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Reader Questions Answered

Account Issues Running Multiple Trading Systems

Frequent emailer Rod had a question recently about running multiple trading strategies.

I would like to run 3 different strategies on a single forex pair. If I do this in one account, everything will be mixed up, and I won’t be sure I am getting the results I am after. To explain this, let’s say strategy 1 triggers a long signal. If the next signal I get is an exit signal from strategy 1, then everything is fine. But if the next signal was, instead, an entry signal from strategy 2, then the entry price and average cost of the position is different than what I intended (I don’t want the signals and the positions to get mixed up).

I believe the solution, somewhat cumbersome, is to open 3 different accounts with my broker. But before doing that, I wanted to know if there is an easier solution.

To answer Rod’s question most directly, the solution may be sub-accounts. Some brokers, such as Oanda, allow you to create sub-accounts within your one brokerage account. This allows you to run separate strategies with their own easily trackable transaction and performance records. That would be my first choice way to go.

Now, having said that, I want to make two points.

First, no matter whether you’re trading one account or multiple accounts and/or sub-accounts, you have to remember to think in terms of aggregate risk. Make sure you do not allow yourself to get into an excessive exposure situation. By that I mean something like having full-sized USD longs in all your accounts because the systems all have a long signal at the same time. A situation like that could see all your accounts hit at the same time and a loss multiples bigger than your general risk management philosophy would normally permit.

Second, keep in mind that no matter how you break out accounts or sub-accounts, the math all adds up the same. If you get long GBP/USD at 1.50 in one account and get long GBP/USD at 1.51 in the same size in another account, it’s exactly the same as if you did those two trades in one account. Granted, you’ll see differences in average entry prices and things like that, but if you keep good records of your trades outside your brokerage system – which you always should (see this story of broker fraud) – then you’ll know what each system is doing and how it’s performing.

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Reader Questions Answered

Do you know a good end of day strategy?

Here’s a question which came in by email from a trader named Adam.

Do you know about a good forex strategy which could be traded end of day?

I admire the brevity of Adam’s inquiry and will respond equally so by saying “Yes”.

That’s not very helpful, of course, and a little bit of a snarky reply, but it does answer the question asked, doesn’t it? ­čÖé

In all sincerity, though, the question needs a bit more clarification. For example, when Adam say “could be traded end of day” what type of holding time frame is he looking for? Obviously, he’s not talking about scalping here, but it is possible to practically day trade based on EOD data. Most people, however, are thinking more swing or position trading when using EOD figures.

A second question I would ask is whether Adam wants to be a trend following trader or a range strategy player. Those are really the two main approaches. The former tends to be a go-with approach, or one where the trader seeks to enter with the trend on counter-trend moves. The latter type of trading seeks to identify ranges and fade moves to their limits in expectation of turns back in the other direction. Some traders favor trends, while others tend to favor ranges.

Beyond that we get into the question of the different types of techniques one can employ.

In other words, I cannot offer Adam any areas to further his market study without getting to know more about his broad trading plan. If he cannot provide the sort of information I noted above, then he needs to take some time to sort out his direction. This is something which trips up a lot of new traders. They try to jump right into things without taking the time to figure out what they should be doing.

If you’re in a situation similar to Adam’s, I encourage you to check out my new book, Trading FAQs.

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Trading Tips

Why You Shouldn’t Fixate on Winning Percentage in Your Trading

I’ve been reading Curtis Faith’s new book Trading From Your Gut, a review of which will follow shortly when I finish. The part I was going through this morning on my commute into work, though, inspired me to address the subject of win rate and good trading. Faith hits hard on the subject, which is one I’ve addressed on a few occasions myself.

Here’s the deal. Traders, especially newer ones, get way too hung up on being right and having a high win %. This comes from two underlying causes. One is the fear of being wrong. The other is the belief that one needs to have more winning trades than losing ones to be successful in the markets. Both are problematic and will cause trouble.

The need to be right is something which kills traders. As Faith puts it, the whole being right thing is for forecasters and prognosticators. Traders who get fixated on being right make very, very bad decisions sometimes – ones that potentially can blow up their account. They are the traders who hold on to losing positions way too long in hopes they come back because they can’t handle the idea that they were wrong and will have to take a loss. Of course that often leads them to eventually panic at some point and bail on a trade at exactly the worst possible time (as many stock traders did in March 2009).

The need to have a high win rate also encourages such silly trading behavior as “hedging” in the forex market. I’ve heard many a trader justify their taking an opposing position in the pair that is trading against them as letting them stay in the trade so it can eventually turn back in their favor. They seem to be ignoring the fact that all they’ve done when putting on a “hedge” like that is to lock in their loss. Like I said, poor decisions – ones based on emotion.

Then there are those who think that in order be a profitable trader you must have more winners than losers. Of course this is true if your winning trades are the same size as your losers. If, for example, each trade will either be a $100 gain or a $100 loss, then you need to win more than 50% of the time to expect to come out ahead in the long run. It’s a straight forward mathematical relationship. If you win 51% of the time then the expectancy for your trades is $2 ($100 x .51 – $100 x .49), meaning that on average you would expect to make $2 for each trade you do.

We can use the same math to demonstrate how you can also be profitable in the long run with a much lower win rate. Let’s use 25% as an example.

Keeping the same $100 gain/loss as above, we come up with a -$75 expectancy ($100 x .25 – $100 x .75). Not good. No big surprise there.

What if we change from a 1:1 winner-to-loser ratio to a 5:1 ratio, though? Let’s call that $500 for the winning trades and $100 for the losers. Running the figures we get an expectancy of $50 ($500 x .25 – $100 x .75). Not bad at all.

In general terms trend trading methodologies are the ones that tend of have low win % but high winner/loser ratios because they have a lot of small losses thanks to whippy, trendless markets but relatively large winners. Other systems go the other way, with lots of small winners and only occasionally a loser, but a big one.

Even for those with no real issue with being “wrong”,├é┬álow win rate systems can be a challenge. They tend to be subject to lots of big equity swings because the high number of losers creates lengthy drawdowns. Those can be very hard to ride out, especially for someone who hasn’t developed confidence in their system.

The bottom line is that you should be focusing on making good trades not on making winning trades. Good trades sometimes lose money, but if you keep making them within the scope of a positive expectancy system or methodology you’ll end up ahead in the long run. Getting caught up in trying to make winning trades will almost certainly end up leading to disaster.

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Reader Questions Answered

The best forex trading technique or trading system

I got the following email over the weekend. Let me know what your immediate response is. I had my own, but I won’t taint your view with what went through my mind at first.

Dear sir,

kindly to inform you that i’m new in forex trading. So far i always lost my money in trading forex. if you don’t mind, can you tell me what is the best forex trading technique or trading system that can make me always win and make money in my forex trading. thanks you.

Aside from any other response, my recommendation to this individual is to read two posts on this blog.

The Secret to Trading Success

Want me to tell you where to buy and sell?

The short answer to this question is this: There is no “best” system and while there are ways to trade where you can approaching having all winners, they are extremely risky.

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Reader Questions Answered Trading Tips

I don’t use stops. What do you think?

I got the question in the title of this post from a “fan” of The Essentials of Trading Facebook page. If you’ve followed this blog for any length of time you know that the topic of stops and how to use them is a frequent concern among new and developing traders (for example Where should I put my stop and take profit orders?). Let me approach this from a couple different angles.

The market will come back
If you are not using stops because you “know” the market will eventually come back you need a history lesson. Sometimes the market never comes back, or if it does it’s after such long period of time or such a big drawdown that you can’t hold on for the duration. Take a look at this S&P 500 weekly chart.

SP500W102009

Imagine if you had bought the market back in the fall of 2007 when the S&P was trading at 1500+. If you had not had some kind of protective downside exit plan you would have seen a loss of more than 50% on that position (not accounting for any leverage, which if employed would have wiped you out). That’s a hard thing to sit through, as many people who attempted to do it can tell you. The market has come back up quite a bit but is still more than 400 points below where it was. How long is it going to take to get back to those 2007 levels? Who knows. It could be years – years to get back to break even, meaning no gains for all that time in the market and your money tied up preventing you from trading anything else.

If you’re thinking “well that’s too long a time frame, I trade shorter-term” then look at charts in your time frame. I guarantee you’ll find examples of formerly choppy markets that would always come back becoming very unidirectional. You play that game long enough you are going to get burned badly.

Want an example? How about what GBP/USD did in a week.

GBPUSDH102009

The market rallied 700 pips between October 13 and 20. That’s a big hit if you were short. If you were trading with a modest 10:1 leverage ratio you might have survived the hit (at least so far), but it wouldn’t take a much higher leverage ratio to have seen a margin call triggered. Poof! Account wiped out. ­čÖü

My trading systems doesn’t use stops
This is a legitimate reason not to use stops, and is the reason why you cannot accept the blanket statement that all traders must use stops. If you do as much system testing as I have done over the years you will observe that there are types of systems which do not show improved performance when stops are introduced, expect perhaps in the most loose of fashion. These tend to be trend trading oriented systems, particularly those which are always in and/or use close and reverse type approaches.

Be warned, however. Some systems do leave you exposed to potentially large losses because of the timing of when positions are exited and/or reversed. You should be aware of these potential holes and make sure you have some kind of protection plan to guard against extreme moves. That might mean a very loose stop loss order or perhaps an out of the money option.

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Reader Questions Answered The Basics

System Back-Testing and Indicative Forex Data

Frequent emailer and commenter Rod sent me another good question yesterday, on the subject of trading system back-testing.

I want to backtest a strategy on some forex pairs. The timeframe would be 1 day, so I would be using EOD data. In this situation, how bad of a mistake, if at all, is it to rely on indicative data? If my forex broker cannot provide a historical database, what options do I have for a reliable test?

The difference between forex data and that provided by exchanges is an important one which a lot of folks don’t really appreciate. Exchange data is most traded price, meaning where actual transactions took place. Spot forex data is indicative price, which is the bid and/or offer where transactions could have taken place (but also may not have done).

Contrary to what Rod fears, using indicative prices is actually more realistic than using traded price. Why? Because you can be more accurate with where your fills would be. You don’t have to leave room for slippage they way you do testing something like stocks or futures where you don’t necessarily know what the bid/ask is. You know the price you could sell at (bid) and the price you could buy at (offer) – or at least one side of that with the ability to fairly easily determine the other in most cases.

The issue, however, is what data source you use. Ideally you want to be testing using the prices from the broker through whom you’ll be trading. This may not be as big a deal for EOD type trading, but for intraday├é┬átrading the little variances between the prices of different sources could make a big difference.

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Reader Questions Answered Trading Tips

Trading System Testing and Risk Management with Multiple Securities

A reader of my book sent me a question that combines system design and testing issues with risk management considerations.

Hi John,

I backtested a strategy on all S&P 500 plus Nasdaq 100 stocks. After checking for outliers, I selected the 10 best symbols in terms of risk adjusted returns and statistical significance. My idea is to trade 10 stocks to increase the number of trading opportunities in a trend following system. Following your book’s approach, I checked fixed vs variable vs stepped sizing methods and determined that in all cases the variable method was the better one. So I ran the calculations and the comparisons again using variable sizing methods, and finally came up with optimal fixed fractions of equity to trade for each stock, given acceptable drawdown limits.

So now I have the following problem: I have different fractions for each stock but one trading account. I am thinking of allocating one tenth of the trading account to each stock and applying the stock’s fraction to that amount, but I am not sure if it’s the right approach.

Thank you !!

Rod

First, I’d like to congratulate Rod on going through the full design and testing system development process. I will tell you flat out that my work doing these sorts of things early in my trading development helped me enormously to understand how different indicators and systems methodologies work. That, in turn, helped me work through the process of finding my trading niche.

Now, addressing Rod’s question….

There are a couple of things I would suggest need to be looked at and thought about at this point in the process. While it’s admirable that Rod is looking to track a specific├é┬ágroup of├é┬ástocks to provide the frequency of trading opportunity he’s looking for, he needs to consider the risk of all 10 stocks moving against him at the same time. My guess is that the stocks he’s selected are relatively strongly correlated, though that’s worth testing.├é┬áIt means they could all move against him at the same time, which introduces the risk for a substantial loss at some point.

That said, I think Rod would do well to perform an additional set of tests. It sounds like he’s done singular system tests – meaning testing the system’s performance on an individual security basis. It does not, however, sound like he’s tested the system in a unified way. By that I mean running a test which encompasses all the 10├é┬ásecurities he’s selected as a full├é┬áportfolio look. That sort of thing will help identify the risks of correlations and see the kinds of drawdowns it could produce (potentially),├é┬áand let him determine his position sizing in aggregate rather than just security by security.

Look at the characteristics

The last bit of advice I’d offer Rod at this stage is to try to identify the├é┬áset of charactersistics which makes those 10 stocks he’s├é┬áselected good for his system.├é┬áIndividual stocks will change how they trade at different points – sometimes temporarily, sometimes permanently. If you know what makes a stock good for your system you can track the ones you are using to see if they change, and you can keep an eye out for other stocks that are good candidates for inclusion.