out prematurely. If this is clearly the start of a much larger breakout, the trailing stop will keep us in the position for an extended period of time.

Automate the Breakout2 trading system via the FXCM Apps store

Strategy Tips and Resources – How We Use Breakout2

Not all market conditions suit the Breakout2 trading strategy, and as such there are definitely factors to keep in mind before taking any of its trade ideas.

Our research on the Donchian channel breakout system shows that it has historically done better during times of strong market volatility. How do we define volatile market conditions?

In our Weekly Strategy Outlook report, we cover market conditions with a special focus on volatility and prices in forex options markets. We report the “Volatility Percentile” of individual currency pairs, which tells us how much options traders believe the currency pair will move as compared to the past 90 days.

Our research shows that Breakout2 tends to do better when that number is at 50% or higher.

Our Forex Technical Analysis page shows a daily update of our Volatility Percentile figure:

Past performance is not indicative of future results, but our experience shows that using the volatility percentile in conjunction with the Breakout2 strategy offers good trading ideas.

Automate the Breakout2 trading system via the FXCM Apps store

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

To receive the Speculative Sentiment Index and other reports from this author via e-mail, sign up to David’s e-mail distribution list via this link.

http://www.dailyfx.com/forex/technical/article/forex_strategy_corner/2013/02/06/forex_crowd_breakout_trading.html 

Buy the Higher Low and Sell the Lower High

Article Summary: Trading in the direction of the trend and buying low while selling high are mutually exclusive. Because we recommend you locate the direction of the trend and find a good entry, DailyFX has a new concept for you to consider. Buy the higher low and sell the lower high. This article will provide you with methods to do just that to prevent you from catching a falling knife.

If you’ve ever heard a trader say that price can’t possibly go any lower, chances are they haven’t been trading for long. That’s not meant to be harsh but simply to say, no trader knows the future. What traders can do is recognize that patterns tend to play out and repeat over and over again which can lead to higher probability entries.

Learn Forex: Buy Low & Sell High Is Cute But Ineffective

(Created using FXCM’s Marketscope 2.0 charts)

One of the principles of every trader who enters an order, whether long or short is that they believe they’ve entered at a good price in relation to where they expect the market to go. One trader will be right and the other will be wrong if they entered at the same price with similar stops and limits. While there is no guarantee which trader will be profitable and which won’t, there are some things we can do to put the odds in our favor.

Learn Forex: Buy the Higher Low with Bullish Trend Lines or Rising Channels

(Created using FXCM’s Marketscope 2.0 charts)

Learn Forex: Sell the Lower High with Bearish Trend Lines or Falling Channels

(Created using FXCM’s Marketscope 2.0 charts)

Methods to Help Prevent Buying a Low Before It Goes Lower

As stated at the beginning of the article, there is no crystal ball or Holy Grail. However, there are methods that you can use to stay on the likely right side of the big moves. The three methods we’re going to look at are pivot lines to identify support and resistance, RSI to understand directional strength, and trendlines or directional channels.

The purpose of these three methods is to help you avoid buying something that’s falling. On the other hand, selling something just because it’s rising can become a fool’s game as well. That’s why studying price action can give a big leg over investors or traders who feel price “can’t go any lower”, which has been the rallying cry of many losing trades.

Pivot Linesfor Support & Resistance

Pivot Lines are a leading indicator of sort. In short, Pivot Lines are a famous indicator to help you forecast likely future points of resistance and support to limit risk and find profit targets. Rising Pivot levels overtime can help you find a significant higher low to enter a buy trade or lower high to enter a sell trade on.

Learn Forex: Pivots Clearly Paint Dynamic Levels of Rising Support for Entries Zones

(Created using FXCM’s Marketscope 2.0 charts)

Knowing that the Holy Grail doesn’t exist, Pivots are a helpful way to get a feel for the directional bias. Combining pivots lines with candlestick analysis is a preferred method of many traders to find strong entries with the trend. A short cut for new traders looking at price action is to fade long wicks (highlighted above) against the trend as they likely are a rejection of a price test and often end up carrying back price in the direction of the trend.

Relative Strength Index (RSI) for Directional Strength

The Relative Strength Index is the utility knife of many traders. When the RSI crosses an extreme level and is making directional moves higher or lower, traders can look for strong entries that favor the RSI bias. One simple way to find a directional bias on RSI is to add a moving average or trendline to the RSI and find bounces off support or breakouts of the RSI for a high probability entry.

Learn Forex: RSI with Moving Average Added For Directional Bias

(Created using Trading Central’s Charts available on DailyFX Plus’ Technical Analyzer. Free Trial Below)

Rising or Falling Trendlines or Channels

Trendlines and channels are nice and simple. The value of a trendline or channel is increased every time it is tested. When markets are moving higher a trendline is a form of support that can be used to identify buying opportunities. When markets are moving lower, a trendline is a form of resistance that can be used to identify selling opportunities.

The purpose of this article is to help you understand that buying low and selling high is not a given trading system. You may be buying something that’s about to go a lot lower or selling something before it skyrockets. Because price is the ultimate indicator, trendlines or channels can help you pinpoint a higher probability entry as opposed to a cheap entry which could end up costing you a lot if it continues to move against you.

Learn Forex: There Is No Guarantee you’ll get the Lower High You Want

(Created using FXCM’s Marketscope 2.0 charts)

Closing Thoughts

Finding a directional bias through the methods above can help you pinpoint entries. There is nothing wrong with buying a low or selling a high as long as it’s in the direction of the prevailing trend. Trading against the prevailing trend is often more trouble than it’s worth so we recommend identifying the trend and then entering on opportunities with the trend.

Happy Trading!

---Written by Tyler Yell, Trading Instructor

To contact Tyler, email tyell@fxcm.com.

To be added to Tyler’s e-mail distribution list, please click here.

Would you like dozens of trade ideas every day with updated charts to identify major levels support and resistance on the currency pair you’re trading?

If so, click here to learn more about our Technical Analyzer on DailyFX Plus.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
Learn forex trading with a free practice account and trading charts from FXCM.

 

http://www.dailyfx.com/forex/education/trading_tips/chart_of_the_day/2013/05/02/Buy_the_Higher_Low_and_Sell_the_Lower_High.html

Forex Education: Why do Many Traders Lose Money?

Why Do Many Forex Traders Lose Money?

In our Traits of Successful Traders series, the DailyFX Research and Education teams go through a year’s worth of trades from actual clients and discusses the results along with surprising conclusions.

Strong growth in forex trading has brought a significant increase in the number of new traders, but the influx has been matched by a similar outflow of existing traders. Why? This article discusses arguably the most important question of all – why do many forex traders lose money?

Why Does the Average Forex Trader Lose Money?

Many forex traders have significant experience trading in other markets, and their technical and fundamental analysis is often quite good. In fact, in almost all of the most popular currency pairs that FXCM clients trade, traders are correct more than 50% of the time:

The above chart shows the results of a data set of over 12 million real trades conducted by FXCM clients worldwide in 2009 and 2010. It shows the 15 most popular currency pairs that clients trade. The blue bar shows the percentage of trades that ended with a profit for the client. Red shows the percentage of trades that ended in loss. For example, in EUR/USD, the most popular currency pair, FXCM clients in the sample were profitable on 59% of their trades, and lost on 41% of their trades.

So if traders tend to be right more than half the time, why do most forex traders lose money?

The above chart says it all. In blue, it shows the average number of pips traders earned on profitable trades. In red, it shows the average number of pips lost in losing trades. We can now clearly see why traders lose money despite bring right more than half the time. They lose more money or their losing trades than they make on their winning trades.

Let’s use EUR/USD as an example. We know that EUR/USD trades were profitable 59% of the time, but trader losses on EUR/USD were an average of 127 pips while profits were only an average of 65 pips. While traders were correct more than half the time, they lost nearly twice as much on their losing trades as they won on winning trades losing money overall.

The track record for the often-volatile GBP/JPY pair was even worse. Traders were right an impressive 66% of the time in GBP/JPY – that’s twice as many successful trades as unsuccessful ones. However, traders overall lost money in GBP/JPY because they made an average of only 52 pips on winning trades, while losing more than twice that – an average 122 pips – on losing trades.

Cut Your Losses Early, Let Your Profits Run

Countless trading books advise traders to do this. When your trade goes against you, close it out. This is difficult to do because it is going against the great deal of work and research you performed to first enter the trade. Closing it out at a loss is admission that you were wrong—invalidating everything you did that went into that trade.

Worse than admitting you’re wrong, however, is letting a small loss balloon into a large one. This is exactly the mistake we watch time and time again: traders are too willing to hold onto a losing trade in the hopes that it will come back. And to be clear, a trade can come back and there will definitely be times that you will have avoided a loss by holding onto a small loser. But those large losses completely ruin the potential reward on your overall trading.

Conversely, when a trade is going well, do not be afraid to let it continue working. You may be able to gain more profits. After taking a series of losses or perhaps one especially large loss, it is natural for us to take profits on a trade due to fears that it can go against us. Taking profits also proves that we were right—the hard work that went into the trade was valid and it feels good. Yet letting losses run and cutting profits short is how many traders lose money.

How to Do It: Follow One Simple Rule

Avoiding the loss-making problem described above is pretty simple in theory, though it is admittedly difficult in practice. When trading, one rule is critical: always seek trades that offer larger potential rewards than losses. This is nothing groundbreaking, and almost every trading book will tell you the same thing.

Typically, this is called a “reward/risk ratio”. If your analysis shows that a trade will pay out 100 pips with a max risk of 100 pips, your reward/risk ratio is 1 to 1. If you risk losing 200 pips to make that same 100, then that same ratio is 1:2.

According to our data on real traders, the average reward/risk on EURUSD trades was 127 pips in average losses versus 65 pips in gains—approximately 1:2.Given that reward/risk, traders would have had to make profits on at least 66 percent of all trades to ultimately make money. Unfortunately the true win percentage was 57 percent and helps explain why most lost.

You should always use a minimum 1:1 ratio.

That way, if you are right only half the time, you will at least break even. Generally, with high probability trading strategies, such as range trading strategies, you will want to use a lower ratio, perhaps between 1:1 and 2:1. For lower probability trades, such as trend trading strategies, a higher reward/risk ratio is recommended, such as 2:1, 3:1, or even 4:1. Remember, the higher the reward/risk ratio you choose, the less often you need to be right in order to make money trading.

Stick to Your Plan: Use Stops and Limits

Once you have a trading plan that uses a proper reward/risk ratio, the next challenge is to stick to the plan. Remember, it is natural for us to want to hold on to losses and take profits early, but it makes for bad trading. We must overcome this natural tendency and remove our emotions from trading.

The best way to do this is to set up your trade with Stop-Loss and Limit orders from the beginning.

This will allow you to use the proper reward/risk ratio (1:1 or higher) from the outset, and to stick to it. Once you set them, don’t touch them (One exception: you can move your stop in your favor to lock in profits as the market moves in your favor).

Managing your risk in this way is a part of what many traders call “money management”. Many of the most successful forex traders are right about the market’s direction less than half the time. Since they practice good money management, they cut their losses quickly and let their profits run, so they are still profitable in their overall trading.

Does This Rule Really Work?

Absolutely. There is a reason why so many traders advocate it. You can readily see the difference in the chart below.

Try the same RSI Trading Strategy on FXCM’s Trading Station Desktop

The 2 lines in the chart above show the hypothetical returns from a basic RSI trading strategy on USD/CHF using a 60 minute chart. This system was developed to mimic the strategy followed by a very large number of FXCM clients, who tend to be range traders. The blue line shows the “raw” returns, if we run the system without any stops or limits. The red line shows the results if we use stops and limits. The improved results are plain to see.

Our “raw” system follows FXCM clients in another way – it has a high win percentage, but still loses more money on losing trades than it gains on winning ones. The “raw” system’s trades are profitable an impressive 65% of the time during the test period, but it lost an average $200 on losing trades, while only making an average $121 on winning trades.

For our Stop and Limit settings in this model, we set the stop to a constant 115 pips, and the limit to 120 pips, giving us a reward/risk ratio of slightly higher than 1:1. Since this is an RSI Range Trading Strategy, a lower reward/risk ratio gave us better results, because it is a high-probability strategy. 56% of trades in the system were profitable.

In comparing these two results, you can see that not only are the overall results better with the stops and limits, but positive results are more consistent. Drawdowns tend to be smaller, and the equity curve a bit smoother.

Also, in general, a reward/risk of 1-to-1 or higher was more profitable than one that was lower. The next chart shows a simulation for setting a stop to 110 pips on every trade. The system had the best overall profits above 1:1. In the chart below, the left axis shows you the overall return generated over time by the system. The bottom axis shows the reward/risk ratios. You can see the steep rise right at the 1:1 level. At higher reward/risk levels, the results are broadly similar to the 1:1 level.

Again, we note that our model strategy in this case is a high probability range trading strategy, so a low reward/risk ratio is likely to work well. With a trending strategy, we would expect better results at a higher reward/risk, as trends can continue in your favor for far longer than a range-bound price move.

Game Plan: What Strategy Should I Use?

Trade forex with stops and limits set to a reward/risk ratio of 1:1 or higher

Whenever you place a trade, make sure that you use a stop-loss order. Always make sure that your profit target is at least as far away from your entry price as your stop-loss is. You can certainly set your price target higher, and probably should aim for 2:1 or more when trend trading. Then you can choose the market direction correctly only half the time and still make money in your account.

The actual distance you place your stops and limits will depend on the conditions in the market at the time, such as volatility, currency pair, and where you see support and resistance. You can apply the same reward/risk ratio to any trade. If you have a stop level 40 pips away from entry, you should have a profit target 40 pips or more away. If you have a stop level 500 pips away, your profit target should be at least 500 pips away.

DailyFX Resources for Successful Money Management

View a presentation from the FXCM Trading Expo on the same materials.

Model Strategy:

Download the model RSI Strategy for FXCM’s Trading Station Desktop

For our models in this article, we simulated a “typical trader” using one of the most common and simple intraday range trading strategies there is, following RSI on a 15 minute chart.

Entry Rule: When the 14-period RSI crosses above 30, buy at market on the open of the next bar. When RSI crosses below 70, sell at market on the open of the next bar.

Exit Rule: Strategy will exit a trade and flip direction when the opposite signal is triggered.

When adding in the stops and limits, the strategy can close out a trade before a stop or limit is hit, if the RSI indicates that a position should be closed or flipped. When a Stop or Limit order is triggered, the position is closed and the system waits to open its next position according to the Entry Rule.

The Traits of Successful Traders

This article is a part of our Traits of Successful Traders series.

The DailyFX Research and Education team has been closely studying the trading trends of FXCM clients, utilizing the trade data at FXCM. We have gone through an enormous number of statistics and anonymous trading records in order to answer one question: “What separates successful traders from unsuccessful traders?”. We have been using this unique resource to distill some of the “best practices” that successful traders follow, such as the best time of day, appropriate use of leverage, the best currency pairs, and more. You can learn more about the project and see further research at the Traits of Successful Traders webpage.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
Learn forex trading with a free practice account and trading charts from FXCM.

 

http://www.dailyfx.com/forex/fundamental/article/special_report/2013/01/03/forex_analysis_why_do_many_traders_lose_money.html

Trading Currencies Against the Crowd - Real Forex Strategies

Our proprietary forex sentiment and positioning data shows that the majority of traders often buy and sell at all of the wrong times. Here are some trading strategies we use to trade against the forex trading crowd.

In our Traits of Successful Traders series, we studied the results of 12 million real forex trades placed by FXCM clients and the findings were significant. Our data showed that retail traders were profitable on 59 percent of all EURUSD trades placed, but further analysis showed an important statistic—most ultimately lost money trading the Euro/US Dollar.

Profitable Trades by Currency Pair

Source: The data is derived from Forex Capital Markets LLC accounts--excluding managed and Eligible Contract Participant accounts--from 10/01/2009 to 9/30/2010. All data is rounded to the nearest whole number.

The winning percentage only tells part of the story. Traders lost money trading the Euro/US Dollar because their losses were nearly twice as large as their winners.

Average Trader Profit or Loss in Pips

Source: Ibid

We dedicated a Forex Education piece to why many traders lose money, and the takeaways are important. Just as significant, we want to know how we can use this information to our advantage in real trading. This is the major motivation behind our use of the FXCM Speculative Sentiment Index (SSI): our measure of retail trader FX positioning.

View a video on the Speculative Sentiment Index from the FXCM Trading Expo

The SSI is simple: we look at how many traders hold open long positions versus those short and is expressed in a ratio. If the ratio is positive, it shows how many open orders are long for each one short. If it is negative, it shows the number of orders short for every one that is long.

For example: A EURUSD SSI ratio of 3.0 tells us that there are 3.0 open orders long for every 1 that is short. An AUDUSD SSI ratio of -2.0 tells us that there are 2.0 open orders short for every 1 long.

How Can We Trade Using Retail Forex Sentiment Data?

In order to understand our SSI-based trading strategies, it is important to recognize a key characteristic of crowd behavior: most will buy when a currency is falling and sell when it is rallying. As our data on real trade information suggests, the crowd is more often profitable as most trades are closed out at a gain. Yet when these trades don’t work, most traders expose themselves to outsized losses.

What does this mean? We most often go against what most traders are doing. If everyone is buying, we like to sell. If most are going short, we like to buy.

Forex Trading Crowds Buy Weakness, Sell Strength

Source: FXCM Speculative Sentiment Index

Our knowledge of crowd behavior and trade results underlines that this is a low-probability strategy: we will probably be wrong more often than right. But appropriate reward to risk on trades likewise suggests we may ultimately be successful.

There are many different ways to do that, and the below strategies use the Speculative Sentiment Index as the ‘heart’ of their trading logic.

Sentiment-Based Forex Trading Strategies Available on Tradestation Desktop:

Automate the Breakout2 trading system via the FXCM Apps store

Automate the Momentum2 trading system via the FXCM Apps Store

Automate the Momentum1 trading system via the FXCM Apps Store

Automate the Range2 trading system via the FXCM Apps Store

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

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http://www.dailyfx.com/forex/technical/article/forex_strategy_corner/2013/02/04/forex_trading_strategy_against_the_trading_crowd.html 

Most Traders Lose During Active Markets, Here is How to Trade Instead

Our research on forex seasonality showed that most traders could be well-served restricting their trading to less-active trading hours, but what if you can’t trade when it’s quiet? For traders who feel the need to be in the market during the more volatile times, here is some advice about how to do it.

Our previous report on trading during certain hours of the day emphasized that most traders do poorly during active markets. We looked through 12 million real trades conducted by FXCM clients, and the data we found was quite revealing.

The chart above shows that average profitability varies significantly throughout different trading session. The takeaway was fairly straightforward: for most traders, avoiding the most active trading sessions can improve performance.

In our hypothetical results, the returns of a simple Relative Strength Index (RSI) trading strategy improved dramatically when we limited its trading to the hours of 2:00 PM – 6:00 AM Eastern Time.

Free Download of the DailyFX Asia Range Trading Strategy

But limiting trading to those hours is impractical for some and unsatisfying for others—there should be a way to take advantage of stronger volatility. And that’s exactly where we come upon breakout trading strategies.

What Strategy Can We Use to Trade the US Daytime?

We believe most should avoid trading during volatile hours due to clear patterns in real trader performance, but we also acknowledge that this may be impractical or undesirable for many. The reason is simple: most retail traders use range trading strategies, which do poorly in volatile trading conditions. If trading during active hours, we believe breakout strategies are more likely to succeed.

What is a Breakout?

A breakout is when a currency that has been trapped in a range breaks through support or resistance, escaping the range. When this happens, the movement in prices can be very powerful and can create a trading opportunity.

Here is an example where the US Dollar/Japanese Yen Daily chart held a narrow price channel for over 12 months. You can see that when this channel broke, the move was swift and powerful.

US Dollar/Japanese Yen Daily Chart Shows Major Breakout

Source: FXCM Trading Station Desktop, Prepared by David Rodriguez

How Can We Trade Breakouts?

Trading breakouts is almost the exact opposite of range trading. Most traders instinctively buy a currency pair when it has fallen and is near support and sell when price is expensive and near resistance. They do this in anticipation that price will reverse and stick to broad trading ranges—or range trade, for short.

Breakout trading strategies buy the currency pair when it rallies above resistance and sell it when it breaks below support. These breakout trades work when price continues significantly higher or lower, and they perform poorly when currencies stick to well-defined trading ranges. In other words, breakout trading will often work when range trading does not. Let’s use this to our advantage.

Sample Strategy: Donchian Channel Breakout

The Donchian Channel Breakout strategy is straightforward. The system draws a channel surrounding price action, with the top of the channel set at the highest high and the bottom set at the lowest low of the past 20 bars.

Free Download of the Donchian Channel Indicator on FXCMApps.com

In the chart below, you can see the top and bottom of the channel in blue. The blue vertical lines show breaks above and below the Donchian channel. The dashed line shows profitable trades made by the system, while the red dashed line shows losing trades made by the system.

Donchian Channel Breakout Strategy on a USDJPY 60-Minute Chart

Source: FXCM Trading Station Desktop, Prepared by David Rodriguez

The strategy sells the currency pair if the price breaks below the channel bottom. If price quickly reverses, it will be taken out of the trade at a loss. Yet if price continues lower, the strategy stands to see profits on the continued moves. It likewise buys the currency pair if price breaks above the channel top.

Thus we can conceptualize this this trade system might work especially well during times of high volatility, when channels tend to be broken. Let’s test by looking at how well it has done on the Euro/US Dollar in the past several years:

Channel Breakout Strategy on EURUSD Pair from 2001-2013, 60min Chart

The channel breakout system did reasonably well overall, and especially well during times of strong market volatility in late 2009. Yet it has also had long stretches of underperformance and noteworthy losing streaks. Since we know that breakout strategies tend to work better during times of higher volatility, how can we instruct our system to trade only during those times?

When Can We Look to Trade Breakouts?

We publish Volatility Percentile figures on the DailyFX Technical Analysis page for reference. The Volatility Percentile is derived from FX options prices.

The higher the number, the more volatile options traders expect the currency pair to be. We can use these volatility percentages to judge when it may be best to use particular strategies. When volatility percentiles are high, we look to trade breakout strategies. When they are low, we look to avoid them.

When looking at the Channel Breakout strategy above, our research shows that the strategy hypothetically improved noticeably when we apply filters. We plot two hypothetical results below.

In one case, the strategy is allowed to trade whenever the EURUSD breaks above its 20-hour high or below its 20-hour low. In the other, it is only allowed to take those trades when the EURUSD Volatility Percentile is above 75%. As you can see in the chart below, the volatility-filtered result is hypothetically an important improvement over the base strategy.

Volatility-Filtered Breakout Strategy on EURUSD Pair from 2001-2013, 60min Chart

Free Download of the DailyFX Volatility-filtered Channel Breakout Trading Strategy

With the 75 percentile filter, the system can only trade roughly 25 percent of the time. Obviously this means that we’re rarely trading—likely frustrating at points—but we feel that the hypothetical improvement in the strategy’s returns could justify the trade filter.

Game Plan: What Strategy Can We Use?

When volatility is above 75%, we may use a Channel Breakout trading strategy. Our data show that over the past 10 years many individual currency traders have generally been unsuccessful trading in times of high volatility. As we spoke about in our earlier article on real trader successes and failures, we generally recommend trading European currencies during the “Off Hours” using a range trading strategy. Such an approach has historically produced good results and best matches how most FXCM clients trade.

We believe that traders who feel the need to trade during times of high volatility should use a different strategy and look to trade breakouts rather than ranges. Breakout trading has historically shown superior risk-adjusted returns if limited to the most volatile trading days.

We can use the DailyFX Volatility Percentage to gauge what FX options traders expect for volatility in the near future. When above 75%, breakouts are historically more likely than normal, so look for opportunities.

Model Strategy: Donchian Channel Breakout Trading on a 60 Minute Chart

For our models, we used one of the most common and simple breakout trading strategies there is, creating channels on a 60 minute chart.

Entry Rule: When price crosses above the highest price of the last 20 bars, buy at market on the open of the next bar. When price crosses below the lowest price of the last 20 bars, sell at market on the open of the next bar.

Filter: Strategy can only enter new trades when the Volatility Percentage is above the specified level (such as the 50% or 75% examples used above).

Exit Rule: Strategy will exit a trade and flip direction when the opposite signal is triggered.

As was shown earlier, in the EUR/USD this strategy has shown the best risk-adjusted returns in the EUR/USD over the past 6 years when it was restricted to trade only when the Volatility Percentage was above 75%.

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Free download of the DailyFX Volatility-filtered Channel Breakout Trading Strategy

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The Traits of Successful Traders

This article is a part of our Traits of Successful Traders series. View the previous installment of this series:

Why do Many Forex Traders Lose Money?

What Time of Day Should I Trade?

The DailyFX Research team has been closely studying the trading trends of FXCM clients, utilizing the enormous amount of trade data at FXCM. We have gone through an enormous number of statistics and anonymized trading records in order to answer one question: “What separates successful traders from unsuccessful traders?”. We have been using this unique resource to distill some of the “best practices” that successful traders follow, such as the best time of day, appropriate use of leverage, the best currency pairs, and more.

Written by David Rodriguez, Quantitative Strategist for DailyFX.com

To receive the Speculative Sentiment Index and other reports from this author via e-mail, sign up for his distribution list via this link.

 

http://www.dailyfx.com/forex/technical/article/special_report/2013/01/30/forex_trading_during_active_hours_breakout_volatility.html