Diversified Trend Trading Approach

Trade Logic applied to Trend Following continued....

Following on from last night's post I thought I would outline the reason for my current entry on NZDUSD.

The chart below on W1 highlights my zone of interest in orange. I am looking for a consistent way to describe recent price action on the W1 chart. The only thing jumping out of me as significant is that overall, price action appears to have an upwards directional bias. This is particularly clear when we extend our lookback to observe a greater history of data.



What I am specifically looking for is a way to describe the overall features of price action over time. A single bar means nothing to me, but a collection of bars holds greater information for my technique.

Let's assume my lookback was to Jan 2014. Is there a way to grossly describe (most simply describe) price behaviour over this period without being pedantic about the specific detail. The way I would describe overall price behaviour across this lookback is as follows:
1. A bear phase commencing from a swing high (X) on 6/7/2014 which extends to a swing low (Y) on 23/8/2015. From the swing low we had a volatile end to the trend with a bit of undecisiveness about whether the bear phase would end or not. This resulted in me extending the width of the SDC over this phase to encapsulate this data as there was some suggestion that we may have some false trend breaks that would quickly arise in mean reversion back into the long term bear phase. Quite clearly at X marked on the chart we were getting more confident that the bear phase had ended as price continued to make higher highs. This was the point I officially declared that according to my trend definition, the bear phase was over. Of course this therefore made me start to think about bull phase opportunities but I needed further confirmation with more recent price data to confirm these views.
2. When price reached a high at point Q there was sufficient price data to draw an SDC from the prior swing low to define the overall volatility range within this general bull phase. The resultant SDC drawn ensured that all price action since the swing low was contained within the channel and the overall direction and width was used to define two important pieces of information (volatility which is an expression of momentum, and the overall directional bias to price determined by a linear regression line of best fit) to 'project' my view of what I would like to see unfold in my definition of a trend. So I then extend the information into the future from what is currently known according to my definition.
3. Furthermore I then place further channels to define overbought and oversold zones within this overall price movement. I now have a context that allows me to trade breakouts or retracement entries in my trend definition.

Now from the high at Q (which is where I last extended my SDC to) price has retraced from this high back towards the oversold zone of my trend definition. I am therefore looking for an entry where price confirms that it is now possibly reverting back towards the linear regression line of best fit.

So I now drill down into the daily chart (D1) to place my entry within this broader context scaled to W1.



I wait until we have an open on D1 within the oversold zone and then need price to retrace back to the mean and cross the level 2 SDC line which it did at point Z. That is my entry point. My initial stop is defined by the outermost point of the SDC at the time of entry. The outermost SDC line then defines the trail within which future price action needs to be contained within for my definition of trend to remain intact.

Some things that the SDC takes care of itself are as follows:

1. It expands and contracts with current volatility and acts in the same way as an ATR measure of volatility. Highly volatile trends therefore have wide SDC's and as a result, position sizes are decreased as the point from entry to the outer SDC is wider than normal.
2. The SDC is continuously redrawn as new highs/lows are made and the width extended to include most recent price action. This dynamic adjustment of the SDC ensures that you let trends breathe in accordance with their volatility and momentum profile.
3. The trailing stop is always sloping in your favour for a quick exit if the trend definition breaks down. Immediately from the point of entry onwards, this technique ensures you remain in the zone of your trend definition.;
4. This projective technique stamps rigid rules that needs to be obeyed for your trend to remain intact. If the market doesn't meet those rules, then you are out. If they do, then you can ride your projection for as long as the rules remain in tact.

Regards

C

I appreciate your detailed response. Thank you.
Effectively helps me and clears my doubts. Only practice from the perspective that exposes help me put everything in context.
No ceases to amaze me the ease with which you explain certain difficult and subjective concepts in such teaching level

It's a pleasure mate. Explaining things helps me ensure that my logic stays intact and I don't get sloppy and if it also helps you then a double bonus.

Ready please Mr Music

Another great interview with Peter Brandt. Just send your email details through to Aaron and he will send you the free podcast.

As a brief background, Peter has had over 45 years direct experience in trading commencing in the 70's and has been full time at the game as a discretionary trader since 1980/81. He trades a subset of classical chart patterns and is active in both forex and commodities.

Here is a summary of some of the points that really piqued my interest .

1. As a general rule, your worst drawdown will be the one that hasn't happened yet. In general terms he expects two drawdowns a year. In his early career he tolerated up to 30% drawdowns once every couple of years, but over time his risk averse nature kicked in to take definitive steps to reduce drawdown impacts through reduced position sizing. Interestingly it was only in the last few years that Peter has experienced his worst drawdown of his career that took approximately 15 months to recover from. It wasn't the most severe drawdown experienced of his career but it was the most frustrating and tortuous due to the length of time before recovery.
2. As a discretionary trader, drawdowns come from one of three origins:

1. The methodology being used itself which is out of sync with the markets

2. The discretionary trader is out of sync with the methodology itself and the drawdown is not a symptom of market conditions; and

3. When both occur, namely when the trader is out of sync with the methodology and the methodology is out of sync with the market.

1. Now a systematic trader does not have the 2nd type of drawdown to contend with as the the non-discretionary nature of the process itself ensures that the former can only be the source of the variation.
2. Peter in his last extended drawdown unfortunately faced type 3) which exacerbated the extent of the drawdown and the ability to quickly recover from this drop in equity. 15 months is a long time and drains you psychologically. The drawdown was a self fulfilling prophecy as he was ultimately talked into believing that the markets had fundamentally changed, which had the adverse effect of changing the core methodology to respond to more recent market regimes.....and as a result, it just got worse and prevented the ability to quickly recover. If he had stuck with his core methodology, the drawdown would have not caused so much psychological pain and been so lengthy. There is no doubt that you do need to adapt to the market and make small changes, but you must ensure you do not compromise the philosophies and underpinnings of your core strategy, or reinvent yourself. It was only when Peter cleared out his head following his confidence crisis and got back to the basics to get his methodology back in sync with the markets that his fortunes turned around and he recovered quickly from the drawdown. The long laborious drawdowns are more difficult to take than the extreme short sharp shocks that you quickly recover from.
3. When you get in times like this, it is worthwhile to just suspend trading to get your head back on straight and analyse your trading history to decipher what is going on. Do not think that as a professional trader you simply need to keep on trading as your livelihood depends on it. Simply suspend trading and have a break to psychologically recover, refocus and build your confidence by assessing what went wrong and how to repair the situation. It is essential that you keep good records of your trades so that in times like this you can review what you did and undertake a postmortem. Capital drawdowns are bad and shouldn't be taken lightly but emotional drawdowns are the most serious form of drawdown for a discretionary trader and can be debilitating that affects the future of the trader. It can turn good traders into gun shy shivering wrecks that end their careers. You need to remain emotionally healthy and emotionally stable to trade the markets.
4. It helps to be able to discuss your trading with other like minded traders (as it is a lonely game) as this can really help in times of crisis, but what is critical is to find traders who you can trust that offer honest and transparent advice. You need others you can trust to talk to as this helps as a sounding board and a method to identify potential psychological issues.
5. You need to avoid at all costs avoiding becoming gun shy and it is essential that you can pull the trigger without second guessing yourself. So in periods of normal drawdown a preferable stance to adopt is to reduce your position sizing to reduce the bleeding as opposed to reducing your trade frequency. Avoid the comfort trap of stating that you are deliberately going to reduce trade frequency when the real ogre at the door is your 'fear of pulling the trigger'. If you sense that fear creeping in to your psyche than avoid it at all costs (as this symptom will stay with you and affect your future trading) and choose another route (eg. reduced position sizing) to reduce your trade risk exposure. You have to still swing at the pitches you normally take under your methodology, so don't change your game and 'lock up' (freeze) because you think you are going to be wrong.
6. You will normally find that you don't realise you are out of a drawdown until it is upon you and you will find that you are automatically cranking up position sizing without really thinking about it. You get one signal and it works, and then another and it works and then you scale up in position sizing with another signal and it works....and hey presto, you are out of the hole. Size down and size up but continue to swing at the pitches.
7. If you scale down your position size when you enter a drawdown you may find that it does take longer to emerge from the drawdown state....but what you are doing is protecting your emotional capital. For a discretionary trader, this is critical. You never know in advance how long you are going to be in a drawdown or what is the full extent of the drawdown. For this reason, scaling down in position sizing is simple prudence and acceptance that you want to survive for the long term in this market and are prepared to be patient. Capital preservation is essential. Defense is the best form of offense.
8. While Peter is a classical chartist, over time he has become a selective classical chartist that trades specific patterns such as rectangles, right angled triangles and head and shoulders patterns. He trades patterns with horizontal boundaries as opposed to obliques and the patterns he prefers are between 12 and 20 weeks duration. He finds that this style of pattern are most reliable. Peter always attempts to judge the maturity of the pattern as he focuses on signals where the pattern is completed before taking action on a breakout. Peter focuses on breakouts from patterns.
9. While Peter uses classical patterns for trade identification he stresses that this is not the most important aspect of the game. It is simply a method to give you confidence to pull the trigger. Too many traders focus on trade identification as the be all and end all, particularly beginners. More important is risk management which is way more than just focussing on stops. Focussing on stops gives lip service to risk management but fails to address the nuances of what comprehensive risk management entails. It is what you do with a trade once you put it on......it's the size of the trade taken.....it's how you manage that trade...how you cut losses short...... how you let profits run....it's dealing with emotions....how to deal with losing periods etc. All these factors are much more important than simply trade identification or simply dealing with where to put your stops.
10. A discretionary trader has different ways of dealing with all these things but what is critical is that all these factors are addressed by the trader. Once all these things come together, that's when real trading starts.
11. Chart patterns or any form of trade identification does not give Peter his 'Edge'. The edge comes in seeking excellence in the trading process itself, cutting losses, how to manage losses, how to mentally adapt to the markets etc. Trade identification is just a way to pull the trigger and it just needs to be better than flipping a coin or throwing darts at a dart board.
12. If you miss a trade, so what. It's nice when you catch them, but it is not the be all and end all as there will always be another pattern that comes along.
13. You need to focus on the process of trading and not the outcome. You need to always ask yourself, does this trade make sense based on how you understand the market. Peter has no control whether a trade makes money or not. The only thing he has control over is the orders that he has entered. You must focus on the process of trading and make sure it makes sense. I prefer pending orders as opposed to market orders as I like to be in control of the process and Peter plans his trades in advance (often the weekend before).
14. Once Peter commits fully to a trade within a day or two of a pattern completing (which may involve slowly scaling in), he does not add to the position. Once fully committed he may decrease position sizing by harvesting some profit or reducing risk exposure and later add the increment to bring it to full position size again but he never adds to the fully committed position or leverage the initial holding.
15. He is a big advocate of trading the forex market as it is highly liquid and simply involves reading price. At the end of the day all technical traders trade price. The name of the instrument itself is inconsequential. In reality you trade the scale that is on the right hand side of the chart. We as technical traders trade price changes. Forex markets are the most liquid markets in the world, they trend well etc. There are some problems in that they are not exchange traded (Traders also frequently forget the counterparty risk associated with brokers), but the real problems with forex for traders is that most traders trade with far too high leverage. Traders forget the leverage associated with forex and most traders trade far too large.
16. Peter takes no heed to fundamentals or economic factors in his trading, but when he identifies that conventional wisdom on the street are all saying one thing, he does like looking for opportunities that go against the crowd.
17. New entrants to the market typically come in with false expectations. These expectations are not practical and will not be realised. They believe they can quit their day job or they borrow $100K from their relatives and believe that they can make it as a full time trader. They believe they can make $1500 a week like an annuity....but markets just do not offer that. Markets are speculative and it does not operate that way. Every month is not going to be a profit. There are no easy answers to trading. You learn trading from making mistakes and paying money to the market for that tuition. It is a steep learning curve. You will not learn the market in a few weeks/months or by reading a book.
18. It takes 3-5 years before you pick up the 'scent' to becoming a trader and then it takes the rest of your life to become excellent at it. That is the reality to trading. Keep your day job as you learn to trade. A realistic expectation is that you will not make a living off trading. Look at the interest rates available today. If you are lucky and make 10-15% per annum from solid trading, is that going to generate sufficient income to live off on your trade capital? By taking $100K off your mum and dad, that is setting you up for failure. To breakeven after the first 1-2 years is doing well and building your skills. That is realistic.
19. Successful discretionary traders look for reasons not to trade events. The human being is his own worst enemy in the market. The more you can delay a trade event the less that any specific event will prevent you from intervening in the trade. Overtrading or constant intervention through second guessing is your worst enemy. Try to delay trading events and focus on process.
20. Writing is a great way to congeal the thought processes. Whether you write for yourself or for others, it is the process of writing that ensures that you can convey your trading thoughts coherently. Keep a journal and write about your processes and experiences.

The podcast is full of excellent advice particularly from the perspective of a discretionary trader and I highly recommend a listen.

Enjoy C

Now back to the important stuff

Thanks C! These are very inspiring. Think I'll read them again...and again.

No probs G. I had my head nodding off my shoulders when I listened to the podcast. When the chips are down it is worthwhile returning to this podcast again and again. So great that he shares this stuff. :-)

A fascinating peek into a professional trader's mind, C. Thank you very much for posting this. I think this is one podcast I definitely will find the time to listen to.

The stuff he said about drawdowns makes me glad I'm not a full-time trader, and have alternative (and more reliable) sources of income to depend on. Suffering a drawdown that took 15 months to recover from must have been incredibly draining for him as a full time trader, even though he persumably receives some income from his company and books. I agree that when you're in dire straits you should carry on trading normally but with reduced size (following a break and some analysis of what went wrong), in order to avoid becoming trigger-shy and to protect what's left of your account. It's true that you will take longer to recover from your capital drawdown if you do this, but at least you'll be reducing your emotional drawdown. Anyway, that's what I've done in the past and it's worked for me.

Talking of dire straits, this one takes me back...


Cheers

Cheers NT.

Imagine the discussions with the wife and kids around the dinner table during a 15 month drawdown when the question arises...."how's the trading going Dad?". The pressure on the dependents let alone yourself makes you stand back and really assess your conviction to full-time trading.

I know everyone is sceptical of traders who publish books, and offer blog subscription services etc and state that those that don't trade teach....but in my mind it is simple prudence to diversify your income streams if you are a full time trader.

Just to add to the mix while we are on the topic.

Stuff the Private Investigator......here's how it should go.

It's a mystery to me, the trade commences
For the usual fees, plus slippage and SWAP
Market information, it's in a price chart
This is my interpretation, it's not open to public query

I go checking out the backtest, digging up the dirt
You get to meet all sorts in this line of work
Treachery and treason, there's always an excuse for it
And when we find the reason, we still blame another for it

And what have you got at the end of the day?
What have you got to take away?
A lighter wallet and a new set of lies
A busted keyboard and a pain behind the eyes
Scarred for life, no steady compensation
A lonely occupation

I can't help but comment on this, like usual, great stuff, bravo.

Great Music, Thank you.

Cheers Bass. Hope all is well on your side of town

Putting the fear of pulling the trigger part apart I understand "periods of normal drawdown" to be "origin 1" drawdown. A trading system, even discretionary, is implicitely a model of the market. As with any model some part of the data is explained by the model and the rest is not. The unexplained part is commonly refered to as noise. When your strategy/model is out of sync it explains nothing and you only have noise. If you trade noise your expectancy is zero minus cost of trading. Therefore reducing the trade frequency will reduce the systematic part of the drawdown (cost times # of trades). Why does Peter Brandt says to not reduce the trading frequency? Is it only to not miss the start of the "resync"? If the DD spans over a long period of time the start-of-resync-you-cant-miss won't balance the accumulated bleeding of trading cost. What is the probability that the trend right after the DD to be the big one? Quite small. If it indeed is the big one how important is it to miss the first 10%? Especially if you use a %-based MM the late entry will be bigger than the early one since you didn't give away your ammos to the broker by shooting in the dark, counter-balancing the lateness.

I think the reason Peter adopts this approach is that as a discretionary trader you will never actually know if your drawdown is of the 1) or 2) type. As a systematic trader you can definitely apply your rationale Pip.....but as a discretionary trader, I am not so sure as the inconsistency of your trade application (the system application) has sufficient variability to never let you identify if it 'actually' is a 1) or 2) type with confidence. It's one of the major pitfalls with discretionary trading as you can never reliably use statistics as a guiding tool for trade management purposes.

Let's assume he is facing a drawdown period. In the back of his mind he would be wondering whether he has inadvertently altered his methodology (a type 2) or whether the market was just not in sync with his model (a type 1). If he adjusts trade frequency, then he is muddying the water as he then needs to contend with the situation that he is deliberately altering his trade habits and how would you then be able to confidently return to previous habits once he has altered them........ Probably the safest bet is to continue applying what you do while decreasing position sizing and assume that your method of application hasn't changed and then look back over your past trades to check for application consistency. If you find that your method has changed, then adjust the method accordingly but keep reduced position sizes to see if that pulls you out. If you find that the methodology hasn't changed then that's probably the best guess that you are in a type 1 drawdown.

Thanks for the link.
Really good insight
Also loving the music you post!

Cheers T34. Great to have you on board.

Been lurking long enough so I thought I'd express something for once!

It makes sense