Article / 21 September 2016 at 13:30 GMT

Knowing what is 'normal' can help you trade

Hypothesis Testing
United Kingdom
  • Markets have an average daily trading range, which can be defined as 'normal'
  • We know how far FX pairs oscillate in any one day, we can approximate new trends
  • With liquid pairs like GBPUSD, EURUSD, USDCAD, 45 pips appeared regularly
  • If stop is hit at 46 pips, we also know a new trend direction is taking place
  • The back-tested trading strategy outlined here produces surprising results
  • Mainstream indices, especially futures markets, have similar quirks of 'normality'

Curve in a road
 It's helpful to perceive when there's a change of direction... Photo: iStock

By fxtime*

Each and every day we measure '"normality" in multiple ways. We walk at a measured pace and our strides are mundane, one foot ahead of the other. In other words, we all know what "normal" means to us. We know from experience that our strides shorten when walking uphill, but that effect is within what we perceive as ''normal''.

Markets are no different. They all have an average trading range each and every day. We can easily utilise an average true range, or ATR, setting to determine over a predefined period of our choice what would be regarded as average or normal for our chosen market. In earlier articles, I have mentioned trading standard deviations, which essentially is seeking to trade within the normal market range/patterns. But what can be done when the market's moves exceed our perception of normal?

First let's ask "what happens if we miss a move?" Can we assess what our chances of success would be in chasing a missed move? For clarification there is a 73.8% chance that your trade would be successful, as is fully described via this link.

All simplistic so far. But we also know where to place our stops; we carefully assess our chosen markets and determine where the optimum stop placement should be to give our opening trade room to move and subsequently generate a profit. Again, I have provided some eight months of trade strategies and updates for you to peruse in the history files on this site. So let's look at the ''optimum stop''. If you place a stop at a point where you know your trade is wrong and has failed, then ask yourself if would you then turn your trade around and open a contra trade. Bear in mind that, if your stop has been hit, clearly the market has moved against you.

It is impossible to answer the above question definitively as some trades may have very tight or very wide stops, and the contra move may well be a short-lived impulse. Remember, however, that we know what "normal" is for the market. We know how far we can expect forex pairs to oscillate in any one day, so we know by approximation how far outside the norm a move must be before the market heads into a new trend.

Apples
 We know from experience what "normal" is. Photo: iStock

Sticking with the value ''optimum'', when we back-test currency strategies for efficacy and maximum drawdowns, success rates etc, we see something interesting. Using only liquid pairings, such as GBPUSDEURUSDUSDCAD, and even the yen, when trying to maximise success and ensure profitability greater than the current risk-free rate of return for the year and above the index growth rate, we saw 45 pips regularly appear. 

In other words, the natural harmonic number or vibration of the general marketplace is 45 pips. So, when we open a trade strategy, we know a stop of 45 pips is the optimum point before we can expect the market to turn in the opposite direction. If our stop was hit then at 46 pips, we also know a new trend direction is occurring.

All straightforward enough, but can we improve on this? A potentially successful trade strategy can be ruined by seeing your stop hit before turning the trade. What we really need is the optimum point for a trade entry without having to endure a loss in the first place.

If you recall, I mentioned normality for a marketplace. What if we measured 45 pips from the end-of-day closing price how successful would a trade be if we simply set an order to go long/short 46 pips away from the close price, and would the trade prove successful?

The results are surprising. But first let's see what occurs if these orders were filled: 

  • More than 90% of these trades exceeded 12 pips minimum profit.
  • 18% exceeded 100 pips profit
  • Average profit, however, was 29 pips
  • Optimum stop: Yes, you've guessed it, at 45 pips

So an average scenario of 90% success and 10% loss equates to nine good trades to one duff trade. 

  • So nine successful trades with the average gain = 9 x 29 pips = 261 pips profit
  • Thus one loss of 45 pips
  • Net gain = 261 - 45 = 216 pips

But what if we use the weakest data and assume our successful trades only made 12 pips each time?

  • Nine successful trades x 12 pips = 108 pips profit
  • One unsuccessful trade = 45 pips loss
  • Net gain = 63 pips

On Monday, September 12, Cable would have earned 20 pips. On Monday, September 13, at the time of writing, it would have earned 35 pips.

I will post live updates and an overview after the article appears.

What is interesting is that not only forex markets have an optimum, but mainstream indices, especially the futures markets, have similar quirks of ''normality''.

Who knows, but perhaps we should consider presetting orders for the minimum move as our ''norm'?

Pounds and dollars
With liquid pairs like GBPUSD, this strategy generated nine 
successful trades to one duff. Image: iStock 

— Edited by John Acher

*fxtime is a pseudonym
21 September
Qi2 Qi2
I enjoy your articles fxtime, always a learning experience, thank you!
21 September
HaythamSabry HaythamSabry
Do you have a website where all your articles are posted?
21 September
kom75 kom75
Thanks for another great article fxtime. If optimum sl for spx is 9 point, minimum movement is 2 points or greater?
21 September
fxtime fxtime
The 9pt SPX is an optimum stop for a Lady Luck trade but it isn't the index optimum stop.
IF using the Bayesian then the optimum stop is your trading range plus ticket price spread.
If using momentum on a EoD basis then 50% of the three day trading range maximum and trail the stop ever tighter.
If using a ratio trade strategy then ensure the ratio is tighter than the trade entry signal but this is down to your risk aversion.
Intraday I normally have a preset 4pt stop...KOM if you want the full breakdown of optimum stops for each trade scenario let me know and I will send seperately :-)
21 September
kom75 kom75
Thanks fxtime. If you could send me would be great:). My email: kom75@wp.pl or if you prefer send a message on TF
21 September
fxtime fxtime
Haytham my articles are posted each Wednesday but the last few weeks I have been on holiday so there were no postings....perhaps the most useful links I can find are;
https://www.tradingfloor.com/posts/drowning-in-ice-cream-correlations-6867790
https://www.tradingfloor.com/posts/mechanical-swing-trading-full-facts-and-real-figures-6968989
https://www.tradingfloor.com/posts/trading-a-break-in-highly-liquid-markets-7085684
https://www.tradingfloor.com/posts/skewed-thinking-7593071
https://www.tradingfloor.com/posts/what-aztec-gold-and-llamas-can-teach-us-7335495
There are others which i cannot find say the std deviation strategy and trading yesterdays news but I will scroll through old links for you
21 September
HaythamSabry HaythamSabry
Thanks :)
21 September
fxtime fxtime
Haytham you should find the strategies can be overlaid upon each other so you get a stronger trade set up !
All are based on probablity functions (basic link below)
https://www.tradingfloor.com/posts/trading-a-missed-move-7206136
or standard deviation theorem...again abasic link below;
https://www.tradingfloor.com/posts/adding-bell-curves-and-whistles-to-your-trading-strategy-7163807
These two are imho probably the best topics for research purposes !
21 September
fxtime fxtime
kom I will sort after FOMC :-)
21 September
kom75 kom75
Will wait;)
21 September
fxtime fxtime
2 emails enroute :-)
21 September
kom75 kom75
I've got them. Thanks
21 September
fxtime fxtime
Hope they both make sense ? :-)
21 September
Michael O'Neill Michael O'Neill
A most excellent article
21 September
fxtime fxtime
Thx Mike and hope you made on the lovely usdcad drop :-)
22 September
zefy zefy
Excellent and profitable article :)
22 September
C.A.L. gr C.A.L. gr
Many-many thanks!!
22 September
fxtime fxtime
Pleased everyone is earning....my view is that if generates one profit for someone on the TF site then the article was a success. The usdjpy was the big mover yesterday for me :-)
22 September
Qi2 Qi2
Your article, now an algo, its up and running :)
22 September
kom75 kom75
Hi fxtime, 3 trades closed this morning, so again thanks for easy and profitable ideas. Btw. 12 pips reversal strategy from your last article is now coded to breakout strategy. I wait for next week:)
22 September
fxtime fxtime
Qi2 well done....I guess its drinks on you then :-)
Kom well done at trading and earning...these trade scenarios are totally different from the usual fibbo and EW set ups and usually it is very hard to get traders to consider an alternative trade theory so well done mate :-)
22 September
fxtime fxtime
Qi2...remember the six line algo works with the following;
usdjpy + audusd for audjpy....these can be made to reference forwards and backwards where as the eurusd +gbpusd only permit eurgbp trades...hope this makes sense?
22 September
fxtime fxtime
A perfect example for optimum stops and market vibration. Spot cable came within a few pips of triggering then pulled back. Whilst there are other obvious trades available on the chart the optimisation model is designed to take advantage in changes of momentum that will give a directional bias which should when it triggers earn you more money faster and safer with minimal drawdown.
22 September
fxtime fxtime
update
22 September
kom75 kom75
Fxtime, maybe stupid question, but why do you use 8-9pm candle and not 9-10pm?
22 September
kom75 kom75
Sorry to bother you, I found already.
23 September
fxtime fxtime
Kom....I am approx 200km away from my office at presentso sorry for the late reply. The 8-9am range is the opening range for the ftse 100 index and the 9-10am range is the highest confidence data for a price breakout mainly due to the amount of data releases in Europe over that period. The timeframes I am quoting are BST (which is currently GMT+1)
23 September
kom75 kom75
Thanks fxtime for your reply, but I was referring to usdcad chart above;). UK100 time stamp is also helpfull. Thanks again and have a good day :)
23 September
fxtime fxtime
9pm BST is where vols drop hard as European markets pretty much shut their desks and the Canadian markets have the same time zone for vol drop off. I find the usdcad market seems to be volatile for the first 5hrs then nothing afterwards.Stats show there is little difference between 8-9pm and the 9-10pm zones you mention....approx 1% more successful using the 8-9 fwiw.
23 September
kom75 kom75
Thank you. I was asking, because I've seen you often refer to 9pm closing time candle
06 October
Estuardorlemus Estuardorlemus
Hi fxtime, reading back your articles. 2 questions: 1.) What time you recommend use for USDCAD ? 2.) How to know if short or long ? "If you recall, I mentioned normality for a marketplace. What if we measured 45 pips from the end-of-day closing price how successful would a trade be if we simply set an order to go long/short 46 pips away from the close price, and would the trade prove successful?" Thanks for the info !
06 October
fxtime fxtime
46pips from 9pm BST is my normal setting for such trades using as described above a 45pip stop seeking the absolute minimum 12pip gain whereby the stop will move to b/e and let the trade run or halve the trade at +12 and let the remainder run. You don't have a bias with this trade for direction...preset your orders long and short 46pips away from the 9pm close and let the market show you what direction it wants to take. As this is a zero sum trade the probability of success is in excess of 90% except a minor skew has been introduced to the trade as described thus you will ensure overall account revenue growth every quarter :-)
06 October
fxtime fxtime
@Estuardorlemus....a recent example is the cable today :-)
07 October
fxtime fxtime
Again today on the cable :-)
12 October
fxtime fxtime
Again on the cable :-)
12 October
Crispee Crispee
hi fxtime, nice example. I am curious to your thoughts about, for example, today on cable when the 46pip target is reached and TP is hit then GBP bounces back above the original 46pip target, do you look to re-enter at original target or are odds/sentiment/momentum against at that point? That is probably confusing, but look at today on cable as an example...thx for your thoughts.
12 October
fxtime fxtime
I can see your point. Normally i trade these as a single trade entity so only once would be my answer. The cable has had a large move today which as you know this trade structure I assume you earned too. However I tend to utilise standard deviations also and there is what I call an 84% rule eg once the market exceeds 2 std devs then 84% of the time it will return to ''normal'' distribution and that is what we have just seen hence your comments about a potential second trade.
Link attached for you.
https://www.tradingfloor.com/posts/adding-bell-curves-and-whistles-to-your-trading-strategy-7163807
KOM and ZEFY have done a lot of work on the std dev so perhaps they could tell you their findings if that helps?
12 October
Crispee Crispee
Thx for your answer.
I have been in touch with KOM who has been very helpful.
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