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.

The best FOREX trading system

This post is a little long but i implore you to consider it seriously and take your time. This is probably some of the most important information you will come across as far as system development is concerned. So please bear with me.
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The title may be catchy but truth be told there is no such thing as the BEST system - only what's best for you.

In my experience, however, trading on what's called Support & Resistance in conjuction with Candlestick Analysis have proven to be one of the most reliable forms of trading out there. There are several techniques to isolate support and resistance on a price chart but the basic definition no matter what is as follows:

SUPPORT: A price point on the chart for which the market has historically had a difficult time moving below.

RESISTANCE: A price point on the chart for which the market has historically had a difficult time moving above.

Definitions aside, i do not want to bog you down with a technical explanation of Support & Resistance and Candlestick Analysis. The recommended reading from previous posts should have you up to speed on that. But a couple of online resources that i have found particularly helpful in putting it all together, that are dedicated strictly to candlestick trading can be found here:
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Click Here! - an amazing e-book that explains the essentials of candlesticks and gets you profiting sooner rather than later.

Great resource if your education budget is limited, too!!
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This course is really the cream of the crop of candlestick courses. Very reasonably priced considering the sheer volume of quality information in there and saves you loads when compared to buying the program's individual components. No stone is left unturned with this course and convincingly demonstrates why candlestick analysis has been around for 4 centuries. Master the information in this course and you will have a discernable edge over so many others who don't have the time or inclinination to dedicate to learning this wonderful art.

Oh and one final thing...don't be thrown off by the fact the author talks about stocks or commodities during his analysis. It doesn't matter! Candlesticks have been around so long because they are adaptable to absolutely any market.
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What i really want you to understand is WHY these 2 forms of trading work so well. I want you to clear your mind of all those indicators and the dozens of variations that you've been reading about, and focus on ONLY these 2 things for now. These 2 methods alone can make you rich over time without ever having to look at another method in your life. There! You should now be able to breath easily knowing that there is all of a sudden much less to learn.

So, what makes these 2 methods of technical analysis so powerful? Simply put, they capture the essence of market psychology. They tell a very clear story of what the market is "feeling" as a whole and what the market is likely to do next.
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Set-ups from some of my previous trades will make this very clear:


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Look at the first chart. Did you see how price tended to bounce around very specific price points and had a hard time getting away from them. I simply used the top resistance line in conjuction with a Spinning Top candlestick formation to tell me that this was a likely turning point.

So, that's a potential entry point. What about a stop loss? A stop is ideally located at a point that would tell you that the trade will likely no longer work. When you enter a short position, you basically want the currency pair to drop or lose value. If it goes up or gains value then you're losing money. How far up does it have to go before you decide to pull the plug and take your loss? If the pair has moved up a reasonable distance above the established resistance line, then it is more likely that the pair will continue going up. Best to get out and preserve your capital. What about a profit target? How about at the bottom of the range where price is likely to re-bounce?

This above was just a simple illustration of how you need to think about planning a trade. There can be many variations in the time frames you use, how you can enter the trade, how you can exit it and set stops. But in essence the basic steps do not change:

- Search for a set-up on a suitable time frame
- Look for entry point on that set up
- Set a suitable stop loss
- Look for exit point.
- Be disciplined and do not change plan mid-trade.

Now look at the second chart. This is just text book set-up!!! Look at how many times price has challenged these trend lines!

These are not some well-picked examples and as your own research is clearly indicating, these are only a couple of common variations of how Support and Resistance can be used. These kinds of trades litter the charts on all time frames. You just have to train your eye to see them by practicing. And these points help keep your trading adaptable, helping you pick out both range-bound (like this case)and trend trades (like the second chart)

You need to realize that reactions to these areas of S&R are not just flukes. They become important reaction points because they reflect the very basic human emotions of fear, greed and regret. This is what drives the decisions of most traders. Price has a memory is what they say, and i believe it to be 100% truthful.

Think about it, if you fail at something it is a very basic psychological response to associate a repeated future attempt with that previously failed attempt and, consequently, hesitate. Alternatly, if you do not try again, you will no doubt regret it if the attempt would have proved successful.

Most technical indicators you've been reading about are lagging or REACTIVE in nature, meaning they are a derivation of what the market has already done. They have no predictive power per se, except that they may be self-fulfilling (if many people are looking at the same thing then it could come true). Now I'm not suggesting indicators don't work as a means of trading, I'm just saying i personally don't use them often. When i do, i don't use them in the traditional sense (more on that in the future)

Support and Resistance and Candlestick analysis are PREDICTIVE. They reflect the market's emotions and illustrate with high probability what might happen next.

Again, please take this advice seriously...You would be doing yourself and your trading career a huge favor by focusing your study of Technical Analysis on these 2 topics. I have only touched on the power of Support and Resistance and Candlesticks in this post and i hope i have convinced you that it is worth further study.

In addition to the ones i suggested in earlier posts, there are literally dozens more books you could read on the topic. Books are great but in my almost 7 years trading, i have not seen an online resource as credible and dedicated to the study and implementation of support and resistance as this:



This program is so worth its weight in gold as it goes way beyond the call of duty as far as quality information. A large part of this course is dedicated to the topic of this post, but it also looks at so many other things to help kickstart your trading career. It is a COMPLETE package from A-Z. This is by far one of the more credible programs in the industry today.

I cannot give you a magic formula here because there is none. What i have shown is a very basic approach to trading support and resistance that is no more or less valid than any other variation you will surely come across. That is the beauty of S&R...it's so dynamic. Experiment with what you read in the recommended resources and test everything (more on testing systems later). You will find your niche!!

FOREX Trading Systems

As i mentioned in a previous post, trading systems are not nearly as important as your mind-set and ability to manage your risk. But make no mistake, you still NEED a system! A proper mind-set and good risk management are meaningless without a system to apply them to.

In layman's terms, all a system is is a methodology on which you decide when to get in and out of trades. It is meant to keep your decision-making process as step-by-step as possible. So how do you build one?

If you're doing your recommended reading, you have most definitly come across different possibilities on which you can build one. Some swear by fundamental analysis, where, in a nutshell, you spend your time analyzing various components of the economy to come up with a decision on how to trade certain currency pairs.

More likely though is that you are reading alot about technical analysis, which essentially operates on the assumption that history tends to repeat itself. Historical prices tend to form patterns that can be used to establish a probable future direction.

There will forever be a battle between the fundamentalists and technicians as to which is better, so let me get it out there now...In my humble opinion, fundamental analysis is completely unnecessary for you to succeed. That's not to say you cannot incorporate it into your arsenal at some point but i know many successful traders who don't bother with it at all.

Fundamentals don't move markets, people do. And people are emotional creatures each with their own unique interpretation of data. It is technical analysis that captures this emotionality so i will focus on this for purposes of helping you establish a system.

If you've read any book on technical analysis you surely must be going crazy by now trying to figure out which indicator to use. Do you use one or a combination? What's better: MACD, RSI, Stochastics, moving average crossovers? Should i trade price ranges or should i try to catch the big trends? Should i take small but frequent profits or should i go for the homerun trades?

I can certainly understand how you can get lost in it all. And it's too easy to get ahead of yourself, seeing dollar signs next to every new indicator that's discussed. So, slow down for a moment and take the time to reflect on a few things that the technical books might not have mentioned:

First, recognize that the act of trading should not be difficult. Learning and preparation take time but when you are ready to trade, it should be easy as pie. And the only way it can be easy is if you accept that trading has to work around your schedule. You cannot alter your life to accomodate trading because it will consume you. So, if you have a full time job then it is unlikely you will be able to day trade, in and out of the market all day long. Time frame is crucial. Trade a time frame that makes sense to your lifestyle. There is a method out there for everyone, but it has to fit YOU!!

Second, know your strengths and weaknesses as an individual. As ridiculous as this sounds it will have a profound impact on which system you ultimatly settle on. For example, if you are a patient and conservative type of person, then you are not likely to select a system that involves hugely volatile movements. It would drive you crazy and you would not be able to see your plan through.

Do not judge the merit of a system based solely on the bottom line. It has to feel right and fit your unique personality IN ADDITION to being profitable.

Alas, this sometimes takes some experimentation with different systems but you keep these things in mind and you will find it.

In the next post, i will try and cut through all the fog with a method of trading that can fit just about everyone. In the mean time, i'd like to recommend the following reads. It captures the essence of what i am saying in this post 10-fold that every great trader always has a system that fits with their personality.

Please do not take this topic lightly as it all falls back to trading with a proper mind-set

Forex Leverage:Traders beware!!

Our previous discussion on selecting brokers would not be complete without touching on the most important thing they make available to you, the trader. And that thing is called LEVERAGE.

Leverage can be a magic word or a painful word depending on how you employ it. All brokers offer it and will often use it as an incentive to attract you: "GET STARTED TODAY! 400:1 LEVERAGE, MINIMUM STARTING BALANCE $250" Wait a minute...i thought it took money to make money?!?! Forex is unique in that it rivals all other markets out there when it comes to the amount of leverage made available to traders.

Picture this: A trader starts with a balance of $1000, places a trade that turns out to be a winner worth 100 pips (a pip, as you have probably already read in your studies, represents the minimum price fluctuation a currency pair can make.)Depending on the type of account this trader has, this 100 pips could represent $1000profit. How about that!! A profit of 100% on a single trade!! INCREDIBLE! It is leverage that makes this kind of return possible.

Is this an exaggeration? Not at all! And it is this potential that attracts so many new traders to this arena. It is possible. But it is also what sees most traders leave significantly poorer than when they came. Leverage is what makes this market most attractive but misusing it makes it most dangerous as well. And unfortunately way too many traders misuse it.

Let's get specific here. I'm not sure how up to speed on this concept you are, but this article provides a pretty complete picture of the idea:

(So you have a more involved understanding of the article, let me just point out that brokers typically offer 2 types of accounts, a standard and a mini account. The standard account allows you to control lots each worth $100,000 worth about $10 per pip, and minis allow you to control lots of $10,000 worth about $1 per pip.)

http://www.investopedia.com/articles/forex/07/forex_leverage.asp

Spend some time with this article and make sure you fully understand the dynamics of leverage. It may seem like there are alot of calculations to consider before initiating a trade to make sure you don't overleverage yourself, but in reality it doesn't have to be that involved. The above is meant to give you a detailed breakdown of things so you fully appreciate the concept. But when it comes time for you to trade, you just need to keep it simple.

Understanding how leverage will fit in to your overall money management plan is important but let's put things into perspective a little more simply by looking at how most professionals deal with it (and this is really what i want you to take home from all this):

Most professional traders and money managers trade in such a way that they are never risking more than 2% of their total trading capital on any single trade. In other words, if you have a $5000 account, you should never lose more than $100 on any single trade. This means you should probably be trading 1 or 2 mini lots per trade at the most. This will probably equate to about 4:1 REAL leverage (depending on stop-losses you use). This is the most leverage a beginner should use.

Do not let emotions like fear and greed influence you at this early stage of the game. Rest assured there are ways to overcome these basic human emotions in the trading arena that we will discuss in later posts, but for now just trust me. Use leverage conservatively and intelligently.

Place your trades with this perspective in mind and leverage will take care of itself. If the pros do it this way, don't think for a second that a newcomer can use loads of leverage and survive for long. Won't happen.