Forex Discipline

I finally found it. Several books gave me some clues. Webinars hinted at some ideas. Online forums and discussions provided more evidence. Finally, it all came together to form my perfect forex trading system.

My perfect system has:

• Solid and logical entry points
• Tight and controllable money management
• Clear exit points for profits and controlled losses
• Auto adjusts to fundamental trends
• Simple methodology
• Highly aligned with my own personal trading style.

What makes my system perfect? It’s the sixth point above. The fact that I spent the last year tweaking and tuning to develop a system that exactly matched my individual trading style, interests and behavior. I learned that this was the only way I could be disciplined with my trading. Of course, my perfect system may be awful for you. You and I trade differently and think differently about all sorts of issues from importance of fundamental analysis to global economic events. I can guarantee you that you and I would develop different “perfect systems.”

I’ll explain a little bit about what I consider to be a perfect system for me. That doesn’t mean that I think negatively of any other type of system but just stating what I discovered about myself.

Some history:

I have a fairly analytical perspective from my career. My background historically has been ROI driven database marketing. I’ve often thought of combining my statistical modelling experience with trading in general. From building multi-variate regression models with unusual correlated variables such as weather and google indexed news mentions to factor analysis looking for similarities between a cohort of stocks that could predict success. I was over thinking and figured I would find that “secret” unusually correlated variable that no one had ever thought to use and make my billions on Wall St. Ha. That didn’t work. Then I started studying fundamentals and felt that understanding the macro as well as micro economic conditions would give me an edge. This aligned with my own personal interests. I love reading about the global economy in general so this seemed like a natural. I kept getting a nagging feeling that I would never be able to know as much as I wanted. Plus, even when I could absolutely predict the outcome of a major economic event, I was really struggling predicting the behavior of the stock or currency. For instance, if Greece ends up with a bail out and tough austerity plan, will the EUR strengthen or weaken. I’d argue it would strengthen as the uncertainty of Greece is eliminated and the markets like closure. However, it could just as easily weaken and reports would rationalize that the austerity measures are too weak, bailout too big, spotlight is now on other Euro countries. You even see this on the same day. Often times, a news report will talk about the futures market opening up positive due to a certain news announcement. Then an hour later, the market opens and actually goes down. Then you see another report talking about the same news announcement but with a different negative spin. Fundamentals are confusing. Don’t even get me started about what happens with corrections after major news. I explored Technical Analysis but that never quite clicked with me for some reason. Maybe just too skeptical.

From a personal perspective, I discovered forex about 5-6 years ago. I’ve been investing in stocks for about 10 years and doing fairly well. Same habit of being overly aggressive and moving up 5 and when I go down 3, I panic and cut my losses. Overall, I’ve done well but this cycle certainly was not working. I tried to be more disciplined with forex and found the same psychological problem. Then I took some time off and discovered automated trading. This was a brand new arena for me. Over time, I started trying out various systems from elaborate hybrid systems full of Donchian/Fibonacci/SMA’s etc. to more basic turtle trading style trend following systems.

I spent the next couple of years casually reading, developing and testing different systems and methodologies. I kept gravitating towards a basic trend following type of system similar to grid based systems. Books about the Turtles helped reinforce this for me. I got rid of fancy variables and focused on price volatility. I always believed that price was the more direct variable to measure anyway when predicting future price. Why look at historic volume and how it correlates to historic price to predict future price when you can just look directly at price.

Next was using analytics that I liked and was comfortable with such as regression and standard deviation channels. Could you do something similar with Bollinger bands or Donchian channels? Sure. But I liked my linear regression channels as they “felt” more intuitive to me.

My personal system means that I will have a much higher percentage of small losses and bigger gains on breakouts. A lot of thought went into mitigating the large potential losses that a grid based system might encounter. Could you stomach seeing your base slowly get nickle and dimes away and start dwindling over weeks and waiting for a hopeful breakout? I’m okay with this as I built the system to do this so I expect it. This would drive some people crazy and they would react manually and trigger trades.

I also focused on keeping automated money management rules in place so I’m typically trading with 2-5% max risk (realistic risk is about 1% based on how system works).

So what about fundamentals. I’m still sorting that out mentally. Right now, the system is purely automated and does not factor in fundamentals. If the trend is upwards, it will enter larger positions for buys and smaller ones for sells. This in essence takes into account fundamental trends. You could argue that the natural state of a currency pair is horizontal. So an upward or downward trend is the fundamental market driving the trend. Again, looking at the price trend takes into account every minutia of fundamental news there is and correlates it perfectly in the reflected price. What I’m grappling with is my passion for fundamentals. Do I just ignore the news? Do I still dive into global news and manually override my buy/sell ratios? That feels like a mistake to me. I’m sort of going through fundamental withdrawal.

I’ve posted my first live account with this system. It’s purely on autopilot. I’ll be setting up another account where I try to incorporate some fundamental views or tweak input settings.

I’m also a strong advocate for test vs control group. So in essence, I have established my control EA. I will now work to build an even better system and when that happens, I will have a new “perfect” system.

Conclusion:

I was sort of being facetious about calling this a “perfect system.” The only person it is perfect for is me. Ultimately, a system is only as good as the person following it and if it does not match well to your trading style then it will fail. The power is combining your unique trading personality with a disciplined system will grounded in risk management and your battle is halfway won.  Good luck to everyone, especially those new to forex. It can feel like a treacherous world out there. Be careful with risk, incorporate your passions and style and have fun with trading.

Got my first custom EA programmed and have been busy back-testing. I’m wondering if I have too many inputs as it is creating a ton o different combinations of results. I’m just using MT4 with minute tick data from ForexTester (wish I could test EA’s with Forex Tester easily).
What’s frustrating is the EA will do great for every year from 2005 but then tank for 2009 and then be okay again for 2010. I haven’t found the right combo of settings that consistently provides a dent return and low drawdown. Maybe my expectations are too high. I’m having a ton of fun though and can’t believe how much time flies by when testing. I’m live testing the EA as well with just $100.

I’ve got my VPS set up as well. I’ll write a detailed post helping beginners understand EA’s as I’m learning as I go as well.

Wow, I can’t believe it’s been over two years since my last post. I’ve been dabbling with forex during that time frame mostly for education purposes and testing things out. I’ve also been doing lots of reading. I’ve really been gravitating towards more methodical trading methods and trying to blend in fundamental analysis along with technical analysis but having strong discipline towards managed risk, drawdowns, leverage, etc.

In the past couple of years, our family has moved from Santa Barbara, CA to New York city as I’ve taken a new job here on the East Coast. We are loving the cultural diversity of the city and have more family nearby. Another interesting aspect is the rapid pace of life here and the world of finance. I’ve always been fascinated by economics, finance, global trade, etc. I feel immersed in that world here in NY whereas it was completely non-existent where we were in California. I met my first hedge fund manager here as well.

Maybe it is this recent move to NY or perhaps the spring air. Regardless, I’m taking a more renewed effort in forex again. Over the past two years, I’ve been doing a lot of reading and experimenting and discovered EA’s. EA stands for “Expert Advisor” and is basically a way to automate your trading. It can be a way to create indicators, signal trades or even execute trades on your behalf. I’m increasingly fascinated by this as it suits my background and interests well and also will help me overcome that emotional discipline problem I have. I’ve been back testing and forward testing several systems and refining my own system for quite some time now. I finally sent it off to a professional programmer to polish it up and will try again with a more thorough forward test.

What makes my EA fun for me personally is that I started the creation of it from a quantitative basis using my experience in the direct marketing world rather than finance. (Regression model with control limits of 1/2/3 standard deviations to form channels) Therefore, it is somewhat unique but at the same time pretty simple. I also factor in longer term macro trends. I’m not a scalper so my EA is pretty long term focused. I might go 2-3 days between trades. Typical stop loss of 40-80 and take profits of 150-200 pips. I had no idea that EA’s even existed but it opened up a whole new world for me.

I should have my final EA programmed within a week and will start a new account fresh. I’ll continue to share results. I already know that my EA is somewhat simplistic and I need to improve the money management side of things. It works fine if I don’t over leverage myself but I want to find a system for that as well.

I’m taking a break for a while. Closed all my positions a few weeks ago and was primarily long USD. I feel the technicals were erroding as well as fundamentals. The fed will cut rates for a prolonged period and the treasury actions and injection of dollars is catching up.

I’ll take a break for the holidays but will most likely come back short the dollar. The yen feels a bit safer than Euro but I need to do more research.

Hope everyone has a happy holiday and remember the truly important things in our lives.

So I’m up 240% since I got back into Forex last month. I should be thrilled right? Wrong. I’m more nervous than ever. The numbers aren’t huge but I’m disappointed in my behavior. I felt more and more confident that I was correctly identifying the trend of a rising dollar and started to increase my leverage. I was up to about 20:1 instead of my max of 10:1. I also increased the number of currency pairs to EURUSD / USDJPY / GBPUSD / EURJPY. Everything was going great and I grew the account to about $2,900 by 8/13 then I sufferred major setbacks on Wednesday with several stop losses triggered. In a single evening, the account dropped to $1,700.

So how did this happen? Well, I was over leveraged on each trade, had too long of a stop loss that incurred larger losses and I was trading more pairs trending the same with the strengthening dollar. So what did I do next? I should have stepped back and re-evaluated why I suffered a 41% drawdown. But instead, I doubled my leverage and re-entered. I did tighten my stop losses but was way over leveraged. By the next day, I was incredibly lucky and regained my losses and now my account was about $3000. I was so upset with the loss on Wednesday that I was mentally prepared to just throw everything away and walk away from Forex. The money didn’t even feel real. If the USD had not recovered so quickly but instead went on a 2-3 day pull back, I’d probably be done.

I’ve pulled back my leverage to about 10:1 again. I’m still trading 2-4 positions and still following the USD strength. The USD keeps rising much faster than I anticipate and my account is now up to $4,800.

As you may recall, I have two accounts. One with an initial $400 start which is now $685. The other account had a start of $980 and is now $4003. Here is a chart showing my balance since 7/30 when this account was opened.

Account Balance Chart

I also have some open positions still with a bit of gain. They are as follows:

EURUSD: short 4 microlots, S/L 1.4745  -  T/P 1.4605

GBPUSD: short 4 microlots, S/L 1.8709  -  T/P 1.8521

USDJPY: long 4 microlots, S/L 109.60  -  T/P 111.25

I’m pretty much sticking to 1 microlot per $1000 equity. I am also seriously thinking of extending my take profit targets by about 200 pips. My profits would be higher if I had a bit more confidence about the rising dollar. I keep taking profits, watch the dollar rise more, re-enter and take profits again. The USD is probably due for another pullback shortly as it looks overbought but all the fundamentals still support USD strength. Oil still has downward momentum (I still suspect speculation will cause oil to decline rapidly even with some tightening of supply by OPEC), gold broke and closed below $800, decent earnings announcements, weak economic data from Japan, England and Euro countries. France is in denial though. I think the US will skirt a technical recession and the race will be on to see which non-U.S. country announces a recession first. My bet is England followed by Japan.

I’ll keep following the trend. I believe in the “re-coupling” strategy and feel that the poor US economy is having a ripple effect on the rest of the world and the US is through the worst of it and other countries are just now starting to bottom. I feel the three year decline of the USD has reversed and we are set to see a long-term recovery of the USD for at least a year or two. This is not based on the strength of the US but rather on the weaknesses of other countries. I’ll also be keeping a keen eye out for positive news and outlooks in Japan/England/Euro.

Of course I’m thrilled with my account balance but I’m dissappointed in my total lack of discipline and aggressive investment style. I consider this to be strike one against me. Hopefully, I can regain my composure. This is almost exactly what happened a year ago… Sufferred major setback, increaged my leverage significantly to “win back” losses, successfully increased account, scared of my own behavior so quit Forex. This time, I’ll stick with it but focus on trying to modify my behavior and reactions. This psychology portion of trading Forex is turning out to be much more difficult than I anticipated.

Woke up this morning and my final take profit was triggered on a 300 PIP gain! I was incredibly lucky. I’ve had very steady and excellent profits riding the EUR down. I ended up determining a bottom support right at 1.5320 back on 7/15:

So I’ve been plodding along the downward path. Fundamental news still supporting a declining Euro. I’m still very bearish on the EUR. US is still a tad bearish but less bearish I’m actually feeling that the USD is bottoming out and starting to recover. Oil is declining as well. The poor economy is starting to ripple world wide so other countries are lagging our poor economy in my opinion.

I honestly thought the EUR would hit the resistance and bounce up. I was struggling with what to do in that scenario. However, I also noted that if the EUR broke through the resistance level in a solid way (not just an occasional dip), then the EUR would plummet down. That is exactly what happened. I had a sell stop order in to short EURUSD if  it hit 1.5310. Sure enough, it did yesterday and my take profit of 300 pips triggered over night. Wow! I felt it would decline but I thought it would take a week or two, not overnight.

Now, I’m in the same position. I suspect a pullback but fundamental news is still negative Euro. I’ve decided to not trade against my fundamental view.

So I’m looking at the USDJPY now. That 110 barrier is tough. While the USD had made grounds on most other currency pairs, the JPY is lagging. Japan was on the verge of announcing a formal recession just a few days ago and things are bearish with the Yen as well. So I feel that there is pent-up upwards momentum for the USDJPY. I need to feel that it is indeed going to break through the 110 barrier. I’d feel more comfortable at 110.8 or so and closing the week above 110. If so, I’ll go long the USDJPY and think it could go to 113-114.8.

I can’t afford to get cocky though and will stay disciplined with lower leverage (about 10:1) and short stop losses. But I’m still thrilled that my $1,380 investment is now $2,600. I feel good because I’m spending a lot of time on fundamentals and what is happening is making sense. Also, I’m factoring in basic technicals for support/resistance levels which are also making sense. Finally, I’m not taking huge risks. Granted, I could have a string of bad trades in a row soon but I can calmly step back and re-evaluate.

So far so good. I’m up about 40% in a month. Somewhat lucky though. I’m posting from my phone so will keep this short. Overall, I’m riding my fundamental view of the declining euro which has been great. We are about 100 pips away from my bottom support.
My toughest decision will be whether or not I should BUY the euro once it bounces off the bottom support. This would be counter to my fundamental view. Or I wait until it goes up to resistance and buy it on the way down again. If it breaks through the support for a day or two, I’ll keep shorting the Euro. So far I feel good that I am riding the trend correctly. I’ve learned to not fight trends so if a trend reverses and I’m positioned the wrong way, I need to step back and re-evaluate instead of forcing my hand.

I’ll have to think about this more. So far, my $1400 investment is now $1900 so I’m thrilled but cautious. I’ve been lucky with rapid dropping oil prices but I’ve always felt speculation that drove up prices can just as easily drive prices down. Sort of the opposite of a short squeeze.

Well, after about a week of waiting on the EURUSD, my take profit at 1.5750 and 1.5650 were both triggered. Sure enough, the low seemed to hit about 1.5628 and then immediately went back up to 1.57.

I experimented with a few positions for short term trends as well and was about 8 for 10 going about 20 pips at a time. I’m still focused more on long term though.

I’m feeling better about my 1.5650 support for the EURUSD though. Now, I think I will wait for it to rise and then trade it downwards again. I’m debating whether I should trade it upwards. I’m hesistant though as that would be trading against my fundamental outlook. But if I feel it will head up towards the resistance level of around 1.6 then perhaps it makes sense… I’ll take a few days to think this over.

Overall, I’m very pleased but proceeding cautiously. I also just registered for the Forex trading conference in Las Vegas this September 12-13. I’m looking forward to attending and perhaps meeting some other new traders in similar positions.