Testing High Leverage Compounding

Updated post 1 with

Rules for Thread:

You are welcomed to post here but please follow these guidelines

1. No commercial agenda please. (or links to the commercial section)
2. Keep the tone of the discussion positive.
3. If you want to make predictions or calls on pairs, please present invalidation points to go with your ideas and at least a vague description of the move potential or your trade idea.

A problem that I struggled with for a long time (and how I solved it)

I am quite sure I'm not the only one affected by this so I hope this post may be useful for some of you.

For a long time, I would observe patterns on charts on higher time frames, and then I would start coming up with trade ideas and forming a bias. Then I would seek to confirm that bias by sourcing for evidence online to support it. If there wasn't evidence then it must be because no one is seeing it yet and it's must be a great time to trade and be contrarian; if there were evidence, then I must be right and soon everyone would know about it.

Well, it's pretty delusional. BUT this alone would not cause any financial damage, as long as my trading methodology does not make use of the flawed logic.

Unfortunately, that's not how things turned out most of the time. Usually, I would get excited about the discovery and then start finding an opportunity to enter a position in the market. I would probably think something like, "Ok I will enter short on the next new high.", but when I see the market moving down, I would second-guess my plan and just enter immediately. And my risk was usually undefined, and I risked way too much on the trade. A few times, I actually made great profits this way, like really really great profits. I thought I must be special and doing something right. But most of the time, the trade would eventually go against me and then I would get wiped out by the high risk used.

It's easy to sum up the above as bad trading, but what exactly were the thought processes and decisions that were bad and how might they be improved?

1. Being unclear about my preferred trading style and timeframe.

Everyone has a style and timeframe that suits them. For me, it's fast-paced intraday trading. I am drawn to the quick decision making involved and the instant feedback the market gives. (Note that this does not mean more trades, it just means more thinking and acting on the spot.) When trading higher time frames and bigger picture trade ideas, the feedback is typically not instant. Moves on intraday are usually meaningless in those contexts. Trying to apply trade ideas and biases from higher time frames to intraday trade plans is typically futile.

2. Poor risk management and position sizing

Typically futile yes, but still doable. Just expect to be wrong a lot and make big money on the one time you are right. But because I sized my positions inappropriately, I could never survive long enough to make enough of such trades to allow the big money to come.

3. No consistency in my approach

I had no clearly defined checklist of what to look for when identifying such opportunities, so I was prone to behavioural biases and bad logic. Also, I had no clearly defined entry filters and this exposed me to making emotional decisions based on greed or fear.

***

Solution?

1. Trade a timeframe and style that fits your personality. This is the most important point. If you don't know yet, explore.
2. Have very clearly defined position sizing that respects the limitations of your methodology. If you expect a high losing ratio, then don't risk too much per trade as it is sure to wipe you out.
3. Make sure to have a clearly written plan and checklist that you can refer to when trading. Even now I still read my trading plan and checklist on a daily basis to make sure I get it right. It's impossible to emphasize how many times the little things may slip away from you.

Applying The Kelly Criterion



First of all, no I am not saying you should use this formula to size your positions. But instead, let us consider what it really means and use it to inform us how we should approach the market.

The Kelly Criterion tells us what is the optimum amount to risk on each trade if we want to maximise returns (without going broke), as a function of our winning % and risk-reward ratio.

Two observations:

1. If you differentiate optimum f with respect to the risk-reward ratio, you see that it is increasing in the risk reward ratio. This implies that the formula suggests you risk MORE when the risk-reward is higher (more in your favour).

2. Of course it is also increasing in win-rate, so you should risk more when your win rate is higher.

All opportunities in the market are not created equal. There are certain set-ups that come to us that have either higher winrate or better R:R. Consequently, we should risk more on these set-ups according to implications of Kelly Criterion. Much of successful trading is learning how to identify which of your set-ups are A+ and which are B or C set-ups and to risk more for the A+ set-ups and less for the Bs and Cs. It doesn't mean you skip the Bs and Cs, because those still offer positive expectancy. It just means you risk a lot less. (Ideas are adapted from Mike Bellafiore in One Good Trade)

This is the whole premise behind scaling in. When you scale in you are basically saying this set-up has higher RR or better win-rate and thus you are risking more. Scaling in by itself usually has an edge because of the trending nature of FX markets especially around high volatility hours.

Averaging down to losers is basically doing the opposite. Most of the times you are adding to positions and increasing risk when the set-up has poor win rate or bad R:R. This is the way to lose.

Thanks for the tip. Bought it and hope to be a good investment.

Some Changes

Swapped out the Demo account with a US-Cent Live Account. Reason being I am intending to incorporate discretion into the approach and this means a demo account is meaningless.

I will use the same rules as the demo for basic filtering of pairs. In particular I would like to apply Mike Bellafiore "Stocks in Play" idea into the FX market and will be exploring ways to do so. This means I might be factoring fundamental factors as well to select pairs to trade and the bias to trade them. But as a first cut, the methodology will still be trend-following and entering on retracements.

The exact entries will instead be discretionary. The aim here is to learn more set-ups that I can potentially add to my "Playbook". Some variables I will consider when entering include, but are not limited to:

- Technical patterns (entering against a counter-trend break-out especially)
- Demand and Supply levels
- "value" areas
- Volume Analysis
- Time of the day
- News releases
- Trendlines
- RSIOMA(14)
- R:R ratios
- EW theory

Exits will follow similar rules (based on ATR) as before except now I will scale out. (for example taking half off at previous reaction high/low and letting the rest of the position run at BE)

SL will be based more on technical levels than on ATR.

Scaling in (i.e. high leverage compounding) will still be done if price clears technical level/reaction high/low and consolidates and offers a good opportunity for adding.

Risk per trade will be cut down to max 1% instead of 5% and will be raised .5% for every 2 weeks of profitable trading until 5%. Oh and a daily loss limit of 3%, weekly 10%.

Spreads are really horrible on this account so if I can make good returns here then it should only get better.

Note the focus here is on learning new set-ups. Not on making money. I want to improve my intraday edge.

Currently I feel a bit frustrated by the lack of opportunities by focusing on only 2 pairs. The optimal end-game for me is to have 2-3 positions on average going at once during intraday trading. This will provide enough diversification and also simulation for my brain. Of course the road to getting there is probably tough and long... I'm expecting it to take 2-3 years before I can reach a level where I can trade large sums with discretion comfortably on an intraday basis. Yes, 2-3 years of daily practice.

We can be better tomorrow than we are today.

This will be a weekly review where I look at the events for the past week and think about how they might affect the currency pairs and also a preview of the following week's news.

## AUD
May 27: Construction Work Done q/q: -2.4% / -1.5% / -0.6%
May 28: Private Capital Expenditure q/q: -4.4% / -2.3% / -1.7%
May 29: HIA New Home Sales m/m: 0.6%/ - / 4.4%
May 29: Private Sector Credit m/m: 0.3% / 0.5%/ 0.5%
Generally a splatter of bad news for the AUD across the board. This is likely to increase the odds of further easing of monetary conditions. However, home sales have reached a all time high and this may affect the CB's decision.
Overall, I expect AUD to maintain its downtrend and continue selling off on bad news. However, it might be prone to sudden reversals if news improve next week.

## CAD
May 27: BOC Rate Statement
May 27: Overnight Rate: 0.75%/ 0.75%/ 0.75%
May 28: Current Account: -17.5B / -18.6B/ -13.1B
May 28: RMPI m/m: 3.8% / 1.7%/ -1.5%
May 28: Corporate Profits q/q: -6.0% / - / -2.8%
May 28: IPPI m/m: -0.9% / -0.1%/ 0.2%
May 29: GDP m/m: -0.2%/ 0.2%/ -0.1%

Profits are down, inflation is weak, GDP is negative -- all signs that there will not be a rate hike anytime soon by the CB. The dovish statement issued confirms this and as a result I'll expect CAD to stay weak or neutral.

## CHF
May 27: UBS Consumption Indicator: 1.25 / - / 1.34
May 28: Trade Balance: 2.86B / 2.77B/ 2.50B
May 29: GDP q/q: -0.2%/ 0.0%/ 0.5%
May 29: KOF Economic Barometer: 93.1/ 90.1/ 89.8

Some contradictory data here. But key piece of news is from weekend statement from CB to the press that they think CHF is overvalued and should weaken and will not hesitate to intervene in the market. This should pressure CHF down in the coming weeks, but is prone to a 'barrier' effect and sudden bounces.

## EUR
May 27: GfK German Consume Climate: 10.2/ 10.0/ 10.1
May 27: German 30-y Bond Auction: 1.18|1.1 / - / 1.07|1.3
May 27: Belgian NBB Business Climate: -4.9/ -5.7/ -6.2
May 28: German Import Prices m/m: 0.6%/ 0.5%/ 1.0%
May 28: Italian 10-y Bond Auction: 1.83|1.4 / - / 1.40|1.6
May 29: German Retail Sales m/m: 1.7%/ 1.1%/ -1.4%
May 29: French Consumer Spending m/m: 0.1%/ 0.4%/ -0.7%
May 29: Spanish Flash CPI y/y: -0.2%/ -0.5%/ -0.6%
May 29: M3 Money Supply y/y: 5.3%/ 4.9%/ 4.6%
May 29: Private Loans y/y: 0.0%/ 0.4%/ 0.1%
May 29: Italian Prelim CPI m/m: 0.2%/ 0.1%/ 0.2%

Data from the EU is getting better. Plus news on Friday suggest that the Greek crisis may be a false scare. These factors should push the EUR up in the coming week(s).

## GBP
May 26: CBI Realised Sales: 51/ 18/ 12
May 28: Second Estimate GDP q/q: 0.3%/ 0.4%/ 0.3%
May 28: Prelim Business Investment q/q: 1.7%/ 1.2%/ -0.9%
May 28: BBA Mortgage Approvals: 42.1K/ 39.2K/ 39.2K
May 28: Index of Services 3m/3m: 0.4%/ 0.5%/ 0.7%
May 28: GfK Consumer Confidence: 1/ 4/ 4

On their own these data seem mixed but if we contrast them with other countries we see that UK is outperforming them significantly. The rise in mortgage approvals may prove worrying to the CB and pressure a sooner rate hike. All in all, based on fundamental factors alone, I expect GBP to rise on neutral to good data next week.

## JPY
May 25: Trade Balance: -0.21T/ 0.38T/ 0.01T
May 26: SPPI y/y: 0.7%/ 0.6%/ 3.1%
May 28: Retail Sales y/y: 5.0%/ 5.3%/ -9.7%
May 29: Household Spending y/y: -1.3%/ 3.1%/ -10.6%
May 29: Tokyo Core CPI y/y: 0.2%/ 0.2%/ 0.4%
May 29: National Core CPI y/y: 0.3%/ 0.2%/ 2.2%
May 29: Unemployment Rate: 3.3%/ 3.4%/ 3.4
May 29: Housing Starts y/y: 0.4%/ 0.3%/ 0.7%

Mixed data slanted to the negative side. Things does not look good for JPY. Technical break of 124 level suggest that a huge upmove in USD/JPY may be impending. However, earthquake this weekend in Tokyo introduces some uncertainty and may derail the carry trade in the upcoming week. My sensing is that it's best to stay away from the JPY pairs in the upcoming week.

## NZD
May 25: Trade Balance: 123M/ 105M/ 754M
May 28: Building Consents m/m: -1.7%/ -/ 10.3%
May 29: ANZ Business Confidence: 15.7/ - / 30.2

Mixed data. Nothing much new here. Probably just follow technicals.

## USD
May 26: Core Durable Goods Orders m/m: 0.5%/ 0.5%/ 0.3%
May 26: Durable Goods Orders m/m: -0.5%/ -0.4%/ 4.7%
May 26: HPI m/m: 0.3%/ 0.7%/ 0.6%
May 26: S&P/CS Composite-20 HPI y/y: 5.0%/ 4.6%/ 5.0%
May 26: Flash Services PMI: 56.4/ 57.0/ 57.4
May 26: Richmond Manufacturing Index: 1/ 0/ -3
May 26: CB Consumer Confidence: 95.4/ 95.2/ 94.3
May 26: New Home Sales: 517K/ 501K/ 484K
May 28: Unemployment Claims: 282K/ 271K/ 275K
May 28: Pending Home Sales m/m: 3.4%/ 0.8%/ 1.2%
May 28: Natural Gas Storage: 112B/ 95B/ 92B
May 28: Crude Oil Inventories: -2.8M/ -1.5M/ -2.7M
May 29: Prelim GDP q/q: -0.7%/ -0.8%/ 0.2%
May 29: Prelim GDP Price Index q/q: -0.1%/ -0.1%/ -0.1%
May 29: Chicago PMI: 46.2/ 53.1/ 52.3
May 29: Revised UoM Consumer Sentiment: 90.7/ 90.0/ 88.6
May 29: Revised UoM Inflation Expectations: 2.8%/ - / 2.9%

Mixed data. But the nail in the coffin is GDP. Is US entering another recession? This could have significant impact on CB policy. I am neutral on the dollar in upcoming week based on fundamentals.

***

## Upcoming Week
1. China Data: could weigh on the NZD and AUD pairs and also indicate whether the world is entering into another recessionary phase.
2. AUD CB Statement: high impact obviously
3. GBP CB Statement: high impact especially after relatively strong data.
4. NFP: probably nothing much here.
5. Greek Crisis resolution: probably nothing much here. Greek will pay back or get a deal. Doesn't matter much to the EUR imo. Most of it has already been priced in by the looks of it. But volatility could increase close to the date.

## Summary
Based on fundamentals, favour the following trades this week:

Short AUD, CHF & CAD
Long EUR, GBP
Neutral on USD, JPY, NZD

After filtering with fundamentals and technicals, I am left with

Long GBP/AUD
Long EUR/AUD
Short AUD/USD

as pairs in focus for Asian session later.

The general strategy will be to enter on retracements.

Lesson 2: Psychological Visibility and Your Relationship with Your Trading Coach

"The best relationship is achieved when goals are linked to values are express distinctive strengths. Relentlessly identify, repeat, and expand what you do best -- even (and especially) after the worst of trading days...

Set a positive goal, based on strengths, to keep you in touch with the best within you."

The Daily Trading Coach, Dr. Steenbarger

Goal for today:

I am taking the best entries based on my understanding of "price action" when trading discretionary, or based on clearly defined rules when trading systematically. This means they are right sized, offer a good RR, and should feel unforced. I do this because it will allow me to express my strengths (built from years of chart/screen time) as well as to build good habits and win at this game.

Sold AUD/USD at the intraday level I marked out earlier while preparing.



But only took 1/3 size because there was no clear patterns and neither was the move a conventional EW retrace or anything. perhaps this is common during Sunday but in that case I am not familiar with it and couldn't possibly put on a larger size. In other words, I deem the trade to be a B or C trade, and not an A+ set-up. Still it's worth taking because it likely has an edge giving my preparation and planning (both technicals and fundamentals are in my favour). My SL is around 17 (including spread of 5 pips) pips and TP 70 pips.

Long EUR/AUD

Full sized. Hit into my intraday support level drawn earlier and also clear EW retrace pattern and coincides with value area (200EMA) + high volume move. A+ set-up.

Actually it's not even A+, it's A++. One of my favourite set-ups of all time.

The 7 pip spread is a bit steep, but I can deal with it as my initial target is 1:1 RR (at reaction high), where I will take half off and look to scale in on a retrace.

SL hit.

Was it a loser. Yes.
Was it a good trade. Certainly.

Exited all positions. Thesis/Trade idea today didn't work out all round (or maybe it will eventually but I wouldn't be able to trade it)

Hit intraday loss limit of 3%. Done with discretionary trading for the day.

Set-ups on EA and GA were great with fantastic RR and even news was in favour but I guess maybe it's the first of the month effect, price has to retrace the previous monthly candle and do a more significant retrace to attract longer term buyers.

Would take these trades anyday though. Unless I spot a pattern as to how they might fail like today.

Unlucky mate. Losing the first trade of the week is always a bummer. But if it aligned with your system then you have nothing to feel ashamed about. Get out the scotch!

This is the dilemna, isn't it? Almost all consistently profitable systems require some discretion, due to the ever-changing market conditions. Yet how can you prove to yourself that they are statistically profitable over long periods of time - in other words, backtest them - if they require some discretion? The only way to prove them is by trading forward in a live account in realtime, but if your system is flawed in some way then you'll end up losing money and confidence. And how long long would you give it? It's important to set predefined drawdown limits in this situation.

This is the dilemna I'm facing now in my TZ thread. I'll elaborate on it shortly.

Probably shouldn't trade the market open. Seems like I generally don't do well during this time as the moves are rather bizarre.

There's no system to speak of. I am the system here. It's a work in progress. I'm developing my best set-ups, and I just found one (even though it didn't work out today). Hope to catalogue these set-ups over time. I set-up a private worpdress blog to do so and I'm logging 1 trade set-up per day. The best one that is. Doesn't have to be a winner. So over a year I'll have 200+ set-ups and I can look and choose which are my A+ ones and which are B or C and then from there I can build my arsenal of trading edges. This is exactly what the "Playbook" is about.

Hmm I suppose the key is to define variables. When all the variables' conditions are met, then the trade is on. Although the exact execution still depends on the trader's skill at finding good prices in the market. One thing I can't seem to master is, when do I reenter into a trade? I know many pros will say don't use a hard SL and instead watch the price action around the exit point and see if it breaks. But I don't think it's helpful for FX when we have 1. high leverage 2. effective spreads tend to be wider than the spread shown.

Number 2 might be an bit strange but what it means it actually there are alot of different prices in the market and the spreads are being compressed artificially by algos. The actual "effective" spreads are a lot bigger. So price can spike through your SL but doesn't mean the trade idea is invalid. In fact a lot of times, it tends to bounce in those areas because the S/R is not broken.

I suppose the skill to develop here is to read the bids/ask ticks at those levels. Still trying to learn how to do it better. Sometimes I can get it.

***

Anyway I have no doubt that I will be able to find a way. As long as I follow proper position sizing and keep exploiting the edge from technical and fundamental and good set-ups in a more or less consistent manner, it's just a matter of how profitable. Losses are ok as long as not catastrophic.

Why I think so is because there are certain principles that just work in the long-term. It's not rocket science. It's just the same patterns over and over that produces the really profitable set-ups. End of the day we are trying to identify institutional interest or some kind of strong order flow and to ride their coattails and these tend to exhibit the same price behaviour.

For instance, for price to go up, IT HAS TO GO UP. I know it sounds obvious but you basically can't go wrong when you buy as price goes up when the big players are around. The issue is, they are not always around, and we just have to try to time our entries to the times when they are more likely to be around. lol.

I'm just a bit pissed at this broker though because it doesn't allow me to place stop-loss or limit orders close to the current price. I think it's ridiculous. The range is extremely wide. But these issues will go away with a proper broker like Global Prime. Eventually I'll open a 1k account to continue testing there. But gonna give this a few more months first.

I see. Thanks for clarifiying . And yes, that broker sounds naff.

haha. yup. Anyway it's almost Europe session and time to trade my rags2riches account.

green pips to you.

Entered short at 1.0950, but this still looks like it could go either way

So getting stopped out isn't such a bad thing if your system allows your to reenter appropriately

Risk on this trade was 12%.

RR is about 10:1

Back from breakfast...

Looks like price did quite a retrace while I was gone.

Trade Management

Stop shifted to lock in some gains after price hits 000 level.