Setups

What have you been working on recently?

My focus has been setups.

That is how to recognise better a setup—and how to enter from that setup.

As a price action trader, I’m looking at high to low timeframes to identify a trend and qualify my breakout trade entry.

Nothing too complicated. We look for trend setups utilising high/low-one entries and, more often, high/low-two breaks.

Practised knowledge of price action is essential too.

From the chart below, we can see how volume, when presented on the y-axis, affects the price.

Currency pairings—unlike stocks—are decentralised.

The volume in this instance is a representation from a single liquidity provider.

But it is sufficient to show how high-volume consolidation levels are often formed and become a support or resistance zone.

A zone from which we can determine a setup and consequently an eventual breakout.

The reason we need a setup rather than just a break of a level is the propensity for false indications.

A setup and an understanding of the market structure and other traders’ probable intention strengthens our trade entry.

By determining where traders’ stops and targets are, we can anticipate the subsequent market reaction when the price hits those levels.

Even news events often follow a technical path.

We realise that we need to be focused and highly familiar with all aspects of a (single) pairing.

Even though we trade together—via Microsoft Teams—James as the analyst and me as the trader, we find more than one pairing to be too much.

Which will seem odd to those traders—and that was us not so long ago—that view a dozen or so pairings at a time.

My only reply is to try a single pairing with very selective setups and see if P&L improves.

It helps if the selected pairing has one currency that is open and the other closed.

For example, EUR/USD at New York open would have both currencies simultaneously active and therefore wouldn’t be a suitable pairing for us.

Moreover, like us, focus on a single volume session. Our preference is a couple of hours on either side of the New York open time.

Managing risk is a skill and needs—but is rarely given—as much if not more thought than the setups and entries.

Don’t forget awareness of over-trading. That is essential too.

A simple, focused trading plan

What would I say to my younger self about how to trade?

I’d start by explaining how financial trading works.

In essence, financial trading is no different from any other exchange—buy and sell higher or sell and repurchase it at a lower price.

And the concept of opening a ‘short’ position and repurchasing it at a lower price to make a profit would take some convincing.

So, let’s assume I understand anything that is googleable and get down to what matters.

What matters most is the risk—because the risk is under the trader’s control.

I control risk through overtrading awareness, trade size and my take profit and loss plan.

Each element of the above has to be a thoroughly ingrained and practised habit.

As part of the loss plan, I look at it for what it is and let it go—because every trade has its discrete outcome.

Detachment means the outcome of a trade does not define me. It does not mean separation from risk—as that would be foolhardy.

My goal when I trade is to find my alignment with the market.

I take every setup opportunity. However, if I’m not happy with either the market or myself somehow, I reduce my trade size—but I must take the trade.

I grab small definable chunks in repeatable rotations of the market in a timeframe that’s comfortable to me.

I take one or two trades a day—win or lose. But I often go a few days without a setup and, therefore, without an entry.

I’m interested in the statistical probability of something continuing after a specific event.

That event is defined by price action, zones of support and resistance and bar by bar momentum.

I focus on one currency pairing and one market session.

The pairing is the British pound to the Japanese yen (GBP/JPY). And the market session is a couple of hours on either side of the New York open.

Yes, my approach has become significantly more focused recently. I ought to have had this conversation a couple of years back!

The fund—what’s happening?

Fund results, once posted, are guaranteed. Therefore, I only put them out there at intervals of about nine to fifteen months.

On the other hand, investors can enquire ‘how goes it’ often, weekly if you like.

The fund is up a bit on my last report.

Though I mostly day trade (very occasionally holding a swing overnight), the fund’s object is risk management first.

My experience is that trader’s misfortune is due to improper risk management (over-risk) or over-trading (or both).

Since realising this, my trading style has matured, even recently from the New Year until now.

In that time, we have had success and maintained that position by reducing the currency pairings I trade (actually down to one). A pairing that I, therefore, get to know exceptionally well.

Patience and discipline are crucial to trading this way.

My trade entries these days are decisive but at the same time incredibly selective. Much more so than previously.

I also now trade with more attention to the momentum generated by the market sessions. Namely the London and New York open and their subsequent pre- and post-periods.

Moreover, I am now more risk and goal orientated with my trading—based on one trade, on average, a day. And only one entry per market session, whether that be a win or a loss.

Our losses have to be smaller (much smaller) than our wins—that is an imperative aspect of my approach.

I will keep you apprised regularly on ‘how goes it’ with this subtle but significant change—maybe it will prove to provide a cumulative low-risk bumper boost?

Which trading broker?

Once we’re settled on a particular way of trading and are profitable, we don’t want to mess with it too much. 

That’s not the same with the preferred platform and brokerage. We need to review these from time to time to see if we still have the best setup.

We’ve given both—mainly ‘which broker is best for us’? —a lot of thought recently. 

Each trader has their requirements depending on style and trade frequency. 

As a discretionary day trader, my own needs include:

  1. Low spread (the difference between the bid and ask price).
  2. Speedy and reliable execution.
  3. An intuitive dealing platform. 

Recently I wasn’t getting the first two points from our current broker. The market (the GameStop story) has caused some brokerage turmoil. However, getting trapped in a trade two days running was not calming. Nor was their excessive increase in the spread at any slight adverse change in volatility.

I want to say a thank you to Chris Lee (Pipmaven blog) for his recommendation of IC Markets. 

IC Markets and Pepperstone fit our needs. I particularly liked their associated ctrader web platform. 

Our analysis is via TradingView with the broker’s platform only needed for trade execution. 

TradingView have various brokers that allow entries directly on the TradingView chart. Oanda, for example, who in the last few days were given on-chart trade access for UK residents via TradingView.

(Nick’s preferred option as it more suits his systematic approach). 

For me, it’s IC Markets with their very low spreads. However, anyone following my path should look at Pepperstone and Oanda—as they provide UK regulated account protection.

IC Markets, Pepperstone’s and Oanda’s prices are direct to market—no broker’s dealing desk in the way. And the indication is that Pepperstone will link to TradingView shortly too. 

Some traders (those with larger accounts) might like to have more than one brokerage, which is also useful if they employ different strategies and different timelines. 

Personally, I aim to get as good as I can be at one clear strategy and with the same broker and platforms. 

Data continues

The algorithm data continues at pace. Now at nearly 60% profitability with a 2.88 profit factor or reward/risk ratio for EURGBP. But that is not the whole story.

The above is the figure for our best pairing. The one on which Nick has focused. However, a dozen others (majors and a few significant minors) run a close second.

Each pairing is individually tested, and the algorithm adjusted as needed. For example, best market entry timings are specific to each currency and its pairing based on volatility look back.

And determining the market cycle has been improved by introducing a Japanese line break chart—a movement chart rather than a time-based chart.

A minimum Euro VIX (volatility index) is incorporated in the algorithm which—being USDEUR based—will require testing as to its applicability (if any) on other FX pairings.

Nick’s test is designed for an hourly chart and looks for entry/exit solutions over the past 750 days—figures above are providing trades (tested yesterday) on 223 days. In other words, we’re seeing trade entries from one to three days on average.

This delicate balance of ratios provides the best net profit. However, Nick can make adjustments to the algorithm (in the VIX and others) whereby per cent profitability increases significantly and the reward/risk balloons, amazingly, to well over five.

However, in this instance, the number of trades closed and the net profit achieved decreases substantially. In this instance, we could increase each transaction to a higher average per cent per entry (currently trading at one per cent of account), but we know that to do so is not sustainable or practical in the real world—drawdown for some trades could go through the roof for one.

I do remain a discretionary, rather than a system, trader—for the time being at least. But Nick has brought a quantifiable aspect and improvement to our methodology. This week, I found that taking trade entries from Nick’s quantified indicator system and transferring them to James’ subjective value drawings (rather than the other way around) have worked very nicely thank you.

Data

We needed more trade data, so Nick taught himself to code. In other words, computer programming to test trade conditions. He has become extremely good at it.

Okay, he started from a high baseline. A spreadsheet wizard—and a master’s degree in engineering—he has some mathematical skills!

As a trader himself, he already knows what’s practical. We both spent a couple of weeks of the festive break poring hours into coded trade development.

What I’m talking about here are algorithms that give trade entry and exit conditions.

Did it work?

The surprise was what didn’t work—off-the-shelf indicators for one. We tweaked and adjusted the conditions and continually run the strategy tester. But the results were poor.

That was when we knew that we needed to develop original code, based on an edge.

We went with a (structured and systematic) trial that tested intraday price conditions against the previous day’s daily price levels.

With a trend-criterion agreed it then took dozens of pages of code to run the what-if conditions. Some worked, many didn’t.

Each test looked at the past two years of hourly price movement. We studied the results of net profit, trades closed (total), per cent profitable, profit factor, maximum drawdown, the average per cent per entry and the average number of bars in a trade.

Without a similar test of strategy—carefully coded and adjusted trade parameters—how would anyone know what they’re doing works?

They don’t.

In our testing, each change or addition to a strategy often improved some figures—or increased drawdown slightly —but significantly reduced the number of trades taken and, therefore, the overall profit.

To make a small correction in condition improves one trade but taken over multiple entries is often a loss-maker.

The trial confirmed that the change in profit factor (reward/risk) has more effect on profit (per improvement condition) than an increase in the percentage of wins.

However, our limitation with intraday is the end-of-day close. We elected not to take a trade overnight as brokers’ do not provide an automated exit condition that met our needs.

A trailing stop was not profitable, and other solutions increased the maximum drawdown unacceptably.

However, we achieved some 60% profitability and with wins being twice that of loses, and with acceptable drawdown. We were jolly pleased too.

Use a checklist.

Gambling, betting or speculating? What’s the difference?

After reading Jim Paul’s book, it got me thinking about my system. What was I doing each time?

What we want to do is trade, but are we sometimes betting? What’s the difference?

How Paul sees it:

  • If it’s for entertainment, then we’re gambling.
  • Emotionally attached to the outcome—and ego is involved—then we’re betting.
  • Assessed the risk and the probability the chances are it qualifies as speculation.

Trading, on the other hand, is speculation that follows a plan.

(The same applies to investors, just over a longer timeline).

Sounds straightforward. But in the heat of the (trade) moment what was I doing? What are the clues?

Do I get upset, even mildly, when taking a loss?

Alternatively, do I get quite pleased with myself when I record a win?

Was my risk measured, apportioned and applied?

Did my ‘trade’ follow my plan (precisely)?

Did I improvise in some way?

To ensure I have a trader’s approach—and that I don’t lapse into what could be categorised as betting—I use a checklist.

Checklist

When I’ve developed my trading plan, and tested it, I take a lot of time to distil it into a checklist format.

As an ex-aviator, checklists were very much part of working life. However, ironically it was the book ‘The Checklist’ by Atul Gawande (a surgeon taking lessons from aviation!) that brought home the more profound need for a checklist.

Checklists are not a bullet abbreviation of a plan. That wouldn’t work. Still too detailed more likely. An index for aviation, surgery and trading is often time-critical. Therefore, such a reference is an item all on its own.

It contains stuff that if missed, could be very unhelpful if not catastrophic.

Maybe items not found in a manual or plan.

An example Gawandy uses is the checklist from a light aeroplane where one emergency starts with the words ‘fly the aircraft first’.

My trade entry checklist has such a beginning: ‘(on review) at the month’s end, will this entry be apparent?’

My trading plan is one thing, but to make sure I implement it speculatively (as a trader)—and keep mister ego at bay—I need my checklist.

What’s most important: trade entry, management or psychology?

In the last blog post, I mentioned that a trade entry process, management of the trade and the emotional challenges are each equally important.

The vast majority of the information available to us is, however, based solely on entry procedures.

Some gurus say (and for a good reason) that profitability is a function of the management only and—what is now becoming more realised—the emotional decisions we take with each trade.

I’m staying with the full package, evenly split approach—an exact entry requirement balanced with proven trade management and a no doubt (unemotional) exit strategy.

As for entries, there is a myriad of ways to trade. We have to find what works for us. I use a combination of trend and channel lines, price action and—thanks to Nick’s coding—unique indicators.

The channel lines are provided by James, who has a very natural affinity for this work. To look at the simple trend line structure below, you may get a false impression. Simple but—for anyone that has tried to do this for a living will attest— far from easy. To determine a workable contextual trend with barely one touch is exceptional.

The crosshairs in the chart above represent my short entry position in a trade last week.

The charts below show Nick’s objective indicator of the same trade. The lower red line (green line above if I were long) represents a 50% probability objective based on the yearly bar averages. The white dots are my ‘average true range’ to establish risk, and the shaded red and green areas represent the wicks of the prior daily bar that assist with macro price action.

The objective probability indicator is handy in a ranging or (medium to shallow) trending market.

We can see from the above example—of acceptable probability—how our entry, management and exit process might work in unison.

Of course, it is when it doesn’t go so well that the synchronicity or not of the three elements shows.

Beyond Mediocrity

In day trading, what is the most essential—process, management or emotion?

The answer is all three, equally. However, we naturally prioritise the ‘how to’. We ignore the second and nearly all of us are ignorant to the third.

But without each working synergistically success (the one per cent of trader’s status) is not possible.

Discretionary or system trader? A muddying of the water, as without an algorithmic programme we are both.

And when we are both (nearly all professional traders are), success depends on the resilience of our so-called system and management plan (and therefore our confidence) and the curtailment of discretion—in other words, keeping instinct (emotion) at bay.

Through backtesting or paper trading, we practise our trade entries and management. But it is only in live trading, and at an amount appropriate for our account, that emotion can interfere.

Instinct, psychology or emotion—by any name it is primarily responsible for a trader’s eventual mediocrity.

Discretion dominates in the first few years of a trader’s progression.

Our trade process then takes on a more systematic approach; we become consistently profitable.

Our trade management is precise and appropriate to all conditions.

We are on a roll!

However, without control of our emotions, we will only tick along.

A stoic approach in itself is not the answer. Indeed, by itself, it is a sure way from profitability back to mediocrity.

It is more. To achieve precision in our work is to trade without inappropriate emotive decisions interceding. It comes from preparation, mind and soul in harmony, systematic processes and the harnessing of ill-suited discretion.

It is beyond mediocrity.

1% profit—super

“There is a world of difference between a net profit trader and a super trader”, Schwager says in The New Market Wizards.

Getting to the level of net profitability is an exciting achievement. Not to be undermined. However, to graduate as a super trader, which I guess means being super-profitable, is every trader’s goal.

That sentence will mean entirely different things to each individual. But if we say it is relative to account, then the meaning ought to be proportional to everyone—to some extent or other.

But let’s not get too carried away with the term ‘super’. We’re not some Marvel reincarnation. Indeed, we should not associate the word exciting with trading. Better to use, calm, focused and flow.

What is possible

My aim is 1% profit per day. As a day trader, this is appropriate. Traders using, say, daily signals will need to determine their profit timeline. But that is the beauty of day trading—precisely bracketed, a start and a finish.

I previously thought that a profit for each trading session (a day for me) was inappropriate. I thought it was too precise and that a week, month or quarter was a better profit timeline. But it is too loose, too undefined. It allows inappropriate bets because we feel that we have time to correct. Trading is not an allowing game!

But I agree, a beautifully crafted methodology, edge and management come first. Once sorted, we take responsibility and narrow our profit goal to the finest of timelines.

Is it enough?

One per cent does not sound a lot. But over 200 trade days a year (allowing for weekends and time away) We are considering a 200% annual mark-up. Is this not worth the trading perseverance necessary? If we sensibly compound our risk-reward (such an increase is a challenge in itself), then we might conceivably be looking at a significant increase on the original sum.

Is this possible? It seems to have been for a very select few. But as Schwager mentioned in The New Market Wizards in the late ’80s, we are up against tens of thousands of professional traders.

Goodness knows what the figure is today and with computer algorithms.
However, if we work our edge with patience, confidence and attention, the consistent 1% incremental results are (super) achievable.