29th Feb 2012 - update on USDCHF

My pending short was finally triggered this afternoon. At the moment price is meandering around support as you'd sort of expect. The last half dozen bars have formed a descending triangle so I feel it's only a matter of time before the bulls are defeated. As always, anything can happen.

I decided to move my TP much further along to 0.86150, a little short of the next support level. Because this is such a large R:R ratio, I've put in a trailing stop loss of around 75 pips.

28th February 2012 - inside bar on USDCHF

An inside bar just formed around a support level on the USDCHF which looks promising. It's currently testing a support/resistance level that was last breached back in November 2011. The next significant support level is around 0.85750, providing plenty of scope for bearish action. As you can see in the graph below, my TP is very short of this level, at around 0.87900. My TP is currently set at 2 * SL. Once my TP is hit, there's a good chance the USDCHF will continue to fall to 0.85750 but I'm going to stick to my 2:1 R:R rule and leave my TP for now.

27th Feb 2012 - USDJPY hits TP

This was a textbook trade. My pending long on the USDJPY was triggered on Friday as resistance from August 2011 broke and the pair entered a bull run. It hit my take-profit target today before bouncing off resistance from July 2011. Profit = 99 pips.

USDCAD

I saw an inside bar form in the USDCAD, but price action over February looked pretty ugly. Price WILL breakout, but there's alot of potential to get whipsawed in an undecisive market before then, so I decided to sit this one out. 21 EMA looked very flat too.

24 Feb 2012 - inside bar on USDJPY

I took a bit of a break over the last week. I'd spent so much time backtesting that I couldn't use my mouse for more than an hour. My index finger needed a rest from all the clicking.

Two inside bars formed on the GBPUSD and USDJPY at the close of yesterday's market, which was only 15 minutes ago.

USDJPY

Of these two bars, the USDJPY presents a cleaner setup with a TP target slightly below a significant resistance level at 81.500. This has been illustrated below. What I like about this setup is if the inside bar breaks, it will simultaneously break resistance around 80.250-80.350, providing plenty of space for a bull run. The 21 EMA also indicates a clear trend. Summing the probabilities, this looks like a suitable trade.

GBPUSD

This setup is not as clean. Probably the most important observation is the fact that the 21 EMA is flat. Flat EMA = ranging market. This is where inside bars fail. Having said that, the inside bar is around a level of support, so if that support breaks, there is scope for a bearish run. However, price movement over the last few weeks suggest the cable is currently ranging.

Since inside bars are a trend-trading strategy, a pre-existing trend presents better probabilities, hence why I will trade the USDJPY and not the GBPUSD.

Three black crow backtest continued - USDJPY 2000-2009

I spent the latter half of today backtesting the USDJPY from the years 2000 to 2009, using the same three black crow / three white soldier candle pattern I identified in the previous post.

The results aren't quite so positive. A reward-to-risk ratio of 2 provides a meek positive return on risk, and higher reward-to-risk ratios return negative results. I've provided a comparison between the USDCAD and USDJPY below.

Overall, I would say that this strategy is viable with a reward-to-risk ratio of 2. Because of such a large stop loss, this strategy will require you to keep your trades open for weeks to provide a 2x reward.

Three black crows / three white soldiers backtest: USDCAD 2000-2009

I just finished a backtest on the three black crow / three white soldier candle pattern. This candle pattern is quite basic. It consists of three consecutive bearish or bullish candles. Three black crows represent a bearish pattern as seen below, while three white solders are the complete opposite (bullish).

The three candles must be of the same "colour" for it to be considered 3BC or 3WS.

For this backtest, I focused on the USDCAD pair with a 21 EMA to measure the trend. The years 2000 to 2009 were tested, as well as the first half of 2010. I thought about extending the backtest all the way to 2011 but too many orders would've been left open by the end of the backtest.

Stop loss will be located at the start of the first candle, and entry will be triggered at the break of the third candle.

RESULTS

Trading with the trend yielded superior results. In order to prevent cluttering of this post. I'm not going to bother posting the results of trading against the trend.

Final results have been tabulated by year and R:R ratios and are displayed below. 99 trades in favour of the trend were initiated.

Those are nice results. Trading with a reward-to-risk ratio of 6 would have yielded a beautiful average return of 50% on risk. However, that isn't a number that I'm comfortable using. A reward-to-risk ratio of either 2.5 or 3 seems ideal for me.

I'll backtest another currency pair to validate these results.

London Breakout Strategy

I spent yesterday and this morning backtesting variants of the "London Breakout" strategy. I tested the first half of 2010 and the end of 2011 and yielded negative results.

The premise of the strategy is quite simple. You mark the highs and lows of the overnight Asian session, and trade the break of these highs and lows once London opens. The reasoning is that most major market movements will occur during the London session, and the break of the Asian high or low will point the direction of such movements.

So why did my backtest provide poor results? I don't think this is a true "breakout" strategy. It's a given that the Asian high or low will break, even when London decides to horizontally range. I feel that such breaks aren't widely respected by the market, which is what you need to generate momentum behind a breakout.

Rather than solely rely on the break of the Asian range, I may configure my backtest to include candle patterns just prior to the London session e.g. two consecutive bearish candles may signal a bearish breakout on London's open.

USDJPY inside bar backtest - 2001 to 2008

I just compiled a backtest of inside bars for the USDJPY pair between 2001 and 2008, using a 21 EMA to measure the trend. I'm completely fatigued. This took around eight hours to complete, a great way to spend my Saturday, but I think it's a good indication of my seriousness.

The results of the USDJPY backtest are comparable to the EURUSD, which is excellent, as the USDJPY and EURUSD are one of the least correlated currency pairs. Trading inside bars would be profitable, as seen below.

RESULTS

Trading with the trend
187 trades initiated

Risk:reward ratio = 1:3
Expected return per trade = 19.79%

Risk:reward ratio = 1:2
Expected return per trade = 13.9%

Risk:reward ratio = 1:1
Expected return per trade = 17.65%

Trading against the trend
182 trades initiated

Risk:reward ratio = 1:3
Expected return per trade = 16.48%

Risk:reward ratio = 1:2
Expected return per trade = 13.74%

Risk:reward ratio = 1:1
Expected return per trade = 9.89%

CONCLUSION

It's good to see positive results for a different currency pair. It means that inside bars can be traded beyond the EURUSD. Trading with the trend seems to yield slightly better results, which is expected. Scalping with the trend seems like a safer way of trading with a 1:1 risk:reward ratio.

I'm very pleased. This strategy is looking solid.

11 February 2012 - potential weekend setups

Gold

On Friday's close, a promising pin bar formed as a rejection of the 21 EMA, short-term support and a Fibonacci retracement level. How to trade this pin bar is a little tricky. I'll most likely enter a pending long that'll trigger on the break of the pin bar, with a stop-loss around 50% of the pin bar. Take-profit will be set just below resistance at 1760. This resistance level has been respected twice already. The setup should provide a 1:2 risk:reward ratio, which is how I like it.

EURJPY

An inside bar has formed just above a resistance-turned-support level, so this setup is looking optimal. Take-profit has been highlighted below.

What I don't like about this setup is that other yen currency pairs are much more bearish. I assume the neutral-ish tone of the EURJPY is due to a prospect of a breakthrough over Greece. I'll probably trade this, though.

10th Feb 2012 - inside bar backtest 2001-2009

I've spent most of this week researching and backtesting. 90% of successful trading is psychological. No matter what strategy you use, if you don't have confidence in your setup, you will fail. The best way of building confidence is to do your own research and backtesting. Manual backtests are very time-intensive but it gives you a better idea of a strategy than automating your backtest.

This week I decided to extend my backtests of inside bars from the start of 2001 to mid-2009. I focused on the EURUSD on the daily timeframe and used a 21 EMA to measure the trend.

RESULTS

Trading with the trend
156 trades initiated

Risk:reward ratio = 1:3
Expected return per trade = 28.21%

Risk:reward ratio = 1:2
Expected return per trade = 23.08%

Risk:reward ratio = 1:1
Expected return per trade = 15.38%

Trading against the trend
130 trades initiated

Risk:reward ratio = 1:3
Expected return per trade = 29.23%

Risk:reward ratio = 1:2
Expected return per trade = 20.00%

Risk:reward ratio = 1:1
Expected return per trade = 3.08%

CONCLUSION

I was quite surprised to see that counter-trend trading is just as profitable as trading with the trend. A 1:2 or 1:3 risk:reward ratio seems ideal, although I am leaning towards 1:2, just to be a little conservative. Higher rewards usually take longer to achieve. The longer you leave your trade open, the more exposed you are to market shocks that invalidate your entry.

2 February 2012

I attempted to trade a trend-reversing pinbar that appeared on the AUDUSD yesterday but was stopped out. I lost 53 pips from the trade. The AUDUSD is currently trending in an ascending triangle so I'm predicting a bullish breakout in the next few days.

Lesson:
- don't trade into resistance / support zones, especially if they've been well-respected.