stop Archives - Algorithmic and Mechanical Forex Strategies

Tactics for Managing a Trade in a Range

March 11, 2015 by Richard Krivo 5 Comments

Range trading is simply finding a currency pair that has been moving between a defined level of support and a defined level of resistance for an extended period of time.

Once the setup has been identified, the trading plan is to buy at support and sell at resistance as long as the range remains intact.

Let’s take a look at the range on the historical 1 hour chart of the NZDCAD below…

In this straightforward scenario when price trades at support the trader would take a long position with a stop just below the lowest wick in the range. The limit (take profit) would be set at the top of the range and the trader would let the trade play out. If all goes according to plan and price trades up to the limit, a profit of 40 pips would be gained. If price retraces and take out the stop the trader would incur a loss of about 8-10 pips.

Now let’s take a look at a few trade management variations on this same trade…

Here we have the same trade set up but we are going to increase our likelihood of taking profit by moving our limit down slightly – a bit closer to our entry.

Here’s why this can work. Notice that price has hit the very top of the range four times. (This would be each time a candle body or wick touched or pierced the .8130 level.) On the other hand, price has touched our pierced our new take profit level a total of 15 times!

By doing this we will give up some profit if the pair does trade to the top of the range. However, we are increasing our odds of having our limit hit while still achieving a solid profit and having at least a 1:2 Risk Reward Ratio in place.

The choice is yours…

Take the chance of gaining more pips but with a lower probability of success or take the chance of gaining a few less pips but with a greater probability of success.

Now let’s take a look at the same set up but this time we will open two positions instead of one…

Personally, I like to trade multiple lots since it allows me more flexibility in my trade management.

Keep in mind, however, that anytime we increase our position size, we also increase our risk.

For example, if our stop is set at 10 pips, with one lot we are risking 10 pips; with with two lots we are risking 20 pips and so forth. To stay within our Money Management guidelines of never placing more than 5% of our trading account at risk, check to be sure that the trading account can handle the added risk.

When looking at the chart above, the set up remains the same but this time we would open our trade with two lots instead of one. (This strategy would remain the same whether we open two, six or ten lots.)

The flexibility that this allows is that we can close out one or a portion of the trade when price reaches the halfway point in the range. By doing that the trader locks in profit when that position is closed. Additionally, the stop at that point can be moved to breakeven , that price at which the trade was entered.

Now, if price retraces and hits our stop we are closed out of that portion of the position with no gain but no loss is incurred either. We also have the 20 pips from the first portion of the position locked in.

Should price continue to move to the top of the range, the second position would be closed out thereby gaining the full amount of pips encompassed in the range. In the case of this example that would be 40 pips. Those pips would then be added to the profit gained when the first position was closed out at +20 pips for a net gain of 60 pips.

Bottom Line: There are a variety of ways to manage the same trade setup. Choose the one that makes the most sense for you and the size of your trading account.

All the best and good trading,

Richard Krivo

RKrivoFX@gmail.com

#RKrivoFX

Using Long Wicked Candles for Stop Placement

January 5, 2015 by Richard Krivo 6 Comments

dinner-candles-rainbow

Candlestick charts, using the individual candles as well as the patterns that they form, can provide an abundance of information to the trader. An oftentimes overlooked aspect of these charts is the trading information provided by longer wicked candles – especially when it comes to stop placement.

Many newer traders will decide where to place their stop based on some random number. That number may be derived from how many pips they are comfortable losing or simply some nice round number like 10 or 50 or 100 or whatever.

The point is that their number is arbitrary and, most likely, bears no relationship whatsoever to the price action that they see on a chart.

A more effective way to place a stop is to look for levels of support in a buy or levels of resistance in a sell.

When buying the stop would go below a level of support and when selling the stop would go above the level of resistance.

(Needless to say, when placing any stop by any method, it is imperative that the 5% rule of Money Management be followed.)

To fine tune this even more, a better guide for stop placement is to bring long wicks, if they are present on the chart, into the analysis.

The historical 1 hour chart of the GBPJPY below provides an excellent example of long wicks…

The black rectangles on the chart identify where longer wicks are making an appearance. You can see that the wicks are extended relative to the length of the other wicks around them on the chart.

Notice that after a long wick(s) makes an appearance, oftentimes price will move in the opposite direction of the long wick for a period of time.

In other words, if the longer wick is below the body of the candle, price has a tendency to move up. Conversely, if the longer wick is above the body of the candle, price has a tendency to move down.

So why is that you may ask…

An extended wick at the bottom of a candle shows that sellers were able to push the price down significantly. That is one aspect of what has created the long wick.

However, the selling volume was not great enough to keep the price at that low level. The buyers were able to push price back up from the low – the bottom of the wick – thereby showing strength. That is the second aspect of what creates the long wick.

Since buyers triumphed in that sense, the likelihood exists that the strength of the buyers will endure and, if that is the case, the price will rise.

(In the case of the long wick being above the body of the candle, the opposite scenario might play out and the price would fall.)

So how can a trader effectively make use of this in their trading?

As I always point out, a trader must first take note of the direction of the trend on the Daily chart. If the trend is down, as it is on the pair above, seeing a candle (or several candles for that matter would be even better), with long wicks on their tops, would point toward a strong potential for price to move down…in the direction that the market has already been taking the pair.

So, to continue using an example of a downtrend, if the pair retraces…that is, move against the trend…and stalls at a level of resistance or a Fib level, I am going to be looking for long wicks at the tops of the candles.

There are two reasons for this:

1) Those long wicks indicate the potential for the pair to trade to the downside back in the direction of the Daily trend as the retracement has stalled.

2) The top of the extended wicks provide an excellent guide for a trader to place their stop. The rationale here is that the buyers pushed price to the top of that wick but could not push it beyond that point. As such, placing the stop just above that wick represents a level that has a much lower likelihood of getting hit.

Bottom Line: Observing long wicks forming at levels of support or resistance, especially when they signal potential movement in the direction of the daily trend, can create a beneficial “edge” for the trader especially in regard to stop placement.

Remember – anytime you try out anything new, be sure to try it out numerous times in a demo account until you achieve a level of comfort and understanding.

All the best and good trading,

Richard

@RKrivoFX

rkrivofx@gmail.com

What Quantitative Value Do Stops Actually Have?

December 20, 2013 by Andrew Selby Leave a Comment

One of the questions that every quantitative trader must address is whether adding a stop-loss component to their system will help or hinder its performance. I have written a good deal lately about the pros and cons of different types of stops, but haven’t had much actual backtesting data to work with.

When I wrote a post about about Cesar Alvarez’s S&P Rotational Strategy a few weeks ago, I suggested that adding a stop-loss might lower the maximum drawdowns. This would give the strategy a way to exit losing positions during the month, rather than waiting for the monthly redistribution. Theoretically, this would have reduced some of the big losses that the strategy suffered in 2008.

We assume that adding a stop loss component has the quantitative value of a safety net, but that isn’t always the case.

In addition to writing about that idea here, I also commented on Alvarez’s post. In response to that, he has written a follow-up post addressing my suggestion to implement stops:

Continuing from the post, we are adding a maximum stop loss. The stop is evaluated at the close each day with the exit happening at the close. The tested stops are 5%, 10% and 15%.

Interestingly, Alvarez finds that adding stops can be helpful in some situations and terrible for performance in other situations. While adding stops may always seem like a logical idea in theory, Alvarez shows that actual performance can prove otherwise.

Best Performing Stocks

The version of the best performing stocks strategy that we looked at in the previous post utilized a market timing indicator and a six month look-back period. That strategy produced a CAR of 10.48% with a maximum drawdown of 42.22%. Here are the numbers when 5, 10, and 15 percent stops were added:

5% Stop: 10.51% CAR, 26.30% MDD
10% Stop: 10.85% CAR, 38.05% MDD
15% Stop: 10.84% CAR, 39.48% MDD

As you can see, adding the stop loss doesn’t do much for the CAR, but it does a great job of reducing the maximum drawdown. When the stops were applied to the version of the strategy with a 12 month look-back period, the impact on maximum drawdown was similar, but the CAR saw a bit more of an increase. When the stops were applied to each of the two versions without the market timing indicator, we saw a slightly less impact on drawdown and a much greater impact on CAR.

Alvarez also commented that in almost all cases, the 5% stop was the best performer, which he thought was unusual:

Normally close stops tend to be the worst but the 5% stop tends to be the best.

Worst Performing Stocks

The worst performing stocks version of the strategy that we looked at used the market timing indicator and a six month look-back period. The strategy without stops had a CAR of 13.05% and a maximum drawdown of 27.88%. Here are what the numbers look like when the different levels of stops were applied:

5% Stop: 5.11% CAR, 28.26% MDD
10% Stop: 8.36 CAR, 30.90% MDD
15% Stop: 10.47% CAR, 30.87% MDD

In this case, adding the stops has really hurt the strategy. While there was some improvement in the maximum drawdowns of some of the versions, adding stops basically crippled the CAR of all of the worst performing stocks strategies.

Alvarez notes that this is the result he expected:

For the worst N-month ranking, stops appear to hurt the all results. These results support previous research that stops on short-term mean reversion hurt results.

Picking Trade Entry Signals

May 17, 2013 by Edward Lomax 3 Comments

So far in this series about building a solid trading strategy, I’ve gone over time frame, trend direction and using higher time frames and trend direction to filter trades. Now it is time to go over what most traders focus on when creating a trading system… entry signals. Basically, when do I pull the trigger and buy or sell in the market?

Before I start, I want to make one thing clear…

When to enter the market is not necessarily the most important part of your trading strategy.

Many traders think that if they can just nail down the right entry signals, nothing else matters. This is just not true. While deciding when you are going to enter the market is important, the other characteristics of a solid trading system are just as important or even more so.

Signals to enter the market are exciting. Just make sure that you don’t neglect the other important elements in a trading system.

Entry signals get a lot of attention because the topic is exciting, and things like money management and trade management are boring. But if you want to be successful, you cannot just focus on the things you like. You need to create a trading strategy that addresses every characteristic of solid trading, even the boring stuff.

Obviously your trading strategy needs a set of rules to tell it when to get into the market. I’m not going to claim to have the magic entry that always wins and can make you rich in a month. Frankly, that is not what you should be looking for either. I just want to go over some issues you are going to have to come to grips with when building your trading strategy.

Types Of Entry Orders

There are a few types of orders you can use to get into the market. Some wait for price to reach a certain level in the market before taking action, and some are immediate.

Pending Orders: A pending order is an order you place above or below current price action. When price reaches that level, an action (Buy or Sell) takes place.

Buy Stop Orders: An order is placed ABOVE price action. If price reaches this level a Buy trade is entered.
Sell Stop Orders: An order is placed BELOW price action. If price drops to this level a Sell trade is entered.
Buy Limit Orders: An order is placed BELOW price action. If price drops to this level a Buy trade is entered.
Sell Limit Orders: An order is placed ABOVE price action. If price reaches this level a Sell trade is entered.

Market Orders: A Market Order gets you into the market immediately. If you you want to take action at the current price level, you use a market order to Buy or Sell instantly.

Types Of Entry Signal Criteria

There are limitless ways to get into the market. They can range from the very simple to the incredibly complex. Here are some types of entry signals that can be used either alone or in combination.

Time Based Entry Signals – At a specific time a day, you place a market or pending order based on previous price action.

Set And Forget Entry Signals – These are either market or pending orders that you set up once, and then let price run to either the take profit or stop loss. Orders that have not triggered or are still running are normally closed the next day when new orders are placed.

Straddle Entry Signals – These are pending orders that straddles market price. At a certain time a day you place a Buy Stop order above price and a Sell Stop order below price. (These are normally set and forget style trades where you set take profit and stop loss for each order and come back the next day to see what happened).

Price Pattern Entry Signals – There are many price patterns (triangles, wedges, head and shoulders, etc.) that can be used to determine when to get into the market. There are also Harmonic Patterns (butterfly, bat, etc.) that have their own trading rules.

Candlestick Entry Signals – Candlestick patterns can be used to determine market reversals or continuation moves and pinpoint entries.

Divergence Entry Signals – Divergence happens when price action and an indicator (like MACD) are out of alignment. For example, price is trending up, but the MACD is going down. The thought is that price will follow the indicator at some point, and can be used to look for trade opportunities.

Indicator Alignment Entry Signals – There are thousands of indicators. There are also thousands of different settings for the indicators. This makes for a unlimited combination of indicators that can be put on your charts. When these indicators line up for a buy signal, you can enter the market long. When the indicators line up for a sell signal, you can enter the market short.

2 Considerations Regarding Entry Criteria And Expert Advisors

Since we are primarily talking about programming a trading strategy into an expert advisor, there are a couple of things you should take into consideration.

Complex Is Not Always Better – Many people think the more entry criteria they have, the better and more accurate the system will be. But that is not always the case. Sometimes a system can be so complex you get conflicting data which makes making a confident trading decision impossible.

The point of your entry criteria is to give you an edge in the market and identify high probability opportunities. You are never going to be able to create a system that wins all the time… so don’t try. Identify entry criteria that gives you an edge and avoid trying to search for the Holy Grail of trading systems.

Limiting The Times Of Day You Enter The Market – A lot of people want to build robots because they can look for trading opportunities 24 hours a day. I agree, this is one of the benefits of programming your strategy into an expert advisor. However, limiting the trading times might increase the effectiveness of your system.

The market is more active at certain times of the day like during the London open or when the London and New York markets are open at the same time. Sometimes limiting the hours a day your robot can trade improves accuracy and profitability.

Read the next article in the series: How to decide where to place your stop loss and take profit

Stop & Limit Order

December 22, 2011 by Shaun Overton 3 Comments

Stop and limit orders are direct opposites. A limit order is jargon for “better price”, while a stop order means “worse price”. Many find it especially confusing that a stop entry order uses the same terminology as a stop loss. Technically, they are the same thing. A stop entry and stop loss are both prices worse than what you would get if you accepted the current market price.

Stop entry versus limit entry

Stop entries are used with momentum or breakout strategies. The theory is that if the price moves up, then it will be more likely to continue moving up. The trader loses out on the difference between the price at the time he decided to trade and the actual entry price. What he hopes to gain is the extra information that the price has moved, which might imply a higher probability trade.

A price that is worse the current market price for buying in the future is up. So, buy stops go above the current market price. Sell trades receive a worse price in the future if they wait and the price goes down.

Limit entries take the opposite approach. Market often tend to wander. They very rarely shoot off in a single direction without wiggling a little bit up and down. The idea behind a buy limit order is that you think that the price will increase in the future, but that you might be able to pick up the fx pair at a better price than what you’re seeing now. A buy limit goes below the current market price. A price improvement for a sell entry requires a price increase, so sell limit entries always go above the current market price.

Stop loss exit and limit exit

Most people find this part a lot simpler. Here, a stop loss means you lose money. The buy trade that you opened is going down. If it hits your stop loss, then the loss is realized. Stop losses go below the entry price for a buy trade and above the entry price for a sell trade.

Limits are the opposite. An open long trade is a bet that the price will increase. If it hits your limit exit, it means that you’re satisfied with the amount of profit on the table. Long trades place the limit above the entry price. Short trades place the limit exit below the entry price.