scalping Archives - Algorithmic and Mechanical Forex Strategies

43 million real trades reveal the tactic of profitable forex traders

June 20, 2016 by Shaun Overton 4 Comments

Traders that follow one simple rule are 3.118 times more likely to be profitable 12 months later than those that don’t.

The critical feature of profitable traders is their reward to risk ratio. Yes, you’ve probably read that before, but this time it’s backed up with research. FXCM studied 43 million real trades from traders around the world to produce this analysis.

Image credit: DailyFX

Everyone “knows” that 90-95% of traders lose money. The good news is that the real percentage is noticeably lower. 83% of all traders lose money. And, that’s among the worst group. When traders use a reward to risk ratio of 1 or more, 50% of all traders are profitable after 12 months.

Be warned: the phrase “correlation is not causation” very much applies here. I cannot promise you that based on the data that using reward to risk ratios greater than 1 will automatically give you 50-50 odds of being profitable in the long run.

Logic, however, suggests that using good reward to risk ratios is a good idea. The advice to use reward-risk ratios above one appears in every trading book ever written for a good reason.

When traders use a reward to risk ratio of 1 or more, 50% of all traders are profitable after 12 months.

I suspect that it’s not the ratio itself that’s important. Instead, a large ratio discourages the worst mistakes that traders make.

I remember a project when I worked as a broker at FXCM. The systems desk analyzed the trades of the company’s most consistent losing traders. Perhaps taking the opposite signal of the worst traders might lead to profitable trades?

Alas, we found something far more mundane: the worst traders lose because they over-trade.

Trading costs

Think about how trading costs apply to the reward risk ratio. If you earn $2 for every $1 that you lose, it makes scalping an impossible activity

Traders using a 2:1 ratio need to use more patience. Even though FXCM offers low spreads and commissions, a 2:1 reward risk ratio implies further distances to the profit target. Longer pip distances lower the cost of every pip of profit.

Cost examples

FXCM averages a 1.4 pip spread on EURUSD. Let’s see how our reward-risk ratio affects trading costs using the 1.4 pip spread for our 2 examples.

Scalping

Profit target: 10 pips
Spread: 1.4 pips
Spread as a percentage of the profit target: 14%

Intraday Trend Trading

Profit target: 50 pips
Spread: 1.4 pips
Spread as a percentage of the profit target: 2.8%

Your cost as a percentage of profit in these examples are 5x higher when you scalp. That’s not good!

Holding trades with bigger profit targets minimizes the impact of trading costs. Said another way, you get to keep more pips when you win by increasing the distance of your profit target from your entry price.

The advice to use reward-risk ratios above one appears in every trading book ever written for a good reason.

Following a reward risk ratio greater than 1 naturally pushes you towards lower trading costs. Lowering your trading costs logically suggests you have a higher likelihood of long term profitability. If you want to get other critical tips for similar results, then make sure to sign up for the Foundations of Profitable Trading Checklist.

Reward risk ratio explained

The reward risk ratio compares your average profit to your average loss. If your average winning trade is $30 and your average losing trading is $15, then you have a reward risk ratio of 2:1. If your average winning trade is only $8, but your average losing trade is $16, then your reward risk ratio is 0.5:1.

Does the winning percentage matter?

Amazingly, the percentage of winning trades doesn’t seem to matter. The high frequency trading firm Virtu is a great example of this. Virtu wins on 99.999% of trading days even though it only wins on 49% of its trades.

The FXCM data shows that the average trader wins more than 50% of the time. EURUSD trades won 61% of the time, while some pairs were closer to 50%. The percentage of winning trades on all currency pairs is greater than 50%.

Image credit: DailyFX

Despite winning more than 50% of the time, trades with a poor reward risk ratio only had a 17% chance of earning a profit 12 months later.

… you get to keep more pips when you win by increasing the distance of your profit target from your entry price

If you’re currently struggling with your profitability, you’ve probably thought to yourself, “I need to win on more of my trades.” It’s like a business owner saying, “I need more customers.”

Smart business owners know that finding more customers is time consuming and expensive. It’s often much easier to sell more stuff to the customers that you already have.

It works the same way in trading. Instead of worrying about winning more often, you should focus your efforts on squeezing a few extra pips out of your winning trades.

If there’s anything that you should learn from this research, it’s this: the fastest way to improve is to earn more pips on your winning trades. You do not need more winning trades to do better.

Types of strategies with good reward risk ratios

The type of strategy that you select almost automatically dictates your reward risk ratio. Ranging strategies usually have ratios less than 1, which the FXCM data shows have a 17% likelihood of long term profitability. Trending strategies have ratios greater than 1, which have 50% probabilities of long term profitability.

Ranging strategies

If you daytrade EURUSD where the daily range has recently been around 80 pips, then that 80 pip range is the hard ceiling of what you could possibly make in a day. You know from experience that getting the bottom tick or the top tick of the day almost never happens. If you’re lucky, you may enter within 10-20 ticks from the bottom.

Upon entry, you also need to give the trade breathing room. That stop loss probably needs to be something like 25 pips if it’s a tight stop or 40 pips in order to have plenty of breathing room.

The best exits in a ranging market occur in the middle. You don’t know if the market will push back to its ceiling. It has just as much chance as going back to support and it does up to resistance.

The mid point of an 80 pip range is 40 pips, but you’re likely entering 10-20 pips from the true bottom. That only gives you a potential range of profit targets from 20-30 pips.

The most realistic, good ratio is a 30 pip profit target on a 25 pip stop loss, which is 1.2. Most strategies will probably risk 40 pips to make 20, which is a ratio of only 0.67.

Consider what a range trading strategy is. The market is stuck. It’s having a hard time going anywhere. You should only range trade if you have a well researched strategy with a long term edge. Otherwise, the typical trader is 83% likely to walk away with losses after a year.

Trending strategies

Trend trading strategies should last for weeks or months at a time. Looking again at EURUSD on a multi-month time frame, the current long term range is from 1.05 up to 1.16. That’s a range of 900 pips, but it’s not like the market wobbles up and down through that range. Instead, it gets stuck near 108, then briefly pushes down. It comes back to 1.08, then pushes up to 1.12. It might push up again to 1.15, then trade back down to 1.08. It’s hard to guess whether the next move will be up or down.

A 3,498.4 pip move in the EURUSD over a 10 month period.

Better long term plays are to sit on trades and let them pick a direction. The best recent EURUSD example began on May 8, 2014 at 1.39934 and ended March 13, 2015, at 1.04946. That’s a colossal 3,498.4 pip move in just 10 months.

Is there a scenario where you’ll risk almost 4,000 pips on a trade? Of course not. What about 1,000? No! What about 500? No!

The natural risk reward ratio for these types of trends is astronomically high. For a few hundred pips of risk, you can make 10 or more pips for every one risked.

As long as you’re not aggressively trading, trending strategies are far more difficult to mess up. If you can click a button, enter a stop loss and then do nothing for months at a time, then you’re qualified to consider trend trading.

The practical application is of course more difficult than that description, but that’s the idea in a nutshell. If you’re a newbie forex trader and wondering where to start, long term trends are the place where you’re less likely to get hurt.

The problem for newbies, though, is that they’re looking for excitement. It’s not terribly exciting to place on trade and then do nothing for months. It’s one of the paradoxes of the market that less work can often lead to better results.

How to improve your trading

The reward to risk ratio is a critical element for new traders to increase their chances of success, but it’s not the only one. Click here to register for our free Foundations of Profitable Trading Checklist. You’ll learn simple, but useful, tips to improve your trading.

Trading by the Minute

January 18, 2016 by Lior Alkalay 11 Comments

Trading in a minute interval is difficult and risky but also has some distinct advantages. But, and that’s a very big but, it has to be done right.

Unfortunately, the rather fast paced nature of the minute interval tends to draw the worst behavior from traders. It might be simply inherent but when things move fast, when minutes count, traders tend to rely more on instinct than logic. It’s as if trading at a fast pace is akin to driving rather than trading.

Ironically, it’s those instincts that traders so blindly rely on that lead to the inevitable crash. In this article I will focus on how to trade in a minute interval with logic rather than impulsiveness. That way, you can really be in the driver’s seat.

Put your Risk Belt on Before Trading

Continuing on with the driving analogy, what’s the first thing you do before you put the car in drive? You put your seat belt on. In trading, and especially in minute trading, you need to first calibrate the risk you’re able to take.

The key risk when implementing short-interval strategies is too many consecutive losing trades. That string of losses can throw you for a tailspin and leave you with no margin.

When you trade in order to gain single pips, or even 20 pips, you’re effectively taking more risk and gaining less.

Hence, the first step would be to decide how much of a stop loss you need. That way even if you have a string of losing trades you won’t be tossed out of the game. The fact is short term strategies can produce many consecutive losing trades before turning profitable. And if you’re not able to take that risk you’ve practically guaranteed your own failure.

Of course, it also depends on how frequently your strategy performs a trade. To illustrate, let’s say your strategy generates 3-4 entry signals a day. In that case, you would need to be able to lose at least 20-25 consecutive trades to weather bad days.

Trade Simple

Another pitfall to avoid when trading in minutes is using complicated strategies that are hard to follow quickly. Usually those strategies tend to have a lot of gray areas, especially at the “moment of truth.” In other words, at that crucial moment, it’s not clear whether or not you should engage.

And when you encounter gray areas and are forced to make a snap decision? Well, you know what happens. You let your gut instinct take the driver’s seat. It is, in fact, those hunches that will end up drying up your account.

On the other hand, a very simple, easily implementable strategy gives you a much better chance. A simple strategy becomes the norm and you gain consistency.

Of course, if you have a problem with that as well the simplest thing would be an algo. An algo would automatically execute based on your simple rules of engagement.

Don’t Ignore the Long term

Even if you trade in short duration you must always relate to the mid to long term trend above you. Because going against a long term trade, even if your duration is merely 30mins, is a recipe for disaster. That was a lesson that I learned the hard way.

For example, say you’re trading long while the long term trend is bearish. There’s a greater likelihood for the trend to unexpectedly flip to the other direction.

Then you can pretty much flush your profits down the drain. Because if the long term trend is heading one way it means that the market’s big movers might be looking for an opportunity to jump on the trend.

And that could happen just when you’re trying to squeeze out a 30 pips profit. But if you at least consider the long term trend when trading in minutes you reduce the chance for a negative surprise. Think of it; a multi-week support on a minute interval is much more reassuring than a support generated only a few hours ago.

Take More than a Few Minutes

Once again, we return to the risk of impulsiveness and how to avoid it. Which brings us to our final point; don’t trade at a duration that is too short. For example, if your trades are an average of 2mins you’re taking a bigger risk than if you trade at 20min or 50min.

Because, let’s face it, who can make a wise decision in just 2min, when the clock is ticking down? So when you trade in such short durations you, once again, leave room for your impulses to take charge. The more minutes your average duration the easier it will be for you to make logical decisions.

Mind the Spread

And finally the last point you should take notice of is the spread. When you gain 100 pips and pay a spread of 2 pips that’s okay; the commission is “merely” 2% of your trade. So, when you trade in short duration, let’s say 20min or less, it’s tempting to settle for smaller gains.

But be forewarned; say you expect to gain 10 pips in total from a single trade and you pay 2 pips as a spread. Your commission is not 2%; rather it’s 20% of your total profit. And guess what? You pay that 20% when you lose, as well. When you trade in order to gain single pips, or even 20 pips, you’re effectively taking more risk and gaining less.

Weigh the Pros and Cons

Finally, and in conclusion, weigh the pros and cons. The pros being that trading by the minutes, when done correctly, can be useful and lucrative.. And the cons? It takes a lot of discipline, adherence to the rules and work to keep your risk low and your profits steady. Certainly, it’s considerably more effort than in longer term trades of days or weeks. So while you can squeeze profits out of a “dead’ market you have to work harder for it.

Want a free scalping EA? Check out the Scalper EA, a free expert advisor developed by Shaun Overton.

What you should learn from me getting kneed in the face yesterday

October 5, 2015 by Shaun Overton 40 Comments

I’m not sure if Texas is more famous for its football or religion. My church likes to combine both with a Sunday night flag football league.

I played on the defensive line last night rushing the passer. The quarterback rolled right. I blitzed trough the two offensive lineman guarding me and got within 3 feet of the quarterback. Just as I dove for the flag around his waist, he turned to throw the ball. My eye crashed right into his knee, followed by my face sliding across the turf (hence, the bloody cut above my eye).

I may be the first man to bleed during a flag football game, but the minor wound reminds me a lot of trading. Taking your licks with no goals or purpose is dumb. Nobody sets out to get hurt. Accepting losses and learning from them is smart.

The author freely admits that he may be the first man in history to bleed from flag football.

A lot of readers get caught up in the idea of winning all the time. Pick your favorite sports team: the Blackshirts, the Yankees, the Cowboys, the Brazilians in the last World Cup. The world’s most storied sports teams don’t win every single game. They don’t even win every season (Cowboys fans know what I’m talking about).

Drop down to the individual level. Is Cristiano Ronaldo a ball hog? Does Alex Rodriguez hit every pitch?

Even the world’s most elite athletes have strengths and weaknesses. It’s ridiculous to expect anyone to perform their best every single day.

I’m especially directing this at newer forex traders. At the risk of offending you with reality, you need to hear this if you’ve been trading for less than 6 months. Your expectations for trading are out of this world ridiculous.

Why you started trading forex

The Challenge

More experienced traders – even the ones struggling with losses – will freely admit getting into trading for the wrong reasons. I started trading because I’m over-the-top competitive. I hate being in 2nd place, but I thrive on being challenged. Beating Mr. Market is extremely difficult. I placed my first trade because I liked the challenge.

The Gamblers

Fewer people will admit to gambling. They’re “investing” or “trading.” Among this group, I’d wager (pun intended) that 90+% of them attempt to scalp at some point. Unless you have a very clearly defined strategy, scalping is the forex version of the slot machines. You see the flashing lights and numbers bouncing everywhere, but over the long run you’re destined to lose.

I’m the guy sitting on the far left side of the bench.

If you’re guilty of ~~scalping~~ gambling, run some back of the envelope numbers. Where do you place your stop losses? What’s your average take profit?

Say that the stop is 15 pips away and that you average 3 pips of profit. Your typical spread is 1.5 pips. That means that you really have to earn 4.5 pips on every trade (3 pip TP + 1.5 pip spread), but you only get to keep 67% of the profit (3/4.5). Even before trading costs, you have to be right in 5 out of 6 trades, 83.3% accurate, to break even. With trading costs added in, the minim accuracy to break even is an astounding 90.1% of the time and you still would not have any profit.

Redundant question alert! Is it realistic to grind out an extra income by being 91.1% instead of 90.1% accurate? It’s absurd.

The Greedy

The final group of traders get involved with forex out of pure greed. It’s all risk, all the time with these guys. I routinely get emails touting a million bajillion percent returns in a month. It happens every month.

I remember FXCM’s King of the Mini contest. Anyone with an account balance under $10,000 was automatically enrolled. Whoever earned the highest percentage return that month won the content prize of $2,000.

Some small trader in Pakistan would turn his $300 mini account into $5,000 in 30 days. It’s true that somebody in the world is doing that as we speak. What’s also true is that their final account balance will be $0. They will invariably blow up. Nobody is ever smart enough to take the profits and run. You are not smart enough to take the profits and run. You’re not the exception. Everyone does this.

Do you know how I know? Nobody ever won the king of the mini contest twice! The client blowing up within 30 days was the closest thing to a sure bet. Trading on leverage that enables spectacular returns isn’t just dumb. It’s suicidal.

The new type of forex trader that doesn’t exist is the guy that enters with an actual business plan. Or even more amazing would be an actual strategy.

This prepared neophyte trader doesn’t exist because beating the market requires experience. And let’s be honest. Experience is a synonum for losing money.

You can throw your money away through gambling or greed. Or you can get an education with your tuition money.

How to Get Hurt for a Good Purpose

The element which makes trading insanely difficult is the lack of feedback. When new trades swap strategies every 3 days, it’s utterly impossible to learn why something worked or failed. The only thing that you really control in the market is yourself and especially, controlling the feedback mechanism.

Any trader that’s losing needs to apply their tuition money to a set, defined strategy. The strategy cannot change. When you observe the profit and loss of a strategy over 6 months, you observe how seasons and varied market conditions impact the performance. You’ll even start to get the “uh-oh” feeling in your stomach ahead of certain trades, only to realize that your intuitions are completely wrong. It’s only when you get the uh-ohs and your feelings are correct over and over again that you know to trust your instinct instead of fearing it.

Your tuition strategy

The first step is to write your tuition check. Kiss the money goodbye. You’re not doing this to earn money. You’re trading the money for experience.

This strategy consistently covers long stretches of time with consistent returns. It’s prone to catastrophic failure, though. All mean-reversion systems are. Nevertheless, I feel it is a good system.

Chart: AUDCAD H1
Indicator: SMA 50 applied to the close
Rules:

Buy when the price crosses and closes below the SMA 50.
Sell when the price crosses and closes above the SMA 50.
Place an emergency stop loss 1% of the current market price away from your entry.
Your lot size should be 2x your trading account. That means your minimum tuition check needs to be $500 so that you can at least trade 1 microlot, which is worth $1,000.

Aside from the market rarely hitting your stop loss, you’re in the market 100% of the time. You’ll notice streaks of winners and streaks of losers. You are expected to keep trading during losing periods. You’ll be convinced that the next trade will be a loser. Maybe it is, but you won’t have the experience to know if your intuition meant anything or if luck happened to deliver a loser.

You are not allowed to exit a trade at any moment in time other than when the bar closes. Taking profits 45 minutes into a 1 hour candle is cheating. Again, you do not have the intuition to know if this improves or hurts your overall performance.

As for my face, the sacrifice was worth it. My pressure on the quarterback made him force a pass… right into the hands of my teammate.

Scalping under the Radar

September 28, 2015 by Lior Alkalay 8 Comments

One of the top questions scalpers want an answer to is whether their broker allows scalping. Among scalpers, it’s constant fear that if their profits swell to significant amounts they’re going to get black listed. But the real question is can you scalp trade without your broker noticing? Theoretically, yes; but in practice it’s not quite that simple.

Why Hide Your Scalping?

The problems you may have with your broker when scalping is not necessarily your worst fear come to life. That, of course, is your broker finding out you’re scalping and cancelling your withdrawal privileges. Poof! The “million dollars” you successfully scalped is now stuck in limbo.

The reality isn’t quite so harsh. Your broker may do one of two things. He may widen the spread if it’s a variable spread you’re paying. Or, if it’s a fixed spread, be prepared for hidden slippage every time you close a trade.

Now, many times slippage is not intentional, but you can never really know, can you? After all, slippage by a few pips here and there or widening the spreads a bit is common practice. It’s also quite legal for a broker to do.

So if you are scalping on big amounts you probably won’t know if you’ve been “filtered” as a scalper by the system. That may explain why you experience some “minor” issues that bite into your profit. Or perhaps it’s just how the broker’s liquidity is on a big trading position. Sometimes, though, it might be worthwhile to try scalping under the radar.

How to Avoid Detection

The way most brokers filter scalpers is simply by duration of trades. If a trader trades at very short intervals (less than 2 minutes, say) he’s often identified as a scalper. But what if you fool your broker into believing you trade on longer durations. Then your trades couldn’t be “filtered” as scalping.

How would you do that? By opening two accounts that will each cancel out the other.

Let’s say you have one account with one broker (Broker A) and another account with another broker (Broker B). Now you’ve opened a trade on the EUR/USD for +100 lots long with Broker A. But you trade by the minutes and after 2 minutes you want to close it. So what do you do?

You open a short position with Broker B. The two trades will cancel each other out. Essentially, you have “closed” your first position with Broker A. You can then close the two positions at the end of the day when your duration is a few hours.

And the result? In each account your average duration is several hours. And neither Broker A nor Broker B has a clue that you are a scalper that actually holds trades by the minute.

How to do it Properly

Of course, there are three problems you might face. First, you might end up paying double the spread. Second, you might find it hard to open the opposite position in Broker B quickly enough. Third, you have effectively less margin because now you have your money divided into two accounts.

How would you handle those problems? Well, right off, as you might have expected, there’s no getting around the third problem. But what about the others? Here’s how they could work to your advantage:

If you open an account with brokers that have variable spreads often the bid of one will overlap the other’s ask. How can you close two opposite trades when the spread you effectively pay (i.e. the distance between the bid and ask) is minimal? You need a trading algo. Yep; as I said previously, this is not a simple thing to implement. For those of you that are familiar with the concept of triangular arbitrage this method might be simpler for you to grasp.

Nonetheless, a rather simple algo can compare price quotes of the two and decide when to close. Of course, as you might have figured, if your broker has fixed spreads this will not work well. Moreover, brokers with fixed spreads do tend to have slippage.

Of course, this may not be worth the effort. And the reality is that in most cases it’s not. Naturally, there are exceptions to every rule that could make this worthwhile. Especially if you’ve got a very good scalping strategy but suffer from slippage or widening spreads.

Pip n Run

November 6, 2014 by Shaun Overton 2 Comments

Greg McLeod started out teaching English to inner city youths in South Central Los Angeles. Many were brothers and sisters of founders of the Bloods and Crips. How do you get kids to respect an education when you’re a teacher making $20,o00 a year and driving an old beat up car?

Greg shared his passion for day trading and used it to further their education. “If you’ll stay and learn in my English class, I’ll stay late and show you what I learned about trading.”

20 years later and now Greg is day trading full time. Learn how as Greg shares his story in the interview. Don’t trade Manic Mondays, and why trading is like a kid eating a peanut butter and jelly sandwich (25:58-28:00).

Blockade With Polarity Oscillators

July 16, 2014 by Eddie Flower Leave a Comment

The forex blockade trading strategy is one of the simplest ways for disciplined independent traders to profit from currency price moves. It’s a great strategy for mechanical trading systems because it relies on a polarity oscillator and only a few other indicators and parameters, which can easily be programmed. It’s well suited for trading on 5-minute time frames.

Best of all, when the blockade strategy is traded in combination with the related reversal strategy, experienced traders can profit by “scalping” the polarity oscillator.

The forex blockade strategies use the twenty-day exponential moving average (20 EMA) by itself or in combination with the middle Bollinger Band, as a polarity oscillator to indicate likely test and retest price levels. Depending on the market, this combination usually provides the mechanical trading system with the most accurate assessment of forex blockade points.

Traders should also look for confirmation of signals from nearby round-number price levels, pivot points, and support and resistance.

This strategy is called a “blockade” because the 20 EMA or polarity oscillator acts as a price barrier on either side. If the price is over the EMA and staying above it, and then the price retests the EMA, it will probably bounce off and continue higher.

Likewise, if the price is under the 20 EMA and then retests it, the trading system’s bias is “short” and the price will probably reject and move lower.

Trading blockades using the polarity oscillator

A typical polarity oscillator combines the EMA and the Bollinger middle band together. On the charts accompanying this article, the 20-EMA is shown as a solid yellow line, while the combined polarity oscillator appears as yellow streaming. For example, on the chart below, the circle shows a bullish signal at the polarity oscillator.

Of course, the retest of the 20-day EMA is the meat of the signal. Using the polarity oscillator as a combined EMA-Bolly Band indicator increases reliability of the signals, and gives forex traders a clearer picture of the market.

Below are more sample charts showing the forex blockade strategy:

Changes in polarity and bias

At the far right side of the chart above, if the currency pair price convincingly closes above the 20 EMA, this means it has switched polarity and the trading system now changes to a long bias.

Going forward, the mechanical trading system will be prepared to sell when the currency price drops down and touches the 20 EMA.

When to trade the blockade

The forex blockade strategy can be applied to any currency pair. It can be traded on any of several time intervals, yet some of the most-successful blockade traders work on 5-minute time frames.

And, this strategy can be traded anytime during the trading session, but some time ranges offer more reliable trades. As an example, there may be a good breakout and retest, so the forex trader enters the trade.

Yet, the afternoon session in Asia may be very slow. Then, at the opening in London prices may be too volatile for entry. Finally, after the initial flurry of volatility from news announcements, the price may settle so that it’s once again tradable.

So, the trader must adjust the forex blockade strategy to fit each market and session.

Time of day

For best success, the forex blockade strategy should be traded during the optimal liquidity times. The time-of-day in a particular currency market is critically important: The blockade requires liquidity, so it’s best applied when the major trading centers are most active.

In Asia, the best times to trade the forex blockade are after Tokyo and Singapore begin trading currencies. And, when trading during the European session, both London and Frankfurt should be open before entering any trades.

Basic trading rules for the blockade forex strategy

• Establish trend or bias using the 20 EMA or other polarity oscillator

• When price is comfortably higher than the polarity oscillator indicator, the trend is bullish

• When price is trading lower than the indicator, then the trend is bearish

• The price tests the polarity indicator, then rejects it and moves away

• Once further confirmation is shown through nearby round-number price levels, pivot points, or support and resistance, the trade is entered

• Enter trades by using buy-stop or sell-stop orders set one or two pips in front of the price

• It’s best to set the stop-loss order above the polarity indicator for sell-stops, and below the polarity indicator for buy-stops

• Set the profit target at twice the amount at risk on the trade

• Once the price reaches a profit amount equal to the initial risk, move the trailing stop to break-even

How to quantify a successful retest?

If the currency price is over the 20 EMA it must rebound from and remain above it. And, when the price is under the EMA, it must bounce off and remain below it.

For programming mechanical forex trading systems, the signal rule is: The first candlestick to touch the 20 EMA is expected to close on whichever same side that it originally approached from.

This first candlestick is the trading signal. Once the price has rejected away from the 20 EMA, the trading system waits for a possible confirmation by the next candlestick. If the candlestick of the next time period shows a continuing move away from the 20 EMA, the trade signal is confirmed.

The more confirmations of a forex blockade, the better

The mechanical forex trading system should use multiple confirmations before entering any trade. Beyond relying on the retest and rejection at the 20 EMA to show blockade, this strategy is more reliable when several other indicators and parameters are used. These include confirmations such as nearby round-number price levels, pivot points, and support and resistance levels.

It’s important that the mechanical forex trading system never take a trade based purely on a price rejection from the 20 EMA. Ideally, nearby support and resistance levels, round-number price levels, and any other significant price point should also confirm the direction and timing of the trade.

Forex traders should also be careful to filter out the effects of pending business announcements and news. Successful forex blockade traders often decline trades within thirty or forty-five minutes before a scheduled press conference or news announcement, and wait at least fifteen minutes after the announcement before considering whether to accept trades.

Likewise, the reliability of a winning outcome is enhanced if the forex blockade trade is in the same direction as the current trend. This can be determined according to which side of the 20 EMA or polarity oscillator the currency price is currently located on.

Entry qualifications and orders

Qualifications

• The price is trending – It breaks out of a range or consolidation before the entry signal

• The price successfully retests the 20 EMA

Orders

Some forex traders divide their entries across two or more orders so they’ll have more flexibility, while others simply place a single entry order.

For long entries, using multiple entry points:

• Place 2 buy-stop orders at an entry point 2 pips above the high of the confirmation candle;

• Set orders to expire at the beginning of each new candle. So, for example, when trading based on a five-minute charting time frame, if limit orders are set they will expire at the beginning of the next five-minute candlestick unless triggered by price action during the current five-minute candlestick;

• Place the stop-loss orders 2 pips under the signal candlestick, which was the one that touched the 20-day EMA;

• The stop-loss orders can also be placed just behind a nearby swing point or support-resistance level;

• When trading multiple orders at the same entry price, set the profit target for the first order at the equivalent amount of the risk in pips. So, for example, if the forex trader’s total risk in the trade is 20 pips, the profit target for the first order is set at the same 20 pips;

• The profit target set for the second order is calculated at double the risk in pips. Continuing the above example, the profit target for a second order would be 40 pips;

For short entries, with multiple entry points:

• Place 2 sell-stop orders at an entry point 2 pips below the low of the confirmation candle;

• As with long trades, for short entries forex traders should set the sell-stop orders to expire at the beginning of each new candle;

• Place the stop-loss orders 2 pips over the signal candlestick, which was the one that touched the 20-day EMA;

• The stop-loss orders can also be placed just behind a nearby swing point or support-resistance level;

• As with long entries, profit targets are set at an amount equal to the total risk of the trade expressed in pips. So, if the forex trader’s total risk in the trade is 20 pips, the profit target for the first order is set at the same 20 pips; and, the profit target for the second order is set at double the total risk in pips;

Trailing stops to achieve profit targets

Once the currency price has moved favorably by a total amount equal to the initial risk, the first position has reached its profit target and is closed out. At the same time, the mechanical trading system changes the stop-loss order on the remaining position to the break-even level.

Continuing the same example above, once the price has moved 20 pips in the favorable direction, the first position is closed and the stop-loss on the remaining position is set at the next increment.

The remaining position’s trailing stop is left at the break-even point until the marketplace closes out the trade, either by achieving the next profit target or by triggering the stop at break-even level. Regardless of the performance of the second position, the first position’s gains are a significant prize.

Blockade reversal

The blockade reversal is a variant of the forex blockade trading strategy. It likewise uses a polarity indicator such as the EMA or a combined 20 EMA and Bollinger middle band. The variant trades currencies based on crossovers of the two indicators combined in the polarity oscillator. On the charts here, the oscillator is shown as a contracting or expanding yellow band.

In a blockade reversal, the price will stall, reverse its direction, and pass through the polarity oscillator before finally returning to retest the oscillator from the other side.

On the chart below, the Asian session (shown in blue) experienced a gradual price drop below a fairly narrow band, after failing at the day’s central pivot (the yellow line) earlier in the trading session.

The price then continued downward, slicing through the weekly pivot (the blue line) before stalling and reversing at a nearby round-number price level (the gray line).

Blockade Reversal

Next, the price moved indecisively until the end of the Asian session, when a final surge from below the polarity oscillator pushed the price toward the round-number level. This represents the level at which the 20-day EMA and Bollinger middle band would cross over.

On the chart above, the left-side circle shows a bullish entry signal. The right-side circle shows another bullish entry signal with a close above the current price range, indicated by the white line.

Differences between forex blockade and blockade reversal

The forex blockade strategy involves waiting for the trend confirmation, then trading price bounces off the polarity oscillator in the same direction as the trend.

The blockade reversal strategy comes into play once this trend finishes, and the price reverses and closes on the opposite site of the polarity oscillator.

Both of these two related strategies are traded in the same direction as the current trend, which is determined when the currency price closes on the particular side of the polarity oscillator.

Bearish Reversal

The previous example showed a forex blockade reversal traded with a bullish expectation. The above chart shows the opposite scenario – A bearish trade entered from below the polarity oscillator.

In the current example, the upward move has ended and the price has broken down and closed repeatedly under the polarity oscillator. A bearish technical signal (circled) occurred below the polarity oscillator.

Scalping the polarity oscillator

Deploying both the forex blockade and blockade reversal strategies together during the same trading session can help bring trading success during long periods of time when prices are range-bound. Savvy traders use both strategies together as an EMA-scalping strategy.

Forex blockade crossover strategies

As with the basic forex blockade strategy and the reversal variant, a variety of related blockade crossover strategy can also be developed with the power of expert advisors (EA) and mechanical trading systems programmed to watch for currency prices to break out of channels and trend strongly. Because of versatility, forex blockade trading provides a profitable opportunity to “scalp” the EMA and other polarity oscillators.

Do you use similar strategies in your own trading?

Scalping Trading Strategies

August 2, 2013 by Edward Lomax 2 Comments

I got interested in forex because of the promises made by forex robot vendors. While my experience with robots was hit or miss (at best), the trading bug bit me hard.

I came across a form of trading called “scalping”, as most novice traders do. Scalping is “a trading strategy that attempts to make many profits on small price changes”, according to Investopedia.com.

You want to get into the market, bank some quick profits and get out of the market.

What Drew Me To Scalping Trading Strategies

Flexibility

Since I would only be going after small profits in the market, I thought I would be able to trade any time of the day or night. I thought I would be able to wake up and make some decent money while I enjoyed my morning coffee. Imagine how nice the rest of the day feels after collecting nice profits in the morning.

I also thought I could just pick any time to get into the markets for some quick profits. If I was bored, or couldn’t find something to watch on TV, I could open my trading platform and make some money. Can’t sleep? Just make a few bucks and hit the bed with a smile on my face and a bigger bank account.

Speed

Nobody likes sitting in front of the computer for hours at a time. With scalping, I thought this was not going to be a problem since I would only be going after small moves. And how long could it take for the market to go 2-5 pips in my favor, right?

Basically, you want to get into the market, bank some quick profits and get out of the market.

Scalable Profits

If I could just jump in the markets any time to bank some profits, I thought the amount of money I could make was up to me. I could scale up my profits just by adding a few minutes or trading sessions. I thought the more I traded, the more money I could make.

My Experience With Scalping Trading Strategies

Scalping is HARD!

I quickly learned that scalping was much more difficult than it seems on the surface. Even though you are only going after small price moves, it can be very hard to get them. And the stress of being in the market going after those moves is very intense. Every tick of the market is important; the fluctuating profit and loss pushes the trader on an emotional roller-coaster. Even when I would win, sometimes I would kick myself for getting out of the market when the move went on for 50 pips or more.

I did not have what it takes to learn scalping on my own. So, I joined a trading room with someone who considered himself an “active” trader. This means they get into the market frequently and look for smaller profits. The trade room hours happened to be at 5 in the morning during the winter. I would get up in the cold darkness and hook up my computer in the living room to not disturb my wife. And then I would try to follow along with the trader.

It was HARD!

The trader would go so fast and watch so many different currency pairs at once, I could not keep up. Sometimes I would win and sometimes not. I learned quickly scalping was an art. You must know what you are doing to make it work. After about a month in the trade room, I was exhausted and with little to show for my efforts. Scalping was just not for me.

My Conclusions About Scalping Trading Strategies

Time Consuming

While you are only looking for small moves in the market, you need a scalping trading strategy that helps you identify the RIGHT time to get into the market. And, as fate would have, most of the time is NOT the right time to get into the market. This means waiting around, staring at the charts looking for the right time to pull the trigger.

The longer you wait for a new setup, the more likely you are invent the right setup. Boredom increases your need for action, so you start inventing entries that are not really there. The poor decisions result in losses, causing you to abandon your scalping strategy.

Extremely Stressful

While in theory you are in the market for only a short time, the time in the market is extremely stressful. Everything is more intense because you only need a few pips to be a winner. But sometimes, it is not that easy to get even that small amount of pips, or it could take a long time.

Imagine this… you have been waiting for over a hour for a setup when finally one comes. You pull the trigger and get into the market. Your heart starts racing.

To make things worse, you used a big lot size because you need to make enough money on only a few pips to make trading worth it. Immediately, price goes against you and you see a lot of money at risk. This scenario is frequent and very hard to accept emotionally.

Expensive

Since you are going after only a few pips of profit, spread becomes a big issue. If you are trading a currency pair with a 3 pips spread and you want 3 pips of profit, the market has to move 6 pips. And even if you win, you are paying half of the move to the broker. This is a very costly way to trade compared to trading on higher time frames where you look for 100, 200, 300 or more pip moves.

Potential For Large Losses

Due to random market moves, you need to place the stop a decent distance from price. Otherwise, any spike in price knocks you out of the trade. Your natural risk to reward ratio is lousy. The take profit is often a tiny fraction of the total risk.

Get stopped out often enough where a spike takes you out and then goes in your original trade direction and you’ll start doing one of two things. You’ll either widen your stop or start trading without a stop. In either case, you are setting yourself up for devastating losses that will negate many previous wins.

In the end, I proved to myself that scalping was not for me. The next logical progression was to move on to intraday trading strategies. Next time I’ll go over my experience with intraday trading strategies, tell you a strategy I like and how creating trade management robots really help.

If you have any experiences with scalping strategies you’d like to share, please leave a comment below.

Position Sizing for the Scalper EA

April 2, 2013 by Shaun Overton 10 Comments

Andrew posted a great comment on the Scalper EA noting how he increased profits dramatically with position sizing. You can think of the expert advisor as the orange and the potential profit as the juice. We want to squeeze out every last drop.

Squeeze more profit out of your expert advisor with position sizing rules

I always talk about winning percentage and the R multiple together. It doesn’t matter that if win 99% or 15% of the time. It matters how much you win compared to how much you lose. Winning frequently does not correspond to profitable trading.

Only when you know the percent accuracy and R multiple can you determine expectancy: do I expect to make a profit or not following this expert advisor?

The explanation reveals two assumptions:

I know the real accuracy of the system
I know the real R multiple

NinjaTrader backtest reports show the percent accuracy and the R Multiple (ratio of avg win to avg loss)

I don’t know either for a certain fact. The real accuracy and real R multiple may be above or below the numbers seen in backtesting.

It’s important that we consider how we developed these numbers. I found them after analyzing an entire year’s worth of chart data. There’s a real risk that they overestimate future performance.

The forward test for 2012 discounted that notion – the R multiple and percent accuracy numbers actually improved on the blind data. But, as most of you know, I’m extraordinarily risk averse.

I assume the worst case scenario in nearly everything that I do. If the worst case isn’t so bad and the average case is fantastic, that’s the only threshold that pushes me past my risk inhibition. It has to be a really amazing opportunity for me to pull the trigger.

A pessimist’s view on position sizing

The goal is not to maximize profits. It’s more complex than that. The real goal is to maximize profits with a view to how many losses you can stomach.

That number is pretty low for me. Use bigger numbers if you can tolerate more pain.

I operate with the same attitude when selecting my position sizing strategy. It’s important to make reasonable, yet pessimistic, assumptions when selecting your money management approach.

Step 1: Decrease the strategy’s accuracy by 5%

Strategies vary in their accuracy with the chart and instrument where it operates. I have not done an analysis, but my rule of thumb is that accuracy fluctuates ±5%. The worst percent accuracy seen is usually within 5% of the best percent accuracy seen.

The rule generally holds across multiple instruments and time frames. Once you get a feel for the accuracy, you take the observed accuracy and subtract 5%.

The scalping strategy profited 75.93% of the time after including trading costs. Removing 5% off of that number leaves a reasonable worst case assumption of 70.93% accuracy.

Step 2: Decrease the R multiple by 20%

The method used here depends on the expert advisor’s trading style. Range trading expert advisors usually come out with an R multiple (average win/average loss) within a consistently narrow band. Trending EAs exhibit wild fluctuations in the R multiple.

This should make sense to readers with several years of trading experience. Range trades earn profits on the majority of trades. No individual trade contributes dramatically to the final outcome.

Trend trades do exactly the opposite. A small handful of trades contribute enormously to the overall result. The traders faces the risk of overemphasizing how well volatility played to his in advantage in the past. If trends of similar magnitude fail to materialize, the trader’s estimate for the R multiple will be wildly off the mark.

Rules of thumb for adjusting R multiple assumptions:

Cut the observed R multiple for a ranging strategy by 20%
Cut the observed R multiple for a trending strategy by 33-50%

The scalper EA trades ranges and showed an R multiple of 0.53. Cutting that number by 20% reduces it to 0.424.

Apply pessimistic assumptions to model money management

The adjusted numbers for the scalping strategy are 70.93% accuracy and an R multiple of 0.424. I can now take these numbers and start playing with the money management software.

The first thing that I did was to reduce the number of trades in the test to 100. That equates to roughly 1 year of trading, which is a meaningful period of time for this expert advisor.

Fixed fractional money management using 1% risk and the pessimistic assumptions puts the trader slightly ahead of breakeven after trading costs (a 1% profit). The worst case scenario shows an annual loss of 25%. Nobody wants a loss like that. But, it’s something that I can handle as a plausible worst case.

Final numbers

The pessimistic money management assumptions still show an average profit.

Increasing the percent number to 2% doubles the minimum and maximum outcomes. Tripling it to 3% triples the worst and best outcomes. You should select a number whose worst outcome strikes you as something personally acceptable to you.

I selected 1%. The worst case scenario is something that I can handle. The next step is to split the difference between the observed numbers and the pessimistic number for the percent accuracy and R multiple.

The numbers are 73.43% accuracy and 0.477 for the accuracy and R multiple. When I plug the numbers into the software, it spits out an average return of 8.9% with a maximum upside of 40.9% after 100 trades.

Moderate assumptions for position sizing show an average return of 8.9%.

Using fixed fractional money management squeezed more juice out of the orange. We brought the worst case scenario up to -25% and the best case scenario on moderate assumptions to over +40%. More importantly, the average return increases without affecting the best and worst cases.

What position sizing ideas do you have? Leave your thoughts in the comments section below.

Scalper EA Other Pairs

March 26, 2013 by Shaun Overton Leave a Comment

A number of readers are using the scalper EA in live accounts. The number one issue that many of them cited is that my research focused solely on the EURUSD. Does it work on other forex pairs?

Absolutely. However, it doesn’t work on all of them. It’s important to follow the same logical process that explained why the expert advisor works so well on the EURUSD.

Analyze the scalper EA in Excel charts

We must dive back into Excel to evaluate the original hypothesis. My expectation was that the strategy should work on charts where the distance of the price from the 200 SMA forms a nice inflection midway through the curve.

GPBUSD price & SMA 200 distance frequency for the scalper EA

The frequency of various distances of the price from the 200 SMA on GBPUSD.

The area right around the 0.5% marks the inflection point. As a reminder, you can think of the curve as being composed of two parts. There’s the steep part, which is where the price is highly likely move. Then there is the flat part. That means the price drifts instead of moves.

Think of slope as rate of change. A steep slope means a fast rate of change. The price is likely to be anywhere but here on the next bar.

Flat slopes make for slow rates of change. The price is in fact very likely to remain a similar distance from the SMA in future bars.

Slope of frequency of price and SMA 200 distances.

The graph contains 2 slopes. A steep slope and a flat slope. Both are marked in red.

The strategy only works when price is likely to stay in the same spot. We are, after all, scalping. The opportunity only exists when the expert advisor can trade in the chop. The chop only exists when the slope of the frequency line is flat.

I used my experience on the EURUSD to infer that 0.75% would make for a natural starting point to evaluate for the moving average envelope. It’s far away enough from the inflection point to overcome spread costs, but close enough to yield a solid number of trading opportunities.

The initial results came out even better than the EURUSD. These results do not include slippage, commissions or spread costs.

GBPUSD Results

Results for 2011 for the scalper EA on GBPUSD

The results are very much in line with the original idea. Percent accuracy stayed in the same ballpark, coming out to 81%. The profit factor jumped very nicely to 2.99, which is substantially better than the EURUSD performance of 2.16. The sample size consists of 113 trades, which is enough to infer a reasonable expectation of performance.

Equity curve of the scalper EA on GBPUSD for 2011.

The final test is “does it make money when including trading costs?” The answer is yes. On a 2.5 pip spread, the total trading costs of standard lots on 113 trades is $25/lot * 113 lots (trades) = $2,825. That number is substantially less than the raw profit of $5,360. It makes sense to trade this strategy.

The final step of walking forward unfortunately doesn’t offer enough data points to draw a conclusion. It only placed 13 trades for the entire year. It broke even.

USDCAD scalping stats

Performance for USDCAD 2011 with a band of 0.9%.

Equity curve of USDCAD for 2011

USDJPY is a bad idea

The frequency graph for the USDJPY looks much, much different than the other currencies. Instead of being steep and mostly flat, it’s more like free falling and perfectly flat. The massive size of the tail and the severe contrast between the steep and flat portions led me to believe, correctly, that trading USDJPY would not be a good idea.

The frequency of various distances of the price from the 200 SMA on USDJPY.

Although the areas near the inflection point are indeed the most profitable, the profit factor for USDJPY plummets to slightly above 1.0. When trading costs are factored in, it doesn’t make sense to trade.

Trade performance for the scalper EA for USDJPY in 2011

Have you read the article explaining how and why the scalper EA works?

If you have any suggestions on how to make the rules apply to more currency pairs or instruments, then please share in the comments section below.

FXCM Spreads

October 26, 2012 by Shaun Overton Leave a Comment

FXCM launched a new web site this week. The company shifted its marketing strategy to emphasize lower trading costs. The lower spreads, however, come with a catch. The trader must choose to trade either on a dealing desk or using pass through execution. Leaving the account on pass through execution means paying a whole extra pip on trades.

Dealing desks mean that the company chooses to take risk against its clients. When Joe Trader goes long the EURAUD, the dealing desk simultaneously goes short by selling Joe Trade the EURAUD. Most people forget what a trade is because of the electronic trading environment. It’s easy to associate clicking buttons with “stuff happening” afterwards. Nonetheless, it’s important to remember that you are trading. That is, you are exchanging currencies with someone. A trade is impossible to do without that other someone.

The risk of trading through a dealing desk is that the broker perverts its incentives. The job of a broker is to ensure that his client receives quick and satisfactory execution on all orders. When a company like FXCM chooses to also act as the counterparty to the trade (i.e., a dealing desk), those goals are in direct conflict with the client. Poor execution directly harms Joe Traders while directly benefiting FXCM.

That’s the risk. The vast majority of the time, dealing desks provide quick and appropriate execution to their clients. Egregiously abusive practices would lead to clients closing their accounts and bad mouthing the company all over the internet. The degree to which brokers indulge in questionable execution on trades obviously varies heavily from company to company.

Dealing desks hate scalpers and scalping expert advisors for two reasons. Scalping involves opening and closing trades within a short period of time, usually within a few minutes. This causes headaches for dealing desks because they need to manage the net risk of all open orders. Joe Trader opening and closing microlot trades causes very little harm to the dealing desk. When there are 500 other Joe Traders doing the same thing, however, it becomes a hassle. The net exposure of the order book fluctuates from minute to minute, usually to the dealing desk’s short term disadvantage.

Scalperes work to the advantage of the dealing desk over the long run. Scalpers pay an absolute fortune in spread costs, which quickly and silently drains the account of its equity. Scalpers tend to go through lengthy periods of picking up pennies consistently every day. Then the steamroller comes along and flattens them and the little gains that they accumulated. The dealing desk bleeds while those pretty equity curves are drawn. Then, when volatility picks up, the desks make out like bandits as huge percentages of scalpers start blowing up. The dealing desk earns exactly as much as the destroyed scalpers lost.

Despite the long term advantage, the desks hate watching the equity drain slowly everyday. The common tactics result in price shading, poor execution and dealer intervention where the dealing desk outright refuses to close the trader’s position. If you like scalping the markets, trading on a dealing desk is not a good idea.

Traders with average holding times in excess of four hours might consider trading with a dealing desk given an appropriate incentive. FXCM now offers a fairly compelling reason to seriously consider the idea. Despite all the breathless criticism of FXCM across the internet, my primary gripe with the company is that they charge an outrageous amount of money. Their spreads are consistently higher than every other major brokerage. I consistently see them charging 2.6 pips on the EURUSD, yet their interbank feeds run average spreads around 0.5 pips. Charging a 400%+ markup is outrageous.

The new dealing desk offering reduces the lowest possible spread to 1.5 pips. That one pip of difference takes FXCM from being one of the most overpriced in the market to offering one of the lower spreads available among major brokerages. The spread pricing is far more reasonable and offers the opportunity to trade with a reputable company.

I am comfortable endorsing the idea of trading on FXCM’s dealing desk so long as the traders holds his positions for at least several hours. Although it comes with obvious disadvantages and conflicts of interest, those factors are much less likely to apply to a trader the longer that he holds a position. Carry traders and those with multi-month holding times have the least reason to be concerned. Trading with a dealing desk in exchange for a 40% discount in trading costs is worth it.

Scalpers should avoid the setup. No dealing desk wants scalpers on its system. I’m told that FXCM will push scalpers who trade on the dealing desk automatically onto pass through execution, which FXCM refers to as NDD (no dealing desk). Scalpers can maintain the dealing desk pricing but are secretly switched onto FXCM’s NDD feed.

Nonetheless, I feel that the conflict of interest is to great for this category and that traders should not rely on the company’s unwritten policies for decent execution. Scalpers at FXCM are better off trading on the NDD feed. Better yet, scalpers should find a broker with pass through execution that charges reasonable spreads.

If you trade six figure balances and/or do a lot of trading volume (more than 100 million notional) and are concerned about trading costs, please contact me directly at info@onestepremoved.com. OneStepRemoved.com is not an introducing broker and does not receive rebates on its referrals. I am happy, however, to introduce readers to companies and introducing brokers that offer trading costs under 1 pip and without any spread markups.