Recently, I’ve been going over the characteristics of a solid trading strategy. The idea is to help you build a profitable trading strategy that can be programmed into an expert advisor. So far, I’ve gone over choosing the time frame you want to trade and determining trend direction. If you missed the previous posts, here are the links:
Before I go forward with other characteristics of a solid trading system, I think we should go over using higher time frames and trend direction to filter trades. But first I want to answer a question some of you might be asking…
Why filter trades when using an expert advisor for automated trading?
Through many conversations with up and coming traders, I feel some people get the wrong idea about automated trading and using expert advisors. Here are two themes that come up often…
Automated Trading Is BETTER Than Manual Trading. When people hear words like “robot” they often think “better than human”. The truth is, the robot is only as good as the strategy programmed into it. Automated trading can perform the tasks of trading better than an human (24 hours a day, no emotions, etc), but the strategy still comes from a real human being and needs to mimic what a human would do according to the rules of the trading strategy.
Automated Trading Means You Are In The Market More. There is a difference between taking more trades, (being in the market more often), and not missing high probability trading opportunities. The point of automating your trading strategy is to monitor the market on autopilot and not miss excellent trading opportunities (which can happen to a human trader). It does not mean you should try to be in the market all the time or take many trades at one time.
The point is this…
Your trading strategy should strive to give your trading an edge and only enter the market with the highest probability trade setups. Often, this means trading LESS. You need a way to filter the trades and keep you out of the market when the conditions are not correct.
Examples Of Using Higher Time Frames And Trend Direction To Filter Trades
Independent of which time frame you choose to make your trading decisions, you have to admit higher time frames give you a better perspective on overall market activity. Looking at the Daily time frame gives you a better view of the market than looking at the 15 Minute time frame. So, even if you are taking trades off a lower time frame, it is a good idea to look at the higher time frames to make sure you are making a wise decision.
Here is an example of how you can use higher time frames to filter trades on a lower time frame. Let’s say we are trading a Moving Average Crossover on the Hour charts. It is a good idea to use the 4 Hour Charts to filter your trades.
In this photo, you see the H4 charts and where the Moving Average crossover occurs. From this point on, you should only look for SHORT opportunities on the H1 time frame.
In the next photo we are on the H1 time frame. You can plainly see where we should be looking for short trades. Using the higher time frame filtering method would have kept you out of a losing long trade.
This was just a very simple example using Moving Average Crossovers. The truth is, any indicator you are using can be used in the same way.
If you were manually trading, you could simply look at the Daily charts and visually see the trend direction, use trendlines, etc. However, if you are programming an expert advisor, you need some way of programming in the higher time frame filter, and indicators work better for this.
Will This Method Filter Out Good Trades As Well?
Yes, of course. Filtering out good trades is going to happen. And I think this really is the problem people have with using a filtering system for their trading strategy. They just don’t want to miss ANY opportunity to get into the market.
In my opinion, this is a question of Maximization vs Optimization. Most people want a trading strategy (or expert advisor) to maximize profits. This means somehow figuring out how to take advantage of EVERY trading opportunity.
I would argue that optimizing your trading strategy (or expert advisor) by using a higher time frame filter is better. Yes, you are going to miss some trades that would have been winners. But sitting on the sidelines during periods that are not right for trading is easier to handle emotionally than suffering through a string of losses. In the long run, filtering can greatly increase your win rate and produce a smoother equity curve.
If you’ve already programmed a trading strategy into an expert advisor, could it be improved by adding a higher time frame trend filter?
Read the next article in the series: Picking trade entry signals
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