Conservative breakout trading

Our style of trading has progressively moved to conservative breakout and where we compound our traded amount daily.

Even on the 5-minute charts, this approach provides for few entry opportunities. But as we are trading at our maximum amount ( after we have established that we are consistently profitable), this is not an issue.

The compounding aspect missed by most traders but is a most powerful aspect to the methodology. 

Our method lends itself to observing a few charts at once (three to four). However, we only have one entry open at any one time.

The pointers below provide suggestions on setting up the charts and for the daily calculation of trade amount per pip.

Chart set-up

The four markets below fit the screen better than three. We use the top left (EUR/USD) as our anchor screen. That is we scale every other display in proportion to the anchor screen.

Four markets fit the screen better than three.

To do so, we manually adjust the ‘price’ axis to provide the look that we need. For EUR/USD this is a width of about 100 pips. The other screens scaled accordingly.

A low vertical scale density works best.

Our method is for a fixed stop and target providing an essential and consistent 2:1 reward risk. (adjusted for spread). Again, using EUR/USD as the template, we scale the other charts accordingly as a percentage of their opening price for the day.

The candles seem tighter than most will be comfortable but with a little practice, it quickly becomes apparent why this less volatile appearance is more suitable to the conservative breakout trader.

Risk level

EUR/USD example

We trade a single market at any one time and, therefore, a single price level. In this regard, we can be accurate with our amount per pip. Take the example of our favoured market, EUR/USD. At the start of each trading session, we calculate our amount per pip which, unless the market makes a significant price difference, is maintained throughout the day.

Assumptions for the example: market value 11,640, margin 3.33%, equity 15,000 (50% of equity 7,500) and overall risk not to exceed 2% of equity. Note: we use 50% of our equity as we are looking for a margin during any one trade to be very close to the 50% mark.

EUR/USD 10.8 pip stop.

Margin at 3.33%       11,640 x 0.0333 = 387.6    then    7,500/387.6 = 19.3 (price set per pip)

2% check         A: 15,000 x .o2 = 300 (max risk)    B: 19.3 x 10.8 (stop distance) = 208.4

The 19.3 in the example above is our amount per pip. In the 2% check, ‘B’ is not to be greater than ‘A’.

Note that (as is the case with AUD/USD) a market with a margin of 5% then the margin calculation above would be multiplied by 0.05 rather than 0.o333.

In our fledgeling expert period, we complete the daily calculation but trade quarter of the amount and increase in quarters as we become surer that we can fly.

When entered into a trade using the amount per pip as calculated above margin will go a few percentage points against us if the deal is negative and vice versa if positive.

 

The Ticks have it

(x) Ticks

Many advanced charts have an (x) ticks facility. A tick represents a transaction between a buyer and a seller at a given price (and volume, except in FOREX). In the (x) ticks chart each candlestick shows the price variation of x consecutive ticks.

The (x) tick chart is not time-based. Therefore, each currency pairing in our trade list will close at different times. Moreover, the bars in an (x) ticks view are representations of transactions, and their frequency is variable. For example, over one period we may have 50 bars, and in another period of the same timeline, we could have 75 bars.

Backtesting

Backtesting of multiple currency pairings is the best way to determine if (x) ticks provide suitable trade opportunities for the individual. The example below shows EUR/USD 30 minute bars with one trade entry opportunity in the leg shown.

30-minute bar, one trade opportunity.

The chart below uses the (x) trade setting with x being 3,000. In this leg example, two trade opportunities are available. However, this is not to say more trade entries exist with (x) ticks as it all depends on the timeline set (above) or the ticks set (below).

(x) ticks often provide more trades, particularly on a breakout.

How many (x) ticks

How do we select the (x) number of ticks to view? As with the classic intraday time-based view, this is a personal choice but one which must be mostly proportional to market spread and the mean of the bars traded being a suitable size. If we use 3000 ticks in EUR/USD for example, the leading price action of using 3010 or 2940 will not alter, but the trade opportunities could be significant.

Based on Bob Volman’s day trading with 70 ticks we backtested higher amounts divisible by 70. Some areas of the test are subjective as to whether we would or would not have entered a prospective trade.

Lower timeframe

In the lower timeframe (or tick frame), 1470 and 2940 ticks provided, for us, the best results over a wide range of tests. Tick bars do not correlate well to traditional time-based bars. However, our ticks above would at certain times of volume provide similar representation to 5-minute and 10-minute bars respectively.

Higher intraday

Our favoured higher (intraday) tick frame is 4410 ticks; this equates closely to the half-hour bars on a standard time-based chart. The image below is a 30-minute chart superimposed on a 4410 tick chart over the same period.

In the first half of the image, the ascending 30-minute bars are on the left and in the second half of the picture, the tick bars descend on the right. Those proficient in price action identification will notice a tick bar entry opportunity in both the ascent and descent that is not available to the 30-minute bars.

Superimposed 4410 tick bars and 30-minute bars.

To Achieve the higher levels of ‘amount per trade’

Amount per trade and consistency define the top 1% of traders.

Our aim

From our last report, we had some trades go against us for a time. We managed that occasion to an eventual near breakeven. However, it was an uncomfortable period of trading.

Our principal aim is to protect the fund. (Which seems a contradiction if a detrimental trade is allowed to build).

In defence, we got very good at scaling-in and turning a negative situation into a profitable or neutral outcome.

Reward to risk

However, a disproportionately magnified stop distance to a planned target, will, from time to time, result in a loss that is more significant than our usual win.

Psychologically this is hard to take. We can find ourselves moving our stops to accommodate the possibility of one more scale-in to save the day. Works sometimes but is a recipe for a shocker.

From taking a breakeven after a two-week hold and management of a detrimental trade has been a good thing because going forward we have reaffirmed our trading rules.

We now trade a planned reward to risk of not less than one to one. No exceptions.

We do not have the flexibility to scale-into a detrimental trade, but actually, that is a good thing. Moreover, as a result, we expect to take smaller (controlled) losses which is acceptable.

After our experience that concluded soon after my last report, we’ve traded small as we build confidence and consolidate our revised approach.

5-levels of ‘amount per trade.’

We have 5-levels of ‘amounts per trade’. We trade the lowest amount when our approach changes and until we can prove profitability. Also, our trade amount increases to the next level after a string of three successful trades. It reduces, however, one level with any failed trade. With three failed trades in a row, we reduce back to the lowest setting and start the build process again.

This method is in contradiction to nearly every beginner; they, generally, increase trade amount after a loss and reduce after a win.

How many traders win?

There are no definitive figures on how many are profitable at trading. But from everything that we have read, it seems to be in the region of 20%. That is not the full story, however. The 20% contain vast differences regarding profitability.

Tennis provides a useful comparison. Consider the world tennis rankings. Those within the top 200 (the 20%) are net winners. In other words, they win a bit they lose a bit, and with expenses, it is difficult to make a living. The top 100 (the 10%) are more consistent winners and consequently win more significant amounts. But it is in the top 10 of players (the 1%) where we find big rewards.

To stretch this analogy one last time, where do we stand in the rankings? Entering the top 100 with a goal of reaching the top-ten within two years. Which, in trading reality, is nothing more complicated than systematically building the higher levels of ‘amount per trade’ for extended periods.

August

Light trading only expected in August. A family wedding then, as others are on holiday,  two dogs to look after and probably more involved than usual in the family business until the end of the month.

Return relative to risk

Below we have our previous 30 days of trading results.

They look similar to the last report regarding gain and percentage win. But in reality, are very different.

Such summaries provide useful figures but often not the important ones. It is nice to know the overall gain. After all, that is our purpose. However, I would like to know how we achieved that gain, or more accurately ‘what was our return relative to risk’?

The amount of leverage we can use is about to change significantly with the European regulation on margin to be introduced at the end of next week.

I have tended to trade on margin rather than on a firm stop. That is, if a trade went against me I would often hold and look for a suitable scale-in point to provide a break-even opportunity or, quite often, a profit.

All well and good until we are caught out with a massive move against us. That happened to us this period on not one but three currency pairings simultaneously.

Our return relative to risk was poor this period. And that has to change. Not only are such trades overly difficult to manage they are likely to create an excessive loss. In any case, the new regulation and change in margin will make such a strategy untenable.

Setting hard stops that provide a planned reward to risk of not less than one to one will offer more (albeit smaller and controlled) losses but also free us early to reenter with a new trade; rather than sometimes being locked into a scaled-in extended detrimental equity trade.

Stats for the last 30 days of trading.
The stats often don’t tell the whole story.

Why momentum strategy and how have we done recently?

We consider a momentum strategy. How distraction coupled with an uncertain approach usually does not go well. The European regulation effects our methodology, oddly in a right way. Our statistics, how did we do over the last 31 days?

We have two strategies that we have employed successfully over the previous month. One of which, however, in an earlier month gave us a loss.

The strategies are mentioned in our recent blogs.

(1) ‘Price value’ trading is where we look to buy or sell at the extreme value of a price. We do this by assessing trend and channel lines.

(2) In probability or ‘momentum’ trading we read the price action of the bar(s) and with measuring tools determine entry points, stop and target positions.

I learnt the lesson some months back that I cannot mix strategies and, of course, timeframes. I did this when on a visit to my elderly mum. (Don’t tell her she’s elderly!) With my daughters dog in tow and tried to trade through the distraction. I ended up mixing my strategies and my timeframes and took a well-deserved hit for my troubles.

With the European regulation coming into force very soon we need to think carefully about how the new rule may or may not affect our tactics while trading within a strategy.

As a reminder, the regulation significantly increases margin required. The margin is the ‘good will’ of a broker to allow a trader to leverage a trade. Without the leverage, other than institutions, few would be able to trade the currency market.

Margin does not affect the mechanics of a trade in any way. It does, however, change the amount of cash needed in our accounts to place a deal; and, more importantly, be able to correctly manage a trade when price often, and inevitably, goes against us.

For this reason, we (Slow Trader) are trading exclusively via our momentum strategy. We have increased our accounts so that we can bet as we have been before the regulation. That is, reward and risk remain the same.

We have chosen the momentum strategy because of the regulation but also as the procedure provides control and has a reduced average duration of trade compared with our value strategy.

Below are our statistics for the last 31 days (19th May to 19 June 2018).

Notice the reward graph at the bottom of the statistics; the shape of which is the desire of all traders.

How we did over the last 31 days.
How we did over the last 31 days.

To scale-in, or not?

To Scale-in is an excellent technique if used correctly.

A few moments ago we exited our USD/CHF trade in profit. See the last blog post.

We all make poor trade entries from time to time; often they are not poor but merely a bet admission that goes against us for no particular reason that we can determine.

Our priority is to protect our account and to let any profits take care of themselves. Our last trade warranted, to us, a scale-in trade. To do so correctly takes some practice as to get it wrong compounds any loss.

However, to get it right provides a trader with options. Either to minimise loss or ambitiously take a reasonable profit.

From our previous blog post, we entered short yesterday afternoon from a reasonable trend entry bar. Unfortunately, this was not correct, and the trade went against us and back to the top of the trading range.

However, the head of the trading range provided an opportunity to scale-into the trade. Our aim here was not to breakeven but achieve a satisfactory reward to risk return.

A consideration was the USD interest rate decision later this evening (UK time). With that pressing, we would not want to be delayed in the trade allowing a pullback as we would typically do.

Scale-in to minimise loss or maybe achieve a profit.
Scale-in to minimise loss or maybe achieve a profit.

Trading range management, can we get out of the woods?

Trading range management, a lesson as it happens live.

As we write we do not know the outcome of our trade in USD/CHF that we started yesterday.

We’re hopeful that this trade will become a suitable lesson in trade management. Having entered our bet short in the chart below at the red circle price quickly goes against us. (the second chart is the same but zoomed-in).

My initial entry of the bar (lower chart) within the red circle was a reasonable bet short; however, lower wicks to the left reduce the probability and what quickly became apparent was that the entry was against a trading range of which we’d taken the worst position!

Having established the trading range, the many lines on the chart attempt to do this, we now ensure that our stop is at least ‘a measured’ move above the trading range.

We see that we have two possible trading range top lines of which we scale-into the trade at each. We are now at maximum risk for this trade, and with a turn in our favour, we may still achieve a successful reward to risk return.

However, any further assent in price will necessitate the management of a breakeven (and therefore, overall, an unsuccessful reward/risk trade).

We have one additional consideration. At 7 pm UK time this evening we have a USD interest rate decision. We do not want to have any trades open, based on hourly bars, at this point as price volatility with such an announcement can exceed our stop positions.

Chart perspective of trend and channel lines.
Chart perspective of trend and channel lines.
Bar by bar perspective of price action and the traded channel lines.
Bar by bar perspective of price action and the traded channel lines.

Price action strategy – the whole chart

To trade the price action of a chart rather than the price action of the bars is an assured strategy.

Take a look at the chart below. Individual bars in this strategy are secondary to the context of lots of bars. Maybe 600 bars on one screen from which we can identify price channels.

A price action chart strategy identifies channels, support and resistance levels and trends.
A price action chart strategy identifies channels, support and resistance levels and trends.

The chart above is hourly bars, but the same is achievable with any timeframe. Hourly bars provide a trade lasting from a few hours to a few days.

We need to check for scale-in opportunities at the close of each bar, in this instance every hour. In the chart above the lower blue arrow represents our first entry short point; this worked well in the previous two touch points marked by the green circles to the left.

However, this strategy is not always plain sailing. As we can see, the price climbed some 60 pips above our initial entry. Stops have to be at least the width of the channel and ideally beyond a significant premise point.

A trader also needs to be comfortable being out of the money for most of the trade. From the initial entry to the final scale-in entry we went £2,702 out of the money with a marked increase in our usual margin outstanding.

We had a maximum of three entries in each of the pairings, GBP/USD, AUD/USD and EUR/USD. USD links each trade; we, therefore, have to expect that a failed bet in one could result in a fail in all three.

Each pairing provided a different momentum. GBP/USD, once it turned our way dropped to target rapidly. AUD/USD having stayed in the money for much of the trade duration casually moved to target but tempted, which we took, an early, albeit profitable, exit. (The only part of the overall trade that was poor on my part).

EUR/USD, on the other hand, went out of the money more than the other pairings and took longer to turn. Holding all pairings until target would have provided a profit more than £4,000. Or 67% above actual risk.

However, we exited EUR/USD at breakeven. That is when the aggregate position of the trade went positive we exited. Eventual price of this pairing went some 40 pips below our breakeven position but as we write has not made our original target.

As we had a lower than an ideal entry point for EUR/USD in debrief we consider the decision to exit at breakeven was correct and within our criteria. Our actual profit was £1,782. Or 34% below actual risk.

A well-understood strategy, trading in such a way is not without its issues, trade management being high among them.

(1) Stop positions being too close is probably the principal reason for failure. Moreover, (2) trading above our means makes the inevitable loss occasion far exceed many win opportunities. (3) Not scaling-into a trade, or trading at maximum from the initial entry; either due to a limited trading account or entering from the outset at a maximum bet size. And finally, (4) exiting too early due to fear or too late due to greed.

Below is the outcome of GBP/USD.

Target against the trend, so profit taken before the trend line.
Target against the trend, so profit taken before the trend line.

As we are against the trend, our pre-planned exit was at the yellow arrow. Price did hit the channel line at the red circle.

The European regulation coming into force within a couple of months and thereby significantly increasing margin rates will exacerbate the usual reasons for failure mentioned above for the retail trader. For example, stop positions will be shortened rather than positions reduced.

Retail traders may thus be encouraged to move from a ‘price action chart strategy’ to a more difficult ‘price action bar strategy’.

Accurate measurement of bars – measure, and measure again

Accurate measurement of bars and the like.  Not appreciated by many retail traders, but accuracy provides the clue.

We are continually looking for that measure. It may be an explicit support or resistance level, or one that is not so obvious.

It may be within a channel, or a trading range may define the boundaries.

My favoured measuring tools are a simple mirror rule and an edited version of the Fibonacci retracement to provide a quick way to find the middle of something.

Below is an example from yesterday and this morning. Although we show only one measure per chart, in reality, many tests would be performed to find, what we think is, the best clue.

Our point of interest is the last significant bear bar (seven bars from the end). We feel this bar strongly supports the probability of a further reduction in price.

The question is at what point do we enter the trade? The bear-bar we are measuring is a trend bar but has a  prominent tail; this indicates either buyers below or, and more likely that sellers are buying back their trades – taking profits.

It provides some uncertainty and a stop immediately above our measured bar would be vulnerable. We, therefore, look for the workable trade solution that the majority of ‘institutional’ computers will employ.

We consider that the next premise point (marked by the red arrow) is a candidate. To provide a traders equation of reward and risk, we measure the halfway point between stop and target and determine our entry level; this we have marked with a yellow arrow.

Contextually it makes sense. In other words, we like what we see if we stand back and take in the bigger picture.

Below is how the trade developed over several hours.

From this morning we have an early, but a viable consideration. In this example, we are against the trend but contextually a probable scalp of 26.9 pips.

After the close of the third of the last four bull bars, we take our entry as marked by the yellow arrow.

Our measure is from the third bull bar, from the bottom of its tail to the close providing a measured extension above.

However, as before we feel that a viable stop position is the base of the recent low. Again our reward/risk is satisfied if we enter at the yellow arrow.

The trade concludes as shown below.

A point on the spread. As retail traders, we have to consider spread in our bets. That is, we allow for half spread on trade entry – if we had not in the last example we would not have been successful with our entry.

Our measurements, however, are a determination of what the institutional computers are taking, and they, by-and-large, do not have to deal with anything as distracting as spreads!

Trend indicators, are they needed?

Trend indicators are useful but are in lag? Our method is systematic price action with trend identified through context.

Price action is a good fit for the methodical approach to trading. Relatively easy to establish, back-test and edit. Based on the close of a bar and that bar relative to as many prior bars as is necessary.

Trading range or trend?

The market spends most of its time in a trading range. Trends take up only a small proportion of the demand. Our systematic approach must, therefore, work in both markets. To do otherwise, as many trend-following systems do, is to miss the majority of trade opportunities.

The problem with price action and a systematic approach is the identification or confirmation of a trend. To help, many traders rely on trend indicators. For example, the  MACD is a valid trend indicator when employed in the correct time frame.

Moreover, there are many ‘to buy’ trend systems available that claim to provide a reliable trend identification system; this may be. However, all indicators take their cue from price, and the price has to change sufficiently to give the trend.

A pure price action trader, on the other hand, will read the context of the chart to indicate a trend; this is made to sound natural to achieve by established price action traders. But as with anything after many hours of practice and once mastered will always seem easy from that point.

Let’s take a look at a trending opportunity this week with Sterling.

We can see from the yellow box that we have three bear bars. Our system took the close of the first of the bars within the yellow box short. But we are now flat waiting for more information. We know that the more significant trend supports a sell short but in our timeframe, an hourly chart in this instance, we are at the bottom of a trading range indicated by the red arrow. A reversal is 50/50.

The two bull pull-back bars, however, are weak and support an early entry short at this point, or if uncertain we can wait for an entry bar, which comes next. We sell short for a target equal to a measured move of the yellow box.

Trading range or trend? It's all in the context.
Not yet a trend but the last two pull-back bars are weak.

It is the second move down (the second yellow box) that established the trend short for at least three to four times the distance of the first yellow box.

We need to sell short and join the trend.
Trend short, at least for another measured move, is probable.

We can either hold our second trade (most advisable for intermediate traders) or exit with profit and re-enter for the final leg.

We say most advisable above as many traders once out with profit would not get back into the trade quickly enough to take advantage of the trend.

Take the profit as the trend has a possible three push short already, or hold for price action?
Exit at the measured move or hold until price action says otherwise?

To finish our point about trend identification. The remainder of the day, as shown by the chart below, are tradable pull-back bars. As we are reactive and not predictive, we can trade each appropriate bar or sequence of bars relative to context.

Context does not support a trend long, therefore scalp only.
Context does not support a trend long, therefore scalp only.

Notice there are three possible pushes long with the final bar being an extension driven, probably, by the welcome UK financial news released at the time.

We do not consider this a trend due to the context to the left, the identifiable three pushes already and the news-driven extension or possible exhaustion bar.

We only traded the close of the bull bar, the fifth bar after bar 1, long for a scalp. The imminent release of financial news of significance at about bar 3 kept us flat.