In this episode of Truth About FX, Walter puts the pieces of the puzzle: what type of market should you be trading based on your system? Or, should it be the other way around? Walter breaks it down into several parts and gives emphasis into identifying the market mood and figuring out which trend is tailored for you based on your system and biases.
Download (Duration: 07:18 / 8.36 MB)
In This Episode:
00:50 – not working
01:47 – different moods
03:51 – not very clean
05:13 – the way it works
06:35 – filter
Announcer: Sometimes, forex trading is a wild and wooly place to be. That’s why Hugh is here, to post your questions to Walter, the naked forex guy. Hugh’s got questions and Walter’s got the answers. Here at the Truth About FX Podcast.
Hugh: Hi, Walter. What are the biggest reasons why traders have a few great months then give it all back? How can we solve that?
Walter: This is such a great question because I’ve been working on this for the last 18 months, 16 months. Here is something that I’ll share that I’ve learned. First of all, why this happened?
The first part of the question, why this happened? Obviously, this happens because if you are trading one-trading system, your trading system is not going to work in all types of markets.
If you are trading a trend system, system that breaks out or there’s something similar like that, what’s going to happen is when the market is in a strong trend, moving really strongly in one direction — up or down, it doesn’t matter — you’re going to do well.
Likewise, if you have a reversion to the mean system where price goes too far and then it snaps back and Bollinger Band edge, and you traded it back in the middle or whatever — those sorts of things like Stochastics or whatever — if you’re trading that kind of system, you’re going to do really well when the market is ranging and not really going anywhere but as soon as it starts trending, you’re going to get blasted.
Here’s the question: how do you deal with this? How do you solve it? It turns out that — and this isn’t my idea but I’ve been reading and many traders and researching on this. Many traders basically set it up say you can characterize the market in different moods.
If you can identify what the mood of the market is, you can switch on and off your various systems. Let’s say I’ve diversified and only have two systems. I have one system where if the markets gets to the upper edge of the Bollinger Band, I sell and I sell it back to the moving average in the middle of the Bollinger Band. That’s my reversion the mean system.
Then I have a trend trading system which is like the trending Kangaroo Tail. Whenever the market starts going into one direction and prints a trending Kangaroo Tail, I’ll take those trades and I’ll go with the trend.
So, those are my two systems and I know that one of them is going to do well during trends and one of them is going to do well when the market is going to go directionless. What you can do is you can identify what type of market you are looking at.
What are these markets? One would be a quite range-bound market. It’s not really that volatile. It might be kind of tight range, it is not really moving very far. Maybe for example on the Euro, it’s only moving about a 120 pips and it’s been that way for two weeks. That would be a pretty quiet market. Pretty tight, not very volatile.
You can also have a range-bound market where it’s volatile. Maybe like the GBP/JPY hasn’t really been moving but it’s been like 550 pip range. It’s been in that 550 pip range for three weeks or something like that so that would be a volatile range bound market.
Then, also you could have quiet trending markets and you could also have volatile trending markets. Like a quiet trending market, it might be where the market sort of jumps up and then just flat lines, then it prints a bunch of little tiny candles all in a row and then it jumps up again and a bunch of little tiny candles in a row like that.
Whereas the more volatile trend, let’s say it’s going up, this really volatile strong trend candles that goes straight up and then it pulls back violently. Maybe pulls back 61.8% of that strong move up, it pulls back that much and then it makes another strong move up and it pulls back another 50% on that or whatever.
It’s really a sharp up and down sort of a retracement move and it’s not very clean. That would be one way to do it. So now, you have to decide, will your system work in the volatile trends and in the quiet trends or do you only want to trade the trend trading system in the quiet trend and not really that volatile?
Same thing with the directionless market. When the market is kind of range-bound, do you want to trade your reversion to the mean in both the volatile range bound market and the quiet range bound market?
Or, do you just want to decide, “No, I’m just going to play it on the volatile range bound market, for example. Take advantage of these bigger moves till it gives me a better chance to take a buyout of that move back to the moving average.”
These are the sorts of things that I’ve been working on and I think that most of the listeners out there can come up with the framework where you’ll go, “Okay, I see what you’re talking about. I just need to categorize the market into one of these four and then what I needed to do is test and see, my system. System A works in this kind of market so if I’ve identified that it’s a quiet trending market, I’ll trade that but if it’s a volatile kind of market, I won’t trade that system. I’ll just flip it off.
These are the sorts of things that I would encourage you to do. Now, it’s always going to be the case that you’re going to be in a range-bound market and then it’s going to explode and take off and go into a trend and you’re not going to have your system turn on because you have to wait for the trend to form.
It’s going to feel like you’re late but that is just the way it works. You have to wait for the trend to show up before you can say, “Haha! We’re in a trend.” You are not going to know beforehand. Hopefully that makes sense. That might help you guys because if you just leave both systems on all of the time then, they’re not going to give it back.
Like you say, as the listener says here — the question came in from a listener who says “makes money then gives it all back” — if you want to avoid that, one way to do it is to just basically identify what style of market you’re in when you’re looking at the chart and then decide whether or not that system is going to be on or off for that style of market.
Hopefully that makes sense. Am I making sense there?
Hugh: Yeah, totally. That makes total sense. In the wrong market condition, you’ll feel like you are hitting your head against the wall and if you want to stay out then you’ve just saved all that money.
Walter: Exactly. I have a friend who is really good at pyramiding into winning position and he trades a trend but he only do it with certain type of market. He’ll only do it with those really quiet trends.
Like I said where you get a strong move in the trend direction, let’s say up and then it just flatlines and you get a bunch of little small candles that are sitting there and then, boom! It’ll do another trend move. That’s the market that he likes because he can pyramid into that and really make a big winner out of those.
That’s something that I would encourage you guys to do. Look at the market from that filter, just say “Okay, I see what’s going on here. This is a volatile directionless market, what kind of system should I turn on here?”
It’s pretty simple stuff but it does take a little bit of practice to set it up so that you’re very deliberate in the way that you do it. You are going to miss the beginning of the trend because it’s got to form in the beginning of the trend before you could even say, “Hey! We’re trending”. That is basically how it works.
Walter: Okay, hope that helps.
Hugh: Thanks for the insights, Walter.