Back to basics backtest - quality inside bars (OBSOLETE)

4 May 2012: Please note this post is now obsolete.

Results of my recent backtest on inside bars. 

Trading system:

- Place stops at either end of inside bar to trade breakout

- SL = opposite end of inside bar

Criteria:

- inside bar must be in top or bottom 50% of previous candle

- trade breakout in NEXT candle only

Here is a visual example:

Backtest Results

Six currency pairs were tested on the daily timeframe from 2004 to 2011. 257 trades were compiled. Trades with 1:2 risk:reward seem to be the most practical. 1:3 and 1:4 yielded slightly superior returns, but would require you to hold the trade for much longer.

I didn't include the overnight swap rate as it would be near-impossible to calculate for each trade.

Observations:

- The longest losing streak was six straight losses.
- Inside bars tend to fail breaking out in ranging markets ("stuck in traffic"), flat 21 EMA.
- Seem to perform better at new swing points in "virgin" territory.

25th April 2012 - loss on XAUUSD

This trade on gold didn't work out. A pinbar formed around support so I decided to go long. I saw a potential resistance level shortly above the pinbar so decided to place my entry some distance away. My SL was locked below this resistance level, so if resistance broke, it should turn into support and help repulse price from my SL.

My entry was triggered but price reversed shortly after, taking out my SL. My trade is graphed below.

Damage to my account was minimal.

I spent most of today mechanically backtesting inside bars (with very positive results), and will post my results later tonight or tomorrow after cleaning up my results.

24th April 2012 - loss on AUDNZD

While this trade is technically a loss, I'm learning where to place my take-profit stops (at first support/resistance). A pinbar formed on the AUDNZD overnight at a resistance level and BRN (big round number) of 1.27000. I checked for a second opinion with other traders, and the biggest concern was the close proximity of first support level, around 1.26500. 

Price broke the low of the pinbar before bouncing off support. It's quite amazing how these levels act as decisive points. I placed my SL at the 75% mark of the pinbar, which was taken out later today. I should pay more attention to resistance / support when placing my SL.

Since I'm only trading microlots, damage to my account was negligible. 

Lesson: Respect first support / resistance levels, place SL and TP around here.

In order to instill discipline and learning, I will extend trading in microlots for an additional week (May 4).

Lessons learned

Lessons learned so far. As time goes by, I hope to expand this list.

1. Respect first support / resistance areas. Set possible TP here.
2. Remain faithful to your original order setup (SL and TP), especially if they have been well thought-out. Avoid impulse trading. Exception: release of big news
3. Do not overtrade. Trade quality setups only.
4. Entering at the end of a retracement presents the best opportunity to maximise R:R and probability. 
5. Do your own homework
6. Question EVERYTHING, even if it comes from Dr. Alexander Elder (i.e. the 2% rule)
7. Use context-sensitive, self-adjusting rules rather than hard, arbitrary rules
8. Equity curve growth rate is influenced by profit factor, equity risk % and frequency of trades.

17th April 2012 - nominal win on GBPNZD

A very minor win on the GBPNZD. I went long after seeing two consecutive bullish candles (pinbar and engulfing bar) moving off support and in favour of the trend. Price moved in my favour to within 15 pips of my TP before reversing. I moved my SL to slightly above breakeven, and the SL was hit, resulting in a very minor win. Thankfully it wasn't a loss. 

GBPCAD

An update on the setup that I closed this morning. Looks like price did turn back in my favour once resistance was hit. When I saw this, I felt like laughing. TP#1 would've been hit if I had kept my trade open and stuck to my original SL.

 ^ Before

^ After

On that note, I will be taking tomorrow off.

How to Handle Losses

HOW TO HANDLE LOSSES by Kevin LaCoste

1. Do not live and die with each trade. A single trade is insignificant in the overall scheme of trading.

2. Regard each loss as a single event. If you experience a string of losses, each loss is an independent event. Consecutive losses are nothing more than coincidence. The market is impersonal and not out to prove you wrong.

3. Take a break from trading if you find yourself too emotional, or reduce your position sizes (preferably to minimum) until confidence is regained.

4. After a loss, do something productive or take a walk to gain some perspective.

5. Have faith in your trading system. It is logical and has been backtested extensively.

6. Look forward to your next trade and move on.

7. Remember your long-term goal - financial independence. The pain is worth it. You will look back and admire your resolve.

8. Analyse every loss and salvage lessons. Lessons create future profit.

9. A loss is a stepping stone to future success.

10. Every trader experiences losses. You cannot avoid them.

11. When using a valid trading system, a loss is nothing more than a cost of business.

12. Coping with losses creates mental muscle and discipline. Bear the pain and become a stronger trader and person.

17th April 2012 - loss on GBPCAD

I'm about three months into my trading journal, and I've run into what feels like a horror streak of losses. My last six orders have all ended as losers. This is when traders are psychologically tested, and I can definitely feel it. 

First, I'll briefly discuss my last trade.

GBPCAD

A strong bearish engulfing bar formed off resistance late last week. I decided to trade it. Because of its strong bearish momentum, I decided to split my trade into two shorts, with TP#1 at support level #2 and TP#2 at support level #3. I suppose this seemed quite greedy, but the size of the engulfing bar gave me confidence.

Price did move my way for a bit, but then bounced off support level #1 with a BULLISH engulfing bar. As soon as the bullish candle closed, I closed both orders. I had that gut feeling, hope, that price would return downwards. It was the same feeling I had in one of my recent losses. But I saw no technical signs suggesting a return to a bearish trend. Following the Zurich axiom, if all you have is hope, you should jump. That is precisely what I did. 

Right move? I think so. The bullish engulfing bar is a long signal and can be traded in itself. Remaining short against a bullish engulfing bar seems irrational. Not only would I have to beat newfound bullish momentum, I will also have to try breaking support level #1 again. Probability-wise, I think I made the correct move.

Lesson: Respect first support/resistance areas. Set possible TP here.

Handling losses

I felt quite emotional this morning as I got out of the trade. Somewhat frustrated, especially in the face of consecutive losses. I was acutely aware of the possibility of trading "out of control" and so I've sworn to trade in single micro-lots (smallest size possible) until the end of April. I will still be trading and logging my results, but I won't be making much money (or losing much either!).

Discipline is key.