Trading System Examples
In the last ‘Traders’ edition, one of the trading systems we trade was very similar to the Donchian trend trading method. This and other examples of end of day(EOD) swing/breakout systems are explained below.
Trading System 1 – Lift Off(LO)
The Lift Off(LO) system is based on the concept of entering a trade when the stops are taken out and momentum comes back into the market.
Here, the 20,50 and the 100 moving averages are used. For a long trade, the 20 EMA has got to be above the 50 and 100 EMA.(Refer to Fig 1)
We first look for price to close below the 20 EMA (to take out the stops). This is the set-up bar. Then we wait for the price to close above the 20 EMA which signals that momentum is resuming. This is the confirmation bar. We then place a pending order in the market. Once triggered, we trail our stop loss behind the 20 EMA. The 20 EMA is used for the 4-week average closing price, similar to the Donchian trend method which uses the 4 week high or low price.
Fig 1. Lift Off Trade concept
Look for a setup bar then place a pending order for the high of the confirmation bar.
*The vice versa is true for the short trade.
Source: MTM training manuals
Trading System 2 – Dynamic Breakout(DB)
The Dynamic Breakout(DB) system is a price action based breakout strategy on the concept of a market going against its previous preconceived swing highs/lows in a strong bullish or bearish market. The swing highs and lows are based on algos formulas.
The trend is defined by the simple definition of an uptrend being higher highs and higher lows and the downtrend being vice versa. However, the most important thing here is to define those swings consistently based on quantifiable parameters. This is one area I have seen a lot of traders struggle to define consistently on a quantified basis.
When you analyze the charts, there are 6 variations of trend breakouts. These can be categorized into trend established breakouts(TEBO) or trend defining breakouts(TDBO).
For example, if we are taking a short trade we will place a pending order for the swing low and the stop loss will be for the high of the bar that makes the swing low. Below is an example of a short AUDUSD trade taken on a variation 5 breakout. It had an amazing 10.49% run.
Fig 2. Dynamic Breakout AUDUSD trade
Entry for the break of the swing low of AUDUSD formed on the 07052013. This is a Variation 5 Dynamic breakout trade.
Source: Tradesignal charts
Trading systems performance
Understanding your trading system’s statistical performance is vital to trade with conviction. Three trading systems (including the two above) were traded live and the results were collated over 22 months.
Trading System 1 – Lift Off
Reliability – 36.96%
Profit Factor – 2.14
Trading System 2 – Dynamic Breakout
Reliability – 64.44%
Profit factor – 1.17
Trading System 3 – Price Run
(Based on price reversals)
Reliability – 63.64%
Profit factor – 0.67
The interesting thing to note here is that the system with the lowest reliability gives us the highest profit factor. In fact with most of the trading systems, the ones with a high profit factor usually have a reliability of less than 50%.
Plotting an equity curve for your trading systems can help you track your performance on a monthly basis. And most importantly, to get aware of your peak to valley drawdown – this is your largest consecutive drawdown at any period of time. Below is the equity curve over 21 months based on the 3 EOD swing trading systems(refer to Fig 4). This includes the LO and the DB trading systems that we discussed above. The 3 systems have made a total of 40.23% over a 21 month period which is on average 2% per month.
Fig 3.Equity curve
Equity curve for the 3 trading systems traded live. Peak to valley drawdowns are the retracements of the euity curve.
Source: LTR Equity charts
Start getting systematic and build the 3 components of a trading system. Before you enter a trade, know your set-up, the trade management, and its winning probability. Continually, review your trading stats and optimize your system. This way, you will not trade in fear, you will Trade like a Master.