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Avoiding a Trading Tragedy

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1Avoiding a Trading Tragedy Empty Avoiding a Trading Tragedy Fri Apr 24, 2015 9:50 pm


Global Moderator

You may have spent time, money, and effort learning about indicators. You may have learned through experience that trading with indicators can be very difficult. In some ways, trading with indicators makes it difficult to find profits. Perhaps a close look at why indicator-based trading systems have difficulty finding profits in forex is in order.

All indicators are created from price data. This is what all indicators do to price data: Price data enters into an equation and is spit out as something else. Sometimes the end product is a squiggly line, sometimes a straight line, sometimes a color or a number; it depends on the indicator. The end result is always the same: The indicator changes price data via a formula. The form of this end result (the indicator) may vary, but the process is always the same.

These very same indicators, based on price data, are meant to hint at future movements in the market. Stated another way, an indicator will suck in price data, massage and process these data, and then spit out a graphical representation of these data. Indicators offer price data in another form. Perhaps this new form of price data is easier to interpret; perhaps this new form of the price data will hint at what the market may do in the near future. All indicator-based trading systems are founded on the idea that price data is in a better form when presented as an indicator. Trade decisions based on indicators assume that the data in indicator form is more valuable than raw price data.

A metric derived from price data. Historical price data—such as the open, close,
high, and low—are entered into a formula to calculate the metric. This metric
is then represented graphically to anticipate and interpret market movements.

Traders want to know where price will go in the future. Traders pay millions upon millions of dollars for educational seminars, DVDs, website lessons and, yes, even books such as this one. The great hope for most
 traders is that there is a valuable indicator (or recipe of indicators) that will hint at where the market is headed in the future. Millions upon millions of dollars are spent each year by traders (and also investment companies, hedge funds, banks, etc.) because a slight edge may provide millions of dollars in profits. In forex a slight edge may mean billions of dollars in profits.

by Alex Nekritin and Walter Peters

Last edited by gandra on Fri Apr 24, 2015 10:35 pm; edited 1 time in total

Short info about me! I am a software developer at the same time. I developed several trading robots (expert advisors) for trading on the MetaTrader 5 and 4 trading platforms.
  • Expert Advisors on the MQL5 Market. My Current Offer
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2Avoiding a Trading Tragedy Empty Is there a better indicator Fri Apr 24, 2015 10:21 pm


Global Moderator

Which indicator is best?
Which suite of indicators offers a clear edge in the markets? Perhaps it is best to find out who is making money in forex, and then do what they do. Which is the magic formula? Unfortunately, the answer to this question is “It depends on who you ask.” This may very well be the correct answer. As we will see later in the book, trading is often relative and rarely, if ever, a one-size-fits-all endeavor. Some indicators are considered shams, others are misinterpreted by the masses, and still others are best used contrary to their original design intent. Indicators may be incorrect.

What if the indicator is correct, but a bit slow to hint at the direction the market will take?
The indicator might provide valuable information, but might also be slow to the party, and thus not of much value. Perhaps a slight change to the indicator formula will speed it up a bit. Perhaps indicators are similar to a wristwatch, constantly improving, more features available as needed, but would it be possible to take a wristwatch, and manipulate time by running a formula through the hours, the minutes, and the seconds displayed on the wristwatch? Would the wristwatch keep better time once the formula manipulated the actual time of the day?

Using a formula to create a better time on a wristwatch may seem weird and counterproductive, but this is precisely what indicators may accomplish by changing and massaging price data. Indicator-based trading is taking a wristwatch and changing the time with a complex formula in the hopes that the wristwatch will somehow tell time better. Who wants a wristwatch with something other than the real time displayed? Do indicators (all of which are calculated using price data) allow us to understand price better?

Perhaps it is best to put aside any philosophical differences with technical indicators. Let us assume that our indicator is based upon a magical formula and this formula allows us to get a glimpse of the future. Our indicator magically transforms price data into some other number, color, or line, and suggests where price is headed in the near future. Unfortunately, even if our indicator is able to accomplish this, difficulties may endure with indicator-based trading.

Indicators are inherently slow. The market will be moving up long before an indicator suggests it is time to buy. Likewise, an indicator will suggest it is time to sell long after the market has started falling. This is one
of the main complaints with indicators: they lag behind price.

FIGURE 2.1 Traditional RSI Sell Signal on AUD/USD 4-Hour Chart.
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This is a fair concern. Figure 2.1
contains an AUD/USD four-hour chart with the Relative Strength Index (RSI) indicator. Traditionally, there are two RSI signals. If the RSI is above the 70 level, the market is overbought, and once the RSI falls back down below 70, a sell trade is initiated. Likewise, if the RSI falls below 30, the market is said to be oversold, and, traditionally, a buy trade is signaled once the RSI moves back above 30 (see arrow in Figure 2.2).

FIGURE 2.2 Traditional RSI Buy Signal on AUD/USD 4-Hour Chart.
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In these examples we see that the RSI indicator suggests a trade at about the right time. The market turned around near the RSI signal in both examples. However, the RSI did not signal a trade at the precise turning point in the market. To find these turning points, an indicator of a different type is required. One of the primary reasons why naked trading is so attractive to forex traders is because naked trading allows for early entries into trades.

Indicators may alert traders to the fact that the market has turned around after the market has turned around, but naked traders may find turning points in the market as they occur. Naked trading strategies are based on the current price of the market, and, therefore, they allow for an earlier entry. Indicator-based trade signals will lag because it takes time for the price data to be processed through the formulas that make up the indicator.

Significant moves in the forexmarket occur before a technical indicator provides a signal

Naked traders have an incredible advantage. Entering a trade early often means the entry price is closer to the stop loss price. A tighter stop loss may mean more profits, the precise reason for this is examined later in the topics. After mastering a few simple strategies, naked traders find it very difficult to move back to indicator-based strategies simply because nakedtrading strategies remove the lag time that is inherent with indicator-based trading.

Here is another example, this time with the EUR/USD daily chart (Figure 2.3). In this example the indicator at the bottom of the chart is the Moving Average Convergence Divergence (MACD). The construction and theory behind the MACD is not important, the MACD consists of a few moving averages. The critical signal for the MACD is when the two moving averages cross (see the dark circle in Figure 2.3).
A traditional buy signal occurs when the MACD has been traveling lower for some time and then turns around, and the faster-moving average crosses the slower-moving average.

FIGURE 2.3 Traditional MACD Buy Signal on EUR/USD Daily Chart marked with a circle.
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In Figure 2.3 the EUR/USD daily chart has been falling for some time. Price starts to turn around and trade higher, and consequently the MACD moving averages start to creep upward. Finally, we see the faster-moving average on the MACD has crossed above the slower-moving average. This signals a buy trade for the MACD trader. After crossing upward on the MACD, the market does indeed move higher (see Figure 2.4).

FIGURE 2.4 The EUR/USD trades higher after the traditional MACD Buy Signal on EUR/USD Daily Chart.
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Although this trade looks like a nice trade, the naked trader would have entered this trade earlier than the trader using the traditional MACD trading strategy. The naked trader and the MACD trader both profit, but the naked trader is able to enter the trade sooner and use a tighter stop loss.

Tighter stops mean more money. The naked trader and the MACD trader could have both exited at the same price, but the naked trader captures more profits because the stop loss is placed closer to the entry price.
The money-management section of this book will have more information on how naked trading strategies enable traders to make more money simply because naked signals appear earlier than indicator-based trading

The MACD and the RSI are not the only indicators that lag. All indicators lag. The stochastic is a popular indicator used to time trades according to the natural rhythms of the market. One traditional stochastic trading method is similar to the RSI strategy. A sell signal is indicated when the stochastic falls below the 30 level and then crosses higher (see Figure 2.5).

FIGURE 2.5 EUR/USD 1-Hour Chart—Traditional Buy Signal on the Oversold Stochastic.
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The EUR/USD 1-hour chart shows the stochastic falling below 30 on the stochastic. A few hours later, the stochastic crosses upward and rises above 30, a clear buy signal. The stochastic is moving up, so price should follow. However, the market then falls a further 90 pips. For most traders this trade would be a big loser.What about the naked trader? In this instance, the naked trader gets a very clear buy signal after the stochastic buy signal (see Figure 2.6).

A “pip” is a percentage in point. One pip is equal to 1/100th of 1 percent. It has traditionally marked the smallest move a forex pair can make. Forex traders track trades in terms of pips. However, many brokers are now using “pipettes”—these are 1/1000th of 1 percent units.

FIGURE 2.6 EUR/USD 1-Hour Chart—Naked Buy Signal versus Stochastic Buy Signal.The traditional stochastic buy signal occurs immediately before the market falls.The naked trader has a buy signal at the market turning point.
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What happens after the naked trading signal? The market jumps more than 40 pips immediately. The naked trader avoids many losing trades by waiting for a price action signal and quickly finds profits. Not all naked
trades are winners, of course, but this trade is an example of how the naked trader is able to avoid some of the very common indicator-based mistakes because the naked trader uses the price action of the market to determine entry signals.

Notice how the naked trader avoids the drawdown with this trade signal. The market immediately moves in the expected direction, upward, after the signal. Contrast this entry to the stochastic entry signal.
The characteristic indicator lag associated with the stochastic means that the stochastic trader not only enters a losing trade, but immediately after the stochastic signal the market trades in the wrong direction, and the trade enters into a protracted drawdown. In fact, it is unlikely that the stochastic trader ever had profit on this trade. Naked-trading strategies enable the trader to enter a trade based on current market price action, and often avoid the severe drawdowns associated with indicator-based trading.

Most traders believe severe drawdowns are a part of trading. This is simply not true. Severe drawdowns are characteristic of mistimed entry signals, and most traders use indicators to find entry signals, so most traders mistime entries.

by Alex Nekritin and Walter Peters

Short info about me! I am a software developer at the same time. I developed several trading robots (expert advisors) for trading on the MetaTrader 5 and 4 trading platforms.
  • Expert Advisors on the MQL5 Market. My Current Offer
  • Official Telegram Channel: [You must be registered and logged in to see this link.]
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3Avoiding a Trading Tragedy Empty Taking responsibility for losing trade Sat Apr 25, 2015 11:37 am


Global Moderator

All traders experience drawdowns. All traders experience losing trades.However, naked traders take responsibility for losing trades. Indicatorbased traders often blame their indicators for unsuccessful trades (e.g., “the MACD looked like it was going to cross here,” “my indicator did not load correctly,” “maybe I should change the settings on my indicator because the market has been choppy lately,” “that moving average crossover was a fake out—whipsawed on that one,” etc.), but the naked trader does not have this excuse. There is no scapegoat when you are using market data (price action) to take trades. Trading with price action, that is, the actual price on the chart as the basis for all trading decisions, means that the naked trader has no excuse for losing trades. This is extremely liberating for many traders.

The indicator-based trader also has the added advantage of an indicator to blame when things go awry; the naked trader can blame no one but the market for losing trades. This is a subtle but very important difference point of reference for the naked trader. All trading involves an aspect of luck. All traders experience a lucky streak of winning trades and an unlucky streak of losing trades. Without the crutch of indicators, naked traders are more likely to take responsibility for their trading results.Perhaps we should take a close look at this idea of trading responsibility.

If you decide to trade a new trading system, you may have put the system through a screening process. After spending time testing the system, you have convinced yourself that the trading system is worthwhile and will indeed make money over the long run (at this stage your research may far exceed the effort that 90 percent of forex traders put into their trading research). If, after all of your research, when you start trading live you see the first seven trades turn out to be losing trades, you may be discouraged. What would you do? Perhaps you decide to maintain trading the system, and you suffer through an additional three more losing trades. After 10 consecutive losing trades what would you do?

Would you stop trading the system?Would you create a new rule to filter out some of losing trades that you have experienced? Would you decide the trading system is no longer profitable, and give up on trading the system? There are many possible explanations for the reason why the trading system failed after you launched it into live action. Maybe the market has changed. Maybe the system no longer works. Perhaps the 10 losing trades were just an unlucky streak. Your decision, after faced with the 10 losing trades, will place you into one of two groups: the terrible-system group or the bad-market group (only naked traders can avoid these groups). If you are unsure about your group,pay attention to what you think about the next time you have a string of losing trades, you will quickly learn which group is yours.

Terrible-system traders, after a string of 10 losing trades, blame the trading system. Terrible-system traders will say “the trading system is not working anymore” or “this trading system must be modified to get it back
on track.” Terrible-system traders decide to modify or give up on the trading system after a losing streak. Often, terrible-system traders will suggest adding another indicator or otherwise slightly modifing the trading system to help filter out some of the losing trades recently triggered. The other strategy employed by these traders is to give up on the trading system. “The system is broken,” they say, or “This trading system worked well before, but now it is breaking down, all systems have a shelf life, and this trading system has expired,” or “the system may have made good profits in the past, but it simply doesn’t work anymore.”

If you find yourself saying something similar, you are probably a terrible-system trader. If you are constantly changing trading systems, particularly after a losing streak, you are a terrible-system trader. All terriblesystem traders blame the system when finding profits becomes difficult. Bad-market traders take a different approach. Bad-market traders analyze the losing trades after a drawdown and instead conclude that the market has changed. Bad-market traders can come up with many reasons that this market is structurally very different from before, and may be heard muttering things like “the Bank of Japan’s intervention has changed the market,” or “things have changed with the Euro since Spain went bankrupt.” The precise reasons may vary, but the essence of the argument remains the same. Sometimes the bad-market trader will use subtle arguments such “themarket is too volatile,” “there is not enough volume today,“my broker is unable to execute my trades fast enough.” The latter argument hints at a common scapegoat for the bad-market trader—the broker.

Bad-market traders are often identified by their willingness to engage in broker conspiracy theories. The fact is that dishonest brokers are found out, and forex traders will eventually abandon the dishonest brokers. Word spreads quickly, particularly among intelligent, Internet-savvy traders with high-speed Internet connections. But for the bad-market trader, the broker offers the perfect excuse for a failing trading system. Bad-market traders place blame on the broker or the market, and thus have a reason for abandoning a losing trading system.Many bad-market traders engage in fundamental analysis, but not all fundamental traders belong to the bad-market camp. The interpretation of economic data and engaging in fundamental analysis is often an opportunity for bad-market traders to further their argument.

These traders will decide to give up on a trading system after a series of losing trades, just as the terrible-system traders decide to abandon a losing system; it is only the reason for giving up on the system that varies. The terrible-system trader places blame on the system, and the bad-market trader is convinced the
market has fundamentally changed. Both bad-market traders and terriblesystem traders will end up searching for an entirely different trading system.

Interestingly, the difference between a terrible-system trader and a bad-market trader is often conscientiousness. The conscientious trader is usually the bad-market trader. This is because the conscientious trader will spend time testing and ensuring that any trading system employed is viable before risking money in the market. The end result of the system testing is confidence in the system for the bad-market trader. For the bad-market trader, the experience of a drawdown is quite harrowing and unexpected, because the trading system has been tested and seems viable; if the system cannot be wrong, the market must be “wrong.”

Our terrible-system trader is unlikely to have spent the same effort testing the trading system. The terrible-system trader probably found the system on a forex Internet forum, purchased it from an Internet marketer,
learned it from a friend, or perhaps heard a circle of forex traders discussing the system in hushed tones at a party. The terrible-system trader may be trading a profitable system, but without spending the time testing
the system, the terrible-system trader is unlikely to hold the system in high regard.

So how might you avoid falling into the terrible system or bad-market groups? What might you do to change your fate? You may want to carefully consider adopting naked trading. Trading naked means trading without indicators, and removing indicators from your chart will make it difficult to adopt the attitude of the terrible-system trader. Also, if you decide to trade naked you will be trading on price action or the market movements. You could blame the market for a string of losing trades as a naked trader, but that would be a bit like blaming the river for being wet.

Naked traders find trades based on market movements, so, unless the market is moving “incorrectly,” there is no such thing as a bad market for the naked trader. Naked traders may only blame losing trades on poor execution (the trader’s fault) or poor luck (sometimes you flip a coin seven times and it lands on tails every time). Naked traders may find that trading without indicators is extremely liberating.Traders around the world have found that adopting naked-trading strategies means letting go of a trade. There are no indicators to give false signals, there are no settings to tweak; there is simply the market price and the trading decision. Naked traders have a true advantage because the focus of the trade is the current market price.

There is no better indicator of the sentiment, attitude, or exuberance of the market than the current
market price. Naked traders make the current market price their indicator.In fact, for many naked traders, the current market price is a bit like a biofeedback machine. I certainly look at the market price as biofeedback.
A biofeedback machine will allow you to tune into the physiological changes in your body, in the hopes that you can better control your physiology. For example, if I am an anxious person, and I am always suffering from stress, I can hook myself up to a biofeedback machine. The machine will alert me if I become anxious (blood pressure increases, heart rate increases, etc. would cause the machine to produce the sound) by
sounding off an alert.

I can then pay attention to the sounds of the machine and use relaxation techniques to decrease my anxiety. The machine simply alerts me when I need to recalibrate my physiology. Over time, I should be able to wean myself off of the biofeedback machine and reduce my anxiety on my own, without the aid of the biofeedback alerts.

Short info about me! I am a software developer at the same time. I developed several trading robots (expert advisors) for trading on the MetaTrader 5 and 4 trading platforms.
  • Expert Advisors on the MQL5 Market. My Current Offer
  • Official Telegram Channel: [You must be registered and logged in to see this link.]
  • Official Facebook Channel: [You must be registered and logged in to see this link.]

4Avoiding a Trading Tragedy Empty Learning from market biofeedback Sat Apr 25, 2015 11:49 am


Global Moderator

It may seem strange, but you will eventually be able to do the same thing with your trades if you decide to adopt naked-trading strategies. In the beginning, the market price is your biofeedback machine. If the market is going in the wrong direction, you have valuable feedback on your trade. Learn from this. Was the entry too early? (Most traders I know are much more likely to jump into a trade too early than to wait too late.)

Was the entry too late?
The market will tell you how your trade rates. Why is it important to pay attention to the market biofeedback? Because you will learn more from Market Biofeedback than you will learn from any guru, any trading book, or any online course. Another way to state this is as follows: Paying close attention to how the market behaves after you enter a trade is one of the best learning tools available to you.

A psychological, behavioral, and trading response to the market price after a
trade has been entered.

Market Biofeedback involves two distinct domains, The first is how the market reacts (price action) after you enter your trade, and the second is how you react to the price action in the market after you enter your trade. Both parts of the Market Biofeedback equation are needed for you to get a clear picture of what you are learning, and more importantly,what you should learn, from your trading experiences. You should learn
from the price action the market offers after you enter a trade. You should also learn from your reaction to the market after you enter a trade.

Even if you do not consciously intend to learn from Market Biofeedback, it is important for you to recognize that Market Biofeedback will yield all your important trading decisions. How you approach your trading, which trading systems you employ, whether you give up on your trading or go on to a long and successful trading career, all these things are determined by Market Biofeedback.

Most traders allow Market Biofeedback to completely dictate their trading approach, even without realizing this is happening. For example, some traders start out trading the five-minute charts and then slowly gravitate toward longer timeframes, such as the four-hour or daily charts.

Why do these traders do this?
The answer is Market Biofeedback. Other traders, after several losing trades, will give up on a trading system and search for a new one. This change in trading strategy is, once again, due to Market Biofeedback. Other traders may trade the exact same trading system and will experience seven losing trades in succession and hold steady, knowing that the current drawdown is simply an aberration. Market Biofeedback is the difference between the traders who give up on a trading system and look for a new strategy and those traders who maintain confidence despite the losing streak.

How you react and respond to a drawdown, to a windfall of pips, or something in between is exceptionally valuable information. The easiest way to see Market Biofeedback is to record your thoughts as you trade. You can record your voice before, during, and after a trade. You can take screenshots of the trade before, during, and after. You may also record video of the trade before, during, and after with a desktop-computer
recording software. Here are the important questions to answer as you record Market Biofeedback:

  • Where has the market moved since I entered my trade?
  • If I looked at the market now, would I take the same trade?
  • How do I feel about my trade?
  • What do I like about this trade now?
  • What do I dislike about this trade now?
  • On a scale of 1 (poor decision) to 10 (great decision), where would I
  • rank this trade now?
  • If I were not in a trade now, would I take the opposite trade?

If you ask yourself these questions and record your answers before, during, and after the trade, you will have built up a database of your personal Market Biofeedback—an invaluable tool. More importantly, you will bring into conscious awareness how you react to the market. Most traders will trade their whole lives without recognizing that Market Biofeedback dictates how they adapt and change as a trader.

By simply acknowledging Market Biofeedback, you can understand how you react to the market in general, and how your trades, in particular, mold your approach to trading. Market Biofeedback is the one area that most traders neglect, most traders are not quite aware of this process. By paying attention to Market Biofeedback over time, you will be able to become aware of, and eventually control your trading behaviors. This will allow you to take a big step towards consistent profits.

Short info about me! I am a software developer at the same time. I developed several trading robots (expert advisors) for trading on the MetaTrader 5 and 4 trading platforms.
  • Expert Advisors on the MQL5 Market. My Current Offer
  • Official Telegram Channel: [You must be registered and logged in to see this link.]
  • Official Facebook Channel: [You must be registered and logged in to see this link.]

5Avoiding a Trading Tragedy Empty Back-Testing Your System Sat Apr 25, 2015 12:03 pm


Global Moderator

The consistently profitable forex trader is an expert. Just as an expert farmer understands seeds and soil, and the expert mechanic can hear the difference between a blown gasket and loose muffler, the expert
forex trader knows markets. Where does this expertise come from? How does the novice forex trader become an expert? This is the million-dollar question.

Make no mistake about it, when you step into any market, including the forex market, and decide that you want to make money, you have decided you will outwit and outperform some of the most determined, intelligent, and well-resourced people in the world. All these impressive people have one goal: to take your money. How can you make money in the markets, knowing whom you are up against? The answer is simple. Perhaps the answer is much simpler that you would believe. You must practice.

Practice your craft. Practice your trading. This is the simple way to become an expert. Simple does not mean easy, because many traders expect to become experts without practice, and sadly they never achieve expertise.Consistently profitable trading is yours if you practice trading and become an expert.

You now have the secret formula to achieve consistently profitable trading. Will you use this secret? The best estimates suggest as many as 74.8 percent of traders do not use the secret. This is because 74.8 percent of forex traders do not consistently make money trading .The 25.2 percent of consistently profitable traders practice trading to get better at it.

Only 25.2 percent of all of the traders reading this will decide to practice trading to become an expert. It is no coincidence that about 25.2 percent of all traders are consistently profitable. Practice helps achieve expertise in nearly every sport and vocation. It is interesting to see how the vast majority of aspiring traders expect to immediately become successful without putting the effort into becoming an expert.

Expert traders put the effort into becoming an expert. It is ironic that many traders are attracted to the trading lifestyle, thinking that trading will allow passive income to accumulate. This is certainly true, any trader can make money while sleeping, but expert traders are much more likely to achieve consistent, passive income from trading. Trading is like any other job: Practice and effort must be well-placed in order to reap the rewards.

The expert trader may be able to quickly make trading decisions and place trades, but these decisions are the fruits of many hours of practice, in nearly every instance. Traders must earn their pips through practice.Practice means confidence. Practicing your trading system will enable you to keep trading your system, and avoid all distractions and excuses (e.g., terrible-system traders and bad-market traders) along the way. Practicing your trading system will allow you to enjoy the confidence of knowing
when you place a trade how likely you are to be successful with that particular trade.

Would you enjoy trading more if you had a quiet, unshakable confidence in your trading system? Would you find it easier to walk away from your computer if you knew the precise likelihood that your trade would be a winner? Would it be nice to know that you will avoid the excuses bad-market traders and terrible-system traders make? What would happen if, from today onward, you maintained confidence in your ability to extract profits from the market even through the ups and downs that are inevitable in any trader’s life?Consistently profitable traders, otherwise known as expert traders, have one thing in common: They test their trading systems.

These traders practice their trading systems. There are many methods for testing a trading system. Each of them has advantages and disadvantages.Depending on your personality and how you approach your trading, one of these approaches is likely to resonate with you more than the others.Decide which of the three methods you will adopt to become an expert trader.

Each of these methods are back-testing methods. Back-testing is a common term used in trading that simply means “testing a trading system through historical data.” All traders know that using historical data is not the perfect solution to testing a trading system. A much better alternative would be to have future data to test our trading systems. Failing that, historical data is the next best thing. There are many pitfalls and problems associated with testing trading systems on historical data; however, the consequences associated with trading a system in live market conditions when it is not tested on historical data are much more problematic.

Short info about me! I am a software developer at the same time. I developed several trading robots (expert advisors) for trading on the MetaTrader 5 and 4 trading platforms.
  • Expert Advisors on the MQL5 Market. My Current Offer
  • Official Telegram Channel: [You must be registered and logged in to see this link.]
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6Avoiding a Trading Tragedy Empty Tree goals of back testing Sat Apr 25, 2015 12:26 pm


Global Moderator

Your back-testing will allow you to do two things: First, you will identify how suitable the trading system is for you. This does not mean you are discovering whether the trading system is profitable, but, rather, you are examining the fit between you, the trader, and the rules of your trading system. Second, you will learn to trust your trading system and learn to let go of your trades. You may trade in a more relaxed manner once you have taken thousands of trades over years of market data.

The confidence gained by trading your system repeatedly will show up in the form of a relaxed approach to your live trading. Third, you will gain expertise with your trading system. This may only happen if you take many trades, and back-testing is a quick way to accumulatemany trades. A close look at each of these three goals may help you to get the most out of your back-testing.

Is the System Suitable?

How suitable is your trading system? The first goal of back-testing is to find out how suitable the trading system is for you. I have a good friend, who introduced me to forex, named Ashkan Bolour. Bolour is a well-known forex trader, you may have read about him in the Millionaire Traders book by Kathy Lien and Boris Schlossberg. Bolour trades the three-minute and fiveminute charts. He does exceptionally well trading these charts. No matter how many times I watch him trade his systems on these charts, I always fail when I try to trade as he does. I fail because his trading system does not fit with my view of the markets. I prefer the daily, weekly, and four-hour charts.

I have great difficulty watching my trades fluctuate, which is precisely what Bolour does when he trades. I have learned to trade systems that make sense to me. I am better at extracting profits from the longerterm charts. Your job is to find out how you should be trading, and trade only what makes sense to you.

Perhaps you have traded several trading systems in the past. Most of these systems probably looked outstanding at first glance. Maybe you paid for the trading system, and the website you bought it from painted the system as an invincible profit-collecting machine. Or maybe you read about the system on an Internet forum. Or perhaps a friend told you about the trading system. No matter how good the trading system appears, it is remarkable how your trading results often differ from your expectations of the system. How can a perfect, profitable system fall apart in your hands?Why is it that a system that sounds good does not work once you start trading it?

The answer is fit; if a system does not fit your view of the markets, your approach to trading, your ability to execute trades, it will not make money for you. A system must fit with your understanding of the markets. If you believe the five-minute chart is “random noise,” you may be better suited to trade the daily chart. If you believe moving averages are useless indicators, you will not be comfortable with a moving-average-based system. If you think that the USD/JPY is a terrible pair to trade, you are not going to trade a system on the USD/JPY. Your beliefs about trading must fit your trading system.

Your lifestyle will also determine the types of systems you may trade. If you have a full-time job, and spend 10 hours of the day at an office where you will not have access to your trading platform, you probably will be drawn toward longer-term charts. Daily, weekly, or four-hour charts may be best for you. This way, you may take your trades and manage them by checking the charts once or twice each day.

Your makeup as a trader will also determine how you should trade. Perhaps you freak out when you are in a trade on the lower-timeframe charts, such as the five-minute charts. Perhaps it is torture watching the profit and loss fluctuate greatly with each pip gained or lost on these lowertimeframe charts. If this is the case, you will probably want to trade highertimeframe charts. If you are risking the same percentage of your account on each trade, it is likely that a trade on a lower timeframe chart will risk more per pip because the stop loss is closer to the entry price than a trade on a higher-timeframe chart.

Your back-testing experience with the trading system will show you whether you will be able to find profits with a system.Testing will also show you whether your lifestyle will fit with the system.Perhaps most of the trade signals for a trading system occur during the European market, and you are fast asleep during that time; this may mean that the trading system is not for you.

Confidence Is Letting Go

After you have found a system that fits your personality, your view of the markets, you need to get comfortable trading this system. This will be the second step you take on your way to consistent profits in forex. The key here is to gain experience over a broad range of market conditions. Relaxing while you are in a trade will often help you manage the trade better. Just the simple fact that you are relaxed means your decision-making will be better.

Relaxation will come for you once you have confidence in your system, a confidence gained by trading your system repeatedly, over years of market conditions and a variety of signals. You will learn to trust your trading system and learn to let go of your trades. Micromanaging trades, particularly trades on higher timeframes, is a common mistake of novice traders.If you can walk away from your computer after making a trade, you have confidence in your system. This confidence is only available to traders who have back-tested extensively.

Accelerate your learning curve by back-testing. It does not matter your method of back-testing; it only matters that you do it. Testing over thousands of trades will enable you to be better prepared to make a decision on your trading system. Once you deem your system profitable, you can begin to get comfortable with the system by testing extensively, slowly building your database of trading experience with the system. Your next step willbe to become an expert with your system.

You Are the Expert

The number-one reason traders fail in forex is this: Most traders do not have expertise. Most traders begin trading a system without much experience trading a system. When the first bump in the road appears (e.g. an extended losing period, a lack of signals for a week, a couple of difficultto- interpret signals, etc.) the system is abandoned. The traders who consistently pull profits from the market are experts, without exception.To become an expert at anything, you must do it at least 10,000 times.

If you want to become an expert in your chosen trading system, you could take 10,000 trades, which will probably take you years to achieve, or you could back-test your system. By seriously testing your system over thousands of trades, you will quickly achieve expertise with your system.Seriously testing your system means making trades just as you would with your live account: trading from the right-hand edge of the chart, without the benefit of hindsight bias, using a strict application of your trading rules.

The naked trader has an advantage over traders who trade “normal,” indicator-based systems. A trader who is trading a system incorporating seven indicators must view and interpret all seven indicators for each trade, before, during, and after every signal is initiated. This is cumbersome and slow. The naked trader has a chart with no indicators, a very clean chart. These charts are easy to interpret. In fact, the naked trader gains experience with his system every time he sees a chart in a newspaper,on television, in a book, regardless of market.

This is because the naked trader can see, at a glance, whether the chart suggests a buy signal, a sell signal, or no trade signal. A chart on the nightly news helps the naked trader march toward expertise. In this way, the naked trader has a distinct advantage over traders using indicators. Expertise will come more quickly, more easily, and allow the naked trader to interpret any chart, in any market, at any time.

Experts in cognitive psychology agree that experts at the highest level find it difficult to teach their expertise. Experts know what to do, in fact, because their expert behavior is automatic. They do not think about what they do, they just do it. Novices spend a lot of time thinking about the procedures, setting things up correctly, and so forth. Experts spend time thinking about how they interpret information—a very different approach.

So what does this mean for your trading? It means you should backtest extensively. Your goal should be to pull out of the novice trader stage and into the expert level as quickly as possible. The fast way to achieve expertise is to gain experience trading your system via testing. All novice traders spend a good proportion of time in orientation, “Is this a good signal?” “Does this set-up qualify as a valid trade set-up?” “Should I take this trade? I am not sure if this constitutes a good signal . . .” Expert traders spend more time evaluating the trade once it is initiated. In other words, experts are concerned with Market Biofeedback, and novice traders are concerned with understanding the system rules. This is understandable, novice traders spend time thinking about possible trade set-ups, novice traders are still learning the trading system. Expert traders spend more time managing trades and focusing on making sure that open trades are managed efficiently, to extract maximum profits from the market once those profits become available.

One of the true paradoxes of expertise is this: Experts find it difficult to verbalize the decision-making process. Expert traders are often unable to adequately explain how to duplicate their results. This is frustrating for the novice. Experts often rely on unconscious thinking, or a “gut feeling” when making decisions. The subtle cues experts use to make a decision are ingrained and rote, often inaccessible to conscious consideration, and this is frustrating for novice traders who are seeking expertise. Novice traders are better off spending time gaining experience through testing, building toward expertise, rather than trying to find a shortcut to expertise by mirroring experts.

Unless you want to allow a computer to do all the trading for you— in other words you trade only fully automated trading systems—you probably will want to achieve trading expertise. Your shortcut to trading expertise is to back-test.

Although it may seem like hard work, the fact is you can simply accumulate years of experience over hours when you decide to manually back-test. It is, quite simply, the best shortcut to trading success. The very successful traders, who are consistently finding profits in the market, who are trading for a living, all of them share one characteristic:They back-test their systems and earn their pips on their back-testing software. Why not join this successful group of traders today?

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