Step 5... Not Quite There Yet

Step 5 for developing a system is "Determine the best historical moves in that time frame and notice what those moves have in common." Tharp suggests having at least 50 to 100 sample market moves to examine, including both up and down moves. This is a very simple, but time consuming step. I have almost 10 years worth of daily data for the EUR/USD, AUD/USD, and GBP/USD pairs, so I'm certain I have the necessary volume. What I don't have is the time, or more honestly, the patience to inspect the charts to spot the big moves.

While I think the best way to do this step is to visually inspect the charts, I'm going to create a calculation of moves based on 1, 5, 10, and 20 day price changes. My hope is that this will help me find the big moves and some of the action before and after it.

Until next time....

Step 5 is coming... eventually

I've gathered quite a bit of daily info on the GBP/USD pair, and I'm currently trying to work my way through it. I realize that for system testing I'm going to need MT4 to build some expert advisers. Looking at data and even charts on Excel is excruciating!

That's it for now, next time I'll have more info.

Determine Your Time Frame for Trading - Step 4

I've covered this before, perhaps more than once, but I'm probably leading toward a longer-term system. In fact, I'll most likely be trading off of daily data. Given the cost my chosen broker has on automated trading and the fact that I will not be able to sit and watch a trading terminal to enter or exit positions, a long-term system that is relatively low maintenance is best for me.

I like the fact that long-term trading is more hands-off, as well as its potential simplicity and the fact that, according to Tharp, it is least stressful time frame.

The negatives of long-term trading are substantial. The ones that concern me the most are the whipsaws that happen, the low reliability, and the infrequency of trades. It will be psychologically difficult to take a relatively low number of trades and endure the frequent small losses en route to the big gainers. I like to be "right" and only being "right" less than 50% of the time would be a challenge for me. Of course that is where the confidence in my self-tested system will *hopefully* permit me to continue taking trades.

Tharp suggests that, to compensate for the infrequent trading, multiple markets should be traded. In my last post, I touched on the correlation of currency pairs and how that may negate the advantages of trading multiple markets. Its great to be able to have more opportunities in different pairs, but if they're all in the same wrong direction, I've only succeeded in losing money twice as fast. So in order for multiple pairs to work, I'll need to find some pairs with a low correlation to GBP/USD. That will probably lead to the crosses, which may be a bit sophisticated for me, at least at the advent. I'll most likely wait a predetermined amount of time, or trades before I venture into other pairs.

While I know I'm going to be going long term, eventually I'd like to also implement a short-term system. The first 2 advantages Tharp lists are what I like about the idea of short-term trading: lots of opportunities to trade and the stimulation induced thereby. The latter benefit is countered by Tharp, "excitement usually has nothing to do with making money -- it's a psychological need." While I want to believe I can stick to a long-term, patient, and uneventful approach, it will be difficult when looking at intraday charts and seeing all the volatility and potential trades I'm missing out on. However, this is where I hope the confidence in my system will allow me to stay the course.

I think I've reached the point now where I need to start plumbing some data. The next step requires looking at historical data, which should be easy enough to find on a daily basis.

Next time I'll go through Step 5.

Determine Your Objectives - Step 3

I believe I went through this already when I read through Chapter 3 of Trade Your Way... and conducted an interview with myself. Nonetheless its not a bad idea to revisit and maybe expand on my objectives for trading Forex.

I think I have a handle on the more concrete objectives. I want to earn 10% over the course of a year on my capital. I intend to accomplish that with what will most likely be a trend-trading system, designed to be traded on daily data. With automation its hoped that I could go to a smaller time-scale and trade more often, but that would require signing up with a new broker, which is something I'm not yet ready to do. Also I believe its in my advantage at present to work on a system and understand the logic and performance characteristics behind it before I commit the effort into automation.

I intend to trade only the GBP/USD pair to start, while still tweaking and learning the ins and outs of trend-trading. Eventually I'd like to trade multiple pairs, but my concern with that ambition is correlation. It won't do me a great deal of good to trade in a highly correlated pair, like I'm guessing the EUR/USD is. However even a highly correlated pair could give me another opportunity to have a great trade, and in trend-trading, missing one trade could be the difference between a profit and a loss in the long term.

I don't want to risk more than 1% of my capital on a trade. I need to be able to stay in the game for the big trade that could make the year. Not having really looked at any numbers, I think I'll size each trade so that 1% of my capital is based on the ATR. I think one of the Donchian systems mentioned in Way of the Turtle used a 2*ATR stop, so I may do something like that.

On a more personal level, my objectives are to grow through handling the adversity and the success of trading Forex. I think it will be a great experience to understand more about myself. On an educational level I think I will learn more the Forex market, like economics and statistics among other things. I definitely aim to engage in continuously learning throughout this process.

Although I think I've already covered it in this post, I'll write about determining a time frame for trading.

Develop and Open Mind and Gather Market Information - Step 2

Step 2 of system development according to Tharp in Trade Your Way... involves the mindset that one brings into trading. He stresses the importance of having an open mind and being aware that your beliefs shape the way you perceive the markets, and you are trading according to those beliefs. I don't think these are necessarily mind-blowing ideas, but its very easy to confuse our beliefs or ideas with incontrovertible truths. These beliefs become so ingrained that they become our reality, even though the true nature of things could be completely different.

The first thing I think of when I read those lines are related to what mental health practitioners refer to as "self-talk". Once we begin to have thoughts, ideas, and beliefs about ourselves, they become a "truth" of how we perceive ourselves, and they influence the way we conduct our lives. It essence, those beliefs become a self-fulfilling prophecy.

I tend to be very hard on myself at times and so I know the propensity for negative self-talk for me is high. I know Tharp's ideas are geared towards beliefs about the market, but I don't think you can examine your approach to the market until you have probed your own beliefs about yourself. For me, it is important to remind myself that I have not failed or am not a failure because some of the ambitions I've had for my life have not come to pass. I also have to remind myself that just because the past didn't work out as I had hoped, it does not mean the future is permanently inaccessible and pointless to hope for.

I'm not sure how that would impact my trading, other than to think I'll need to remind myself that the most important trade is the one I'm about to make, not the (potentially) several losses that preceded it. In the course of developing a system my goal is to find a system in which I can place confidence so I can believe that its positive long-term expectancy will overcome the sure-to-come losing streaks.

I think my beliefs about the market support a positive outlook that will enable me to be successful with trading. I don't believe the market rewards or punishes, nor will it act with any specific malice toward me. Its simply a manifestation of expectations and a record of opinion, essentially. My job isn't to be right or wrong about the markets, but rather to follow it, to just flow with it.

Tharp recommends several books, including Market Wizards, which I think I may already have. I'm going to look for some of the others to aid me in gathering market information. I actually think I've done a great deal of that already, but it doesn't hurt to do more of it.

Next time, I'll work on determining objectives.

Developing a System - Step 1

Chapter 4 of Trade Your Way... is about the steps necessary to develop a system. Tharp lists 12 steps in the process which are

1. Take an inventory


2. Develop an open mind and gather market information


3. Determine your objectives


4. Determine your time frame for trading


5. Determine the best historical moves in that time frame and notice what those moves have in common


6. What's the concept behind those moves and how can you objectively measure your concept?


7. Add your stops and transaction costs


8. Add your profit-taking exits and determine your expectancy


9. Look for huge reward trades


10. Optimize with position sizing


11. Determine how much you can improve your system


12. Worst-case scenario: mental planning

I find it odd that Tharp gives a list of steps to take before he fully explains some of the concepts involved in these steps, like position sizing and expectancy. What I'll most likely do is try to follow these step-by-step and jump to the pertinent chapters as needed.

First off, "take an inventory".

I went through a lot of this in a couple of previous entries where I conducted Tharp's interview with myself (that sounds a bit schizophrenic, doesn't it?). I think my computer and data management/manipulation skills are solid, so I know I won't have a problem in that area. My temperament is pretty even, although I do have moments where I lack composure. I believe that comes from an accumulation of negative feelings that I don't express. Then these feelings overflow and I express them inappropriately. This is something I've known about myself for a while, and something I really need to work on.

Other than that, I think my temperament is mostly good. I can work towards a goal for a long time and I tend to stick to plans that I make, so both of these indicate patience. I am a little concerned that I could get caught up in the excitement of having a trade on and think about it more than I really need to. Hopefully once I've traded long enough I won't focus too much on any open trade. Naturally I won't like taking losses, but if I can build a system in which I can have a positive expectation, I won't bail on it. That's a big emphasis of both Trade Your Way... and Way of the Turtle; when you do the work of creating a system yourself, you have much more confidence in trading it, which makes you less likely to quit on it.

Time could be an issue since I will only have about 2 good clean hours to devote to research and testing. I think I can make up for it by trading a system that's more long term in nature, although eventually I want to be able to trade more on a short term basis using automation. Of course that's a goal that will come later.

As for capital, I'm only willing to commit $100 right now. The good thing about OANDA is that I can trade very small amounts, so I can size my positions to any level of risk. I consider this to be an exploratory exercise, to see if I can become proficient enough to commit a higher level of capital someday. With this being such a small amount, I can afford to lose it all, which may very well happen.

I think that's a good first step today. Next time I'll work on Step 2.