Algorithmic and Mechanical Forex Strategies | OneStepRemoved

Effective Trendline Navigation

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As with virtually any trading scenario, we must first determine the direction that we need to trade the pair for the greatest likelihood of success.

By looking at the historical 4 hour chart of the GBPUSD below, there are several reasons we know that we want to go long (buy) the pair.  Price action is above the 200 Simple Moving Average and is pulling away from it.  The pair has been making higher highs (green lines) and higher lows which indicates an uptrend.  Also, at the time of this chart, the GBP was the strongest currency and the USD was one of the weaker currencies.

All these point to a buying opportunity.

But, the question remains, when do we enter the trade?

Here’s where we bring in the trendline…

Screen Shot 2013-06-24 at 2.58.57 PM

Let’s take a look at the historical 4 hour chart of the GBPUSD pair below…
trendline 1

 

We can see that price action has come in contact with trendline support at several points – note the blue boxes.

Since price has tested and respected the trendline for at least three “touches”, we know that our trendline is valid.

Our entry strategy to buy this pair using trendline support will be to wait for price to trade down to the trendline and into the “Buy Zone”.  If price trades into the Buy Zone and stalls and a candle does not close below trendline support, just as in our blue box examples, we can take a long position on the pair with our stop just below the trendline or just below the lowest wick that penetrates the trendline.

The trader could exit the trade if price reaches resistance, the previous high, or by employing a simple 1:2 Risk Reward Ratio.

Now let’s take a look at a historical 4 hour chart of the USDCHF for an example of selling against Trendline Resistance in a downtrend…

trendline 2

This trading scenario will be virtually the opposite of what we did in the previous buy example.

We want to sell the pair a it has been making lower lows (red lines) and lower highs.  Price action is below the 200 SMA and pulling away from it.  Also, at the time of this chart, the USD was weak and the CHF was strong.

Again, price action has tested our resistance line at several points (the blue boxes) so we know the trendline to be valid.  In this example we would wait for price to trade up to trendline resistance in the “Sell Zone”.   As long as a candle does not close above the trendline, we would sell the pair with a stop just above the trendline or just above the highest wick to penetrate the trendline.

The trade could be closed should price reach the previous low or we could use a 1:2 Risk Reward Ratio to exit the trade.

 

RKrivoFX@gmail.com

@RKrivoFX

What’s the Main Advantage of Trading with the Trend? PIPS!!!

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Whenever currency pairs begin strong trending moves, traders will ask about the merits of the old trading adage, “the trend is your friend”. What does the trend have to offer? What not trade against the trend as well as with the trend and make pips going both ways?
A valid question to be sure…

While pips can be made trading counter trend, they will definitely come with a greater amount of risk.

Essentially, when taking trades in the direction of the trend, the trader has the “push”, the momentum of the market behind their trade. Since a major trading objective is to mitigate risk, one way we can do that is to eliminate trades that are against the prevailing trend.
When trading countertrend there is less momentum pushing in that direction since such a trade is going against the majority of traders in the market at the time. As such, the dominant trend can kick back in at any time quickly negating some/all profits which may have been earned by trading against the trend.

bigarm-littlearm
Also, when a trader knows that they have the “market behind their trade” when trading with the trend, they have more confidence to stick with the trade and let it mature as opposed to closing out the position too early.

Lastly, countertrend entries need to be much more precise since you are trying to time an entry while it is moving in the opposite direction that the market has been taking the pair over time. (Think of a relay race – is it easier/more forgiving to pass the baton to someone running in the same direction as you or someone running in the opposite direction?)

Entries with the trend can be much more forgiving.

Let’s take a more in depth look at this idea using a historical Daily chart of the USDCHF as our example…

arms

 

The approximate number of pips in each move to the downside – the direction of the overall trend – is shown in green.  The approximate number of pips in each move to the upside – counter trend – is shown in red.

While we can definitely see that pips can be made trading countertrend, 4,070 in this example, there is a very significant difference in the number of pips earned by the trader who only took trades in the direction of the trend.

Based on this chart, trading only with the trend would have accumulated 7,755 pips – about 90% more.

Admittedly, 4,070 pips is nothing to turn up one’s nose at.  For me however, factoring in the greater risk of more precise entries and the need to spend more time monitoring the trade even more closely, I’ll stick with trading in the direction of the trend.

 

RKrivoFX@gmail.com

@RKrivoFX

Free blow up insurance?

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Last week’s drama with the collapse in the EURCHF peg hammers home an uncomfortable truth: you can lose more in your account than you deposit.

Trading on leverage is inherently dangerous. Although an instant 20% move in a major currency is a once in a lifetime event, it goes to show just how quickly the markets can charge over alleged safety features.

Did placing a stop loss at 1.19 for an open EURCHF trade do any good last week? Not a bit! As soon as the market breached 1.20, it instantly gapped down 10%.

When markets go bidless, it means that there is no liqudity in the market. That’s jargon that means everyone is too scared to do any buying or selling. There literally is no price at the moment where anyone is willing to trade.

It was at 1.20. The next thing you see is 1.08 and the price falling fast.

I was fortunate enough to be awake at 3 a.m. when the proverbial cow-pie hit the fan. Although I’m an alogrithmic trader, I confess that my immediate instinct was to hop on the bandwagon and buy!, Buy!, BUY! all the Swiss francs that I could handle (when you go short EURCHF, you’re selling euros and buying francs).

The way I coped with the urge was to IM a friend and pass a running commentary on the insanity. Posting on Facebook and Twitter also kept me busy. Basically, it was a strategy to keep myself wholly occupied and distracted so that I wouldn’t be tempted to jump in.

I’ve seen mega moves before and, more importantly, I know from experience how badly people can get hurt. My favorite war story from working as a broker was a wealthy client in Kuwait that opened an account with $250,000 the night before NFP. He went long on 100:1 leverage and of course the report was the complete opposite of expectations. The market gapped instantly and before his trade could close, his account balance was -$20,000.

You don’t read stories like this on the forums because… who on earth wants to go advertise their financial destruction on the internet? It’s embarrassing and, if we’re honest with ourselves, that person is probably doing everything humanly possible to not think about their situation.

raised hands

Nobody raised their hand to tell me about catastrophic losses in the CHF

 

Free insurance

The primary reason to trade with maximum leverage is because it’s like free insurance against devastating losses. You never know when a peg will go bust or the next 9/11 is going to happen.

Let’s game this out. You were long USDCHF on Thursday and there was no stop loss in the world that could protect you against an instant 10% gap. Consider two scenarios:

  • You had a $30,000 account balance and were trading an institutional level of leverage like 5:1. That means your position value was 30k * 5 = $150,000. The instant gap created a loss of 10% * $150,000 = $15,000.
  • You had a $3,000 account and were trading the “crazy” leverage of 50:1. The position value was also $150,000 and yields a $15,000 loss.

Now let’s talk about what happens in the real world. In the first sceario, the money is on deposit with the broker and you 100% have lost $15,000. It’s a guaranteed fact and you can safely kiss the money goodbye.

In the second scenario, you may legally owe the broker $12,000 (3k-15k=-12k). However, what is the broker’s likelihood of recovering the money? If you’re in the UK and you trade at Pepperstone in Australia, they’d have to sue you in an Australian court. The attorney’s fees alone would be several thousand dollars. And most convincingly, you probably don’t have any assets that the court could award to the broker.

Even if you are in Australia, think about all the bad PR hitting the forums when the big dog starts suing little retail traders. There’s almost no business-case for pursuing the negative balances of retail forex traders.

You’re going to see a lot of hooplah this week about brokers “forgiving negative balances.” It’s great PR and it’s the best way for them to play it. They know darn well that there’s almost no chance of recovering that money. It’s the best way to turn lemons into lemonade because the brokers lost an epic amount of money.

How to protect yourself

Chris Zimmer, the programmer here at OneStepRemoved, sent me this as soon as the day ended.

I was already on board with it but this recent event makes your method of pulling money out of FX accounts look very obvious.

I just checked and the USDCHF dropped over 1600 pips on that bar. That really hits close to home as we could have easily been Long that pair and something tells me any stop would not have been filled.

Trade on leverage and, for goodness sake, withdraw the money at regular intervals. Nobody can take it away if you don’t keep it in their hands.