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.

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.

The music process of questions and answers can help in financial trading

Story and conversation with questions and answers as explained by Hans Zimmer can help the technical, financial trader.

Many traders have their trading ideas that help them win.

Such ideas, however, are not a panacea or substitute for all the hard work that goes into understanding how to trade the financial markets.

They are more to do with a traders discipline and a traders personal way of trend and context identification.

Hans Zimmer and answers

We like the thought process of the composer Hans Zimmer.

In composing his music, he says it can be summed up in one word – Story. For the financial trader, the story is the market cycle.

We apply his methodology in our trades. Conversation is context; question and answer notes are price action.

Below we have a series of ‘trade’ questions and answers. For us, the sequence of bars following the green arrows are the questions, and those within the red arrows are the answers.

We will trade a question but only from an entry bar and just as a scalp. Answers, however, can be taken from signal or entry bars as swings or scalps.

When does a question become an answer?

If the bull bar with the blue circle had closed above the resistance – the next price level that is determined by the bars about midway across the screen – this ‘blue circle’ bar might have premised into an answer.

Questions and answers are a price action.
Questions and answers are price action

We concluded that the blue circle bar would close low and remain a question. Therefore, we shorted the bar at about the centre of the blue circle.

Accurate enough, the answer bar came next and resulted in over 60 pips of profit in less than an hour.

Hans Zimmer’s explanation of Q and A in his music can similarly help a technical trader maintain the all-important market perspective on the chart.

Reactive or predictive in financial trading, what’s best?

Did our career ethos demand reactive or predictive decisions? What about financial trading?

It is right that most professions require predictive decision making. Engineers, doctors, entrepreneurs, lawyers, pilots.

Many of us from these disciplines have a go at financial trading in some form or other.

Why not apply the same predictive philosophy to trading that has always stood us in such good stead.

Mistake

Sorry, but that is mistake number one. To have any hope of success trading the financial markets, we need to change our career lessons of predictive bias to reactivity.

We all find this hard to do, it takes time to relearn, and most will never truly grasp the new concept.

We need to think of probability as the belief in an alternative outcome; it is not about the odds.

Highly probable trades are the essence of our (Slow Trader) strategy and paradoxically the most difficult to trade reactively.

Reactive, always

To do otherwise, to trade predictively rather than reactively, is to mistake possibilities for probabilities.

And knowing when not to trade is as important as knowing what trades are probably worth making.

Investor or speculator?

To be categorised as an investor or speculator can be made at all levels of finance.

Traditionally an investor is a long-term contributor to securities that have undergone a rigorous fundamental analytical process.

Shudder at the thought, the traditionalists consider, that a technical trade can be anything other than speculative.

But Mr Market can sometimes be nuttier than a fruitcake, and most financial decisions are bets if taken for less than 20 to 30 years. (Graham, The Intelligent Investor)

Controlling ourselves

Investing isn’t about beating others at their game. It’s about managing ourselves on our own. And as we are pattern seeking animals we technically convince ourselves of a particular market flow where one does not exist.

We know that if we speculate instead of invest, we lower our odds of building wealth and raise someones else’s.

An investment is not based on fundamental or technical detail per-say but is the safety of principle that attracts an adequate return. It is (1) analyse, (2) protect and (3) performance that is satisfactory, not extraordinary.

In other words, an investor calculates and a speculator gambles; regardless of whether it is based on technical or fundamental information or taken over a short or longish period. 

Online investor?

To that end, arguably online trading can be either depending on our approach. 

Remember the investor will analysis, protect and target. 

The speculator treats online financial trading as a way to mint money, a nonstop commercial video game. They busy themselves trading the low and medium probabilities.

The ‘investor’ of the online financial trades looks for high probability trades.

Screenshot 1, investor

In the screenshot below a high probability, entry presents itself at the green arrow. The target is 30 pips distant and the stop 60 pips. Would we hold if the trade went against us all the way to the stop? Probably not.

In any case, the stop distance makes sense. The doji bar soon after entry made us question the trade, but six hours later we achieved our high probability target.

An investors high probability trade.
Investors high probability trade

Screenshot 2, speculator

From the following day, our screenshot below provides a different picture. We considered this a high probability trade and entered long where indicated. We measured bar 2 for a measured move target.

Bar 3 was short of the goal. At the close of bar 3, we set to break even which we achieved. If we had not fortuitously done this, we would have exited with a loss at the close of bar 4.

It was only afterwards in debrief that we knew that this trade was speculation. The investors stop, having to be so distantly disproportionate to the target is a giveaway.

The investors (high probability) trade was short at the close of bar 5. In this trade stop and target were in proportion. 

Not an investors trade as stop too disproportionate to target.
Not an investors trade, as it turned out

Strategy and tactics are often confused by traders

Strategy and tactics, what’s the difference?

In the military fast jet world determining a clear strategy was the responsibility of the Generals. Throughout the Cold War period, most Western countries got it wrong.

Politics and industry drove strategy.

In the 70’s The United States Air Force (USAF) allowed a different approach. They put strategy above everything else. The outcome was the achievement of world air superiority, which they maintain to this day.

The USAF influence was from the “Fighter Mafia” and fighter pilot mavericks such as Colonel John Boyd. They realised the F15 and F16.

Colonel John Boyd, USAF fighter pilot, maverick and strategy.
Colonel John Boyd, USAF fighter pilot, maverick and strategy (ist)

A strategy is (almost) immovable. It is a principle on which to base all tactics.

As in warfare, a trader determines a strategy from which they can hang many tactics.

Most trading websites say strategies when they express tactics – “means by which a strategy is carried out”.

Low probability low risk

All beginners enter low probability trades. Reversals and trades that have a 40% or less chance of success.

We associate such trades with low risk which suits beginners that are frequently risk-averse. However, stops are often too close further reducing the probability.

Moreover, to counter the low probability when such a trade is successful the bet has to be held for a distant target to balance the strategy.

Medium probability medium risk

From an entry bar rather than a signal bar. However, an entry bar without good trade premise and thus a 50% probability. Traded by beginners and intermediate level traders.

High probability high risk

A trade that is (1) with a trend or (2) in the ‘probable direction’ from a significant break in a premise (3) or opposite in direction to an exhaustion bar.

Stops are distant which in turn provides high risk.

Can provide a 60% probability of success, better if we scale-in correctly. Almost exclusively traded by experts.

Our intraday trading strategy

“We take every HIGH PROBABILITY trade that fits market cycle, context and the economic calendar; we manage it procedurally whether the trade takes us in or out of the money, and a measured loss is acceptable”.

Conclusion

“Tactics are disposable. A strategy is for the long haul.” (Seth).

If high probability trades is our strategy, then everything else is tactics.

To Colonel, Boyd strategy was a compass, and tactics made the map.

Market cycle is more reliable the higher our time frame

Market cycle favours the higher time frame charts.

Why it’s easier to trade from a higher time frame chart?

A time frame is not a direct representation of decision time available. If we trade from a five-minute chart, we don’t have all five minutes to analyse and make a decision.

On such a chart we often have but a moment.

Mostly, however, we feel that ‘time’ to decide is what we gain from trading higher charts.

Another aspect of time and a higher chart, the daily for example, we need only look at a chart briefly but once a day.

Contrast that with a 5-minute chart where a trader looks at the chart all day long.

However, more important than the time available is the representative market cycle.

Take a look at the diagrams below to see the various market cycles, all screenshots taken within a moment of each other of sterling/dollar.

See how each time frame mostly projects a different cycle.

The higher the time frame traded, the more stable or more assured is the corresponding market cycle.

Traders work in larger or smaller market cycle microcosms the higher or lower the time frame chosen.

We can assimilate this to a swell at sea. As the swell approaches land, we get waves. In the shallows, we get choppiness and back currents.

The swell represents the weekly chart; waves are daily charts and the choppy shallows the five-minute chart.

Our current preference is the one-hour chart. As a full-time trader, this chart is mostly intraday; many bars meet the minimum scalp criteria and the market cycle, we think, is suitably defined.

Market cycle within a weekly chart
Market cycle, a weekly chart
Market cycle within a daily chart.
Market cycle, a daily chart
Market cycle within an hourly chart.
Market cycle, an hourly chart
Market cycle within a 5-minute chart.
Market cycle, a 5-minute chart

Time frame, which is best for intraday and short-term traders

Train with lower time frame charts, trade with higher.

We often like contrarian solutions. It says ‘doing something different from the crowd’.

About day trading they say: ‘do not’, ‘it’s risky’, ‘short-term volatility’, speculator’.

In the assimilation of information from a lower time-frame chart is the determination of probability possible?

Often it is not.

In a figure title in The Intelligent Investor Graham uses “the faster you run, the ‘behinder’ you get”.

Benjamin Graham, his time frame was value.
Benjamin Graham

He makes a point superbly by showing a bar chart that reflects the extremely patient keeping their gains and how the hyperactive made their broker rich, not themselves.

A dilemma, however, is that a technical trader dealing solely in the higher time frame will not trade often enough to gain the necessary skills to succeed.

The day trader is the tennis player that is on the court all the time. She attempts shots from every angle, overhead, volley and smashes.

The higher time frame trader, in this simile, takes a couple of swings a week or a month – are they match ready?

Traders with experience, skill and emotional stamina might profit in the lower time frame. For the rest of us, this area is our training ground for the higher charts.

What higher time frame to choose depends on our circumstances and personality. The 1-hour bars are the lowest so-called higher time frame that we ought to consider.

We favour the 1-hour, but we are happy to trade full-time intraday.

Others may prefer the daily bars.

For UK share traders using daily bars this is fine but other areas such as FX then New York close bars are required for correct price action.

Plan, Brief, Execute and Debrief

The quality of our trades depends on the quality of the decisions we make. We are not born with this ability, we learn it. Strategies guide and define our choices. Therefore, based on sound principles, a good plan is a vital step for us to produce right decisions.

Once we have a clear understanding of each part of our strategy, we can invent our way of recalling its sequence (as an ex-military pilot I like the plan, brief, execute and debrief order of things)

  1. Plan (News and Market Cycle)
  2. Brief (Backtest and Probability)
  3. Execution (Valid Entry)
  4. Debrief

Our ebook has many pages, but the simple block above helps collapse all our work into a process that allows, more often than not, to provide a profitable solution.