Absolute Simplest KISS Method. Also, how do we measure risk reward?

Howdy all,

I'm sorry but I like open discussions around theories of trading. I'm not going to give you a system saying when X currency is above this MA with RSI here then buy 3 lots, blah blah blah. Here is the latest theory that's been mulling around my head.

How KISS can a trading system get? How about if I told you all you had to do was place on order at the open of a new candle without consideration of any past price movement? What if I told you the system was at the very least 80% correct? You'd say get out of town right? Maybe its not that easy, but it can be!

It all hit me when d3vil posted a thread about a strategy he was considering. You can read about it here:

http://www.strategybuilderfx.com/showthread.php?t=17439

My idea is nearly exactly the same except on one thing. d3vil's system requires that a currency move 50 pips to trigger a trade in that direction. My idea is, why wait for the 50 pips? I say, at the open of a new candle on a daily or weekly chart open a trade in any direction with a take profit of only 10 pips or so. No thought required, just enter a trade.

Look at a daily and weekly chart. There is a lot of movement in those candles. This system doesn't care about all that movement though. This system cares only about a few pips, 10 perhaps. What do you see in each candle on those charts? Rarely, very rarely do you see a candle open and go in one direction without any form of shadow in the opposite direction. Meaning, if a candle is a long white candle, there is still usually a shadow of a few pips below the open.

That's what got me thinking. What if when a new candle on a weekly or daily chart is formed you enter a long or short trade for only 10 pips profit. Why do I mind only taking 10 pips? Well look at the chart. How many times did a new candle form where you would have entered a position and not made the 10 pips? (I should note I'm looking at GBP/USD, EUR/USD, and USD/JPY) I'd say the win/loss ratio is 80/20. That's a very conservative number I'd say.

Also note the problem with the 80/20 number. Out of the trades that would have gone wrong, how many of those would you have been on the bad side of? If the trades were picked at random we can assume you would have been on the right side in those losing situations 50% of the time and 50% of the time on the wrong side. So the win loss ratio would probably actually be 90/10. Not sure how much better actual judgement could help, but then consider if you were able to use some chart reading experience to place yourself in the winning position of the possible losing trades better then 50% of the time. Win/loss then becomes upwards of 95/5.

I just got back from a trip to the SEMA convention in Las Vegas so I haven't looked at the charts to confirm those win/loss numbers. I'd say on a weekly chart those numbers will stand up pretty well though.

Here is another thought that came from this. What is risk/reward? Why do most of us measure our reward in pips rather than by how risky the play actually is? I see the above strategy as very safe considering the extremely low pip goals and high frequency of being correct. It is up for discussion, but I would feel very safe placing much more than just 2% of my account towards such a trade. Thus, when you're making $100 a pip consistently do you mind only taking 10 pips a week? $52K a year is probably a lot more than most make here trading. The idea is to just keep reinvesting and adding more funds to slowly build the value of your pips. When we try to take more pips, in any strategy, our probability of success begins to drop dramatically.

Right now I am having difficulty determining an exit strategy for a stop loss system though. With such long time frames we allow plenty of movement and don't want to wipe out our 10 pip profits with one long candle of 100+ pips. There are plenty of times when a currency will retrace 60 pips to give us our profits as well though. This makes me wonder how many of those 80% good trades did this and would be eliminated by a stop loss to reduce our chance of success to only 80% overall or less.

The take profits and losing exit strategy still need to be worked out. I've been thinking about taking only 5 pips from a daily candle to average 25 pips a week. The success rate would be increased on a daily candle while still giving us more pips than taking just 10 on a weekly chart. The system could also be applied to many different currencies at once to give a possible 100 pips per week if just 4 currencies are used that work well. The more volitile with low spreads the better. Isn't that cool? A system that works well with volatility. EUR/USD would work well too. We need currencies with many shadows in their candles.

This thread was also to get people thinking about different forms of trading. Many systems try to be successful based on how many times the thought process is correct. This system is based off of how many times in a time period currencies actually do something. I'm having trouble putting it into words, but do you understand what I'm saying? It's like, when a candle first opens on a long time frame chart it is 100% certain that it will move from the open in one direction or the other. What other certainties can we base a system off of? I'm going to look at a similar strategy, but with entries near the very end of a candle to see if the candles after it tend to overlap the previous close by a few pips. Could we increase the probability of success with that?

I'll finish by saying the last benefit of this system. It's so easy even an EA could do it! (Thinking of the geico caveman commercials, haha) Seriously though. No indicators. No thought process. Trades for long/short could be completely random and still be in situations where it wouldn't matter which position you take and still be upwards of 80% correct. Simple strategies could be entered though. For example, when the previous candle was red then enter a short on the open for the next candle. If it was green enter a long trade. This would add some decision making to the strategy and might help eliminate those losing trades better than 50% such that the win loss is 95/5 right off the bat.

What do you all think? The beginning would be slow, but once you start earning $50 or more a pip, the profits will add up quickly. Matt

Very nice post Matt! I hope this spawns a fluteful discussion!!

BTW, you're breaking forum rules by posting a link while you have less than 50 posts. Therefore, I'm quoting the link here before the mods delete it from your post.

Michele UU

What you are talking about is actually a way of trading & it's a very famous method..This is the Market Makers methodology of trading...Market Makers make their profits from the spread and they have a win/loss ratio of 90/10 or even more....Their profit per trade is slim, but given the high win/loss ratio, they usually come ahead....If you want to know more about this methodology, you can read what Van Tharp said about it in his book "Trade Your Way to Financial Freedom"...The difference between the market makers' method & what you are stating here is that your method already includes the spread of the market maker, so you are basically looking to overcome the spread & get some more extra pips....The win/loss ratio will be lower than that of the market maker, so it can't be 95/5, it might be 80/20 as you mentioned before even after all the made optimizations...Also remember something very important, market makers widen their spreads during volatile times, you won't be able to do this, all what you would be able to do is to stop trading at such times...


Thanks,

Nader

Some thoughts:

I think the problem isn't having your profit target hit 9 times out of 10, the problem is the one time it fails becoming a few hundred pips and bigger or equal the sum of the previous 9 trades.
You cannot outrun r/r.
You WILL have to figure out what to do with the one trade that fails.
If you use a stop, you will face the usual dilemma of the bigger that is, the more probability you need for winning if it's only a fraction in size what you earn compared to lose.
If you don't use a stop, when do you intervene? Do you intervene at all?
What about the rollover costs if you don't close?
Unfavorable interest means accelerated degradation.

Basically if you're so bent on trading without stops or cashing in on movement, you could always consider "Bird Watching In Lion Country" which basically says within a set boundary price is bound to move from one extreme to another eventually, within limits. You just make sure you're sufficiently close to the boundaries and close out in the appropiate direction enough and should be in cash.

Quite frankly, I also don't see the difference to a "no matter EA" which just randomly opens 1-2 positions a day with limits at 10 pips and without stops, either undetermined or in the direction of the previous days open/close tendency.
Spread however WILL come to haunt you if you trade a lot of trades with a profit target that's only 3 times as much as your spread / cost of the trade itself (25% of your profits go to your broker that way, that's almost as bad as tax....).


Nice idea and intriguing and all etc pp, no idea if it's practical.

SeekingLight

Am I missing something here, or does this sound like Orange Roshan's SRDC Method, found on the FF???

Roshan's system is to buy at the high or low of the previous candle. This system is about buying at the open.

The reason why this is a difficult technique is outlined below. This was my first trading approach when I started trading professionally. 10 pips - How Easy Can This Be!
This is as old as trading is - and the psycho BS that comes with it too:

"What are my SL's? Heyyy, I can take out my stops just this once b/c I have such a great hit-rate for I know it's going 10 pips in my favor! Man - I know can make more than 10 pips this time! Hey, how about scaling lots. Now I have 45-60 pip loss if my stops are hit,...but...and so on..."

Maybe you can do better with this than most of us who tried.
More power to you if you can and I hope so.

Just make sure you have a great risk mgmt. plan with this, yeah?

k

I am not going to knock you permanentjaun, I think anything requires some research before a conclusion can be made. I'm going to try to make an EA of this tonight. It should be pretty simple.

andersenws

Made an EA and tested it on EURUSD for year 2005. Report attached. Results, with a static order size of 1 lot, showed profit of $4629 with no Absolute drawdown and 52% accuracy.

andersenws

Sorry, I forgot to mention the SL and TP method. I started with a Stoploss of 25 and after 25 pips, I move it to breakeven and it becomes a trailing stop. I will test it on some other pairs tonight.

andersenws

narafa -

I understand wider spreads occur during volitile times. Do most daily and weekly candles form during news releases though? Weekly charts particularily don't open with much action. I assume in playing a weekly chart there wouldn't be a problem of dealing with wider spreads.

Seekinglight -

I understand all that. I mentioned the problem Im having right now is determing a solid stop loss system. It may come down to a filter that either determines when a trade shouldn't be entered or one that shows the most likely direction the candle will go. I prefer it does the latter. Unfortunately, in doing so it may not make it any different from other systems.

In reference to the "no matter EA" however, it is possible to do that. I'll be thinking more about it. However I think the idea of using the open as starting point works well because of trader psychology. Why is it that nearly all the weekly and daily charts have shadows? A simple theory that just ran into my head is a lot of indecisiveness between bulls/bears at the start of a new candle, especially on such long time frames. We wonder, is this new candle going to continue the trend or not? A lot has yet to be determined and I think this system is trying to capitalize on that wariness among traders. Even in strong uptrends there is still somewhat of a shadow below the next candle before it rallies hard. Traders worry if this new candle is going to continue the trend of form a hanging man.

Right now I think the problem of stop losses needs to be addressed. I don't think the problem is the stop loss. The problem is at the open we have the opportunity of being 100% correct. We should be looking more for ways to accomplish that. We only need something to tell us how to alter the 20 out of 100 trades that will affect us. Could it be as simple as if a 5 HMA is above the 20 HMA on a 1 hour chart to show current momentum going into the new candle then enter long and short if their positions are reversed? What if that gives us a better than 50/50% chance on those losing 20 trades? How much better a chance does it give us? If there is no shadow in those candles then I will assume the trend is very clear at that point in time. Which indicator makes it clear what that trend is? Maybe it's just about giving us or an EA an educated guess. There has to be a huge advantage over a random 50/50 entry. This would probably also help our peace of mind as we enter trades such that they're exited nearly as quickly as theyre opened.

carmel and ntmg12 -

I will look into that system shortly. Although from your description I am cautious if it is based on the highs and lows of the candle. Highs and lows have a higher chance of being around support/resistance than normal I believe. Entering a trade using those numbers could leave you with a trade that immediately bounces in the wrong direction. I'll read up on it though.

ktrade -
I appreciate your post. I know there is a lot of BS out there and a lot of people with false hopes who think this is an easy game. I think a lot of the problems people have are their goals. They don't have them laid out. I know I'm not going to get rich overnight with forex unless I have an extreme run of profitable trades. Since the work in doing that would be tremendous and still unlikely, I am looking for other methods. If I can find a method to make me 10 pips a week on a currency then I'll be happy. I'll have to sit down to see exactly what the percentage of winning trades vs. losing would have been to see how practical this system idea is.

You are correct though. An exit strategy for risk management MUST be determined before entry. The entry and TP are so simple it takes no effort to describe it. The SL is the hard part. What is it about other systems then that look for 50-200 pips a trade that makes them more profitable? How is it this system has a hard time making profits in the long run when looking for only 5-10 pips a trade while others are profitable when they search for 50-200 pips? The problem is the conservative goals we're looking for in this system. How do you set a SL against only a 5 or 10 TP? If I can't find a way to do so with this system I'll surely examine more closely a system that finds opportunities of 50-200 pips a trade.

pipripper -

Why should we concern ourselves with systems based off of price triggers rather than indicators? Many argue that using indicators doesn't work because they lag. I can't tell if you're looking down on a price triggers or not. I think they may be more useful than indicators at times. I'm not so sure how much of a price trigger the simple act of a new candle forming is though. The system is successful roughly 80% of the time just on a random 50/50 choice between going long and going short. Previous price action was completely disregarded.

I'll close by repeating the success of something like this is in finding a way to not make decisions of long or short randomly. We want to affect the 20% of trades that would be encountered by random 50/50 entries. Give us an educated guess somehow. Where is the edge in those decisions? I liked the concept of a random time entry EA. It makes me wonder if it really does matter when we enter a trade so long as we are on the right side. I'd like to focus at the open of candles for reasons I described in this post, but I think we need to now focus on what strategies could be implored to give us a decision as to which direction we should take on the entry. Let's start using indicators as indicators and not triggers.

I really need to learn how to program an EA and backtest. I hope someone here can quickly write something just to see how it works out. Perhaps try a system based off of 50/50 entry. Then one based off of the positions of two MA's comparatively. Perhaps one where the entry is short if RSI is above 50 and short if below 50. Maybe the value of Parabolic SAR could give us a healthy indication. We should discuss and try these different approaches. BUT, lets try to KEEP IT SIMPLE.

Thanks for the posts. Matt

something to read...

andersenws,

From your EA SL guidelines I'm led to believe you're not following the system. The system isn't based off of the total movement in a candle. I'm only concerned with a few pips, 5 or 10, away from it. I believe your EA was simply an EA to test randomly entering a position at the start of a new candle. This system doesn't need a trailing SL. It's concerned with the high probablity of 80% or so that a currency will move just enough to make 5-10 pips. Future movement beyond that is immeasurable to the system. If you're letting it run with 25 pips and a trailing stop loss then that doesn't follow the guidelines of the system.

How did you tell the EA to go long or short by the way?

Right now I think SL should be abandoned in EA's for testing this since we don't know how they really affect the system. What if a simple method to tell an EA to go long or short gives it 100% success even though at times it will take a day or a week for the candle to give the profit? Would you still institute a SL or rather let it ride with certainty it will profit in the end? The point is I would much rather focus on solving how to make those 20% losing trades better and if we can't eliminate those after some serious thought then try to distinguish them from the rest somehow either through SL or indicators recognizing when they happen.

andersenws -

Again, I think your EA doesn't reflect the system well. A 52% accuracy doesn't seem very close to the reality of many candles having shadows below them that would give us our profits. Perhaps try running the EA without a SL just to see how many winning vs. losing traders there were. That would give us a good count as to what percentages we are playing with in terms of losing trades. Also, are you looking at a weekly or daily chart? Run a 5 pip profit on daily and 10 on a weekly.

Thanks for the help. Matt

Ok. here's how I set it up. It calculates the High and Low of the last day and sets a BuyStop at the High and a SellStop at the Low. If these orders are not triggered in that day, they are closed. The way I did it I described earlier, so i will not reiterate.

My feeling on this is that a 5 pip TP is insane. I understand what you are going for, what with the high %, but I highly doubt this could survive like that.

I just ran the test you asked for, with a 5 pip TP, and accuracy on EUR/USD was 72% for the year 2005, with 90% modelling quality. This is on daily. I cannot test on weekly.

Keep in mind, often times when we backtest systems by "eyeballing it", somehow we skip over the losses and only see the wins. So keep this in mind when you visually backtest systems.

andersenws

There is no such thing as certain in life, much less in Forex. I would institute a SL. Capital Preservation and Risk Management are key in Forex, and going without a SL is crazy, no matter how confident you are.

andersenws

andersenws -

Still not sure how close to the system your EA is. It looks like you look for a 25 pip movement off the open before a position is entered. This system would only work if positions were entered immediately at the open with no movement accomplished yet. I'll manually go through the weekly and daily charts tonight to count possible losing situations.

I understand 5 TP is insane. Is it less insane to try and predict 50+ pips? I think what is used to indicate a long or short on those types of systems is what is needed to indicate the direction we need to take on the opens of these candles. MA order. RSI location. Parabolic SAR location. This system wins when we increase the accuracy. All ideas welcome on how to accomplish that.

5 TP may not be insane enough. All situations should be considered I believe. How much more accurate is the system if on a daily chart we only look for 2-3 pips. 2 pips a day would equal a success of 10 pips on a weekly chart but may reduce risk more than playing the weekly. Playing 3 pips also increases profit potential by 50% over 10 pips on a weekly chart.

I agree these are very extreme TP's. My thinking is that profits will grow tremendously if we can get extreme accuracy rates and throw massive amounts of money into the play. Would you rather put money into a system that is 60% correct or 85%+? If I can work this out I would not feel bad about cutting back on my leisure expenses to put more into the system. Compounding power will take care of the rest. Matt

Oh and BTW, I don't think SL should be abandoned entirely. I'm saying in testing, SL need to be abandoned. We need to focus on increasing accuracy solely. Then study possible SL or exit strategies to protect profits while not decreasing the accuracy of the system. That'll be hard to accomplish, but for testing let's forget about stop losses unless you run across a strategy that doesn't reduce success rate and protects profits more than average. I'd still suggest researching if success through educated guess systems will help though. Matt

Wrong
andersenws

Ok, got it now. I wasn't thinking for a little bit. Still, how did you have the EA select when to enter long or short?

Just to give a heads up so far. I've looked at a daily chart for GBP/USD manually going over every candle. I started on February 8th, 2004 and got to June 27th, 2005. That is 357 days I believe. I got tired of counting.

I wrote down dates where the shadows would not have been enough to make a profit in one direction. I counted profits in the move. So to make a 5 pip profit I marked anything less than a 9 pip move from the open. Out of 357 days this happened 56 times, or 15.6% of the time. Surprisingly, moving to only a 3 pip profit would have only saved 9 of those trades. If a 2 pip profit was used only 4 more trades would have been saved meaning a 2 pip profit would have worked 87.3% of the time.

I also marked on my sheet if an entry decision of long/short based on the previous candle would have saved any of those 56 trades. Meaning if the previous candle was down then the entry signal for the new candle would be short and long if the previous candle was up. This only saved 21 out of 56 trades. I'm not sure how to analyze this number. 21 of 56 is 37.5%. My thinking is this may be too close to 50% to use. It would actually make more sense to do the opposite of what the previous candle was if you use these numbers. Is it just a fluke though? If we had used the opposite to generate a decision and saved 35 of the 56 then our success rate would have been 94.1%. Not bad I suppose for over a years worth of trades.

So at 5 pips profit we would have made 1679 pips for the year if we had reversed the entry signals based on previous candles performance. Not sure how many we would have lost though. I got tired going through all the candles.

Dare I get even more insane though? Perhaps even 2 pips on a daily chart is too much for 100% success in this system. What if we only looked for 5 pips on a weekly chart? Lol, I'm getting crazy now. I can already see even this would not give 100% right off the bat on a weekly chart. Perhaps using the previous candle for an entry signal would give different results however. I still want to look at Parabolic SAR and other techniques to see how they would affect the results as well.

Also wondering how time affects these trades. Are the candles opening in periods of inactivity which makes them hard to get the pips on either side? If so then this would support the idea of an EA entering 1-2 trades throughout the day at random. Not sure what to think. Matt