Forex Trading Articles

PROOF OF THE PUDDING

By Dick Thompson for Forexmentor
©2011, Forexmentor.com, October 2011

A couple of months ago I wrote about the importance of testing a trading system before trading it with real money. I discussed the reasons why I thought is was important and some of the different ways a trader might go about it. I also outlined a process that might be followed.

In the past few weeks I have been studying the FST Position Trading methodology that was previewed by Frank Paul in the AM reviews earlier this summer, and now has been released as part of the Fibonacci Swing Trading (FST) course offered by ForexMentor. Once I felt that I understood the concepts, I began testing the system and gathering data to see how the method worked for me. This is still a work in process but I thought it would be informative to write an article on the activity to date.

As of the date of this article, here are my results in summary:

* Note: Large values due primarily to trades on GBPJPY which, because of its volatility, tends to have large movements. This is compensated for by proper position sizes.

My initial Trading Plan followed the basic methodology of the FST Position Trading material.
I say "initial" because I will modify the plan during the process of testing as I learn its details and nuances and find out what works for me. We must all remember that we are who we are; we are not someone else and what someone else can make work well for them, may or may not be able to work for us, at least without some modification and tweaking. So, I fully expect to integrate my own trading experience, my personality and psychological makeup, and my style with the basic methodology to make the system my own.

The FST position Trading methodology is a series of go-no go filters derived from a Top-Down analysis of price charts. The charts use a form of Japanese candlesticks called Heikin Ashi candles and a modified Stochastic indicator to illustrate and qualify a trend. It includes entry and exit techniques and risk management. (Note: this is an adaptation of the Triple Screen trading system developed for stock trading by Dr. Alexander Elder that I wrote about in a November 2010 article titled "Top Down Trading") The methodology has been described in various AM Reviews over past months and is summarized as follows:

• Scan a group of currency pairs for momentum on the Monthly/Weekly/Daily charts as an indication of trend. If a pair does not have a trend, either up or down, based on the modified Stochastic indicator, it does not pass the first filter is no longer in consideration.
  
• Confirm the trend on the Daily chart by assessing market flow; higher highs and lows in an uptrend or lower highs and lows in a downtrend. If there is no market structure or flow, for instance a range-bound or sideways market, then this pair does not pass this filter and is no longer in consideration.
  
• On a confirmed trending pair, look for, and identify a non trend-changing interruption to that trend on the Daily chart. This will likely be represented on a lower timeframe as a dip in an uptrend or a rally in a downtrend. If no interruption is visible, then the pair does not pass this filter and is not yet in consideration. However, as long as there is a confirmed trend in place, this pair should be monitored and reconsidered if an interruption appears.
  
• Identify any support or resistance that could possibly become a barrier to price movement near a potential trade entry. If this barrier is within an average daily range of price, the risk on the trade will be higher than desired and this filter is considered failed. Again, if the pair moves beyond the support or resistance, with a closed daily candle, and the confirmed trend is still viable, reconsider this pair at that time.
  
• For the final filter, check the last closed weekly Heikin Ashi bar and confirm that it is not a reversal bar, which would be counter trend. If it is, then this filter has failed.
  
• If all filters pass at this point, prepare enter the trade. After a closed Heikin Ashi daily bar that has a very small or no trailing wick, enter at the open of the next candle. (A trailing wick is defined as a wick on the candle top in a down trend and the candle bottom in an up trend.)
  
• I need to mention here that my money management was to only risk 0.5 % of my balance on any one trade. I traded micro lots to give me the ability to fine-tune the number of lots taken per trade, which in turn, depended on the size of the stop set by the current 5 day average of the daily range (ADR). I did not consider pip cost, assuming that one PIP was worth $0.10 (micro lots) across the board, regardless of currency pair.
  
• Place a stop one ADR away from the entry. Once price has moved as much as one ADR in our favor at a daily close, move the stop to break-even.
  
• Close the trade when a daily Heikin Ashi bar has closed with a reversal bar, even if the trade has not yet made a profit.

My chosen method for testing was using a software package called Forex Tester 2, (http://www.forextester.com/) . This software is based on the popular Metatrader 4 trading software that is offered by numerous brokerages and allows the trader to "re-live" the price movement of 18 different currencies, placing trades, recording results, and doing so at any speed from real time to about as fast as you want.

I took 10 trades on each of ten pairs, starting in January 2008. I exported the trade data to an Excel spreadsheet ( summary data is presented in the table above). After completing all 100 trades, I reviewed the charts and tried to identify possible faults in the losing trades. I did not spend much time looking at the winning trades because I see the exit to be more mechanical and less subject to discretionary decisions than the setup and entry. The following are my observations, grouped in broad categories :

• Market flow was unclear or did not make sense to me.
• Nearby support or resistance was ignored.
• The correction was weak or missing clear swing points.
• The entry was late or otherwise mis-timed.
• The entry was a sale after a period of selling, and into an area of demand; or the reverse.

I also made general observations along the way, some of which I might incorporate into my trading plan, depending on further testing.

• I found some currency pairs difficult to trade, although all ten pairs were traded without a net loss.
  I think that over the time period I tested, January 2008 through early 2010, some pairs were not trending strongly and I traded them anyway. Perhaps it would have been better to stand aside on those.
  
• Along the same lines as above, it is critical to observe the monthly, weekly and daily together in some way to assess the strength of the trend. Simply speaking, if price is not moving in a way that makes sense to me, I should not be trading it .
  
• Market Flow should be reviewed on more than just the daily chart. It certainly should be clear on the daily chart, but it should not be counter-indicated on other charts, including the 4 Hour and possibly lower charts as well.
  
• The basic methodology advises an exit when a reversal candle closes on the daily chart. I am considering a daily doji supported by a clear and unambiguous correction on the 4 Hour chart to also signal an exit.
  
• I am considering using a 3-Bar trailing stop, placed after I have moved to break even. This would complement the reversal candle exit criteria. I have found that it gives similar results to the reversal candle but gives you an increasingly better exit as the size of that reversal candle grows. I also like the idea of a Limit order sitting in the market for my exit.

That is where I am at this time. I think that I should be able to improve the statistics as well as the overall return. I intend to study my results further, modify the plan as required and continue testing. If the results of further testing are informative, I will report them to you in a future article.

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