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Playing
a Game You Can Win |
by:
Paul
King |
Imagine
a simple coin-tossing game where
you win whatever you stake if heads
comes up, lose what you stake if
tails comes up, and you are charged
1% of your stake each turn to play.
Can you win money at this game?
If you are familiar
with the concept of expectancy,
then you will probably answer ‘No’
since over many turns the amount
won will be equal to the amount
lost (assuming the coin is a fair
one) and after factoring in the
1% cost of playing you will lose
money overall.
In fact, there is a way to win this
game, and that is to understand
that the longer you play, the more
you will lose, so the optimum strategy
is to bet everything you have on
just one toss of the coin; just
like Ashley Revell did when he sold
everything he owned, took the $135,300
to Las Vegas, and bet it all on
‘Red’ on one spin of the roulette
wheel. Mr. Revell was fortunate
and he won, but I am not recommending
that you bet everything you have
on one trade!
Obviously risking everything on
one trade is not a useful strategy
since we want a game we can play
for long periods of time to generate
a consistent income. So how can
we change the game so that we can
win? There are three aspects to
the game which can be adjusted to
increase our chances of winning
consistently:
• We can tip the chance of a winner
in our favor from 50/50
• We can increase the size of the
payout from 1:1
• We can reduce the cost of playing
the game
Tipping the chances of a winner
is not possible in a fair coin toss
game, but it is possible in trading.
There are two ways to approach this:
identify conditions that are more
favorable to your winners and include
them in your system definition,
or identify circumstances where
a loser is more likely, and skip
those trades. For example, if you
notice that most of your winners
are entered on days where the overall
market has moved in the same direction
as your trade, then only enter trades
when the overall market is moving
in the correct direction. This means
that your trade is in the same direction
of the overall market, rather than
against it.
Another example might be that trades
that are entered just before major
news announcements, like earnings
calls, often get stopped out as
losers due to increased volatility,
so you should skip those trades.
There may be many patterns of winners
and losers that you can identify
for your own systems and careful
study of past trades is definitely
worthwhile. Note that we do not
want to increase our win percentage
too significantly (i.e. to greater
than 60%) since this would indicate
that we have ‘curve-fitted’ our
system to historical results that
are unlikely to continue into the
future.
It is also important to note that
for some types of trading (i.e.
long-term trend following strategies)
it may not be possible to have a
win percentage that is greater than
50% (and it may be much lower) and
that is where the second aspect
of improving your system comes into
play: the average size of winners
versus losers.
Increasing the size of the payout
so that the winners win more on
average than the losers lose depends
on the way you handle your stops.
Having large winners in relation
to losers can make up for a low
win percentage, and mean that you
will still make money playing the
game. One method is to have a trailing
stop that moves up as a trade becomes
a winner. If you have fixed stops
for losing trades that limit losses,
but trailing stops for winning ones
that allow winners to grow, then
you are increasing your chances
of your average winner being larger
than your average loser. Generally
it is better to be strict on losers
by having tighter stops that keep
losses to a minimum and generous
with winners by having stops that
allow profits to grow. In any case
you want to make losers small and
winners large, so never add to a
losing trade – that would be doing
the opposite of what you want to
achieve.
Lastly, reducing the costs of trading
is probably the simplest change
you can make, and can mean the difference
between winning and losing overall
– especially for systems that have
lower expectancy. There are many
online brokers now that charge 1c
per share for equity trades (and
comparably low fees for other instrument
types) and there is no reason why
you should be paying more than this
if you are trading electronically.
Every trader should do whatever
they can to maximize the expectancy
of their trading system or method
by considering each of the 3 aspects
just described. If we do some, or
all, of these things then the amount
we win now becomes a
factor of how much we stake, and
how often we play because we have
created a true ‘edge’ where we know
that the system we are trading should
make money (if traded accurately).
Calculating the expectancy of your
trading system or method
tells you whether you are playing
a game you can win, and is a very
important piece of information that
every trader should know before
they risk real money.
If the game is rigged against you
because your trading methods lose
money regardless of how accurately
you implement them, how can you
ever be a successful trader?
About the author:
Paul King is owner and head trader
of PMKing Trading LLC, a Vermont-based
proprietary trading company founded
in May 2002. Paul has published
a series of eBooks and articles
about what he considers to be the
important aspects of trading.
Visit www.pmkingtrading.comfor
more details.
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Pivot
Points in Forex: Mapping your Time Frame |
by:
Raul
Lopez |
It
is useful to have a map and be able to see
where the price is relative to previous
market action. This way we can see how is
the sentiment of traders and investors at
any given moment, it also gives us a general
idea of where the market is heading during
the day. This information can help us decide
which way to trade.
Pivot points, a technique developed by floor
traders, help us see where the price is
relative to previous market action.
As a definition, a pivot point is a turning
point or condition. The same applies to
the Forex market, the pivot point is a level
in which the sentiment of the market changes
from “bull” to “bear” or vice versa. If
the market breaks this level up, then the
sentiment is said to be a bull market and
it is likely to continue its way up, on
the other hand, if the market breaks this
level down, then the sentiment is bear,
and it is expected to continue its way down.
Also at this level, the market is expected
to have some kind of support/resistance,
and if price can’t break the pivot point,
a possible bounce from it is plausible.
Pivot points work best on highly liquid
markets, like the spot currency market,
but they can also be used in other markets
as well.
Pivot Points
In a few words, pivot point is a level in
which the sentiment of traders and investors
changes from bull to bear or vice versa.
Why PP work?
They work simply because many individual
traders and investors use and trust them,
as well as bank and institutional traders.
It is known to every trader that the pivot
point is an important measure of strength
and weakness of any market.
Calculating pivot points
There are several ways to arrive to the
Pivot point. The method we found to have
the most accurate results is calculated
by taking the average of the high, low and
close of a previous period (or session).
Pivot point (PP) = (High + Low + Close)
/ 3
Take for instance the following EUR/USD
information from the previous session:
Open: 1.2386
High: 1.2474
Low: 1.2376
Close: 1.2458
The PP would be,
PP = (1.2474 + 1.2376 + 1.2458) / 3 = 1.2439
What does this number tell us?
It simply tells us that if the market is
trading above 1.2439, Bulls are winning
the battle pushing the prices higher. And
if the market is trading below this 1.2439
the bears are winning the battle pulling
prices lower. On both cases this condition
is likely to sustain until the next session.
Since the Forex market is a 24hr market
(no close or open from day to day) there
is a eternal battle on deciding at white
time we should take the open, close, high
and low from each session. From our point
of view, the times that produce more accurate
predictions is taking the open at 00:00
GMT and the close at 23:59 GMT.
Besides the calculation of the PP, there
are other support and resistance levels
that are calculated taking the PP as a reference.
Support 1 (S1) = (PP * 2) – H
Resistance 1 (R1) = (PP * 2) - L
Support 2 (S2) = PP – (R1 – S1)
Resistance 2 (R2) = PP + (R1 – S1)
Where , H is the High of the previous period
and L is the low of the previous period
Continuing with the example above, PP =
1.2439
S1 = (1.2439 * 2) - 1.2474 = 1.2404
R1 = (1.2439 * 2) – 1.2376 = 1.2502
R2 = 1.2439 + (1.2636 – 1.2537) = 1.2537
S2 = 1.2439 – (1.2636 – 1.2537) = 1.2537
These levels are supposed to mark support
and resistance levels for the current session.
On the example above, the PP was calculated
using information of the previous session
(previous day.) This way we could see possible
intraday resistance and support levels.
But it can also be calculated using the
previous weekly or monthly data to determine
such levels. By doing so we are able to
see the sentiment over longer periods of
time. Also we can see possible levels that
might offer support and resistance throughout
the week or month. Calculating the Pivot
point in a weekly or monthly basis is mostly
used by long term traders, but it can also
be used by short time traders, it gives
us a good idea about the longer term trend.
S1, S2, R1 AND R2...? An Objective Alternative
As already stated, the pivot point zone
is a well-known technique and it works simply
because many traders and investors use and
trust it. But what about the other support
and resistance zones (S1, S2, R1 and R2,)
to forecast a support or resistance level
with some mathematical formula is somehow
subjective. It is hard to rely on them blindly
just because the formula popped out that
level. For this reason, we have created
an alternative way to map our time frame,
simpler but more objective and effective.
We calculate the pivot point as showed before.
But our support and resistance levels are
drawn in a different way. We take the previous
session high and low, and draw those levels
on today’s chart. The same is done with
the session before the previous session.
So, we will have our PP and four more important
levels drawn in our chart.
LOPS1, low of the previous session.
HOPS1, high of the previous session.
LOPS2, low of the session before the previous
session.
HOPS2, high of the session before the previous
session.
PP, pivot point.
These levels will tell us the strength of
the market at any given moment. If the market
is trading above the PP, then the market
is considered in a possible uptrend. If
the market is trading above HOPS1 or HOPS2,
then the market is in an uptrend, and we
only take long positions. If the market
is trading below the PP then the market
is considered in a possible downtrend. If
the market is trading below LOPS1 or LOPS2,
then the market is in a downtrend, and we
should only consider short trades.
The psychology behind this approach is simple.
We know that for some reason the market
stopped there from going higher/lower the
previous session, or the session before
that. We don’t know the reason, and we don’t
need to know it. We only know the fact:
the market reversed at that level. We also
know that traders and investors have memories,
they do remember that the price stopped
there before, and the odds are that the
market reverses from there again (maybe
because the same reason, and maybe not)
or at least find some support or resistance
at these levels.
What is important about his approach is
that support and resistance levels are measured
objectively; they aren’t just a level derived
from a mathematical formula, the price reversed
there before so these levels have a higher
probability of being effective.
Our mapping method works on both market
conditions, when trending and on sideways
conditions. In a trending market, it helps
us determine the strength of the trend and
trade off important levels. On sideways
markets it shows us possible reversal levels.
How we use our mapping method?
We at StraightForex (www.straightforex.com)
use the mapping method in three different
ways: as a trend identification (measure
of the strength of the trend), a trading
system using important levels with price
behavior as a trading signal and to set
the risk reward ratio (RR) of any given
trade based on where the is the market relative
to the previous session.
About the author:
Raul Lopez is the founder of www.straightforex.comA
site dedicated to provide high quality training
for Forex traders.
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