Do Indicators Really Work?

My goal throughout this blog is to share with you the tid bits of information that might not be so obvious when starting out. In this particular post I want to talk about technical indicators and how they should and should not be used in your trading.

If you are the kind of trader who feels most comfortable building your own trading system, then all the more power to you. It is the path most professionals take! It makes it all the more crucial that you listen carefully to the advice in this post because you will very likely consider indicators at some point along the way to buliding your system.

As I'm assuming you are already aware, you have many variations of technical indicators. Moving averages, stochastics, MACD are some of the more popular ones, but there are dozens more.

The most important thing i can tell you is to keep your charts CLEAN. New traders have this false sense of security thinking that they improve their ability to predict price moves by packing the charts with 10 different indicators.

There is a psychological rationale that explains why us feeble humans think this way but i'll touch on that in another post. For now just take my word for it and resist the temptation to complicate things. It will only hurt your progress.

Having too many indicators on a chart serves only to confuse you because they often give off conflicting signals. In other words, one might be screaming buy, another might be screaming to sell and yet others will tell you to sit tight! How does a trader handle that much conflicting info?

The simple answer is that they can't. The trader will eventually suffer from a common trading syndrome known as Paralysis-By-Analysis: You are analyzing too many different factors and eventually find yourself acting on none of it. So strip your charts clean with the exception of maybe one or two indicators at most and build from there.

So, we've established that using too many indicators is almost always counter-productive but there is actually another reason so many traders fail with them. The indicators they do use are used entirely the wrong way!

In my next post i'll elaborate with some specific trading set-ups that make use of indicators that i've had some good success with. I'll explain which indicators those are and how you might consider using them to help your trading.

Stay tuned!

The Difference Between a Good System and The Right System

A good system is one thing: a system that has a high profit expectancy.

The right system is two things: a system that has a high profit expectancy AND a system that YOU can trade with consistency and discipline with minimal error.

Before i go any further into different styles and methods of trading, i wanted to take a step back and re-emphasize what i've been mentioning periodocally throughout the blog: YOU MUST FIND A METHOD OF TRADING THAT SUITS YOU AND YOUR UNIQUE PERSONALITY.

You might be asking how that's done or even why you should bother but let me assure you that even though you might not see it now, it will be well worth your time.

Before you ever place your first trade or build or buy your first system you have to do some soul searching. It's important to take a look at yourself and determine what you expect to get out of trading. Determining your objectives is such an important part of learning to trade yet so few take it seriously enough. The answers will ultimately serve as your guide to your perfect system.

Let's take a look at some things you should be finding answers to:

• How much time do you have to dedicate to trading each day?
• How much time will you dedicate to training, which can include personal psychological work, developing systems, reading, etc.
• What are some of your personal strengths and weaknesses? Are you patient? Do you consider yourself the introverted or extroverted type? Are you typically a disciplined person? Do you panic easily?
• Do you have personal conflicts (could be work, could be family or anything else that can arouse emotions with the potential to interfere with trading)?
• How much money do you have to dedicate to trading?
• How much are you willing to lose? How much drawdown are you willing to endure?
• Are you trading to earn a living or build wealth over time? If trading for a living, how much do you need to make in a year to live off?
• What are your return expectations?
• What kind of market conditions would you feel most at ease trading? High or low volatility currency pairs, pairs than tend to trend, range, a bit of both?
• How do you view money management? How will you manage your risk?
• How will you enter trades? Purely technical reasons or fundamental reasons? Combination?
• How exit methodology do you feel is best for you? Trailing stops? hard stops? Technical stops? Do you see yourself going for smaller, more frequent profits or trading less frequently but going for much bigger profits?

I can continue to go on but i think you get the main idea. For a more detailed explanation of this idea, i strongly recommend you read Van Tharp's Trade Your Way To Financial Freedom.

Write down your answers and let them lead you to a system or style of trade that feels right to you and fits your current lifestyle. Too many try to fit the system rather than letting the system fit them. Once all the building blocks are in place trading should be effortless because it's right for you. If it's not right for you then trust me when i tell you that you will eventually find a way to sabotage yourself that will show up in many different forms:

1. It might show up in the form of a lack of discipline, not following your plan
2. It might show up as you quickly losing confidence in a system when it starts losing
3. It might show up as a feeling of boredom, feeling the need to find something more exciting.

You see bad trading is not necessarily the result of a lack of discipline but rather not having the right system to trade with in the first place. Brett Steenbarger in his excellent book Enhancing Trader Performance, mentions that lapses in discipline are often subconcious attempts at moving away from something that doesn't fit to something that does.

So spend some time self-assessing and thinking about your objectives before placing your hard-earned money on the line...you will thank yourself later on.

Forex Signal Providers & Automated Forex Trading

In some previous posts, i was mentioning that one of the most effective ways to trade is by getting a solid grasp on Support and Resistance and Candlestick Analysis. Nothing has changed and i still believe that with 100% conviction. But not all traders are built the same and therefore what i consider to be the best may turn out to be the worst thing for another.

Having said that i would be doing the readers of this blog a serious disservice by not expanding my discussion to other types of trading - which brings me to the topic of this post: Signal Providers and Automated Trading

The fact of the matter is that S&R and Candlestick analysis take time to learn. They probably take more practice than any other style of trading out there. All the literature you get your hands on will tell you that trading has to be kept objective, but trading these methods is considered, by some, to be very subjective and time consuming to back test.

Many traders feel much more at ease with a method that is 100% mechanical, void of any judgement and subjective interpretation. This style of trading is very practical to program and quickly backtest because trading rules are extremely precise. It is, to this group of traders, the best way to remove emotional interference from the trading equation. These arguements are the primary reasons we see automated trading growing in popularity so quickly.

Signal Providers are now, more than ever, providing complete automated solutions to traders. Essentially, they provide you with buy and sell recommendations and automate the execution of the trades for you on your brokerage platform with the ability to override trades if you so choose.

I wrote an article outlining several things to watch out for when choosing providers and under what cicumstances traders can use them successfully because let's face it - there are many scams out there. I won't rehash it here so feel free to read it here if you haven't already. http://www.goarticles.com/cgi-bin/showa.cgi?C=1107835

What i want you to take away from that article is the importance of managing your expectations and CONSERVATIVELY testing everything out for yourself. Question everything and never take anything for granted and you will come out so far ahead of other traders who don't bother. Every action you take should ensure you are protecting yourself.

If you read my article and are 100% serious about my guidelines, then you're ready to give the Automated Forex Trading System by PROSIGNAL a look. I have personally used these guys when i started trading about 6 years ago and they are still around today. They have evolved into something quite impressive as far as automated trading goes.

The way thier automated service works is this: Have a look at the performance data of the 200+ signal providers Prosignal has partnered with and decide which combination of strategies appeal to you the most. You then create a portfolio of providers that PROSIGNAL will trade for you through your brokerage platform.

Why i like PROSIGNAL in particular?

• Creating a portfolio of so many providers allows you to effectively diversify risk
  
• You have the flexibility to trade strategies from only 1 provider to as many as 100.
  
• Loads of statistical data provided to help you decide which providers are best
  
• PROSIGNAL provides plenty of sensible guidance to help you create your ideal portfolio (In my opinion, use a portfolio of providers that offer a profit factor of 1.5 or higher, at least 100 trades on record and a tolerable drawdown relative to total profit)
  
• Performance history also includes live trading results
  
• PROSIGNAL takes education seriously. They have a complete educational package to help get you up to speed on FOREX basics, risk management and trader psychology.
  
• They have phenomenal customer support
  
• Low cost trades.
  

WORD OF CAUTION:
It is very easy to look at the performance pages and get excited. Stay calm and objective and realize that what and how you trade will be dictated by a conservative risk management plan and how capitalized you are. You may or may not duplicate posted results.

In my experience, the posted results are legitimate, Prosignal is legitimate, and you can make money with them. But as with any style of trading, proceeding conservatively and patiently and protecting your downside risk is the only way to go, especially in the beginning. What i like most about Prosignal is that they are very open with this notion. Just decide upfront whether trading a black-box system fits with you. If it does, i truly believe there is no better choice than PROSIGNAL.

FOREX Software: Test Your Strategy !!

FOREX Tester is a brilliant piece of software that not only makes the critical process of testing easier, but more enjoyable, too. You have access to tons of historical data for several currency pairs, which allows you to perform a meaningful and statistically significant test of your system.

It has a complete charting package with various indicators and drawing tools (support and resistance, trend lines, etc...) as well.

In a nutshell, you can manually backtest your system by indicating directly on the historical charts where your trades would have taken place, while the software automatically keeps track of all the necessary statistics described in the previous post

Furthermore, you can tell the software what your money management rules are - basically, what you want to risk per trade. It will then account for that in your profit/loss statement statistics.

FOREX Tester is a truly innovative product that can do wonders for any trader's performance and confidence. Do yourself a favor and check out all the free instructional videos on the site.

You can also give a demo version a try for free. Although the demo version is somewhat limited compared to the purchased version, between that and the tutorials you should have a pretty good idea if it's what you're looking for.

Now, let's fast forward in time a bit and assume you've got a system you've tested. When you view your results, obviously the first thing you will turn to is the total profit. I urge you not to look at your profit in isolation from other important factors such as:

1. Drawdown. This is probably the most important figure and represents how deeply your account equity loses value from a previous equity peak. For example, if you start with $5000 and suffer a few losing trades that brings your account down to $4500, then you have endured a 10% drawdown. You can have a great system that yields insane profits, but how would you feel if on the way to those profits you had to go through a 60% drawdown? I personally cannot endure more than a 20% drawdown, so no matter how profitable a system is, i would never trade it knowing that the potential for this kind of drawdown existed. Reflect on this carefully BEFORE you trade!

2. Largest winner. If the largest winning trade in your testing is responsible for most of your total profit then steer clear. If, for example, you have net profit of $5000 but $4800 of that profit came from a single trade, then the system cannot be considered reliable.

3. Average winners and losers. The software will take all winning and losing trades and calculate their respective averages. The goal is to ensure your average winner is greater than your average loser. This is an important figure in establishing your reward:risk ratio over a series of trades, which is what really counts. As i mentioned in earlier posts, you might have a winning trade only 40% of the time but if, on average, your winners are worth $200 and your losers $75, then your reward:risk is 2.6:1, a very good ratio that would ensure you are still making money over the series of trades.

4. Expectancy. This is what you should be focusing on! It is basically a mathematical calculation that takes into account the accuracy of your system and its reward:risk ratio (also known as an R-multiple) and comes up with a figure. That figure is then multiplied by the number of trade opportunities the system made available. This figure, known as expectancy, allows you to establish how good your system is compared to others in terms of profit per dollar risked.

If we elaborate on the above example, which assumed you have a system that wins 40% of the time and loses the remaining 60% of the time. It also assumes the value of your average win to loss was $200:$75 or 2.6:1. Let's also assume there were 100 trades taken over the test period.

The formula is simply this:

Expectancy = (% winners x r-multiple) - (% losers x r-multiple)
(0.40 x 2.6) - (0.60 x 1)
1.04 - 0.60 = 0.44
0.44 x 100 trades = $44 expectancy per dollar risked

Use this formula when deciding which systems to trade and you will have a discernable advantage over the countless other traders who focus solely on the accuracy of a system. Always trade in favor of expectancy and NOT accuracy

Please do check out Van Tharp's excellent and practical explanations on this essential topic

Until next time, i hope you enjoy the many benefits FOREX Tester brings you
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FINAL WORD OF ADVICE: Keep your system simple! As complex as this world of trading may seem to be, the irony of it all is that success stems from simplicity. Don't litter your charts with countless indicators to try and explain and capture every market movement. If you use them at all, keep it to 2 indicators at most or you run the risk of having a curve-fitted system that perfectly accounts for history but is worthless going forward (more on indicator combinations in future posts)
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Your FOREX Trading System - How To Know You've Got a Winner.

As traders we must feel comfortable living life on the right edge of the chart, where what happens next is unknown.

As I mentioned many times in earlier posts, attaining a proper mind-set is key to long-term success. That said, a key mental characteristic of professionals is confidence; confidence that their systems will be profitable, confidence to pull the trigger despite not knowing how the next trade will turn out and confidence to trade their system with the utmost discipline even when faced with many consecutive losses.

A bit of a paradox if you ask me. How on earth can someone have confidence in a future outcome when, by definition, the future is unknown? That’s the mark of a true professional…to be able to march confidently in the face of uncertainty.

Suffice it to say that most people do not start out with that degree of confidence in the markets and most are not willing to do the necessary legwork to acquire it either. But that doesn’t have to be you. Take the advice in this article to heart and you’ll be trading with the mind-set of a pro in no time flat!!

Since no one can know what will happen in the future the only benchmark you have to work with is what’s happened in the past.

I am assuming that you already have a system, either one you purchased or one you’ve devised yourself, complete with entry, exit, stop-loss and risk parameters as we discussed earlier. So you’re armed with a system and have high hopes but what do you really know about the dynamics of your system? If you haven’t backtested it then you know nothing about it except its rules.

Too many traders get their hands on a system and simply assume it will work. They blindly place their trust in the system without truly knowing where they stand with it. This is why you MUST back test. By testing it you will give yourself an idea if the system can work in the future. It is the only fighting chance you have with a system before you put money on it. If it doesn’t work in testing, don’t expect it to work going forward either.

Whatever you do, PLEASE don't just take my word on any system suggestions i make in this blog! You have to make your own assessments, even on the ones you believe to be top-notch. I have saved myself fortunes by rigorously testing any system I get my hands on. And it is through this tedious, time consuming process you gain your confidence to trade a system, especially during rough times.

So, how exactly do you go about backtesting and what information do I need to get out of it?

First and foremost you have to get your hands on loads of historical data. Some advanced brokerage platforms provide it with their charting and other times you need a separate piece of software. Once you get it, this is the info you need to analyze from your backtested data:

1. Total number of trades you tested (I recommend a minimum of 100 trades over several market conditions)
2. Number of winners
3. Number of losers
4. Accuracy. (What percentage of trades turn out to be winners)
5. Value of winner. (What each winner was worth in dollars, on average)
6. Value of losers. (What each loser was worth in dollars, on average)
7. Maximum number of consecutive losses
8. Maximum number of consecutive wins
9. Maximum drawdown (what percentage did your account value lose from a previous equity peak)
10. The mathematical expectancy of your system – ABSOLUTELY ESSENTIAL CONCEPT

Now that I’ve told you why you have to backtest and what you have to get out of it, what about HOW? That is a good question to which there are a couple of answers. You can manually backtest or if your system is completely mechanical you can program it. I'll discuss each option and where to find the right resources for each in the next post.

The premise here is that even though past results are no guarantee of future performance, it’s fair to at least assume that if a system performed well over a long period of time in the past that the odds are favorable it will continue to please going forward. This is the way you acquire the necessary confidence to trade a system!

This is a crucial topic and I have lots more to say about interpreting your results, expectancy (what's that?!?), win/loss distributions (huh?!?!), software you can use to facilitate the process and actually make it fun. Until then, be well!

MONEY MANAGEMENT - How NOT to Lose Your Shirt (Part 2)

Let's start with a concrete example. If we take a look at this chart again of the EUR/GBP we see it is caught within a descending channel, trading up near the resistance.

Let's say we decide to enter a SHORT trade if the next candle that prints is bearish (red). I'm not sure why but the currency prices have been cut off. Let's assume we eventually enter the short at a price of 0.6740. We decide to place our protective stop loss at some point above the resistance line, say, at 0.6770. Our profit target will be set at the bottom of the channel at approximately 0.6620.

What does this translate to?

We are taking a 30 pip risk (0.6740-0.6770) for a potential gain of 120 pips (0.6740-0.6620). This is a reward:risk ratio of 4:1, meaning we stand to gain 4 pips for every 1 pip of risk. This is a fabulous ratio! How do we decide how many contracts or lots we trade on this trade then?

To figure that out we need a few pieces of information:
1. Account balance, which we will assume to be $ 7500.00
2. What percentage of this account do we want to risk on a trade (1% or $75.00)
3. What is our stop loss in pips: 30 pips

Then we plug that info into this nifty little calculator:
» Adjust the position sizing Mataf.net:

What this will reveal is the maximum pip value you should be trading. The results show that each pip should be worth a maximum of $2.50 in order for you to lose a maximum of 1% should your stop of 30 pips be hit.

I'm not sure what broker you deal with so check their pip values for a single mini contract of EUR/GBP. It should be worth approximately $1.80 per pip. So that means if you trade 2 mini contracts on this trade, you will be trading a pip value of $2.60 - slightly over the recommended $2.50. So, it's best to be conservative and round down to 1 contract.

Play around with the tool and see the changes in pip values according to the parameters you enter.

The above money management methodology is called the Percent Risk Model. It is the one i like the most as it allows you to equalize your dollar risk no matter the size of stop you use. For example, whether if i have a trade on that has a 30-pip stop loss or a 100-pip stop loss, this model adjusts your position size accordingly so that your risk in dollars stays consistent all the time.

There are many other models of money (risk) management that you may feel more comfortable with but the important thing is that they all must be able to put the power of compounding returns on your side. Too many traders start trading and arbitrarily place single contract trades without regard to the power of compounding. I cannot say enough how powerful the impact is on your bottom line.

Which reminds me, i want you to have a look at these guys:

Trader's Club is a highly reputable training group/program for aspiring, struggling and experienced traders alike. They make no claims of instant riches, only that riches are within everyone's reach if you do the right things. Have a look and decide for yourself if they are right for you.

But if you do one thing, sign up for their FREE VIDEO SERIES on risk management. It will drive home everything i've said, only far more effectively. They will send you 4videos (1 per day) explaining all elements of the topic and how to properly implement the power of compounding returns. Specifically it illustrates through live account shots how a $1000 account grew to over $11,000 in about 1 year.

Finally, i strongly advise you to read through Van Tharp's book on the topic here:

This is an authoritative industry resource on system development and does a superb job of describing different money management (AKA position sizing) styles and the impact each style has on trading results. Check out the chapter on position sizing and read it over a few times. You will be stunned at how much of an impact it has on your results. No trader ever questions its importance after reading Van's work.

MONEY MANAGEMENT - How NOT to lose your shirt!

Let's take the previous post one step further.

We talked about one way of timing an entry (after the Spinning Top candlestick formed near the resistance line we went short). We also talked about where to exit the trade if profitable (near the opposite support line) and where to exit at a loss (above resistance line).

But what about how much to risk? How large a position do you put on? How many pairs do you trade simultaneously? These are actually the more important questions.

You see the simple fact of the matter is that trading is and only ever will be a pure numbers game.

A good analogy is the coin-toss. We all know that the odds of any individual toss coming up heads or tails is 50/50. But what are the odds of the coin landing on the same side 6 or 7 times in a row? If you toss the coin long enough, the odds are pretty good that you can get those kind of streaks.

Here's an enlightening statistical chart that drives the point home as it relates to trading:



Print this chart and put it somewhere that you will always see it. Use it to remind yourself that even the most robust systems will have losing streaks. Depending on the nature of the system, many professional traders' winning trades account for about 40-50%. Looking at the table, you can see that over the course of 50 trades there is about a 30% chance that the trader will hit a streak of 6 consecutive losses.

Once you get used to support and resistance trading your accuracy can go as high 60-70%. But even at 60% accuracy you run about a 17% chance of hitting 6 consecutive losses over your next 50 trades.

It is not even a question of if you hit a losing spell...it's WHEN you hit it!

What do you do then if your otherwise robust system hits a losing streak and you're risking 15-20-25% of your account on each trade? BUST!!!! You have a great system that can do well for you but you lost because you were risking too much!

How on earth are you supposed to make money then, you ask? How do professional traders do it then if some of them have only 40% winning trades?

Simple...proper money management (AKA risk management)! They hold on to their winning trades long enough such that over a long series of trades, the value of their winners far outweigh the value of their losers. In other words, if a trader is only winning 40% of the time but his winners are worth, on average, $200 and his losses are worth only $75, then the trader is making money over time. That's the real secret!!! The pros aren't trading for accuracy nearly as much as they are trading to ensure the VALUE of winners outweighs the losers.

They also trade position sizes (lots or contract sizes) small enough to ensure that they survive the eventual losing streak.

Traders make millions in spite of poor accuracy because they have the discipline to respect the relationship between what they risk on a trade and what they stand to gain. They never look at either factor in isolation. They will have the discipline to let a trade go if the potential gain is too little in relation to what they stand to lose. You have to be able to do the same.

It's hard because we are psychologically wired to want to be right all the time. But as i hope you are beginning to understand, successful trading is NOT about being right all the time...it's about making as much as you can when you are right and losing as little as you can when you're not. So, how do you get over this psychological dilemma? It's surprisingly easier than you think but the answer goes beyond the scope of this particular post (...to be continued...)

So, the bottom line question: How much should i risk on my trades?

The answer will largely depend on how robust your system is (which i will be discussing in a future post on testing) but it is safe to say that a beginner should be risking nothing more than 1% of his account value on any single trade.

In the next post, i'll introduce specific styles of money management. You decide which one is best for you. It doesn't really matter as long as some form money management is actually put to use. I will also show you a neat little tool to help you calculate your contract sizes given your account balance, % risk you want to take, and your established stop loss level.