Algorithmic and Mechanical Forex Strategies | OneStepRemoved

Make Sure You Are Processing Market Data Using The Right Tools!

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Traders in 2014 have a virtually unlimited arsenal of analysis tools at their disposal. While this can be a tremendous advantage. It can also work against traders if they are using those tools incorrectly.

One common misconception among traders today is that they confuse the terms price action and technical analysis. Both of these can be used to build profitable trading strategies, but there are subtle differences in their analysis that need to be understood.

price action

It is important to understand the difference between the different types of analysis tools available to traders so that we use them in the correct manner.

Daniel Fernandez from Mechanical Forex wrote a post recently that contrasted price action with technical indicators. He did a nice job of explaining how each of the terms analyzes data differently and showing that both can be used successfully if they are properly understood.

Price Action

Here is how Daniel describes price action:

Price action is generally defined as any interpretation of the market that arises from simple comparisons of raw market data.

He explains that price action basically refers to strategies that deal with raw market data. The example he provides is a strategy that compares the current price to the closing price from 10 days ago.

Price action analysis has the ability to react very quickly to changes in markets, however it can struggle with noisy market environments. It is also considered less likely to be exposed to curve-fitting, but that is a function of how many degrees of freedom are present.

Technical Indicators

Here is how Daniel describes technical indicators:

Technical indicators go through data and return values that are an overall simplification of the underlying price action.

The example he uses to explain technical indicators is the Stochastic Oscillator, which identifies where a price is in relation to its range over a certain period of time. This shows how technical indicators take market data and process it into a more usable form.

That type of processing allows technical indicators to do an excellent job of filtering out noise, but it can also make them slower to react to sudden movements. Technical indicators are generally considered more prone to curve-fitting, which is something that must be considered during backtesting.

Which Is Better?

Daniel concludes his post by suggesting that neither type of analysis is superior to the other. In his research, he has found that profitable strategies can be developed using either price action or technical indicators.

He believes that the best approach to strategy development is to use both types of analysis. He suggests using technical indicators as filters and price action to provide confirmations and quick exits.

Are You Putting Enough Emphasis On Your Exit Strategy?

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Quantitative traders love new ideas. We are always looking for a new strategy that has demonstrated that it has some sort of edge.

Many developers spend a large portion of their time optimizing the entry points of their strategies. Strong emphasis on entry points can lead to a lack of attention on the back end. This can result in a lack of attention being given to a system’s exit strategy.

Simply using the first exit strategy that comes to mind might result in the system working just fine. However, taking the time to consider all of the potential exit options could result in discovering a much more profitable exit strategy for the system.

exit strategy

Have you put as much thought and analysis into your exit strategy as you have your entry strategy?

There was an article published on Forex Crunch this week that took a look at some of the potential exit strategies that a system might utilize. Having a list like this at your fingertips is a great way to ensure that you are considering all of the possible options when putting together your own quantitative trading system.

Here are the different types of exits that the article covers:

System-Based Exits

For many systems, these are the first type of exits that come to mind. They are generally based on the reverse of whatever entry signal the system uses.

 It stands to reason that you already should have planned your exit in advance so if you entered on a moving average crossover, for example, it’s usually best to exit on the opposite crossover.

Likewise, if you bought on a breakout you should probably sell when the price breaks down.

Trailing Stop Exits

Trailing Stops are a very popular way to make sure that your system retains some of its paper profits. As we covered last week, there are many pros and cons to using a trailing stop. The Forex Crunch article points out that one difficulty is knowing where to place the stops:

One of the difficulties when using the trailing stop is knowing how far away from the price action to set the stop as too close means you could take profits too early, while too far away and you might not capture any profits at all.

Price Targets

Price targets are a very popular exit strategy for many Forex systems. They allow traders to specify clear risk to reward ratios. However, those traders have to be prepared to accept the possibility of a price just missing their target and then turning into a losing trade.

The Forex Crunch article suggests that using pivot points as price targets is an interesting option:

Technical levels such as pivot points are often great places to set as price targets for a couple of reasons.

First of all, they use recent data so they adapt to market volatility. This means that the key pivot levels are all realistic profit targets.

Secondly, pivot points are watched by thousands of professional traders. This means they are better at predicting turning points.

Technical Indicators

This is the Pandora’s Box of exit strategies. Just because you are using one particular indicator to enter a trade doesn’t mean that you can’t use any other indicator to signal an exit. The articles suggests that Fibonacci, Elliot Wave, and Average True Range based indicators are all interesting options.

The Fibonacci is a mathematical sequence that manages to anticipate turning points with extraordinary accuracy while the ATR indicator is a good tool in order to gauge price moves.

This is by no means a comprehensive list of exit strategies. However, it is a great starting place to expand your thinking on the topic. How much thought have you put into optimizing your exit strategies?