{"count":17,"next":"https://www.pagoolabs.com/stories/api/?ordering=-excerpt&page=2","previous":null,"results":[{"url":"https://www.pagoolabs.com/stories/api/54/","id":54,"title":"What Determines Which Currency is the Base and Which is the Quote?","slug":"what-determines-which-currency-is-the-base-and-which-is-the-quote","status":2,"publication_date":"2017-11-27T04:10:34Z","lead":"What do the Forex ticker symbols mean in foreign currency trading and how to understand Base Currency, Quote Currency and Account Currency.","excerpt":"We explain what the Forex ticker symbols mean in foreign currency trading and how to understand Base Currency, Quote Currency and Account Currency","poster":"SeanManefield","content":"---\r\n\r\n\r\n##### **Base vs Quote**\r\n\r\n\r\nForex contracts are expressed as a pair of foreign currencies such as AUD.JPY where the first currency is the Base currency and the second is the Quote currency. The base describes the commodity itself, just like oil, gold or Intel stock (INTC). The forex contract is priced in units of the quote currency.\r\n\r\nFor example, an ask price of 84.75 for AUD.JPY tells you that one Australian Dollar will cost you 84.75 Japanese Yen to buy.\r\n\r\nIf your accounts are in Euros or USD then neither the base nor the quote of AUD.JPY is the same as your account currency. Your account currency would be Euros or USD in this case. A trading account will normally stipulate which currency your trading is based in and realized wins and losses from trading AUD.JPY will need to be converted to it.\r\n\r\n![Typical Forex Contracts](/media/uploads/2017/Forex_Setups/Typical_FX_contracts.jpg \"Typical Forex Contracts\"):R28\r\n\r\n BASE.QUOTE | Quoted in:\r\n-------------|-----------\r\n AUD.JPY | Yen\r\n AUD.USD | US$\r\n USD.CAD | Canadian $\r\n USD.JPY | Yen\r\n EUR.USD | US$\r\n EUR.CHF | Swiss Francs\r\n USD.CHF | Swiss Francs\r\n USD.MXN | Mexican Pesos\r\n USD.CNH | Chinese Renminbi or Yuan\r\n\r\nHave you ever wondered why the AUD contract is expressed as AUD.USD but the Japanese and Canadian contracts are defined in terms of the non USA currency, USD.CAD and USD.JPY? Why is the Euro written as EUR.USD and not USD.EUR?\r\n\r\nThe short answer is that you could write them any way you like providing there is a market and your broker supports those reverse contracts. However, most if not all quote vendors express the contracts in the same ratio we use here.\r\n\r\nThe long answer is that, except for the recent Euro, the reasons are many and fuzzily recalled. I have my version of the story to tell based on my own experience working with foreign currencies since the 1970s.\r\n\r\nBack in the dark ages, when researchers would enter data into mainframe computers using stacked decks of cards, there were many more European currencies than today. There were French and Belgian Francs, German DMarks, Italian Lira and many more. Some currency crosses were quoted in one fashion on one side of an international border but quoted in the reverse direction on the other side.\r\n\r\nThe preferred way to quote a currency for US traders or tourists should be just like the AUD.USD. When expressed this way, it gives the price of an Australian Dollar in the same way as the price of an apple: in the locally used US currency. On the other hand, it is less transparent for Australians who see a price quote that is slightly more confusing: how many US$ they get for one A$. That's like seeing how many apples you can buy for $1 instead of the price of one apple.\r\n\r\nBut the real problem was that currencies are rarely related by the same order of magnitude. So there might have been five Francs to the USD, three DMarks or 200 Yen but much more rarely 1.1 or 0.9 units of foreign currency. My memory is that the issue was resolved partially by aesthetics alone: it was never convenient to enter error prone numbers onto punched cards when the forex quote looked like a fractional 0.00512 US Dollars for one Japanese Yen.\r\n\r\nI remember handling currencies using both the normal and the reverse ratio but I and those around me mostly favored the quote where a digit other than zero was on the left hand side of the decimal point. It just felt better, and it was easier to check on the old printouts where decimals were hard to read. No doubt, the older traders around us felt the same way, although it was never discussed, as far as I can recall.\r\n\r\nUp until the early 1980s, one Australian Dollar cost more than one US Dollar. Other than the name, the two currencies developed independently of each other. There is no requirement for the two to trade at parity or any level other than what's determined in the market. The Australian Dollar derived from the Australian Pound (two dollars for every one Pound in 1966) which in turn had earlier derived from the British Pound. The British Pound in turn cost about US$5 through the 19th century until the turmoil of the First World War. Today each Pound costs roughly US$1.33 and is quoted as GBP.USD.\r\n\r\nThe Canadian Dollar traded around parity in the 1970s but closed out that decade around C$1.20 to US$1 so the quote was reversed to look like USD.CAD, with a quote something like 1.20. Had it been the other way around CAD.USD would have been 0.83, less aesthetically pleasing on the old printouts and terminals and slightly more error prone, although not as bad as the Yen or Italian Lira would have been.\r\n\r\nIf you follow all the currencies back to the 1970s you will notice a pattern where the currency with the greater number of units in comparison is usually placed on the right hand side as the quote currency. So the Yen is expressed as USD.JPY where there are today over 110 Yen to one USD.\r\n\r\nI believe we inherit today whichever pattern was common up to the 1970s when computer databases froze the prevailing ratios. This is true even for currencies like the AUD which have more since fallen below one US$. Modern computers with clear screens easily displaying the decimal point or comma mean we don't need to worry about those old punched card concerns anymore, but we do continue to use the ratios that were convenient in earlier times.\r\n\r\n\r\n\r\n##### **What About the Euro?**\r\n\r\nWhen the single currency was introduced the European Union insisted it had to be quoted EUR.USD and not the reverse. It could be that they hoped the USD would be worth less than the Euro, as a matter of pride perhaps, but I don't think so. For Europeans, the natural way of expressing the currency if you had a choice about it or, as in this case, if you were imposing the ratio by fiat, would be to set USD.EUR as the standard. That would mean European tourists and traders would approach a foreign exchange counter and purchase US$ priced in their local Euro currency, just as they would apples or anything else.\r\n\r\nIn the same way as Europeans express a desire to price oil in Euros, they would price USD in Euros. It would make the most sense and be easier for them to discern value. But they didn't.\r\n\r\nI believe the decision was poorly thought through. I think some Europeans saw the GBP.USD and compared that to their own French Francs (USD.FRF) or Deutsche Marks (USD.DEM) and decided they'd be the big boys on the block by insisting the Euro goes first in the ticker symbol, resulting in EUR.USD.\r\n\r\nHistory is littered with accidents rather than plans. Correct me with a better story in the comments if you have one. I am less interested in the official narrative than what the real intention was, if indeed there was one.\r\n\r\nSo that's where we are today - organically grown currency ratios for the most part with the Euro thrown in by fiat.\r\n\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.","image":null,"forums":[{"url":"https://www.pagoolabs.com/forums/api/trading-education/","title":"Trading Education"}],"replies":1},{"url":"https://www.pagoolabs.com/stories/api/45/","id":45,"title":"Important Things to Know About Forex and Futures Trading Signals","slug":"trading-systems-part-3-signals","status":2,"publication_date":"2017-10-24T03:49:44Z","lead":"This third story in the series \"Introduction to Trading Systems\" explains a signal, the trigger alerting us to open a position in an instrument.","excerpt":"This third story in the series on Trading Systems explains a signal, the trigger alerting us to open a position in an instrument.","poster":"SeanManefield","content":"---\r\n#### **Trading Systems Part 3 - Signals**\r\n\r\nA signal is a price pattern trigger that opens a position. It might be a crossing moving average, a candlestick pattern such as a pin bar, or one of a host of other available indicators.\r\n\r\nA Signal then is a general *class* of market events that act like triggers. A Setup is a particular *instance* of a signal and includes all the trade data necessary to open that position.\r\n\r\nThe difference between signal and setup is much like the *concept* of dog versus a *real* dog. In your head you can imagine a dog and there is no chance of confusing one with a horse. But in the real world, dogs come in all shapes and sizes from cute little puppies to Great Danes. We still readily recognize a particular animal as a dog when it exhibits familiar dog-like qualities.\r\n\r\nIn the same way, signals are a class of triggers while setups are the real-world instance of those signals and provide the actual OP, SL, TP and CO you need to make a trade. You can use the terms interchangeably if you like which might result in some minor confusion, as long as you don't confuse either with a horse. When we talk about a signal, we imagine a reversal or some other specific trigger pattern. When we talk about a setup, we describe the particular SL and OP that surround that reversal, as can be seen in the annotated chart of the S&P below which uses a Heikin Ashi signal.\r\n\r\n![Signals vs Setup](/media/uploads/2017/basic_system_trading/SPX-D1-HA-rev-EG-signal-vs-setup-20171012.png \"Signals vs Setup\"):c95!\r\n\r\n\r\n** Open Only with the Trend **\r\n\r\nSo far we have discussed trend which I have argued will determine the direction of our trades. Since we only trade with the trend, we should ignore signals that trigger in the opposite direction. In a bull market we only open long. Since a computer program should in principle be able to flag opportunities on a chart, a signal must include all the rules you have decided to check before opening a trade. For example, if you only open pin bars in the direction of the trend then a pin bar at the top of a swing high is not a signal in an uptrend.\r\n\r\nWithin the trend we can use the setup tool to construct an OP, SL, TP and CS for *any* candlestick bar. Although I do not advocate your trying this, it explains why we discussed the setup first. The setup can be used anywhere, although probably not profitably. Since each bar has a low and a close, the low could be used as the SL and the OP would use the close of this bar or the open of the next. The number of contracts derives from risk (OP-SL). All we need to finish the setup is an optimal TP.\r\n\r\n** Support and Resistance **\r\n\r\nIf we applied such a strategy to every bar on the chart we could expect a disaster. There are too many whipsaw regions where stops would be constantly triggered. This naturally leads us to exclude most bars as open candidates for signals and instead concentrate on the small subset of bars where probability favors our trade.\r\n\r\n![Rejection & Support with a Pin Bar](/media/uploads/2017/basic_system_trading/Pin_Bar.png \"Rejection & Support with a Pin Bar\"):R40\r\nThe key to a good signal is that an area has been tested by the market and rejected. That's where we want to place our stops. The market may come back to test that area again and there is no guarantee our stops will hold. But that's also true everywhere on the chart. The one thing we know about an area of rejection is that it was tested at least once and the level held. Enough other traders entered in the direction of the trend before those levels were breached and that is an important defense of our trade in the future, raising the probability, however slightly, that our trade setup will succeed.\r\n\r\nAny pattern that tests and rejects an area of support is a *candidate* for a signal. Whether it's an acceptable candidate or not remains to be seen. Eventually you will decide on a small class of identifiable patterns that you will use as signals, all other patterns will be considered normal bars. Identifying areas of support (or resistance in a bear market) and how your signal exposes them will be your mission.\r\n\r\n** A Retracement Ending **\r\n\r\n![Retrace before Pin Bar](/media/uploads/2017/basic_system_trading/PB-OK-retrace.png \"Retrace before Pin Bar\"):L20\r\nWe might reasonably impose the extra condition that some kind of retracement occurred before the candidate signal. After reviewing all the historic data we might exclude from our signals any patterns that were not preceded by at least two periods of trading against the trend. This is a filter that *you* will decide for your own favorite signal. Trigger patterns that are not *prominent* in some way have not yet tested and rejected an area. The SL level you use must have a higher probability of surviving a retest than any normal bar.\r\n![No retrace before pin bar](/media/uploads/2017/basic_system_trading/PB-No-retrace.png \"No Retrace before Pin Bar\"):R40\r\n\r\n** Avoid Spikes **\r\n\r\nSometimes the stop loss level is so far away from the open price that the corresponding TP will lie somewhere far in the opposite direction. Reaching such a target price might seem improbable to an experienced trader. This might occur if our prospective SL is a large spike caused by some dramatic news that hit the market, in which case it may be better to wait for the next retracement to enter.\r\n\r\nIn the same way, avoid markets when major unexpected events are under way such as a war starting, the UK Brexit vote, or the USA 2016 election. Clearly there's nothing you can do to avoid these events if you are already in a trade and the unexpected is happening. But you should avoid plunging into a trade to take advantage of the volatility. Your stops will be highly vulnerable and the days following would be a much better trading environment.\r\n\r\n** No Waiting: Open According to your Trading Rules **\r\n\r\nDepending on your signal, you must open at the start of trading of the very next period OR wherever you tested in your simulations. If you wait for a better price you stand to miss out on the trade all together and all your testing results for the signal and system no longer apply. \r\n\r\nFor example, some setups fail and more of the trades that failed may have fallen to a 'better price' at the open than those that were successful, leaving you with positions in a greater proportion of losers. When this is true, your real trading results will underperform your tests results.\r\n\r\n** Only One Position at a Time **\r\n\r\nSince we do not want our total risk in this position to exceed 2%, never open a new trade when one is already open, except in other uncorrelated markets. If your trade is winning, other traders will be on the same ride as you. New signals occurring in the market at that time will be ignored by successful traders because they know not to amplify their risks with more than 2% of their risk capital, or whatever percentage they allocate to an open trade. That means you will be opening a trade where other traders are less likely to join in to help propel the price in your direction.\r\n\r\n![No Multiple Positions](/media/uploads/2017/basic_system_trading/SPX-D1-HA-rev-Single-Positions-20171012-2.png \"No Multiple Positions\"):R50\r\nThis is also true if there had earlier been a clear signal that you missed for some reason. The other traders whom you would like to join you in this trade are already in that earlier one. There are no secrets in the markets - if you can see a signal worth trading then so can many others. What may look like a pin bar to you could look like an engulfing pattern to another trader using a shorter timeframe. If the price moves up then another trader's MAs will cross. Momentum will also change, triggering even more traders to join the trade. So other traders may be following different signals to you but they may still be triggered to open in the same general area as your signal.\r\n\r\nTread carefully once you have open trades and always check the correlations between the markets you choose. If two markets are 100% correlated then you cannot have simultaneous positions in both markets. It would be as if you were trading the same instrument but with double the risk. For this reason, avoid trading in correlated markets until you have exited the other position. If you are unsure about correlation in general or whether two markets are highly correlated then it's best to just trade one market at any one time.\r\n\r\n** Rules and Filters **\r\n\r\nA signal then is a set of rules about when to enter a trade. On the one hand there are the mechanical rules that I discuss below, such as a pin bar must occur or an MA must cross. These are mechanical because they involve no discretion and arise straight from a pattern of market prices on the chart. On the other hand there are filtering conditions we might apply before we open a trade. For example:\r\n\r\n- the trade must be in the direction of the trend\r\n- avoid candles with huge spikes\r\n- a retrace should be of a certain percentage of the previous runup\r\n- the retrace should occur at some key level such as a **`fibonacci`** or support/resistance area\r\n- never open a trade if you are already open in this or a correlated market.\r\n\r\nYou might apply filters such as these after testing and observing their effects on the total profit of the system, as I discuss later. However, you the reader have a lot of fertile territory to improve on what we lay out here. Many filtering conditions will depend on the precise trigger you are using.\r\n\r\nA common set of filters are the momentum oscillators such as RSI and MACD. Filters tend to keep you out of trades, which is their purpose. However watch out in your testing to see if they add to or reduce your total wins. Helping you avoid bad trades is good, but keeping you out of good trades that win multiples of what you lose in bad trades is toxic.\r\n\r\n** Signal Coverage **\r\n\r\nFor a signal to be acceptable it must be immediately recognizable as the pattern you are seeking. Testing should already have confirmed that similar signals are profitable and it should have relatively complete coverage of the trend. \r\n\r\nBy *complete coverage* I mean that the signal will allow us to participate in the full run of the trend. If stopped out, we should receive another chance to enter via a subsequent signal. Buying at the bottom and selling at the top would of course be full coverage, if only such a thing were consistently possible. Missing the entire trend altogether would be zero coverage. We should prefer a signal that has better coverage because it's more likely to keep us in open positions during more of the trend.\r\n\r\nMoving average crosses and Heikin Ashi reversals are two examples having almost complete coverage, while pin bars depend on how often they occur in the relevant section of the trend.\r\n\r\n#### Summary\r\n\r\nThere are many different kinds of signals and traders have their own favorites. Since this is an education site, we are agnostic here about which signal you use. In the descriptions below, I will deliberately use the simplest signal I can find. My purpose is to describe *how* to go about building a system, not to advocate for any particular signal.\r\n\r\nIn other stories and posts I may use different signals just to show how widely the system method can be applied. A system does not require any one signal strategy but it does need a trigger in order to open positions. For this reason, you will have to select a signal method you are comfortable with.\r\n\r\nIt may well be that it does not matter in general what signal strategy you decide upon. What may be more important overall is how you apply it. I will discuss this further in the story about Systems.\r\n\r\nIn the [next story](/stories/46/2017/10/24/trading-systems-part-4-examples-of-signals/) I will discuss several common and not so common signal strategies: the MA cross, pin bars, engulfing patterns and the Heikin Ashi reversal. These are all just examples and you are encouraged to use whatever signal method you have been using to date.\r\n
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\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n\r\n*[HA]: Heikin Ashi\r\n*[MA]: Moving Average over a specified period - 100 periods for eg\r\n*[EMA]: Exponential Moving Average - has a long 'memory'\r\n*[OHLC]: Open, High, Low, Close: the 4 key values for any bar on a chart\r\n*[bull]: An uptrending or rising market\r\n*[bear]: A downtrending or falling market\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[MR]: Maximum Risk\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[EURJPY]: The Euro - Yen cross currency: buying Euros priced in Yen\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[setup]: An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\r\n*[instrument]: A particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: Particular traded forex or futures contracts such as gold or USDJPY\r\n*[underlined text]: Congratulations! You have successfully hovered over text\r\n*[indicator]: A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\r\n*[indicators]: Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\r\n*[H4]: Chart of the four hour timeframe\r\n*[M5]: Chart of the five minute timeframe\r\n*[H1]: Chart of the one hour timeframe","image":null,"forums":[{"url":"https://www.pagoolabs.com/forums/api/trading-education/","title":"Trading Education"}],"replies":0},{"url":"https://www.pagoolabs.com/stories/api/48/","id":48,"title":"Getting the Right Target Price in a Forex or Futures System Using Simulations","slug":"trading-systems-part-6-simulations-on-systems","status":2,"publication_date":"2017-10-24T03:56:39Z","lead":"This sixth and final story in the series \"Introduction to Trading Systems\" tests systems to show how to develop an optimal risk/reward multiplier. This RR is used to calculate the target price in each setup.","excerpt":"This sixth story in the series on Trading Systems tests systems to show how to develop an optimal risk/reward multiplier. This RR is used to calculate the target price in each setup.","poster":"SeanManefield","content":"---\r\n#### **Trading Systems Part 6 - Basic Manual Simulations in Forex and Futures**\r\n\r\nWe are going to apply the techniques discussed in the previous story to show how to simulate a particular market. What we are looking for is an optimal risk/reward multiplier, RR. In the real world, however, we more often find complications.\r\n\r\nI will be writing other stories on this topic because this is a major focus of our web site: **Pagoo** or *Playing A Game Of Odds*.\r\n\r\nHowever to begin, let's take an example where an optimal multiplier may not exist because we all want to remain sceptics about this whole approach. What do we do when our method does *not* work out easily?\r\n\r\nThe **first step** is to find a chart you want to trade where a trend reversal has recently taken place. This means you can enter early enough to profit from the remaining trend. As noted earlier, you may have a notion of why that trend reversal is occurring. As a result you may have reason to believe the new trend is tradable. By 'tradable' I simply mean that the target price of the first signal is achievable.\r\n\r\nFor our purposes, let's take the S&P 500 where the market has been in a longer term uptrend from 2009 but suffered through a period of correction from 2014 through 2016. As you can see from the chart below, at **point A** a trend reversal takes place, made evident by the faster 100 period moving average, MA(100), crossing above the MA(200). You are free to choose whichever relevant MA periods you prefer, or just use price action cycles, or use a regression line or whatever makes you confident the trend has changed. Crossing MAs is just an example I use here. Mistakes are allowed and you will see the outcome of those when you do your testing.\r\n\r\n![Uptrend in SPX futures](/media/uploads/2017/basic_system_trading/SPX-D1-UpT-20171012.png \"Uptrend in SPX futures\"):C90!\r\n\r\nWe can readily see the S&P is in a solid uptrend but we did not know that at point A. In fact, all we knew was that the S&P had been uptrending for many years and had recently gone through a correction. For all we knew, the correction might have become deeper. Once the MAs crossed, we acted *as if* the uptrend had resumed. That's all we needed to know.\r\n\r\n\r\n#### Pin bar example\r\n\r\nFor our first example of a system, let's use the pin bar signal. It's a popular candlestick pattern and many traders already make use of it.\r\n\r\nThe **second step** is to mark every hanging man candlestick on the chart. A hanging man candlestick pattern has a small head and a long lower tail. A bullish pin bar is just a hanging man with a prominent size and location to distinguish it, but that will be clearer as we work along. Each hanging man has been marked with a green arrow. Now let's filter out the candlesticks that do not meet our basic criteria for a pin bar:\r\n\r\n- Ignore hanging men outside the range of the MA cross: marked as red **'OR'**\r\n- Ignore hanging men which have **n**o **r**etrace with at least two previous red bars: **'NR'**\r\n- Mark the spikes which seem too extreme: **'S'**\r\n\r\n![Pin bars on S&P500 futures](/media/uploads/2017/basic_system_trading/SPX-D1-UpT-PBs-20171012.png \"Pin bars on S&P500 futures\"):C90\r\n\r\nThat leaves five candidates that qualify as signals. The spike is disqualified partly because it is not preceded by several down bars and partly because the target price may be so far above today's market that achieving that TP seems improbable - and probability is the name of the game. Pin bar #3 barely qualifies, but it does have two prior down days but is not as prominent as we would like. Pin bar #5 does not strictly qualify but is 'rejecting' the area below the MA(100), which gives it a measure of confluence.\r\n\r\nAlso note that if we lose the second trade we will be out of the market until we reenter for the third trade. During that period there was a big rally in our direction. There's an earlier engulfing pattern in the first week of December 2016 that we could add, but then we need to examine *all* engulfing patterns as entry candidates otherwise we would be selecting patterns based on hindsight. I will just keep this simple for now, but this is the sense in which I mean a pin bar signal is not *complete*.\r\n\r\nThe **third step** is iterative: starting at an RR multiplier of one, consider each trade in turn in the order it would occur in a live trade scenario. We will mechanically simulate what would transpire given our setup and the calculated TP. We will hold that position, opening no others, until it is either stopped out for a loss or triggers our TP for a win.\r\n\r\nTo show the mechanics, I indicate the risk of each trade in the table below, where the risk comes from the OP of the following time period less the SL given by the bottom of the pin bar. I always move the SL a few points beyond the bottom of the pin bar so that my stops would survive a challenge at the same price as the pin bar low. I will count any final open position as a loss because I want to be as sceptical as possible in the simulation and I have no other way to handle it until it's closed or the trend ends.\r\n\r\nThe starting conditions for this table are:\r\n\r\n- A maximum risk of 2%, assumed to be $100,000 here\r\n- A Risk Reward ratio of 1:1, or **RR=1**, so that the TP is 1 x Contract Risk\r\n- We are trading the ES mini S&P500 contract with a contract size or CS=50\r\n- The columns are just the setup parameters except for the final two result columns.\r\n\r\n Trade# | OP | SL | Risk | CR | TP (1) | CO | Result | Win/Loss\r\n----------|-----------|-----------|--------|--------|-----------|------|----------|-----------\r\n 1 | 2078.60 | 2049.70 | 28.90 | 1445 | 2107.50 | 1 | Win | +1445\r\n 2 | 2133.30 | 2112.70 | 20.60 | 1030 | 2153.90 | 2 | Win | +2060\r\n 3 | 2281.80 | 2266.50 | 15.30 | 765 | 2297.10 | 2 | Win | +1530\r\n 4 | 2343.80 | 2320.80 | 23.00 | 1150 | 2366.80 | 1 | Win | +1150\r\n 5 | 2430.20 | 2416.20 | 14.00 | 700 | 2444.20 | 2 | Win | +1400\r\n\r\n Total wins 5/5 $7585\r\n\r\nWe went over the risk limit by 3% on trade #2. A small amount is acceptable but in general avoid extra risk of more than 5%. Also note that we were able to open all trades because each trade reached its limit before the next signal was reached. It's unusual to get five wins in a row but that is a consequence of the strong trend and the fact that we only required an RR of one. A low RR means the market was more likely to reach the TP.\r\n\r\nThe **fourth step** is to repeat the simulation, raising the value of RR by a small step. Let's run the simulation again, this time with an **RR=2**.\r\n\r\n Trade# | OP | SL | Risk | CR | TP (2) | CO | Result | Win/Loss\r\n----------|-----------|-----------|--------|--------|-----------|------|----------|-----------\r\n 1 | 2078.60 | 2049.70 | 28.90 | 1445 | 2136.40 | 1 | Loss | -1445\r\n 2 | 2133.30 | 2112.70 | 20.60 | 1030 | 2174.50 | 2 | Win | +4120\r\n 3 | 2281.80 | 2266.50 | 15.30 | 765 | 2312.40 | 2 | Win | +3360\r\n 4 | 2343.80 | 2320.80 | 23.00 | 1150 | 2389.80 | 1 | Win | +2300\r\n 5 | 2430.20 | 2416.20 | 14.00 | 700 | 2430.20 | 2 | Win | +2800\r\n\r\n Total wins 4/5 $11,135\r\n\r\nEven though we were stopped out of one trade, we received double on the remaining four so our wins exceeded the results of the first simulation. We can conclude for this market under these counditions that holding out for an RR of two times risk is more profitable.\r\n\r\nLet's run the simulation again, this time with an **RR=3**.\r\n\r\nTrade# | OP | SL | Risk | CR | TP (3) | CO | Result | Win/Loss\r\n--------|-----------|-----------|--------|--------|-----------|------|----------|-----------\r\n 1 | 2078.60 | 2049.70 | 28.90 | 1445 | 2165.30 | 1 | Loss | -1445\r\n 2 | 2133.30 | 2112.70 | 20.60 | 1030 | 2195.10 | 2 | Loss | -2060\r\n 3 | 2281.80 | 2266.50 | 15.30 | 765 | 2327.70 | 2 | Win | +4590\r\n 4 | 2343.80 | 2320.80 | 23.00 | 1150 | 2412.80 | 1 | Win | +3450\r\n 5 | 2430.20 | 2416.20 | 14.00 | 700 | 2472.20 | 2 | Win | +4200\r\n\r\n Total wins 3/5 $8,735\r\n\r\n**Step five** is to compare our results. When we raise our TP to three times our risk, the total profit falls compared to the case with two times risk.\r\n\r\nBecause our wins fell compared to the previous round, we would normally turn to target that area 1 < RR < 3 and iterate in smaller steps to focus in on an optimal value of RR. This final **Step six** would result in an optimal RR.\r\n\r\nHowever, in this case, it's worth looking further since this market has been in a long term uptrend. In fact, the S&P 500 climbed over 25% in this same period and it seems that a win of only $11K out of $100K in funds is too low, even if we only risked 2%. Others who are 100% invested in the S&P stocks have made about 25%, but only if they close now. In contrast, we are fully cashed up. Still, 25% is better than 11% so let's see what is going on here.\r\n\r\nFirst, note that in the previous simulation with TP set to two times risk, we won four times receiving twice our risk for each. So in total we made roughly eight times our maximum risk (4 wins x 2 x $2K), except for slippage cause by rounding down. So let's try to see if taking a trade with an **RR=8** will win:\r\n\r\nTrade# | OP | SL | Risk | CR | TP (8) | CO | Result | Win/Loss\r\n--------|-----------|-----------|--------|--------|-----------|------|----------|-----------\r\n 1 | 2078.60 | 2049.70 | 28.90 | 1445 | 2309.80 | 1 | Loss | -1445\r\n 2 | 2133.30 | 2112.70 | 20.60 | 1030 | 2298.10 | 2 | Loss | -2060\r\n 3 | 2281.80 | 2266.50 | 15.30 | 765 | 2404.20 | 2 | Win | +12,240\r\n 4 | 2343.80 | 2320.80 | 23.00 | 1150 | 2527.80 | 1 | skipped | 0%\r\n 5 | 2430.20 | 2416.20 | 14.00 | 700 | 2542.20 | 2 | Win | +11,200\r\n\r\n Total wins 2/5 $19,935\r\n\r\nTrade #4 was skipped because we still had trade #3 open and one of our rules is not to go over 2% risk. Not only did one trade win at RR=8 but we managed to win two trades.\r\n\r\nAlmost $20,000 is a substantial profit for a $100,000 portfolio that never risked more than 2% per trade, although by trade #3 we were down potentially 6%. The system I have used above is one of the simplest. It uses a crossing MA to detect trend reversal and just one type of candlestick, the pin bar, as a trade signal. There's clearly huge potential for improvement.\r\n\r\nThe gains took place over 16 months and the trend is not yet finished. As it finishes you can expect to surrender some of that profit as what appear to be retracements turn out to become trend reversals that trigger stops.\r\n\r\nAt some point it will become clearer that the uptrend is over and either a period of consolidation or a downtrend ensues. At that stage you can stop opening positions on signals. Until then the system does need to book profits to pay for the coming losses, or you could stop now until the next uptrend starts. Whatever you do, you must be consistent so that you can evaluate your performance and make necessary adjustments for the next trend you trade.\r\n\r\nIf we look at the chart, something we can only do in hindsight, we can see a number of pin bars have not yet had their lows retested and the chart is currently trading at all time highs. That means that *any* RR multiple would work, as long as we closed our position now to lock in those profits. But how do we approach this problem before the trading takes place?\r\n\r\nIf we knew the path of prices from the outset with clairvoyence, but determined to only enter trades based on pin bar signals, pin bar #3 would be best because it has furthest to run without being stopped. Yet it is also possibly the weakest shaped pin bar on the chart: small, does not protude from surrounding bars, is in a tiny retrace, is far above the moving averages, and so on. A reasonable pin bar trader would reject it. A position opened on pin bar #3 and held until the last day of trading would yield almost 18x risk, or $27,390 here because of rounded down contract sizes ($765 x 2 contracts x 18). So the optimum RR for this leg of the bull market in the S&P would lie somewhere between RR=8 and RR=18.\r\n\r\nBut you cannot know about this single pin bar in advance. When you see RR numbers going over five, stop and examine the situation further. Your entire simulation cannot depend on one outlier.\r\n\r\nThis chart is typical of the S&P 500. It represents stocks that have risen consistently for a century. The growing companies that comprise the S&P together with general price inflation, cause the index to be in a solid uptrend. There is no guarantee this will last but with all time highs being posted daily, it's unlikely to end anytime soon.\r\n\r\nThe current rapid rise we are witnessing is at the high end of its previous performance, comparable to the post Soviet Union bull market of the 1990s. This suggests that expecting an eightfold increase or more for a pin bar could be unrealistic for other periods. You need to go back further and run the same simulation in earlier time periods. This is the time to break out your programming talents, for those that have them. Even a spreadsheet would make short work of this data and the worksheets or programs could be reused on other markets and time periods.\r\n\r\nIf you don't have the time or inclination to program a simulation, print out the charts and user a ruler to find where stops are triggered. Do rough calculations for the trade risk and TP levels and avoid laboring over decimal places unless necessary for the market in question. The advantage is you will have a permanent record for your files.\r\n\r\n#### Summary\r\n\r\nTo begin our exploration of systems, I have picked an easy chart, although it is absolutely current and has some tricky quirks. Most charts will not be so easy because very few markets at the present time trend so strongly without pause. When inflation picks up, commodity prices should resume their uptrend.\r\n\r\nWhen we turn to other markets that don't trend so strongly, we will see that there is often an optimum RR somewhere in the range one to five. It's up to you to find that optimum so that you can calculate the TP for the setup tool.\r\n\r\nIn the first series on \"The Basic Setup\" I showed you how to bring together all the key components of a trade setup except the target price, TP. We have now come full circle, calculating an optimal risk/reward multiplier, RR, and therefore a TP that completes all the elements you need in the basic setup. Now with the basic setup in place you should be able to apply it to your preferred signal method and estimate an RR as input into a system of trades.\r\n\r\nPerhaps what you discover by measuring the results of your system under different RR values will lead you to calibrate the approach you have been using up until now, or even to change to a different signal method. That's all part of learning and trading.\r\n\r\nNone of these methods or ratios are permanent fundamental constants of the universe in the way that mathematical pi is. In fact you can expect RR and some of the signal filters to change over time and between markets.\r\n\r\nHowever if you apply your time and energy to investigating the trend and measuring the performance of your system rather than constantly second guessing every trade and whether you should take profits or move to break even, I believe you will be far better psychologically equipped to make profits in futures and forex. Micro managing trades will cause you to make so many mistakes you will lose confidence in your ability to trade anything. Aside from excess leverage, there is probably no greater impediment to trading than poor psychology and implementing a system will help you see that.\r\n\r\nIn our future stories I will apply the methods detailed above to calculating the optimal RR for other markets. I will continue to pick tricky examples, such as ambiguous trends or markets consolidating, because that's where I believe there is the most to learn.\r\n\r\n
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\r\n#### Disclaimers\r\n\r\nAlthough the PagooLABS site is educational and does not advocate any position in a futures or forex contract, it is important to present the following disclaimers as additional information. Trading these markets can be risky and you must be aware of the following:\r\n\r\n**U.S. Government Required Disclaimer**\r\nCommodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results.\r\n\r\n** CFTC RULE 4.41 **\r\n\"These results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown.\"\r\n\r\n
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\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n*[pi]: ratio of a circle's circumference to its diameter\r\n*[HA]: Heikin Ashi\r\n*[MA]: Moving Average over a specified period - 100 periods for eg\r\n*[EMA]: Exponential Moving Average - has a long 'memory'\r\n*[OHLC]: Open, High, Low, Close: the 4 key values for any bar on a chart\r\n*[bull]: An uptrending or rising market\r\n*[bear]: A downtrending or falling market\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[MR]: Maximum Risk\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[EURJPY]: The Euro - Yen cross currency: buying Euros priced in Yen\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[setup]: An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\r\n*[instrument]: A particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: Particular traded forex or futures contracts such as gold or USDJPY\r\n*[underlined text]: Congratulations! You have successfully hovered over text\r\n*[indicator]: A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\r\n*[indicators]: Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\r\n*[H4]: Chart of the four hour timeframe\r\n*[M5]: Chart of the five minute timeframe\r\n*[H1]: Chart of the one hour timeframe","image":null,"forums":[{"url":"https://www.pagoolabs.com/forums/api/trading-education/","title":"Trading Education"}],"replies":6},{"url":"https://www.pagoolabs.com/stories/api/44/","id":44,"title":"What you Need to Know About Timeframes, Fundamentals and Reversals in Forex and Futures Systems","slug":"trading-systems-part-2-timeframes-fundamentals-reversals-and-retracements","status":2,"publication_date":"2017-10-24T03:47:29Z","lead":"This second story in the series \"Introduction to Trading Systems\" investigates how timeframes and fundamentals affect the trend. We also look at how to distinguish retracements from trend reversals.","excerpt":"This second story in the series on Trading Systems investigates how timeframes and fundamentals affect the trend. We also look at how to distinguish retracements from trend reversals.","poster":"SeanManefield","content":"---\r\n#### **Trading Systems Part 2**\r\n\r\nThe [previous story](/stories/43/2017/10/24/trading-systems-part-1-introduction/) introduced trends and showed how to recognize them using higher-high and higher-low cycles, (HH-HL, or LH-LL in downtrends) and moving averages. Here we will look further into timeframes and fundamentals to see how they affect the trend.\r\n\r\nIn some cases a trend can be almost indistinguishable from a sideways pattern. Cases like this are to be avoided because if other traders in the market lack conviction why should you be so convinced? Trade another market and come back to this one when the trend is more obvious.\r\n\r\n\r\n#### Shorter Timeframes\r\n\r\nAnother alternative is to move your trading to a shorter time frame: what looks like a series of whipsaws going nowhere on the weekly, may look like a strong trend on the latest section of the H4 chart. Equally, you could move to a longer timeframe: what looks like a sideways market on the H4 may be just a small retrace forming in a steady trend on the weekly. Favor longer over shorter timeframes if you can.\r\n\r\nYour charting software usually allows you to choose between various timeframes. The common ones include:\r\n\r\n- one minute\r\n- 5 minutes\r\n- 15 minutes\r\n- one hour\r\n- 4 hours (H4)\r\n- one day (D1)\r\n- one week (W1) and\r\n- one month\r\n\r\nEach timeframe collapses all the trades for that period into one bar on the chart. The open and the close are the prices where the time period began and ended respectively, and the high and low are the trading extremes over the duration of the period.\r\n\r\nIn general you should aim to trade the daily. This allows you 24 hours to digest a single candlestick, which is often enough time to review the news. You will have several days at least between trades, enough time to recover from a failed trade as well as time to remind yourself after a successful trade that you are very much human. In ancient Rome a slave would whisper in Caesar's ear that he should *\"Remember, you are only a mortal!\"* while enjoying the adolation of the crowd during a victory triumph. A win is often a lot of money so never let success carry you away. It's just a trading system and sometimes it wins, sometimes it loses. A level head helps.\r\n\r\nHowever if the markets are trendless on the daily or weekly charts, you might consider trading shorter timeframes where a tradable trend may be easier to see. Consider the Gold futures contract where gold has been consolidating sideways on the weekly chart after falling from its 2011 European crisis highs.\r\n\r\nHere is how a longer timeframe (weekly) looks for the Gold continuous futures contract:\r\n![Gold Futures - no trend on the weekly](/media/uploads/2017/basic_system_trading/Gold-Wk-NoT-20171015.png \"Gold Futures - no trend on the weekly\"):C90\r\n\r\nThose little wiggles in the chart look insignificant on the weekly but on the H4 they display a tradable trend:![Gold Futures - H4 trending](/media/uploads/2017/basic_system_trading/Gold-H4-T-20171015.png \"Gold Futures - H4 trending\"):C90\r\n\r\nIn terms of the basic operation of your system, nothing much changes in your setup, signals and system as you move to a shorter timeframe, other than the points I discussed above about analysis and recovery time. But there are some notable differences with shorter timeframes you must be aware of:\r\n\r\n- Unless the system is automated or you have trading partners scattered across timezones trading the same system on the same portfolio, no human can trade 24 hours continuously without sleeping.\r\n- You cannot assume the best signals occur while you are awake.\r\n- You will therefore miss many signals.\r\n- News that shocks the daily charts will so overwhelm the shorter timeframe that your stops can slip disastrously. Your system could be thrown into deep losses. Of course, the opposite may happen as well and you win, but then you are limited to a four fold win. Except for the very best, many brokers will force you to carry all losses but will turn on a dime to share in any gains should you win more than you expected.\r\n- Bid/ask spreads and commissions become a bigger percentage of the trade.\r\n- Margin comes into play because you will be buying more contracts given the closer stops and therefore the lower risk - see the series on [\"The Basic Setup\"](/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/) for an explanation.\r\n\r\nChoose a timeframe that most suits your style, favoring longer over shorter timeframes where possible.\r\n\r\n\r\n#### The Fundamentals and Trend\r\n\r\nIf you trade a market you owe it to yourself to become familiar with its news and the fundamental influences that drive it. If the instrument is trading in a bull market you should know why. As it changes direction, ask what fundamentals have now changed? Are they likely to last long enough for a trade? Ask yourself the same question every day. This is your best early clue to a change in trend.\r\n\r\nIn a very important sense, the trend *is* the longer term fundamentals. If prices in the economy are inflating, gold, oil and other commodities will be rising in price. Currencies of countries with prices rising faster will fall against the currencies of countries with more stable prices. At present (2017), inflation is low and lower than many observers expected a decade ago. In consequence, prices for gold and oil are lower than their peaks set at a time when prices were expected to rebound. Of course, there are other reasons for the fall in some commodity prices but keep your eye out for if and when inflation starts to re-enter the system.\r\n\r\nThe fundamentals and the trend should be in sync, and if they are not then you should be cautious about trading that market until they are. Also, different timeframes have different fundamentals. A minor news conference or statement from the Bank of Japan might send the Yen in a new direction on the M5 chart but result in less than a blip on the daily.\r\n\r\nAs technical traders we are accustomed to the rubric that all news is already in the prices. There is a lot of truth to that but we should still be aware of the *major* fundamentals driving the trend, not the day to day press conferences or occasional burst pipe line. When the trend changes, the prices will reverse direction but it may just look like a deep retracement in the early stages. Knowing the major fundamentals and how that affects the markets you follow will help you spot a changed trend or paradigm shift sooner.\r\n\r\n\r\n#### Trend Reversals\r\n\r\n![Trend Reversal](/media/uploads/2017/basic_system_trading/UpT-Rev-EG-20171015.png \"Is the Trend Reversing?\"):R40\r\nIt is rarely clear when a previous trend is coming to an end and has begun to reverse direction. You could wait for a pattern of HH-HL or LH-LL to assert itself. Or you might wait for the faster (short timeframe) moving average to cross the slower. If you trade these markets you should have a good idea of the news in this area. What has changed in the fundamentals to cause this new market behavior? Does it look like these new fundamentals will be market drivers over the time horizen of your trades?\r\n\r\nIf you wait until a new trend is well and truly established, it may be too late to trade. These are normal issues that every trader has to grapple with. Follow rules that are consistent so that you can measure your performance and adjust if necessary.\r\n\r\n![Gold Short Pin Bar](/media/uploads/2017/basic_system_trading/Gold-D1-NG-Rev1-20171019.png \"Gold Short Pin Bar\"):C80!\r\nThere is a tendency for some traders to trade reversals because in looking at the charts, that's where the biggest gains cluster. ![Gold Short Pin Bar](/media/uploads/2017/basic_system_trading/Gold-D1-NG-Rev2-20171019.png \"Gold Short Pin Bar: Whoops!\"):R30 However, for long periods in a row, a trend can progress relentlessly in one direction. Based on probability alone, a series of smaller trades in line with the trend would be far more likely to succeed than guessing that one place where the trend finally ends. If you trade the trend then that last trade where the reversal triggered your stop would be a loss but all the earlier wins should offset that nicely. As you can see here above and to the right, what looked like a prominent pin bar in the Gold continuous futures contract, turned out to be one more bar continuing in the direction of the trend.\r\n\r\nThe one exception to this rule about not trading reversals should be those trading sideways markets, which I do not cover here.\r\n\r\nWhile it may not be clear for some time that a trend has reversed, evidence nonetheless accumulates pointing to that conclusion:\r\n\r\n- the fundamentals have changed\r\n- coming out of a previous downtrend the market puts in a higher low and a higher high\r\n- the moving averages cross, and\r\n- possibly a candlestick reversal pattern is evident at the low.\r\n\r\nAny one of these may not mean much but when several occur then its probably time to change over to a bullish strategy of buying the retracements. Evidence for a trend change applies equally at the start and at the end of a trend. Look to the much longer timeframe to see whether the new trend is likely to be a real trend reversal or a retracement.\r\n\r\n\r\n#### Retracements against the trend\r\n\r\nWithin the trend, retracements occur regularly. On the charts above you can see these retracements between each HH and HL. There are many reasons for why prices do not move steadily in one direction but it's apparent that traders have widely divergent views about the interpretation of events as they occur in markets. Perhaps you are yourself conflicted about which way a particular item of news will send prices. There are two views right there! Profit taking by traders on their winning positions could itself reverse prices for a time.\r\n\r\nEventually whatever was fundamentally driving the trend will reassert itself, the short term profit taking will stop and stronger hands will hold on. The net effect is more buying pressure than selling within a bull market. The retracement comes to an end and the trend resumes.\r\n\r\n![Setup after retracement](/media/uploads/2017/basic_system_trading/Ret-MA-EG-20171015.png \"Setup after retracement\"):R45\r\nAs you can see, this area where prices resume in the direction of the trend is an excellent place to enter a new position. We have a clear area where the market tested further price falls and for now rejected them. Retracements that signal a resumption in trend are valuable sources of the location of support and resistance areas. I will return to explore this area further in the next section on signals in Part 3.\r\n\r\nWhen a trend reverses, it is not clear until much later when prices cut through previous areas of support or resistance. However when a retracement reverses it is from a higher low in a bull market (or lower high in a bear market) and you continue to trade with the trend. The more time you spend with charts the less chance of getting the two confused.\r\n\r\n#### Summary\r\n\r\nTrade the longer timeframes whenever possible. They give you plenty of time to analyze the market and make the necessary pyschological adjustments you need to risk your money on a trade.\r\n\r\nEven technical traders should pay attention to the fundamentals as a guide to understanding the trend.\r\n\r\nDo not confuse reversals of trend with a retracement coming to an end. Check the history of the chart to see if the market is setting a higher low in what was a downtrend (or lower high in a previous uptrend).\r\n\r\nIn the [next story](/stories/45/2017/10/24/trading-systems-part-3-signals/) we will discuss how to receive a signal from the market. Signals are the heart of trading and typically include any special market price behavior that you have previously determined will trigger you to open a position. To do so, you will use the setup tools we have already discussed.\r\n
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\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n\r\n*[HA]: Heikin Ashi\r\n*[MA]: Moving Average over a specified period - 100 periods for eg\r\n*[EMA]: Exponential Moving Average - has a long 'memory'\r\n*[OHLC]: Open, High, Low, Close: the 4 key values for any bar on a chart\r\n*[bull]: An uptrending or rising market\r\n*[bear]: A downtrending or falling market\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[MR]: Maximum Risk\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[EURJPY]: The Euro - Yen cross currency: buying Euros priced in Yen\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[setup]: An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\r\n*[instrument]: A particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: Particular traded forex or futures contracts such as gold or USDJPY\r\n*[underlined text]: Congratulations! You have successfully hovered over text\r\n*[indicator]: A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\r\n*[indicators]: Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\r\n*[H4]: Chart of the four hour timeframe\r\n*[M5]: Chart of the five minute timeframe\r\n*[H1]: Chart of the one hour timeframe","image":null,"forums":[{"url":"https://www.pagoolabs.com/forums/api/trading-education/","title":"Trading Education"}],"replies":3},{"url":"https://www.pagoolabs.com/stories/api/43/","id":43,"title":"Building a Futures or Forex Trading System Using Trends","slug":"trading-systems-part-1-introduction","status":2,"publication_date":"2017-10-24T03:44:35Z","lead":"This first story in the series \"Introduction to Trading Systems\" explains what a system is and what you need to know about trends and signals so you will be able to build your own custom trading system.","excerpt":"This Introduction to Trading Systems explains what you need to know about trends and signals to help you build your own custom trading system.","poster":"SeanManefield","content":"---\r\n\r\n#### **Trading Systems Part 1**\r\n\r\nThis series shows you how to build a trading system. Within a system there is an almost limitless variety of buy and sell signals we could use, but here I purposely avoid advocating any particular method. That's because for many traders it's the system that is missing, not the ability to recognize a valid signal.\r\n\r\nBy learning how to build your own system you will have a trading method unique enough that you will be able to enter profitable positions hopefully before any advantage is arbitraged away by others. When enough traders play the same system, your entries, stops and targets would be discovered. Bigger players may find it profitable to bet against you, knowing that triggering your stops would allow them to enter in the same direction as you at a better price. By trading against you, the bigger players can reduce the profitability of your system and may even cause it to fail.\r\n\r\nFor that reason, I do not advocate you using any simple system outlined here. That's also true of just about any publically known system. It helps that there are so many systems out there, but what really helps is that so many beginning traders don't use systems at all. Instead, they make regular 'donations' to those who do, until their accounts are empty.\r\n\r\nWhat I present below is just for learning purposes. It should be easy to adapt this material to your particular trading style and favorite indicators, and I show you how.\r\n\r\nA system is simply a sequence of trades, all based on the same or similar **`signals`**. It is designed by carefully evaluating the historic data and the longer term charts. Any one trade might fail leaving you with a loss however a system covers multiple trades and the designer of a system looks for an approach where wins consistently beat losses.\r\n\r\n![Sample MA Cross System](/media/uploads/2017/basic_system_trading/SPX-D1-UpT-MACross-EG-20171019.png \"Sample MA Cross System\"):C100\r\n\r\nAbove is an example of a system, although it makes little sense at this point. Nonetheless, you can see that we have six setups on this chart where we could place an open trade based on the crossing of two **`moving averages`** (MAs). They are marked by little crosses below where the MA cross occurred, green for success and red for failure. I will explain this in detail later on but for now it just means that whenever the five period MA, MA(5), crosses above the MA(14) we will open a long position. There is nothing significant in these MA periods, they are just to illustrate a simple system. There is also a pair of longer term MAs, the MA(100) and MA(200), which are only shown to emphasize the trend since point A.\r\n\r\nThe point here is that our first setup failed, as did the 3rd and 4th. However, three of the six trades here were successful. If the TP were twice the risk then this simplistic system would generate three times the risk in wins (2 x 3 wins - 1 x 3 losses = 3), and therefore 6% of our risk funds (2% x 3). Of course, I have to explain why we should be long and not short after point A, why I chose twice the risk for the TP, what's this crossing MA all about and what happened to the right of the chart. I hope this series on systems will answer all these questions and more.\r\n\r\nIn many of the examples I deliberately use a simple MA cross to determine when the trend starts and sometimes even the triggers that prompt us into a trade. Although simple, if we can make a system work well with MAs then imagine what you can do with all your favorite indicators. Also, MA crosses are easy to explain and draw, so just what I need.\r\n\r\nDon't expect a system to be anything complicated. A system is *consistent*, and the easier to understand the better. A consistent system applies the rules in the same way on every trade setup. By being consistent, a system becomes testable. If we subtly change the conditions whenever we feel the normal human emotions of fear or greed, the system could fail but we won't know why.\r\n\r\nIf you have not used a system before it brings a major improvement for very little extra work.\r\n\r\nBefore we can discuss a trading system, I have some ground to cover on a few very important concepts. I have already posted a series on [**setups**](/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/) but we also need to discuss **trends** and **signals**. These two key topics will make up parts 1 to 4 of this series.\r\n\r\nWhile I have tried to keep this presentation simple, I imagine most readers would have already thought about many of these issues. Perhaps you have been trading a while but have become frustrated how often you are stopped out of trades that afterward move in your anticipated direction. For this reason, much of the jargon of trading is not covered here, or when it is covered, perhaps I pass over it too quickly. If you hover over underlined text, a brief explanation will pop up on many uncommon terms. Please alert us via a post in the comments section whenever something is unclear.\r\n\r\nAs you design your own systems I hope you will discuss your experiences on our forums. The best way to learn is to put your own ideas out there for discussion, get help and hopefully have your system improved by other members. Feel free to post replies to existing stories and, when you have enough points earned from posts, you will be able to post your own stories. Eventually you will be able to start and moderate your own forums when you have accumulated enough reputation.\r\n\r\nIf you have not done so already, I recommend that you first read through the series on [\"The Basic Setup\"](/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/). This current series on Systems relies heavily on material discussed there on the Open Price (OP), Stop Loss (SL), Target Price (TP) and Contracts Opened (CO).\r\n\r\nFrom [\"The Basic Setup\"](/stories/40/2017/10/24/the-basic-setup-part-3-risky-trades/) we will assume in what follows a risk capital of $100,000 and a risk per trade of $2000. Because your risk capital is almost certainly different, just divide or multiply the per trade amounts depending on your available funds.\r\n\r\nAfter reading this series on systems, you should know:\r\n\r\n- how to spot a trend\r\n- the difference between a setup, a signal and a system\r\n- how to use your preferred signaling method in a full system\r\n- how to measure the number of wins and losses and\r\n- how to test whether your system has worked in the past.\r\n\r\nEverything I have to say here on trading applies equally whether short or long. However the descriptions become tedious to read when every sentence has to be qualified with something like \"or sell if short\". For this reason, in most of what follows unless otherwise stated, I will assume an uptrend (or bull market) and long positions. This is just for convenience and does not imply that being long is preferable to being short.\r\n\r\n#### The Trend\r\n\r\nMarkets spend most of their time consolidating sideways. You could build a system around this fact alone but it's not what we will do here. Instead we will focus on trending markets because those are more likely to result in a winning trade. Also the market is more likely to move to a TP that is a greater distance from the open price than the SL.\r\n\r\n![Uptrend then Consolidate](/media/uploads/2017/basic_system_trading/consolidating-trend.png \"Uptrend then Consolidate\"):R40\r\nWhen favorable information first hits the market, prices start to rise to some higher level. The prices then either consolidate, or fall back if the rise was too high or too fast. But if the asset such as gold, oil, the S&P or some currency is now worth more to the market, why doesn't the market immediately jump to that new higher level? After all, who would sell below that level and who would not be buying? Both of those factors should push the price up to the new level immediately.\r\n\r\nSometimes markets *do* adjust quickly and when that happens politicians and traders on the losing side howl that something has gone terribly wrong. But in general prices adjust slowly for several reasons:\r\n\r\n- it's rarely clear at the time prices begin to move where that higher or lower stable price range lies\r\n- funds have to be moved out of other markets first and perhaps now is not the best time\r\n- the price rising is itself confirmation to other traders that the news is in fact bullish, so the initial price rise accelerates, sometimes overshooting\r\n- some traders may think that the initial price rise was sufficient for this piece of news and either take profits or short it.\r\n\r\nThere are many different players in every market each with their own competing perspectives. Some players are central banks with a policy to push, others are major corporations hedging against a product they have committed to deliver. Still other players may have misinterpreted the significance of the news.\r\n\r\nAll of these factors combine to slow down the movement in market prices as they adjust from the previous stable trading range to the new higher one. During that period of adjustment we have a trend.\r\n\r\n![Uptrend in SPX futures](/media/uploads/2017/basic_system_trading/SPX-D1-UpT-20171012.png \"Uptrend in SPX futures\"):C85!\r\nSome trends are obvious, such as the recent behavior of the S&P500 on the daily or weekly timeframe from 2009 to 2017, arguably longer (see above). Obvious trends display a clear rise or fall in prices as you look across the chart from left to right. Within a trend, retraces or cycles may occur but they should exhibit a reasonably clear pattern of higher highs (HH) and higher lows (HL) in a bull trend, and lower highs (LH) and lower lows (LL) when the market is bearish.\r\n