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"url": "https://pagoolabs.com/forums/api/trading-education/edit/?format=api",
"id": 1,
"title": "Trading Education",
"slug": "trading-education",
"description": "Learn how to trade many financial instruments from the ground up",
"rules": "1. Do not break the law in your jurisdiction\n2. Be engaged but polite\n",
"html": "<p>Learn how to trade many financial instruments from the ground up</p>",
"photo": null,
"creation_date": "2017-09-23T05:43:28.282282Z",
"parent": null,
"moderators": "SeanManefield",
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{
"url": "https://pagoolabs.com/stories/api/57/edit/?format=api",
"id": 57,
"title": "Examples of how to Manage Risk in a Forex Trade Using AUD.JPY and AUD.USD",
"slug": "examples-of-how-to-manage-risk-in-a-forex-trade",
"status": 2,
"publication_date": "2017-11-27T23:56:40Z",
"lead": "How to manage a forex trade so that the risk and the risk-reward of the trade is set in advance, using the examples of AUD.JPY and AUD.USD.",
"excerpt": "Managing a Forex trade using the examples of AUD.JPY and AUD.USD that set the risk and the risk-reward of the trade in advance.",
"poster": "SeanManefield",
"content": "---\r\nOur [previous story](/stories/51/2017/11/27/trading-audjpy-in-a-heikin-ashi-forex-system/) on risk in forex markets went over the definitions of the <small><strong>base.quote</strong></small> currency ticker format and how the quote defines the currency the contract is valued in. In this story I will go through a couple of specific examples to show how to correctly value any forex contract and have it priced in the same currency you use for your accounts.\r\n\r\nTo begin, imagine you are a United States Dollar (USD) account holder and you want to value a contract to sell <small><strong>AUD.JPY</strong></small>. I am extending the work we went through in an earlier story on the [dollar risk of one futures contract](/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/#Dollar-risk-of-one-contract) by adding the currency conversion rate and converting the quoted currency back to the account currency.\r\n\r\nWe will use the trade data indicated in the following H4 chart of the AUDJPY:\r\n![AUDJPY H4](/media/uploads/2017/Forex_Setups/2017-11-27_AUDJPY_H4_HA_zoom1.jpg \"AUDJPY 4H\"):C90\r\n\r\nHere is the trade from the highlighted setup, with the actual open price and stop loss:\r\n\r\n<a id=\"basic-setup-for-audjpy\">\r\n#### **Example 1. The Basic Setup for AUD.JPY**\r\n\r\n Risk per AUD.JPY Contract for a Sample Trade\r\n OP = 87.605 Open Price in Yen\r\n SL = 88.115 Stop Loss in Yen\r\n CS = 100,000 Contract Size\r\n CR = |OP - SL| x CS ¥Contract Risk (absolute value)\r\n = |87.605 - 88.115| x 100K\r\n ¥CR = ¥51,000 Risk in Yen\r\n $CR = ¥51,000 x JPY.USD Risk in USD\r\n\r\nThis last statement says that the risk in dollar terms is equal to the risk in yen multiplied by the cost of each yen. Because there is normally no traded <small><strong>JPY.USD</strong></small>, we have to *synthesize* it from:\r\n\r\n JPY.USD = 1 / USD.JPY\r\n\r\nThis simply says if the market for <small><strong>USD.JPY</strong></small> is currently trading at 100 then 1000 Yen is worth exactly $10 when valued in US$:\r\n\r\n $value = ¥1,000 x (1 / 100) Where 100 is the USD.JPY rate.\r\n = $10 In USD\r\n\r\nThese calculations are good enough here, but programmers will have to adjust the equations further by swapping the bid/ask rates:\r\n\r\n JPY.USD(bid) = 1 / USD.JPY(ask)\r\n JPY.USD(ask) = 1 / USD.JPY(bid)\r\n\r\nand applying each one correctly depending on whether the adjustment is for a buy (use the ask) or a sell (use the bid). That's a little too much detail for a non-programming article like this so let's just abstract away from the bid/ask for now to stay focused on the general idea.\r\n\r\nAt the time of the trade above from 2017-11-03 00:00 (written in [24 hour time](/stories/50/2017/11/09/where-does-the-day-begin-in-24-hour-trading/), the <small><strong>USD.JPY</strong></small> mid close price was 113.95. Using this to value the contract in US$, gives us:\r\n\r\n JPY.USD = 1 / 113.95\r\n = 0.0088\r\n $CR = ¥CR x JPY.USD Risk in USD\r\n = ¥51,000 x 0.0088\r\n = US$448.80 Risk per contract in US$\r\n\r\nWhat if your account is based in a currency other than US$? In this example so far we have used the inverse of <small><strong>USD.JPY</strong></small> to convert the Yen profits and losses to US$. If you are in another currency, say <small><strong>XYZ</strong></small>, you have two choices. The simple method is to find a direct currency pair from Yen to your currency, such as <small><strong>EUR.JPY</strong></small>, and replace the <small><strong>JPY.USD</strong></small> in the formula above with 1/<small><strong>EUR.JPY</strong></small>. In general you are looking for either <small><strong>XYZ.JPY</strong></small> or <small><strong>JPY.XYZ</strong></small>. In the case of the latter, there is no need to invert it beforehand.\r\n\r\nThe second method, useful when no direct cross exists between Yen and your account currency XYZ, is to add an extra step above after calculating the US$ contract risk. This step converts the US$ amount into your local currency. Every currency in the world should have a forex pair linking its currency to the USD, either <small><strong>XYZ.USD</strong></small> or <small><strong>USD.XYZ</strong></small>. If it is the former than invert it to arrive at the rate that converts US$ values into your account currency: <small><strong>USD.XYZ</strong></small>.\r\n\r\n ¥CR = ¥51,000 Risk in Yen\r\n $CR = ¥51,000 x JPY.USD Risk in USD\r\n CR = $CR x USD.XYZ New: Risk in your XYZ currency\r\n\r\nYou now have the value of one contract in the same currency as your account. Just continue on below, but substitute your currency symbol for the $ sign.\r\n\r\nWe now have enough information to calculate the number of contracts to open.\r\n\r\nAn [earlier story](/stories/40/2017/10/24/the-basic-setup-part-3-risky-trades/) showed how to calculate the amount we could invest in a trade without risking more than 2% of our available risk capital. Assuming $100K to invest, we therefore have $2,000 available for this trade. Now finally we can calculate the number of contracts to buy:\r\n\r\n Number of contracts = ($Funds at risk) / ($risk per contract)\r\n = 2000 / 448.80\r\n = 4 contracts\r\n Cost of position = $1795.20 from: 4 contracts x $448.80\r\n\r\n\r\n<a id=\"basic-setup-for-audusd\">\r\n#### **Example 2. The Basic Setup for AUD.USD**\r\n\r\nIn this example, because <small><strong>AUD.USD</strong></small> is priced in US$, US account holders can view the entire setup as a normal US$ futures contract with a contract size of 100K. But non-US traders will need to convert the US$ contract risk back to their own account currency. Here we consider the case of a trader with Yen accounts, but you could just as easily substitute Euros or any other account currency.\r\n\r\n Risk per AUDUSD Contract for a Sample Trade\r\n OP = 0.76910 Open Price in US$\r\n SL = 0.77310 Stop Loss in US$\r\n CS = 100,000 Contract Size\r\n $CR = |OP - SL| x CS $Contract Risk (absolute value)\r\n = |0.76910 - 0.77310| x 100K\r\n $CR = US$400 Risk in USD\r\n ¥CR = US$400 x USD.JPY Risk in Yen\r\n = US$400 x 113.95\r\n = ¥45,580\r\n\r\nThe second last statement says that the risk in yen terms is equal to the risk in US$ multiplied by the cost of each US$ valued in yen. So in this case we have US$400 and each US$ costs ¥113.95.\r\n\r\nNow assume the Japanese trader has ¥10,000,000 worth of risk funds in a Yen account to invest, of which only 1% or ¥100,000 can be invested in any one trade.\r\n\r\n Calculate the Number of Contracts From Funds Held In Yen:\r\n Number of contracts = ¥Funds at risk / ¥risk per contract\r\n = ¥100,000 / ¥45,580\r\n = 2 contracts\r\n Cost of position = ¥91,160 from 2 contracts x ¥45,580\r\n\r\n\r\n#### **The Account Currency Conversion is Only Needed to Calculate Position Size **\r\n\r\nTo determine whether the trade hits the target or is stopped out, we only need the contract risk which is provided by the SL and open price. The RR multiplier provides a simple way of getting a TP. So we do not need to mess with quote or account currencies. However whenever we need to calculate the number of contracts in order to open a trade, we need to go through the calculations above.\r\n\r\nAnother way of doing this is to calculate the value of one pip per contract in the forex rate you are opening. Then multiply that by the number of pips at risk and calculate the number of contracts to be opened. It's the same formula, just executed in a slightly different order.\r\n\r\nIt is very important to know what you are doing if you want to limit your risk, hence the calculations above. However, you can save yourself a lot of hassle by using one of the many free online calculators. Just search on \"forex calculator\" when you need one. Here are two to get you started:\r\n\r\n**Forex Calculators:**\r\n\r\n- [IC Markets](https://www.icmarkets.com/advanced-trading-tools/forex-calculators/)\r\n- [OANDA](https://www.oanda.com/forex-trading/analysis/profit-calculator/)\r\n\r\n#### **Conclusion**\r\n\r\nI have explained the general format of a currency pair, <small><strong>Base.Quote</strong></small>, and how to assess it as units of the base priced in the quote currency. We walked through how to convert the risk from the quote currency into your local account currency. Finally we were able to calculate the number of contracts to open while at the same time limiting our risk to a small percentage of our risk funds.\r\n\r\nWith this background in forex contracts we are now ready to consider how we might go about building a simple forex system. That will be the subject of our next story. Stay tuned.\r\n\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.",
"image": null,
"html": "<hr>\n<p>Our <a href=\"/stories/51/2017/11/27/trading-audjpy-in-a-heikin-ashi-forex-system/\">previous story</a> on risk in forex markets went over the definitions of the <small><strong>base.quote</strong></small> currency ticker format and how the quote defines the currency the contract is valued in. In this story I will go through a couple of specific examples to show how to correctly value any forex contract and have it priced in the same currency you use for your accounts.</p>\n<p>To begin, imagine you are a United States Dollar (USD) account holder and you want to value a contract to sell <small><strong>AUD.JPY</strong></small>. I am extending the work we went through in an earlier story on the <a href=\"/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/#Dollar-risk-of-one-contract\">dollar risk of one futures contract</a> by adding the currency conversion rate and converting the quoted currency back to the account currency.</p>\n<p>We will use the trade data indicated in the following H4 chart of the AUDJPY:\n<img alt=\"AUDJPY H4\" class=\"center\" src=\"/media/uploads/2017/Forex_Setups/2017-11-27_AUDJPY_H4_HA_zoom1.jpg\" title=\"AUDJPY 4H\" width=\"90%\"></p>\n<p>Here is the trade from the highlighted setup, with the actual open price and stop loss:</p>\n<p><a id=\"basic-setup-for-audjpy\"></a></p><a id=\"basic-setup-for-audjpy\">\n<h4><strong>Example 1. The Basic Setup for AUD.JPY</strong></h4>\n<div class=\"codehilite\"><pre><span></span>Risk per AUD.JPY Contract for a Sample Trade\n OP = 87.605 Open Price in Yen\n SL = 88.115 Stop Loss in Yen\n CS = 100,000 Contract Size\n CR = |OP - SL| x CS ¥Contract Risk (absolute value)\n = |87.605 - 88.115| x 100K\n ¥CR = ¥51,000 Risk in Yen\n $CR = ¥51,000 x JPY.USD Risk in USD\n</pre></div>\n\n\n<p>This last statement says that the risk in dollar terms is equal to the risk in yen multiplied by the cost of each yen. Because there is normally no traded <small><strong>JPY.USD</strong></small>, we have to <em>synthesize</em> it from:</p>\n<div class=\"codehilite\"><pre><span></span>JPY.USD = 1 / USD.JPY\n</pre></div>\n\n\n<p>This simply says if the market for <small><strong>USD.JPY</strong></small> is currently trading at 100 then 1000 Yen is worth exactly $10 when valued in US$:</p>\n<div class=\"codehilite\"><pre><span></span> $value = ¥1,000 x (1 / 100) Where 100 is the USD.JPY rate.\n = $10 In USD\n</pre></div>\n\n\n<p>These calculations are good enough here, but programmers will have to adjust the equations further by swapping the bid/ask rates:</p>\n<div class=\"codehilite\"><pre><span></span>JPY.USD(bid) = 1 / USD.JPY(ask)\nJPY.USD(ask) = 1 / USD.JPY(bid)\n</pre></div>\n\n\n<p>and applying each one correctly depending on whether the adjustment is for a buy (use the ask) or a sell (use the bid). That's a little too much detail for a non-programming article like this so let's just abstract away from the bid/ask for now to stay focused on the general idea.</p>\n</a><p><a id=\"basic-setup-for-audjpy\">At the time of the trade above from 2017-11-03 00:00 (written in </a><a href=\"/stories/50/2017/11/09/where-does-the-day-begin-in-24-hour-trading/\">24 hour time</a>, the <small><strong>USD.JPY</strong></small> mid close price was 113.95. Using this to value the contract in US$, gives us:</p>\n<div class=\"codehilite\"><pre><span></span>JPY.USD = 1 / 113.95\n = 0.0088\n $CR = ¥CR x JPY.USD Risk in USD\n = ¥51,000 x 0.0088\n = US$448.80 Risk per contract in US$\n</pre></div>\n\n\n<p>What if your account is based in a currency other than US$? In this example so far we have used the inverse of <small><strong>USD.JPY</strong></small> to convert the Yen profits and losses to US$. If you are in another currency, say <small><strong>XYZ</strong></small>, you have two choices. The simple method is to find a direct currency pair from Yen to your currency, such as <small><strong>EUR.JPY</strong></small>, and replace the <small><strong>JPY.USD</strong></small> in the formula above with 1/<small><strong>EUR.JPY</strong></small>. In general you are looking for either <small><strong>XYZ.JPY</strong></small> or <small><strong>JPY.XYZ</strong></small>. In the case of the latter, there is no need to invert it beforehand.</p>\n<p>The second method, useful when no direct cross exists between Yen and your account currency XYZ, is to add an extra step above after calculating the US$ contract risk. This step converts the US$ amount into your local currency. Every currency in the world should have a forex pair linking its currency to the USD, either <small><strong>XYZ.USD</strong></small> or <small><strong>USD.XYZ</strong></small>. If it is the former than invert it to arrive at the rate that converts US$ values into your account currency: <small><strong>USD.XYZ</strong></small>.</p>\n<div class=\"codehilite\"><pre><span></span> ¥CR = ¥51,000 Risk in Yen\n $CR = ¥51,000 x JPY.USD Risk in USD\n CR = $CR x USD.XYZ New: Risk in your XYZ currency\n</pre></div>\n\n\n<p>You now have the value of one contract in the same currency as your account. Just continue on below, but substitute your currency symbol for the $ sign.</p>\n<p>We now have enough information to calculate the number of contracts to open.</p>\n<p>An <a href=\"/stories/40/2017/10/24/the-basic-setup-part-3-risky-trades/\">earlier story</a> showed how to calculate the amount we could invest in a trade without risking more than 2% of our available risk capital. Assuming $100K to invest, we therefore have $2,000 available for this trade. Now finally we can calculate the number of contracts to buy:</p>\n<div class=\"codehilite\"><pre><span></span>Number of contracts = ($Funds at risk) / ($risk per contract)\n = 2000 / 448.80\n = 4 contracts\n Cost of position = $1795.20 from: 4 contracts x $448.80\n</pre></div>\n\n\n<p><a id=\"basic-setup-for-audusd\"></a></p><a id=\"basic-setup-for-audusd\">\n<h4><strong>Example 2. The Basic Setup for AUD.USD</strong></h4>\n<p>In this example, because <small><strong>AUD.USD</strong></small> is priced in US$, US account holders can view the entire setup as a normal US$ futures contract with a contract size of 100K. But non-US traders will need to convert the US$ contract risk back to their own account currency. Here we consider the case of a trader with Yen accounts, but you could just as easily substitute Euros or any other account currency.</p>\n<div class=\"codehilite\"><pre><span></span>Risk per AUDUSD Contract for a Sample Trade\n OP = 0.76910 Open Price in US$\n SL = 0.77310 Stop Loss in US$\n CS = 100,000 Contract Size\n $CR = |OP - SL| x CS $Contract Risk (absolute value)\n = |0.76910 - 0.77310| x 100K\n $CR = US$400 Risk in USD\n ¥CR = US$400 x USD.JPY Risk in Yen\n = US$400 x 113.95\n = ¥45,580\n</pre></div>\n\n\n<p>The second last statement says that the risk in yen terms is equal to the risk in US$ multiplied by the cost of each US$ valued in yen. So in this case we have US$400 and each US$ costs ¥113.95.</p>\n<p>Now assume the Japanese trader has ¥10,000,000 worth of risk funds in a Yen account to invest, of which only 1% or ¥100,000 can be invested in any one trade.</p>\n<div class=\"codehilite\"><pre><span></span>Calculate the Number of Contracts From Funds Held In Yen:\nNumber of contracts = ¥Funds at risk / ¥risk per contract\n = ¥100,000 / ¥45,580\n = 2 contracts\n Cost of position = ¥91,160 from 2 contracts x ¥45,580\n</pre></div>\n\n\n<h4><strong>The Account Currency Conversion is Only Needed to Calculate Position Size </strong></h4>\n<p>To determine whether the trade hits the target or is stopped out, we only need the contract risk which is provided by the SL and open price. The RR multiplier provides a simple way of getting a TP. So we do not need to mess with quote or account currencies. However whenever we need to calculate the number of contracts in order to open a trade, we need to go through the calculations above.</p>\n<p>Another way of doing this is to calculate the value of one pip per contract in the forex rate you are opening. Then multiply that by the number of pips at risk and calculate the number of contracts to be opened. It's the same formula, just executed in a slightly different order.</p>\n<p>It is very important to know what you are doing if you want to limit your risk, hence the calculations above. However, you can save yourself a lot of hassle by using one of the many free online calculators. Just search on \"forex calculator\" when you need one. Here are two to get you started:</p>\n<p><strong>Forex Calculators:</strong></p>\n</a><ul><a id=\"basic-setup-for-audusd\">\n</a><li><a id=\"basic-setup-for-audusd\"></a><a href=\"https://www.icmarkets.com/advanced-trading-tools/forex-calculators/\">IC Markets</a></li>\n<li><a href=\"https://www.oanda.com/forex-trading/analysis/profit-calculator/\">OANDA</a></li>\n</ul>\n<h4><strong>Conclusion</strong></h4>\n<p>I have explained the general format of a currency pair, <small><strong>Base.Quote</strong></small>, and how to assess it as units of the base priced in the quote currency. We walked through how to convert the risk from the quote currency into your local account currency. Finally we were able to calculate the number of contracts to open while at the same time limiting our risk to a small percentage of our risk funds.</p>\n<p>With this background in forex contracts we are now ready to consider how we might go about building a simple forex system. That will be the subject of our next story. Stay tuned.</p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"post": "I am still hoping for an update :)",
"html": "<p><p>I am still hoping for an update :)</p></p>",
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"submit_date": "2018-01-07T04:14:44Z",
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"post": "Thanks. When will the next nxt post be up?",
"html": "<p><p>Thanks. When will the next nxt post be up?</p></p>",
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"submit_date": "2017-12-03T05:10:40Z",
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"post": "Coming soon, Constanz. Stay tuned.",
"html": "<p><p>Coming soon, Constanz. Stay tuned.</p></p>",
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"url": "https://pagoolabs.com/stories/api/51/edit/?format=api",
"id": 51,
"title": "How to Manage Risk in a Forex Trade",
"slug": "trading-audjpy-in-a-heikin-ashi-forex-system",
"status": 2,
"publication_date": "2017-11-27T23:46:40Z",
"lead": "How do we manage a Forex trade so that the risk is fixed and we know the risk-reward of the trade in advance?",
"excerpt": "How to manage a Forex trade so that the risk is fixed and you know the risk-reward of the trade in advance. Trading AUDJPY in a Heikin Ashi Forex System.",
"poster": "SeanManefield",
"content": "---\r\n\r\nForex trading is only a little different to trading any other type of security. In this story I show you the main differences so you can apply a systems method to trading currencies. To illustrate, in the next story I will apply the method described below to <small><strong>AUD.JPY</strong></small>, the cross between the Australian Dollar and the Japanese Yen.\r\n\r\nForex trading is conducted in the relatively unregulated interbank market where individual banks conduct foreign currency business over the phone or via networked quote entry systems. These quotes are accumulated by several vendors and distributed back to the banks as well as via trading systems to worldwide forex traders. A very common platform for individual traders is Metatrader which is widely available for free once you've opened a trading or a demo account.\r\n\r\nIn an earlier story on [how to set up a trade in the futures market](/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/), I showed the [different sizes for various futures contracts](/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/#common-contract-sizes). To recap, forex contracts are typically 100,000 units of the base currency and the price for each unit of the base is displayed in units of the quote currency. Currencies are displayed here in the format:\r\n\r\n BaseFX.QuoteFX\t\t\t\t\r\n where:\r\n BaseFX is the currency which is being bought or sold.\r\n QuoteFX is the currency the contract is priced or quoted in.\r\n The Quote currency is also called the Counter currency.\r\n\r\nFor example, we write <small><strong>AUD.JPY</strong></small> for the purchase of contracts of AUD valued in JPY or Japanese Yen. Other common ways you will see <small><strong>BaseFX.QuoteFX</strong></small> pairs displayed are <small><strong>AUDJPY</strong></small> and <small><strong>AUD/JPY</strong></small>.\r\n\r\nOften the joining dot or period is replaced with a division symbol or omitted altogether. In the text below I use a period to help make the relation clearer.\r\n\r\n<a id=\"common-contract-sizes\"></a>\r\n\r\nBASE.QUOTE | Contract Size | Priced In\r\n-------------|:-----------------:|---------------------\r\n <small><strong>AUD.JPY</strong></small> | 100K Australian Dollars | Japanese Yen\r\n <small><strong>AUD.USD</strong></small> | 100K Australian Dollars | US Dollars\r\n <small><strong>USD.CAD</strong></small> | 100K US Dollars | Canadian Dollars\r\n <small><strong>USD.JPY</strong></small> | 100K US Dollars | Japanese Yen\r\n <small><strong>EUR.USD</strong></small> | 100K Euros | US Dollars\r\n\r\nAlthough the *normal* contract size is 100,000 units (100K), many brokers allow fractional quantities served up in mini sized contracts of 10K or even 1K units.\r\n\r\n<a id=\"<a id=\"how-do-base-and-quote-currencies-work\"></a>\r\n#### How do Base and Quote Currencies Work\r\n\r\nWhat makes Forex a little confusing is that there are at least two currencies involved, and often a third - your **account currency**. Let's walk through them one at a time.\r\n\r\nThe **base currency** sounds like a price but it is actually a commodity you can buy or sell, like an apple. And just like an apple, this commodity has a price quoted, but in another currency called, naturally enough, the **quote currency**. Just as an apple costs, say $0.50c, a unit of AUD costs a given amount determined by the current market. For the <small><strong>AUD.JPY</strong></small> contract, at the time of writing, one AUD costs 84.50 Japanese Yen. It is priced in Yen because Yen is the *quote* currency that follows after the period.\r\n\r\nIf you have a trading account, it will be set up in at least one currency called the account currency. When you make a trade, your profits and losses usually accumulate in the quote currency and are converted via a separate transaction to your account currency.\r\n\r\nThat's different to the case where you set out to buy or sell a foreign currency for its own sake, either to purchase from or sell an item to a foreign entity. In this latter case you would take delivery of the foreign currency, the AUD. Your trading account may or may not allow delivery. In the same way, trading futures usually resolves as a cash transfer, not the delivery of wheat or pork bellies.\r\n\r\nSince your trading account is probably a margin account, to open a long position in <small><strong>AUD.JPY</strong></small>, you will be borrowing the Yen to sell in order to buy the AUD. You will pay interest on the Yen and receive interest on the AUD until you close the long position.\r\n\r\nThe <small><strong>AUD.USD</strong></small> contract, on the other hand, quotes the price of one unit of AUD in US Dollars. The current price of one AUD is US$0.7602. Notice the extra decimal places after the usual cents ($0.76**02**)? Each currency has a standard number of decimal places for every market price quote. These are called pips, from *Point In Percentage*. For the AUD four decimal places are displayed in every price quote. If the AUD increases from US$0.7600 to 0.7602 we say that it increased by two pips. That is, the AUD has become slightly more expensive to a US buyer, just as an increase in the price of an apple makes it more costly.\r\n\r\nQuote currencies that do not trade in the street with decimals, such as the Yen and formerly the Italian Lira, will probably only have two decimals places reserved to display pips. For example, the <small><strong>AUD.JPY</strong></small> is quoted as 84.50.\r\n\r\nDepending on your quote platform, you will probably see an extra 5th (and 3rd for Yen) decimal place quoted along with the above four because many vendors provide half pips and smaller. These are sometimes called *pipettes*, or more commonly just \"half a pip\", and written as 0.7602**5**.\r\n\r\nWe will need to go through these numbers in depth so that we can place a trade, but first let's look at the obvious question here:\r\n\r\n<a id=\"which-currency-is-the-quote\">\r\n##### **What Determines Which Currency is the Base and Which is the Quote?**\r\n\r\nWhy is the AUD contract expressed as <small><strong>AUD.USD</strong></small> but the Japanese and Canadian contracts written in terms of the non USA currency, <small><strong>USD.CAD</strong></small> and <small><strong>USD.JPY</strong></small>? Why is the Euro written as <small><strong>EUR.USD</strong></small> and not <small><strong>USD.EUR</strong></small>? Well the short answer is that you can write them any way you like providing there is a market and your broker supports those reverse contracts. However, most if not all quote vendors express the contracts in the same ratios I use here.\r\n\r\nBASE.QUOTE | Quoted in\r\n-------------|-------------\r\n <small><strong>AUD.JPY</strong></small> | Yen\r\n <small><strong>AUD.USD</strong></small> | US$\r\n <small><strong>USD.CAD</strong></small> | Canadian $\r\n <small><strong>USD.JPY</strong></small> | Yen\r\n <small><strong>EUR.USD</strong></small> | US$\r\n <small><strong>EUR.CHF</strong></small> | Swiss Francs\r\n <small><strong>USD.CHF</strong></small> | Swiss Francs\r\n <small><strong>USD.MXN</strong></small> | Mexican pesos\r\n <small><strong>USD.CNH</strong></small> | Chinese Renminbi or Yuan (offshore)\r\n\r\nThe long answer is murkier and almost lost in the history of forex markets. Given my four decades or more working with Forex, I describe my own beliefs on the origin of the currency ratios [here](/stories/56/2017/11/29/what-determines-which-currency-is-the-base-and-which-is-the-quote/), but I am by no means 100% certain. TL;DR I suggest it's because of the ratio of one currency to the other. If a currency back in the 1970s traded consistently under one US$, especially the Italian Lira or the Yen, it was designated the quote currency and vice versa. Today we just keep using the established contract tickers for historical reasons.\r\n\r\n\r\n<a id=\"significance-of-the-quote-currency\">\r\n#### **The Significance of the Quote Currency**\r\n\r\nThe quote currency is the currency of the trade. It is the amount paid or received for buying or selling one unit of the base currency. If you are based in the USA and the quote currency is also the USD, such as <small><strong>AUD.USD</strong></small>, then you can value the contract in the same way as any US futures or equity position. You will receive USD if a long postion rises in value or pay out USD from your account if the position falls.\r\n\r\nYou are simply buying or selling units of AUD like any other commodity. In the special case of USD as the quote currency for US accounts, currencies do not really enter into the calculations!\r\n\r\nYour local currency is your account currency, the currency in which you add up your profits and losses. It might or might not be the quote currency.\r\n\r\nNone of this matters if you are simply looking for signals on the chart because then you are only concerned with the open, stop and target prices and the RR multiplier between risk (OP - SL) and reward (TP - OP). However as soon as you want to open a position, you will need to know the number of contracts. That's when the calculations below come in handy.\r\n\r\nIf the quote currency is not your account currency then the trade will lead to a certain amount of foreign currency flowing into or leaving your account each day as the position is marked to market. Your broker may automatically convert those winnings or losses into your account currency for a fee, but the mechanism remains the same.\r\n\r\nWhen you calculate the trade setup, you must take into account the conversion of the amount at risk to your account currency so that you can compute the number of contracts to open. You will remember from the first series on [The Basic Setup](/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/) that the value of the risk per contract is divided into funds at risk in order to calculate the position size:\r\n\r\n Number of contracts = ($Funds at risk) / ($risk per contract)\r\n\r\nThe funds at risk are normally 1% to 2% of your risk capital.\r\n\r\nSince the funds at risk are in your account currency, you must convert the amount at risk in the trade into that same currency. This step was not required when you were [buying futures](/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/#Dollar-risk-of-one-contract) because there I only discussed futures priced in your local currency. Here we have to convert the risk value back to your local currency. None of this arithmetic is hard but because of the multiple currencies it is no doubt tricky to get your head around. To help, I will do a couple of examples below.\r\n\r\nKeep in mind what I wrote above about how the currencies are quoted - we need to know which currency is used to value the contract whenever we discuss a forex pair. It is always the quote currency on the right hand side.\r\n\r\nI will take the example of <small><strong>AUD.JPY</strong></small> and consider our account currency to be the USD. This works just as well for anyone whose account currency is not JPY. Just replace the conversion from Yen to US$ with your Yen/local rate. I will show you how to do that below. For JPY account holders, this position is just like any other domestic Japanese security priced in Yen except it has a contract size of 100K. Yen account holders should refer below to the <small><strong>AUD.USD</strong></small> example 2.\r\n\r\nAUD account holders could take a short cut and use the inverse of the market price of <small><strong>AUD.JPY</strong></small> at OP and SL to calculate the risk in AUD.\r\n\r\n\r\nLet's look at those examples now in our next story [Examples of how to Manage Risk in a Forex Trade](/stories/57/2017/11/27/examples-of-how-to-manage-risk-in-a-forex-trade/).\r\n\r\n\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.",
"image": null,
"html": "<hr>\n<p>Forex trading is only a little different to trading any other type of security. In this story I show you the main differences so you can apply a systems method to trading currencies. To illustrate, in the next story I will apply the method described below to <small><strong>AUD.JPY</strong></small>, the cross between the Australian Dollar and the Japanese Yen.</p>\n<p>Forex trading is conducted in the relatively unregulated interbank market where individual banks conduct foreign currency business over the phone or via networked quote entry systems. These quotes are accumulated by several vendors and distributed back to the banks as well as via trading systems to worldwide forex traders. A very common platform for individual traders is Metatrader which is widely available for free once you've opened a trading or a demo account.</p>\n<p>In an earlier story on <a href=\"/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/\">how to set up a trade in the futures market</a>, I showed the <a href=\"/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/#common-contract-sizes\">different sizes for various futures contracts</a>. To recap, forex contracts are typically 100,000 units of the base currency and the price for each unit of the base is displayed in units of the quote currency. Currencies are displayed here in the format:</p>\n<div class=\"codehilite\"><pre><span></span>BaseFX.QuoteFX \nwhere:\n BaseFX is the currency which is being bought or sold.\n QuoteFX is the currency the contract is priced or quoted in.\n The Quote currency is also called the Counter currency.\n</pre></div>\n\n\n<p>For example, we write <small><strong>AUD.JPY</strong></small> for the purchase of contracts of AUD valued in JPY or Japanese Yen. Other common ways you will see <small><strong>BaseFX.QuoteFX</strong></small> pairs displayed are <small><strong>AUDJPY</strong></small> and <small><strong>AUD/JPY</strong></small>.</p>\n<p>Often the joining dot or period is replaced with a division symbol or omitted altogether. In the text below I use a period to help make the relation clearer.</p>\n<p><a id=\"common-contract-sizes\"></a></p>\n<table>\n<thead>\n<tr>\n<th>BASE.QUOTE</th>\n<th>Contract Size</th>\n<th>Priced In</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td><small><strong>AUD.JPY</strong></small></td>\n<td>100K Australian Dollars</td>\n<td>Japanese Yen</td>\n</tr>\n<tr>\n<td><small><strong>AUD.USD</strong></small></td>\n<td>100K Australian Dollars</td>\n<td>US Dollars</td>\n</tr>\n<tr>\n<td><small><strong>USD.CAD</strong></small></td>\n<td>100K US Dollars</td>\n<td>Canadian Dollars</td>\n</tr>\n<tr>\n<td><small><strong>USD.JPY</strong></small></td>\n<td>100K US Dollars</td>\n<td>Japanese Yen</td>\n</tr>\n<tr>\n<td><small><strong>EUR.USD</strong></small></td>\n<td>100K Euros</td>\n<td>US Dollars</td>\n</tr>\n</tbody>\n</table>\n<p>Although the <em>normal</em> contract size is 100,000 units (100K), many brokers allow fractional quantities served up in mini sized contracts of 10K or even 1K units.</p>\n<p><a id=\"<a id=\"></a></p>\n<h4>How do Base and Quote Currencies Work</h4>\n<p>What makes Forex a little confusing is that there are at least two currencies involved, and often a third - your <strong>account currency</strong>. Let's walk through them one at a time.</p>\n<p>The <strong>base currency</strong> sounds like a price but it is actually a commodity you can buy or sell, like an apple. And just like an apple, this commodity has a price quoted, but in another currency called, naturally enough, the <strong>quote currency</strong>. Just as an apple costs, say $0.50c, a unit of AUD costs a given amount determined by the current market. For the <small><strong>AUD.JPY</strong></small> contract, at the time of writing, one AUD costs 84.50 Japanese Yen. It is priced in Yen because Yen is the <em>quote</em> currency that follows after the period.</p>\n<p>If you have a trading account, it will be set up in at least one currency called the account currency. When you make a trade, your profits and losses usually accumulate in the quote currency and are converted via a separate transaction to your account currency.</p>\n<p>That's different to the case where you set out to buy or sell a foreign currency for its own sake, either to purchase from or sell an item to a foreign entity. In this latter case you would take delivery of the foreign currency, the AUD. Your trading account may or may not allow delivery. In the same way, trading futures usually resolves as a cash transfer, not the delivery of wheat or pork bellies.</p>\n<p>Since your trading account is probably a margin account, to open a long position in <small><strong>AUD.JPY</strong></small>, you will be borrowing the Yen to sell in order to buy the AUD. You will pay interest on the Yen and receive interest on the AUD until you close the long position.</p>\n<p>The <small><strong>AUD.USD</strong></small> contract, on the other hand, quotes the price of one unit of AUD in US Dollars. The current price of one AUD is US$0.7602. Notice the extra decimal places after the usual cents ($0.76<strong>02</strong>)? Each currency has a standard number of decimal places for every market price quote. These are called pips, from <em>Point In Percentage</em>. For the AUD four decimal places are displayed in every price quote. If the AUD increases from US$0.7600 to 0.7602 we say that it increased by two pips. That is, the AUD has become slightly more expensive to a US buyer, just as an increase in the price of an apple makes it more costly.</p>\n<p>Quote currencies that do not trade in the street with decimals, such as the Yen and formerly the Italian Lira, will probably only have two decimals places reserved to display pips. For example, the <small><strong>AUD.JPY</strong></small> is quoted as 84.50.</p>\n<p>Depending on your quote platform, you will probably see an extra 5th (and 3rd for Yen) decimal place quoted along with the above four because many vendors provide half pips and smaller. These are sometimes called <em>pipettes</em>, or more commonly just \"half a pip\", and written as 0.7602<strong>5</strong>.</p>\n<p>We will need to go through these numbers in depth so that we can place a trade, but first let's look at the obvious question here:</p>\n<p><a id=\"which-currency-is-the-quote\"></a></p><a id=\"which-currency-is-the-quote\">\n<h5><strong>What Determines Which Currency is the Base and Which is the Quote?</strong></h5>\n<p>Why is the AUD contract expressed as <small><strong>AUD.USD</strong></small> but the Japanese and Canadian contracts written in terms of the non USA currency, <small><strong>USD.CAD</strong></small> and <small><strong>USD.JPY</strong></small>? Why is the Euro written as <small><strong>EUR.USD</strong></small> and not <small><strong>USD.EUR</strong></small>? Well the short answer is that you can write them any way you like providing there is a market and your broker supports those reverse contracts. However, most if not all quote vendors express the contracts in the same ratios I use here.</p>\n<table>\n<thead>\n<tr>\n<th>BASE.QUOTE</th>\n<th>Quoted in</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td><small><strong>AUD.JPY</strong></small></td>\n<td>Yen</td>\n</tr>\n<tr>\n<td><small><strong>AUD.USD</strong></small></td>\n<td>US$</td>\n</tr>\n<tr>\n<td><small><strong>USD.CAD</strong></small></td>\n<td>Canadian $</td>\n</tr>\n<tr>\n<td><small><strong>USD.JPY</strong></small></td>\n<td>Yen</td>\n</tr>\n<tr>\n<td><small><strong>EUR.USD</strong></small></td>\n<td>US$</td>\n</tr>\n<tr>\n<td><small><strong>EUR.CHF</strong></small></td>\n<td>Swiss Francs</td>\n</tr>\n<tr>\n<td><small><strong>USD.CHF</strong></small></td>\n<td>Swiss Francs</td>\n</tr>\n<tr>\n<td><small><strong>USD.MXN</strong></small></td>\n<td>Mexican pesos</td>\n</tr>\n<tr>\n<td><small><strong>USD.CNH</strong></small></td>\n<td>Chinese Renminbi or Yuan (offshore)</td>\n</tr>\n</tbody>\n</table>\n</a><p><a id=\"which-currency-is-the-quote\">The long answer is murkier and almost lost in the history of forex markets. Given my four decades or more working with Forex, I describe my own beliefs on the origin of the currency ratios </a><a href=\"/stories/56/2017/11/29/what-determines-which-currency-is-the-base-and-which-is-the-quote/\">here</a>, but I am by no means 100% certain. TL;DR I suggest it's because of the ratio of one currency to the other. If a currency back in the 1970s traded consistently under one US$, especially the Italian Lira or the Yen, it was designated the quote currency and vice versa. Today we just keep using the established contract tickers for historical reasons.</p>\n<p><a id=\"significance-of-the-quote-currency\"></a></p><a id=\"significance-of-the-quote-currency\">\n<h4><strong>The Significance of the Quote Currency</strong></h4>\n<p>The quote currency is the currency of the trade. It is the amount paid or received for buying or selling one unit of the base currency. If you are based in the USA and the quote currency is also the USD, such as <small><strong>AUD.USD</strong></small>, then you can value the contract in the same way as any US futures or equity position. You will receive USD if a long postion rises in value or pay out USD from your account if the position falls.</p>\n<p>You are simply buying or selling units of AUD like any other commodity. In the special case of USD as the quote currency for US accounts, currencies do not really enter into the calculations!</p>\n<p>Your local currency is your account currency, the currency in which you add up your profits and losses. It might or might not be the quote currency.</p>\n<p>None of this matters if you are simply looking for signals on the chart because then you are only concerned with the open, stop and target prices and the RR multiplier between risk (OP - SL) and reward (TP - OP). However as soon as you want to open a position, you will need to know the number of contracts. That's when the calculations below come in handy.</p>\n<p>If the quote currency is not your account currency then the trade will lead to a certain amount of foreign currency flowing into or leaving your account each day as the position is marked to market. Your broker may automatically convert those winnings or losses into your account currency for a fee, but the mechanism remains the same.</p>\n</a><p><a id=\"significance-of-the-quote-currency\">When you calculate the trade setup, you must take into account the conversion of the amount at risk to your account currency so that you can compute the number of contracts to open. You will remember from the first series on </a><a href=\"/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/\">The Basic Setup</a> that the value of the risk per contract is divided into funds at risk in order to calculate the position size:</p>\n<div class=\"codehilite\"><pre><span></span>Number of contracts = ($Funds at risk) / ($risk per contract)\n</pre></div>\n\n\n<p>The funds at risk are normally 1% to 2% of your risk capital.</p>\n<p>Since the funds at risk are in your account currency, you must convert the amount at risk in the trade into that same currency. This step was not required when you were <a href=\"/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/#Dollar-risk-of-one-contract\">buying futures</a> because there I only discussed futures priced in your local currency. Here we have to convert the risk value back to your local currency. None of this arithmetic is hard but because of the multiple currencies it is no doubt tricky to get your head around. To help, I will do a couple of examples below.</p>\n<p>Keep in mind what I wrote above about how the currencies are quoted - we need to know which currency is used to value the contract whenever we discuss a forex pair. It is always the quote currency on the right hand side.</p>\n<p>I will take the example of <small><strong>AUD.JPY</strong></small> and consider our account currency to be the USD. This works just as well for anyone whose account currency is not JPY. Just replace the conversion from Yen to US$ with your Yen/local rate. I will show you how to do that below. For JPY account holders, this position is just like any other domestic Japanese security priced in Yen except it has a contract size of 100K. Yen account holders should refer below to the <small><strong>AUD.USD</strong></small> example 2.</p>\n<p>AUD account holders could take a short cut and use the inverse of the market price of <small><strong>AUD.JPY</strong></small> at OP and SL to calculate the risk in AUD.</p>\n<p>Let's look at those examples now in our next story <a href=\"/stories/57/2017/11/27/examples-of-how-to-manage-risk-in-a-forex-trade/\">Examples of how to Manage Risk in a Forex Trade</a>.</p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
"forums": [
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"url": "https://pagoolabs.com/forums/api/trading-education/?format=api",
"title": "Trading Education"
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"url": "https://pagoolabs.com/stories/api/54/edit/?format=api",
"id": 54,
"title": "What Determines Which Currency is the Base and Which is the Quote?",
"slug": "what-determines-which-currency-is-the-base-and-which-is-the-quote",
"status": 2,
"publication_date": "2017-11-27T04:10:34Z",
"lead": "What do the Forex ticker symbols mean in foreign currency trading and how to understand Base Currency, Quote Currency and Account Currency.",
"excerpt": "We explain what the Forex ticker symbols mean in foreign currency trading and how to understand Base Currency, Quote Currency and Account Currency",
"poster": "SeanManefield",
"content": "---\r\n\r\n<a id=\"base-vs-quote\">\r\n##### **Base vs Quote**\r\n\r\n\r\nForex contracts are expressed as a pair of foreign currencies such as <small><strong>AUD.JPY</strong></small> where the first currency is the Base currency and the second is the Quote currency. The base describes the commodity itself, just like oil, gold or Intel stock (INTC). The forex contract is priced in units of the quote currency.\r\n\r\nFor example, an ask price of 84.75 for <small><strong>AUD.JPY</strong></small> tells you that one Australian Dollar will cost you 84.75 Japanese Yen to buy.\r\n\r\nIf your accounts are in Euros or USD then neither the base nor the quote of <small><strong>AUD.JPY</strong></small> is the same as your account currency. Your account currency would be Euros or USD in this case. A trading account will normally stipulate which currency your trading is based in and realized wins and losses from trading <small><strong>AUD.JPY</strong></small> will need to be converted to it.\r\n\r\n![Typical Forex Contracts](/media/uploads/2017/Forex_Setups/Typical_FX_contracts.jpg \"Typical Forex Contracts\"):R28\r\n\r\n BASE.QUOTE | Quoted in:\r\n-------------|-----------\r\n <small><strong>AUD.JPY</strong></small> | Yen\r\n <small><strong>AUD.USD</strong></small> | US$\r\n <small><strong>USD.CAD</strong></small> | Canadian $\r\n <small><strong>USD.JPY</strong></small> | Yen\r\n <small><strong>EUR.USD</strong></small> | US$\r\n <small><strong>EUR.CHF</strong></small> | Swiss Francs\r\n <small><strong>USD.CHF</strong></small> | Swiss Francs\r\n <small><strong>USD.MXN</strong></small> | Mexican Pesos\r\n <small><strong>USD.CNH</strong></small> | Chinese Renminbi or Yuan\r\n\r\nHave you ever wondered why the AUD contract is expressed as <small><strong>AUD.USD</strong></small> but the Japanese and Canadian contracts are defined in terms of the non USA currency, <small><strong>USD.CAD</strong></small> and <small><strong>USD.JPY</strong></small>? Why is the Euro written as <small><strong>EUR.USD</strong></small> and not <small><strong>USD.EUR</strong></small>?\r\n\r\nThe short answer is that you could write them any way you like providing there is a market and your broker supports those reverse contracts. However, most if not all quote vendors express the contracts in the same ratio we use here.\r\n\r\nThe long answer is that, except for the recent Euro, the reasons are many and fuzzily recalled. I have my version of the story to tell based on my own experience working with foreign currencies since the 1970s.\r\n\r\nBack in the dark ages, when researchers would enter data into mainframe computers using stacked decks of cards, there were many more European currencies than today. There were French and Belgian Francs, German DMarks, Italian Lira and many more. Some currency crosses were quoted in one fashion on one side of an international border but quoted in the reverse direction on the other side.\r\n\r\nThe preferred way to quote a currency for US traders or tourists should be just like the <small><strong>AUD.USD</strong></small>. When expressed this way, it gives the price of an Australian Dollar in the same way as the price of an apple: in the locally used US currency. On the other hand, it is less transparent for Australians who see a price quote that is slightly more confusing: how many US$ they get for one A$. That's like seeing how many apples you can buy for $1 instead of the price of one apple.\r\n\r\nBut the real problem was that currencies are rarely related by the same order of magnitude. So there might have been five Francs to the USD, three DMarks or 200 Yen but much more rarely 1.1 or 0.9 units of foreign currency. My memory is that the issue was resolved partially by aesthetics alone: it was never convenient to enter error prone numbers onto punched cards when the forex quote looked like a fractional 0.00512 US Dollars for one Japanese Yen.\r\n\r\nI remember handling currencies using both the normal and the reverse ratio but I and those around me mostly favored the quote where a digit other than zero was on the left hand side of the decimal point. It just felt better, and it was easier to check on the old printouts where decimals were hard to read. No doubt, the older traders around us felt the same way, although it was never discussed, as far as I can recall.\r\n\r\nUp until the early 1980s, one Australian Dollar cost more than one US Dollar. Other than the name, the two currencies developed independently of each other. There is no requirement for the two to trade at parity or any level other than what's determined in the market. The Australian Dollar derived from the Australian Pound (two dollars for every one Pound in 1966) which in turn had earlier derived from the British Pound. The British Pound in turn cost about US$5 through the 19th century until the turmoil of the First World War. Today each Pound costs roughly US$1.33 and is quoted as <small><strong>GBP.USD</strong></small>.\r\n\r\nThe Canadian Dollar traded around parity in the 1970s but closed out that decade around C$1.20 to US$1 so the quote was reversed to look like <small><strong>USD.CAD</strong></small>, with a quote something like 1.20. Had it been the other way around <small><strong>CAD.USD</strong></small> would have been 0.83, less aesthetically pleasing on the old printouts and terminals and slightly more error prone, although not as bad as the Yen or Italian Lira would have been.\r\n\r\nIf you follow all the currencies back to the 1970s you will notice a pattern where the currency with the greater number of units in comparison is usually placed on the right hand side as the quote currency. So the Yen is expressed as <small><strong>USD.JPY</strong></small> where there are today over 110 Yen to one USD.\r\n\r\nI believe we inherit today whichever pattern was common up to the 1970s when computer databases froze the prevailing ratios. This is true even for currencies like the AUD which have more since fallen below one US$. Modern computers with clear screens easily displaying the decimal point or comma mean we don't need to worry about those old punched card concerns anymore, but we do continue to use the ratios that were convenient in earlier times.\r\n\r\n<a id=\"what-about-the-euro\">\r\n\r\n##### **What About the Euro?**\r\n\r\nWhen the single currency was introduced the European Union insisted it had to be quoted <small><strong>EUR.USD</strong></small> and not the reverse. It could be that they hoped the USD would be worth less than the Euro, as a matter of pride perhaps, but I don't think so. For Europeans, the natural way of expressing the currency if you had a choice about it or, as in this case, if you were imposing the ratio by fiat, would be to set <small><strong>USD.EUR</strong></small> as the standard. That would mean European tourists and traders would approach a foreign exchange counter and purchase US$ priced in their local Euro currency, just as they would apples or anything else.\r\n\r\nIn the same way as Europeans express a desire to price oil in Euros, they would price USD in Euros. It would make the most sense and be easier for them to discern value. But they didn't.\r\n\r\nI believe the decision was poorly thought through. I think some Europeans saw the <small><strong>GBP.USD</strong></small> and compared that to their own French Francs (<small><strong>USD.FRF</strong></small>) or Deutsche Marks (<small><strong>USD.DEM</strong></small>) and decided they'd be the big boys on the block by insisting the Euro goes first in the ticker symbol, resulting in <small><strong>EUR.USD</strong></small>.\r\n\r\nHistory is littered with accidents rather than plans. Correct me with a better story in the comments if you have one. I am less interested in the official narrative than what the real intention was, if indeed there was one.\r\n\r\nSo that's where we are today - organically grown currency ratios for the most part with the Euro thrown in by fiat.\r\n\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.",
"image": null,
"html": "<hr>\n<p><a id=\"base-vs-quote\"></a></p><a id=\"base-vs-quote\">\n<h5><strong>Base vs Quote</strong></h5>\n<p>Forex contracts are expressed as a pair of foreign currencies such as <small><strong>AUD.JPY</strong></small> where the first currency is the Base currency and the second is the Quote currency. The base describes the commodity itself, just like oil, gold or Intel stock (INTC). The forex contract is priced in units of the quote currency.</p>\n<p>For example, an ask price of 84.75 for <small><strong>AUD.JPY</strong></small> tells you that one Australian Dollar will cost you 84.75 Japanese Yen to buy.</p>\n<p>If your accounts are in Euros or USD then neither the base nor the quote of <small><strong>AUD.JPY</strong></small> is the same as your account currency. Your account currency would be Euros or USD in this case. A trading account will normally stipulate which currency your trading is based in and realized wins and losses from trading <small><strong>AUD.JPY</strong></small> will need to be converted to it.</p>\n<p><img alt=\"Typical Forex Contracts\" src=\"/media/uploads/2017/Forex_Setups/Typical_FX_contracts.jpg\" style=\"float: right;\" title=\"Typical Forex Contracts\" width=\"28%\"></p>\n<table>\n<thead>\n<tr>\n<th>BASE.QUOTE</th>\n<th>Quoted in:</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td><small><strong>AUD.JPY</strong></small></td>\n<td>Yen</td>\n</tr>\n<tr>\n<td><small><strong>AUD.USD</strong></small></td>\n<td>US$</td>\n</tr>\n<tr>\n<td><small><strong>USD.CAD</strong></small></td>\n<td>Canadian $</td>\n</tr>\n<tr>\n<td><small><strong>USD.JPY</strong></small></td>\n<td>Yen</td>\n</tr>\n<tr>\n<td><small><strong>EUR.USD</strong></small></td>\n<td>US$</td>\n</tr>\n<tr>\n<td><small><strong>EUR.CHF</strong></small></td>\n<td>Swiss Francs</td>\n</tr>\n<tr>\n<td><small><strong>USD.CHF</strong></small></td>\n<td>Swiss Francs</td>\n</tr>\n<tr>\n<td><small><strong>USD.MXN</strong></small></td>\n<td>Mexican Pesos</td>\n</tr>\n<tr>\n<td><small><strong>USD.CNH</strong></small></td>\n<td>Chinese Renminbi or Yuan</td>\n</tr>\n</tbody>\n</table>\n<p>Have you ever wondered why the AUD contract is expressed as <small><strong>AUD.USD</strong></small> but the Japanese and Canadian contracts are defined in terms of the non USA currency, <small><strong>USD.CAD</strong></small> and <small><strong>USD.JPY</strong></small>? Why is the Euro written as <small><strong>EUR.USD</strong></small> and not <small><strong>USD.EUR</strong></small>?</p>\n<p>The short answer is that you could write them any way you like providing there is a market and your broker supports those reverse contracts. However, most if not all quote vendors express the contracts in the same ratio we use here.</p>\n<p>The long answer is that, except for the recent Euro, the reasons are many and fuzzily recalled. I have my version of the story to tell based on my own experience working with foreign currencies since the 1970s.</p>\n<p>Back in the dark ages, when researchers would enter data into mainframe computers using stacked decks of cards, there were many more European currencies than today. There were French and Belgian Francs, German DMarks, Italian Lira and many more. Some currency crosses were quoted in one fashion on one side of an international border but quoted in the reverse direction on the other side.</p>\n<p>The preferred way to quote a currency for US traders or tourists should be just like the <small><strong>AUD.USD</strong></small>. When expressed this way, it gives the price of an Australian Dollar in the same way as the price of an apple: in the locally used US currency. On the other hand, it is less transparent for Australians who see a price quote that is slightly more confusing: how many US$ they get for one A$. That's like seeing how many apples you can buy for $1 instead of the price of one apple.</p>\n<p>But the real problem was that currencies are rarely related by the same order of magnitude. So there might have been five Francs to the USD, three DMarks or 200 Yen but much more rarely 1.1 or 0.9 units of foreign currency. My memory is that the issue was resolved partially by aesthetics alone: it was never convenient to enter error prone numbers onto punched cards when the forex quote looked like a fractional 0.00512 US Dollars for one Japanese Yen.</p>\n<p>I remember handling currencies using both the normal and the reverse ratio but I and those around me mostly favored the quote where a digit other than zero was on the left hand side of the decimal point. It just felt better, and it was easier to check on the old printouts where decimals were hard to read. No doubt, the older traders around us felt the same way, although it was never discussed, as far as I can recall.</p>\n<p>Up until the early 1980s, one Australian Dollar cost more than one US Dollar. Other than the name, the two currencies developed independently of each other. There is no requirement for the two to trade at parity or any level other than what's determined in the market. The Australian Dollar derived from the Australian Pound (two dollars for every one Pound in 1966) which in turn had earlier derived from the British Pound. The British Pound in turn cost about US$5 through the 19th century until the turmoil of the First World War. Today each Pound costs roughly US$1.33 and is quoted as <small><strong>GBP.USD</strong></small>.</p>\n<p>The Canadian Dollar traded around parity in the 1970s but closed out that decade around C$1.20 to US$1 so the quote was reversed to look like <small><strong>USD.CAD</strong></small>, with a quote something like 1.20. Had it been the other way around <small><strong>CAD.USD</strong></small> would have been 0.83, less aesthetically pleasing on the old printouts and terminals and slightly more error prone, although not as bad as the Yen or Italian Lira would have been.</p>\n<p>If you follow all the currencies back to the 1970s you will notice a pattern where the currency with the greater number of units in comparison is usually placed on the right hand side as the quote currency. So the Yen is expressed as <small><strong>USD.JPY</strong></small> where there are today over 110 Yen to one USD.</p>\n<p>I believe we inherit today whichever pattern was common up to the 1970s when computer databases froze the prevailing ratios. This is true even for currencies like the AUD which have more since fallen below one US$. Modern computers with clear screens easily displaying the decimal point or comma mean we don't need to worry about those old punched card concerns anymore, but we do continue to use the ratios that were convenient in earlier times.</p>\n</a><p><a id=\"base-vs-quote\"></a><a id=\"what-about-the-euro\"></a></p><a id=\"what-about-the-euro\">\n<h5><strong>What About the Euro?</strong></h5>\n<p>When the single currency was introduced the European Union insisted it had to be quoted <small><strong>EUR.USD</strong></small> and not the reverse. It could be that they hoped the USD would be worth less than the Euro, as a matter of pride perhaps, but I don't think so. For Europeans, the natural way of expressing the currency if you had a choice about it or, as in this case, if you were imposing the ratio by fiat, would be to set <small><strong>USD.EUR</strong></small> as the standard. That would mean European tourists and traders would approach a foreign exchange counter and purchase US$ priced in their local Euro currency, just as they would apples or anything else.</p>\n<p>In the same way as Europeans express a desire to price oil in Euros, they would price USD in Euros. It would make the most sense and be easier for them to discern value. But they didn't.</p>\n<p>I believe the decision was poorly thought through. I think some Europeans saw the <small><strong>GBP.USD</strong></small> and compared that to their own French Francs (<small><strong>USD.FRF</strong></small>) or Deutsche Marks (<small><strong>USD.DEM</strong></small>) and decided they'd be the big boys on the block by insisting the Euro goes first in the ticker symbol, resulting in <small><strong>EUR.USD</strong></small>.</p>\n<p>History is littered with accidents rather than plans. Correct me with a better story in the comments if you have one. I am less interested in the official narrative than what the real intention was, if indeed there was one.</p>\n<p>So that's where we are today - organically grown currency ratios for the most part with the Euro thrown in by fiat.</p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p></a>",
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"post": "Yeah I hadnt thought of that. The yen cross makes alot of sense. The euros just wanted to be first imo. Good background.",
"html": "<p><p>Yeah I hadnt thought of that. The yen cross makes alot of sense. The euros just wanted to be first imo. Good background.</p></p>",
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"id": 50,
"title": "Where Does the Day Begin in 24 Hour Forex and Futures Trading?",
"slug": "where-does-the-day-begin-in-24-hour-trading",
"status": 2,
"publication_date": "2017-11-09T03:02:22Z",
"lead": "How do you set a proper 24 hour timezone when trading forex and futures markets?",
"excerpt": "Teaches how to set a 24 hour world timezone when trading international forex and futures markets.",
"poster": "SeanManefield",
"content": "---\r\n\r\nWhen you look up and the sun is directly overhead in the middle of the day, it is night time for the other half of planet Earth. And don't imagine that's irrelevant. If you trade in the USA eastern standard time, EST, more than half the world's people, including India and China, are on the opposite side of the globe.\r\n\r\nThis means that traders across the world would be looking at different candlestick bars on their charts because their day starts and ends at a different time. If the high is set in the last few minutes of New York trading, European traders would instead include that price in their *next* day's chart. [Pin bars](/stories/46/2017/10/24/trading-systems-part-4-examples-of-signals/#Pin-Bar-Signals) would not necessarily look like pin bars to all observers. Better for your trading would be to use the timezone for charting purposes that most other traders use. Then you would be conveniently alerted to the same signals professionals see.\r\n\r\n#### <a id=\"No-existing-timezones-are-suitable-for-charting\"></a>**No existing timezones are suitable for charting**\r\n\r\nSo [which timezone](https://www.timeanddate.com/time/map/) makes the most sense to use? I am going to argue none of the standard timezones are optimal for trading 24 hour markets. Instead I will show you a new timezone, one that is widely used by many professional traders. I call it the FX24 timezone, named after FX for the forex markets. You can choose it here on this site as your preferred way to view the publish times of posts. Some trading software, such as most versions of MetaTrader, have FX24 built in. Our charts here, for weekly and shorter timeframes, all show times in FX24.\r\n\r\nLike exiting an airplane after traveling east or west, adjusting to a new timezone takes some effort. But humans do it all the time and we're quite good at it. But first, let's look at what happens if you continue to use your local time to trade international markets.\r\n\r\nThe first thing you notice, depending on where your trading is based, is that the week does not start or end properly. In the USA, you will see the *Sunday afternoon session*, while in Australia, NZ and east Asia they will face a Saturday morning half day. Almost conveniently for Europe, the FX24 timezone comes within a few hours of their standard day that they are tempted to ignore it. Unfortunately their day is not close enough and they will not see the same candlestick bars that other traders see. Europeans will also have a few hours of Sunday night trading.\r\n\r\n#### <a id=\"Which-timeframes-are-affected\"></a>**Which timeframes are affected?**\r\n\r\nThe weekly and monthly timeframes will not be affected since for the weekly, all trading from Sunday until the next Saturday will be included in each bar. The bars will be the same worldwide until weekend trading starts sometime in the future. For timeframes less than one hour, such as the 15 minute, the same bars will print wherever you are located.\r\n\r\nThe one hour bars will also be the same for most of the world except for timezones that start on the half hour, such as India's. Depending on exactly when your timezone starts its day, the four hour timeframe may or may not look the same to other traders.\r\n\r\n#### <a id=\"same-bars-that-other-traders-use\"></a>**How to see the same bars that other traders use?**\r\n\r\n\r\nThe two major financial centers in the world are in London and New York, five hours apart. That's too far for a happy compromise since it's late night in London when New York finally closes. But this hints at a solution.\r\n\r\nBecause we are referring to a 24 hour day and we do not want to talk ambiguously about am or pm, we need to be familiar with the 24 hour clock, or military time. This clock does not reuse the first twelve hours for the second half of the day, so 1pm becomes 13:00 hours and 5pm becomes 17:00 hours.\r\n\r\nLet's review some USA close times. Equities on the NYSE close at 4pm (16:00) EST. [Futures start to close](http://www.cmegroup.com/trading-hours.html) from 16.30 EST with most closing by 16:45 EST. Except for equities, futures markets start to reopen after 5pm (17:00). The same is true for the interbank forex market where trading slows or stops in the last 15 minutes before 17:00 EST, then restarts after 17:00.\r\n\r\nTo make sense of the timezones we would like to follow the day that begins after the NY and Chicago (-1hr) commodity markets restart their trading session. The NYSE trades within that period, so starting the world trading day at 5pm (17:00) EST is the solution that most trading professionals use.\r\n\r\nAs an example, when trading stops just before 17:00 EST on any Monday, that is the end of the full 24 hour *trading Monday* which started 24 hours earlier on Sunday. So the Sunday afternoon session is really just the beginning of Monday trading and the candlestick for Monday includes all trades from 17:00 EST Sunday until the end of the FX24 day in NY at 17:00 Monday. Now, instead of six trading days in the week, we have the standard five: Monday to Friday. They just don't quite coincide with the same five days you are used to. However that's exactly the same for all people living east or west of you. Humans deal with that level of complexity all the time so we are not going to let this stop us from seeing proper charts.\r\n\r\nThe rest of the details here about UTC and DST adjustments are mostly helpful for programmers who need to implement FX24. Skip ahead unless you have a particular interest in the inner workings of timezones.\r\n\r\nTo make the trading day start at 17:00 EST, we need a timezone exactly 7 hours ahead of NY, where locally the time would be 12 midnight. That would be true whether daylight saving time (DST) is applicable or not because the NY markets close by 17:00 at all times of the year. If DST is not in operation, that would be the timezone two hours ahead of Greenwich Mean Time (GMT, also known as UTC), or UTC+2, since London is five hours ahead of NY. FX24 falls in and out of DST at exactly the same time as New York.\r\n\r\nUnfortunately, DST complicates things immensely because UTC does not change when DST comes into effect. Also, the USA and Europe do not enter or leave DST on the same date. For this reason, we cannot define FX24 as being UTC+x, where x would be a fixed number of hours. We would need to define two timezones, one with and one without a DST adjustment. The DST transition times would simply borrow from ESDT.\r\n\r\n#### <a id=\"FX24\"></a>**FX24 - the 24 Hour Timezone for Traders**\r\n\r\nThe easiest solution is just to define FX24 as seven hours ahead of the time on the east coast of the USA so that 5pm in NY is 12 midnight in the FX24 timezone.\r\n\r\nThe first thing to note is that this timezone does not coincide with *any* other single timezone. Instead, it moves between Moscow, Athens to Nairobi and back again, depending on the phase of DST in each country. This is strangely a good thing as it prevents any one timezone from chauvinistically beating its breast. No one country owns FX24, and it's equally inconvenient for all.\r\n\r\nSecondly, it's within two to three hours of London time, close enough for one of the world's financial centers to try to ignore it. But ignoring FX24 results in six daily bars for the week, all of them different from traders located elsewhere.\r\n\r\nIf you want to see the same charts other traders are working from you need to adjust your trading timezone to the day starting seven hours ahead of the time in New York.\r\n\r\nIn some cases, the FX24 timezone is built into your trading software, such as the widely used MetaTrader (not all versions). In other cases the software may allow you to choose a timezone, but that only works if the FX24 timezone is available as a programmed in choice. Otherwise you will need to make adjustments to a suitable proxy timezone that lines up with FX24 at least two times a year, depending on DST in NY and DST locally in the proxy. That's a major pain. When all else fails, you can put pressure on the software providers to make them aware of the problem and fix their software.\r\n\r\nAs global markets become more and more intertwined there is no longer any excuse for trading software not to provide the FX24 timezone. It's just New York time plus seven hours.\r\n\r\nIf you prefer to see times of stories and posts displayed in FX24 here on PagooLABS, then simply go into the configuration menu and make your selection for FX24. The configuration menu is the little wheel icon on the top menu. You will need to be logged in of course, otherwise you will see UTC times. You can also choose any timezone you prefer if FX24 is too uncomfortable to use at this stage.\r\n\r\nSwap over to FX24 and start enjoying the same charts other traders use!\r\n\r\n</br>\r\n</br>\r\n</br>\r\n</br>\r\n</br>\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.",
"image": "/media/uploads/2017/Fx24_6LbJ13M.jpg",
"html": "<hr>\n<p>When you look up and the sun is directly overhead in the middle of the day, it is night time for the other half of planet Earth. And don't imagine that's irrelevant. If you trade in the USA eastern standard time, EST, more than half the world's people, including India and China, are on the opposite side of the globe.</p>\n<p>This means that traders across the world would be looking at different candlestick bars on their charts because their day starts and ends at a different time. If the high is set in the last few minutes of New York trading, European traders would instead include that price in their <em>next</em> day's chart. <a href=\"/stories/46/2017/10/24/trading-systems-part-4-examples-of-signals/#Pin-Bar-Signals\">Pin bars</a> would not necessarily look like pin bars to all observers. Better for your trading would be to use the timezone for charting purposes that most other traders use. Then you would be conveniently alerted to the same signals professionals see.</p>\n<h4><a id=\"No-existing-timezones-are-suitable-for-charting\"></a><strong>No existing timezones are suitable for charting</strong></h4>\n<p>So <a href=\"https://www.timeanddate.com/time/map/\">which timezone</a> makes the most sense to use? I am going to argue none of the standard timezones are optimal for trading 24 hour markets. Instead I will show you a new timezone, one that is widely used by many professional traders. I call it the FX24 timezone, named after FX for the forex markets. You can choose it here on this site as your preferred way to view the publish times of posts. Some trading software, such as most versions of MetaTrader, have FX24 built in. Our charts here, for weekly and shorter timeframes, all show times in FX24.</p>\n<p>Like exiting an airplane after traveling east or west, adjusting to a new timezone takes some effort. But humans do it all the time and we're quite good at it. But first, let's look at what happens if you continue to use your local time to trade international markets.</p>\n<p>The first thing you notice, depending on where your trading is based, is that the week does not start or end properly. In the USA, you will see the <em>Sunday afternoon session</em>, while in Australia, NZ and east Asia they will face a Saturday morning half day. Almost conveniently for Europe, the FX24 timezone comes within a few hours of their standard day that they are tempted to ignore it. Unfortunately their day is not close enough and they will not see the same candlestick bars that other traders see. Europeans will also have a few hours of Sunday night trading.</p>\n<h4><a id=\"Which-timeframes-are-affected\"></a><strong>Which timeframes are affected?</strong></h4>\n<p>The weekly and monthly timeframes will not be affected since for the weekly, all trading from Sunday until the next Saturday will be included in each bar. The bars will be the same worldwide until weekend trading starts sometime in the future. For timeframes less than one hour, such as the 15 minute, the same bars will print wherever you are located.</p>\n<p>The one hour bars will also be the same for most of the world except for timezones that start on the half hour, such as India's. Depending on exactly when your timezone starts its day, the four hour timeframe may or may not look the same to other traders.</p>\n<h4><a id=\"same-bars-that-other-traders-use\"></a><strong>How to see the same bars that other traders use?</strong></h4>\n<p>The two major financial centers in the world are in London and New York, five hours apart. That's too far for a happy compromise since it's late night in London when New York finally closes. But this hints at a solution.</p>\n<p>Because we are referring to a 24 hour day and we do not want to talk ambiguously about am or pm, we need to be familiar with the 24 hour clock, or military time. This clock does not reuse the first twelve hours for the second half of the day, so 1pm becomes 13:00 hours and 5pm becomes 17:00 hours.</p>\n<p>Let's review some USA close times. Equities on the NYSE close at 4pm (16:00) EST. <a href=\"http://www.cmegroup.com/trading-hours.html\">Futures start to close</a> from 16.30 EST with most closing by 16:45 EST. Except for equities, futures markets start to reopen after 5pm (17:00). The same is true for the interbank forex market where trading slows or stops in the last 15 minutes before 17:00 EST, then restarts after 17:00.</p>\n<p>To make sense of the timezones we would like to follow the day that begins after the NY and Chicago (-1hr) commodity markets restart their trading session. The NYSE trades within that period, so starting the world trading day at 5pm (17:00) EST is the solution that most trading professionals use.</p>\n<p>As an example, when trading stops just before 17:00 EST on any Monday, that is the end of the full 24 hour <em>trading Monday</em> which started 24 hours earlier on Sunday. So the Sunday afternoon session is really just the beginning of Monday trading and the candlestick for Monday includes all trades from 17:00 EST Sunday until the end of the FX24 day in NY at 17:00 Monday. Now, instead of six trading days in the week, we have the standard five: Monday to Friday. They just don't quite coincide with the same five days you are used to. However that's exactly the same for all people living east or west of you. Humans deal with that level of complexity all the time so we are not going to let this stop us from seeing proper charts.</p>\n<p>The rest of the details here about UTC and DST adjustments are mostly helpful for programmers who need to implement FX24. Skip ahead unless you have a particular interest in the inner workings of timezones.</p>\n<p>To make the trading day start at 17:00 EST, we need a timezone exactly 7 hours ahead of NY, where locally the time would be 12 midnight. That would be true whether daylight saving time (DST) is applicable or not because the NY markets close by 17:00 at all times of the year. If DST is not in operation, that would be the timezone two hours ahead of Greenwich Mean Time (GMT, also known as UTC), or UTC+2, since London is five hours ahead of NY. FX24 falls in and out of DST at exactly the same time as New York.</p>\n<p>Unfortunately, DST complicates things immensely because UTC does not change when DST comes into effect. Also, the USA and Europe do not enter or leave DST on the same date. For this reason, we cannot define FX24 as being UTC+x, where x would be a fixed number of hours. We would need to define two timezones, one with and one without a DST adjustment. The DST transition times would simply borrow from ESDT.</p>\n<h4><a id=\"FX24\"></a><strong>FX24 - the 24 Hour Timezone for Traders</strong></h4>\n<p>The easiest solution is just to define FX24 as seven hours ahead of the time on the east coast of the USA so that 5pm in NY is 12 midnight in the FX24 timezone.</p>\n<p>The first thing to note is that this timezone does not coincide with <em>any</em> other single timezone. Instead, it moves between Moscow, Athens to Nairobi and back again, depending on the phase of DST in each country. This is strangely a good thing as it prevents any one timezone from chauvinistically beating its breast. No one country owns FX24, and it's equally inconvenient for all.</p>\n<p>Secondly, it's within two to three hours of London time, close enough for one of the world's financial centers to try to ignore it. But ignoring FX24 results in six daily bars for the week, all of them different from traders located elsewhere.</p>\n<p>If you want to see the same charts other traders are working from you need to adjust your trading timezone to the day starting seven hours ahead of the time in New York.</p>\n<p>In some cases, the FX24 timezone is built into your trading software, such as the widely used MetaTrader (not all versions). In other cases the software may allow you to choose a timezone, but that only works if the FX24 timezone is available as a programmed in choice. Otherwise you will need to make adjustments to a suitable proxy timezone that lines up with FX24 at least two times a year, depending on DST in NY and DST locally in the proxy. That's a major pain. When all else fails, you can put pressure on the software providers to make them aware of the problem and fix their software.</p>\n<p>As global markets become more and more intertwined there is no longer any excuse for trading software not to provide the FX24 timezone. It's just New York time plus seven hours.</p>\n<p>If you prefer to see times of stories and posts displayed in FX24 here on PagooLABS, then simply go into the configuration menu and make your selection for FX24. The configuration menu is the little wheel icon on the top menu. You will need to be logged in of course, otherwise you will see UTC times. You can also choose any timezone you prefer if FX24 is too uncomfortable to use at this stage.</p>\n<p>Swap over to FX24 and start enjoying the same charts other traders use!</p>\n<p><br>\n<br>\n<br>\n<br>\n<br></p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"post": "I am almost convinced but is there a difference between timezone and timeframe?",
"html": "<p><p>I am almost convinced but is there a difference between timezone and timeframe?</p></p>",
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"submit_date": "2017-11-09T10:51:47Z",
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"post": "I could have made the difference between timezone and timeframe clearer in the story above. They are completely different animals that share a similar name.\r\n\r\n**Timezones** are the [north to south slices of planet Earth](https://www.timeanddate.com/time/map/) that share the same time offset from UTC. So the EST timezone in the USA is currently five hours behind UTC. All points within that timezone share the same wallclock time.\r\n\r\n**Timeframes** on the other hand refer to the time represented by candlestick bars on trading charts. When a bar collects all the trades over a 5 minute time interval we say the chart is displaying the 5min timeframe (M5). The start of that timeframe is the open, the end of the timeframe is the close, the highest price printed in the five minutes is the high and so on. Similarly for the four hour (H4) timeframe which summarizes the OHLC bars over the four hours.\r\n\r\nTimeframes are important in the story above only because some timeframes, such as M5, are immune to which timezone the trader is in while other timeframes, such as the daily, are very much affected by when the timezone starts its day.",
"html": "<p><p>I could have made the difference between timezone and timeframe clearer in the story above. They are completely different animals that share a similar name.</p><br /><p><strong>Timezones</strong> are the <a href=\"https://www.timeanddate.com/time/map/\">north to south slices of planet Earth</a> that share the same time offset from UTC. So the EST timezone in the USA is currently five hours behind UTC. All points within that timezone share the same wallclock time.</p><br /><p><strong>Timeframes</strong> on the other hand refer to the time represented by candlestick bars on trading charts. When a bar collects all the trades over a 5 minute time interval we say the chart is displaying the 5min timeframe (M5). The start of that timeframe is the open, the end of the timeframe is the close, the highest price printed in the five minutes is the high and so on. Similarly for the four hour (H4) timeframe which summarizes the OHLC bars over the four hours.</p><br /><p>Timeframes are important in the story above only because some timeframes, such as M5, are immune to which timezone the trader is in while other timeframes, such as the daily, are very much affected by when the timezone starts its day.</p></p>",
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"id": 48,
"title": "Getting the Right Target Price in a Forex or Futures System Using Simulations",
"slug": "trading-systems-part-6-simulations-on-systems",
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"publication_date": "2017-10-24T03:56:39Z",
"lead": "This sixth and final story in the series \"Introduction to Trading Systems\" tests systems to show how to develop an optimal risk/reward multiplier. This RR is used to calculate the target price in each setup.",
"excerpt": "This sixth story in the series on Trading Systems tests systems to show how to develop an optimal risk/reward multiplier. This RR is used to calculate the target price in each setup.",
"poster": "SeanManefield",
"content": "---\r\n#### **Trading Systems Part 6 - Basic Manual Simulations in Forex and Futures**\r\n\r\nWe are going to apply the techniques discussed in the previous story to show how to simulate a particular market. What we are looking for is an optimal risk/reward multiplier, RR. In the real world, however, we more often find complications.\r\n\r\nI will be writing other stories on this topic because this is a major focus of our web site: **Pagoo** or *Playing A Game Of Odds*.\r\n\r\nHowever to begin, let's take an example where an optimal multiplier may not exist because we all want to remain sceptics about this whole approach. What do we do when our method does *not* work out easily?\r\n\r\nThe **first step** is to find a chart you want to trade where a trend reversal has recently taken place. This means you can enter early enough to profit from the remaining trend. As noted earlier, you may have a notion of why that trend reversal is occurring. As a result you may have reason to believe the new trend is tradable. By 'tradable' I simply mean that the target price of the first signal is achievable.\r\n\r\nFor our purposes, let's take the S&P 500 where the market has been in a longer term uptrend from 2009 but suffered through a period of correction from 2014 through 2016. As you can see from the chart below, at **point A** a trend reversal takes place, made evident by the faster 100 period moving average, MA(100), crossing above the MA(200). You are free to choose whichever relevant MA periods you prefer, or just use price action cycles, or use a regression line or whatever makes you confident the trend has changed. Crossing MAs is just an example I use here. Mistakes are allowed and you will see the outcome of those when you do your testing.\r\n\r\n![Uptrend in SPX futures](/media/uploads/2017/basic_system_trading/SPX-D1-UpT-20171012.png \"Uptrend in SPX futures\"):C90!\r\n\r\nWe can readily see the S&P is in a solid uptrend but we did not know that at point A. In fact, all we knew was that the S&P had been uptrending for many years and had recently gone through a correction. For all we knew, the correction might have become deeper. Once the MAs crossed, we acted *as if* the uptrend had resumed. That's all we needed to know.\r\n\r\n\r\n#### Pin bar example\r\n\r\nFor our first example of a system, let's use the pin bar signal. It's a popular candlestick pattern and many traders already make use of it.\r\n\r\nThe **second step** is to mark every hanging man candlestick on the chart. A hanging man candlestick pattern has a small head and a long lower tail. A bullish pin bar is just a hanging man with a prominent size and location to distinguish it, but that will be clearer as we work along. Each hanging man has been marked with a green arrow. Now let's filter out the candlesticks that do not meet our basic criteria for a pin bar:\r\n\r\n- Ignore hanging men outside the range of the MA cross: marked as red **'OR'**\r\n- Ignore hanging men which have **n**o **r**etrace with at least two previous red bars: **'NR'**\r\n- Mark the spikes which seem too extreme: **'S'**\r\n\r\n![Pin bars on S&P500 futures](/media/uploads/2017/basic_system_trading/SPX-D1-UpT-PBs-20171012.png \"Pin bars on S&P500 futures\"):C90\r\n\r\nThat leaves five candidates that qualify as signals. The spike is disqualified partly because it is not preceded by several down bars and partly because the target price may be so far above today's market that achieving that TP seems improbable - and probability is the name of the game. Pin bar #3 barely qualifies, but it does have two prior down days but is not as prominent as we would like. Pin bar #5 does not strictly qualify but is 'rejecting' the area below the MA(100), which gives it a measure of confluence.\r\n\r\nAlso note that if we lose the second trade we will be out of the market until we reenter for the third trade. During that period there was a big rally in our direction. There's an earlier engulfing pattern in the first week of December 2016 that we could add, but then we need to examine *all* engulfing patterns as entry candidates otherwise we would be selecting patterns based on hindsight. I will just keep this simple for now, but this is the sense in which I mean a pin bar signal is not *complete*.\r\n\r\nThe **third step** is iterative: starting at an RR multiplier of one, consider each trade in turn in the order it would occur in a live trade scenario. We will mechanically simulate what would transpire given our setup and the calculated TP. We will hold that position, opening no others, until it is either stopped out for a loss or triggers our TP for a win.\r\n\r\nTo show the mechanics, I indicate the risk of each trade in the table below, where the risk comes from the OP of the following time period less the SL given by the bottom of the pin bar. I always move the SL a few points beyond the bottom of the pin bar so that my stops would survive a challenge at the same price as the pin bar low. I will count any final open position as a loss because I want to be as sceptical as possible in the simulation and I have no other way to handle it until it's closed or the trend ends.\r\n\r\nThe starting conditions for this table are:\r\n\r\n- A maximum risk of 2%, assumed to be $100,000 here\r\n- A Risk Reward ratio of 1:1, or **RR=1**, so that the TP is 1 x Contract Risk\r\n- We are trading the ES mini S&P500 contract with a contract size or CS=50\r\n- The columns are just the setup parameters except for the final two result columns.\r\n\r\n Trade# | OP | SL | Risk | CR | TP (1) | CO | Result | Win/Loss\r\n----------|-----------|-----------|--------|--------|-----------|------|----------|-----------\r\n 1 | 2078.60 | 2049.70 | 28.90 | 1445 | 2107.50 | 1 | Win | +1445\r\n 2 | 2133.30 | 2112.70 | 20.60 | 1030 | 2153.90 | 2 | Win | +2060\r\n 3 | 2281.80 | 2266.50 | 15.30 | 765 | 2297.10 | 2 | Win | +1530\r\n 4 | 2343.80 | 2320.80 | 23.00 | 1150 | 2366.80 | 1 | Win | +1150\r\n 5 | 2430.20 | 2416.20 | 14.00 | 700 | 2444.20 | 2 | Win | +1400\r\n\r\n Total wins 5/5 $7585\r\n\r\nWe went over the risk limit by 3% on trade #2. A small amount is acceptable but in general avoid extra risk of more than 5%. Also note that we were able to open all trades because each trade reached its limit before the next signal was reached. It's unusual to get five wins in a row but that is a consequence of the strong trend and the fact that we only required an RR of one. A low RR means the market was more likely to reach the TP.\r\n\r\nThe **fourth step** is to repeat the simulation, raising the value of RR by a small step. Let's run the simulation again, this time with an **RR=2**.\r\n\r\n Trade# | OP | SL | Risk | CR | TP (2) | CO | Result | Win/Loss\r\n----------|-----------|-----------|--------|--------|-----------|------|----------|-----------\r\n 1 | 2078.60 | 2049.70 | 28.90 | 1445 | 2136.40 | 1 | Loss | -1445\r\n 2 | 2133.30 | 2112.70 | 20.60 | 1030 | 2174.50 | 2 | Win | +4120\r\n 3 | 2281.80 | 2266.50 | 15.30 | 765 | 2312.40 | 2 | Win | +3360\r\n 4 | 2343.80 | 2320.80 | 23.00 | 1150 | 2389.80 | 1 | Win | +2300\r\n 5 | 2430.20 | 2416.20 | 14.00 | 700 | 2430.20 | 2 | Win | +2800\r\n\r\n Total wins 4/5 $11,135\r\n\r\nEven though we were stopped out of one trade, we received double on the remaining four so our wins exceeded the results of the first simulation. We can conclude for this market under these counditions that holding out for an RR of two times risk is more profitable.\r\n\r\nLet's run the simulation again, this time with an **RR=3**.\r\n\r\nTrade# | OP | SL | Risk | CR | TP (3) | CO | Result | Win/Loss\r\n--------|-----------|-----------|--------|--------|-----------|------|----------|-----------\r\n 1 | 2078.60 | 2049.70 | 28.90 | 1445 | 2165.30 | 1 | Loss | -1445\r\n 2 | 2133.30 | 2112.70 | 20.60 | 1030 | 2195.10 | 2 | Loss | -2060\r\n 3 | 2281.80 | 2266.50 | 15.30 | 765 | 2327.70 | 2 | Win | +4590\r\n 4 | 2343.80 | 2320.80 | 23.00 | 1150 | 2412.80 | 1 | Win | +3450\r\n 5 | 2430.20 | 2416.20 | 14.00 | 700 | 2472.20 | 2 | Win | +4200\r\n\r\n Total wins 3/5 $8,735\r\n\r\n**Step five** is to compare our results. When we raise our TP to three times our risk, the total profit falls compared to the case with two times risk.\r\n\r\nBecause our wins fell compared to the previous round, we would normally turn to target that area 1 < RR < 3 and iterate in smaller steps to focus in on an optimal value of RR. This final **Step six** would result in an optimal RR.\r\n\r\nHowever, in this case, it's worth looking further since this market has been in a long term uptrend. In fact, the S&P 500 climbed over 25% in this same period and it seems that a win of only $11K out of $100K in funds is too low, even if we only risked 2%. Others who are 100% invested in the S&P stocks have made about 25%, but only if they close now. In contrast, we are fully cashed up. Still, 25% is better than 11% so let's see what is going on here.\r\n\r\nFirst, note that in the previous simulation with TP set to two times risk, we won four times receiving twice our risk for each. So in total we made roughly eight times our maximum risk (4 wins x 2 x $2K), except for slippage cause by rounding down. So let's try to see if taking a trade with an **RR=8** will win:\r\n\r\nTrade# | OP | SL | Risk | CR | TP (8) | CO | Result | Win/Loss\r\n--------|-----------|-----------|--------|--------|-----------|------|----------|-----------\r\n 1 | 2078.60 | 2049.70 | 28.90 | 1445 | 2309.80 | 1 | Loss | -1445\r\n 2 | 2133.30 | 2112.70 | 20.60 | 1030 | 2298.10 | 2 | Loss | -2060\r\n 3 | 2281.80 | 2266.50 | 15.30 | 765 | 2404.20 | 2 | Win | +12,240\r\n 4 | 2343.80 | 2320.80 | 23.00 | 1150 | 2527.80 | 1 | skipped | 0%\r\n 5 | 2430.20 | 2416.20 | 14.00 | 700 | 2542.20 | 2 | Win | +11,200\r\n\r\n Total wins 2/5 $19,935\r\n\r\nTrade #4 was skipped because we still had trade #3 open and one of our rules is not to go over 2% risk. Not only did one trade win at RR=8 but we managed to win two trades.\r\n\r\nAlmost $20,000 is a substantial profit for a $100,000 portfolio that never risked more than 2% per trade, although by trade #3 we were down potentially 6%. The system I have used above is one of the simplest. It uses a crossing MA to detect trend reversal and just one type of candlestick, the pin bar, as a trade signal. There's clearly huge potential for improvement.\r\n\r\nThe gains took place over 16 months and the trend is not yet finished. As it finishes you can expect to surrender some of that profit as what appear to be retracements turn out to become trend reversals that trigger stops.\r\n\r\nAt some point it will become clearer that the uptrend is over and either a period of consolidation or a downtrend ensues. At that stage you can stop opening positions on signals. Until then the system does need to book profits to pay for the coming losses, or you could stop now until the next uptrend starts. Whatever you do, you must be consistent so that you can evaluate your performance and make necessary adjustments for the next trend you trade.\r\n\r\nIf we look at the chart, something we can only do in hindsight, we can see a number of pin bars have not yet had their lows retested and the chart is currently trading at all time highs. That means that *any* RR multiple would work, as long as we closed our position now to lock in those profits. But how do we approach this problem before the trading takes place?\r\n\r\nIf we knew the path of prices from the outset with clairvoyence, but determined to only enter trades based on pin bar signals, pin bar #3 would be best because it has furthest to run without being stopped. Yet it is also possibly the weakest shaped pin bar on the chart: small, does not protude from surrounding bars, is in a tiny retrace, is far above the moving averages, and so on. A reasonable pin bar trader would reject it. A position opened on pin bar #3 and held until the last day of trading would yield almost 18x risk, or $27,390 here because of rounded down contract sizes ($765 x 2 contracts x 18). So the optimum RR for this leg of the bull market in the S&P would lie somewhere between RR=8 and RR=18.\r\n\r\nBut you cannot know about this single pin bar in advance. When you see RR numbers going over five, stop and examine the situation further. Your entire simulation cannot depend on one outlier.\r\n\r\nThis chart is typical of the S&P 500. It represents stocks that have risen consistently for a century. The growing companies that comprise the S&P together with general price inflation, cause the index to be in a solid uptrend. There is no guarantee this will last but with all time highs being posted daily, it's unlikely to end anytime soon.\r\n\r\nThe current rapid rise we are witnessing is at the high end of its previous performance, comparable to the post Soviet Union bull market of the 1990s. This suggests that expecting an eightfold increase or more for a pin bar could be unrealistic for other periods. You need to go back further and run the same simulation in earlier time periods. This is the time to break out your programming talents, for those that have them. Even a spreadsheet would make short work of this data and the worksheets or programs could be reused on other markets and time periods.\r\n\r\nIf you don't have the time or inclination to program a simulation, print out the charts and user a ruler to find where stops are triggered. Do rough calculations for the trade risk and TP levels and avoid laboring over decimal places unless necessary for the market in question. The advantage is you will have a permanent record for your files.\r\n\r\n#### Summary\r\n\r\nTo begin our exploration of systems, I have picked an easy chart, although it is absolutely current and has some tricky quirks. Most charts will not be so easy because very few markets at the present time trend so strongly without pause. When inflation picks up, commodity prices should resume their uptrend.\r\n\r\nWhen we turn to other markets that don't trend so strongly, we will see that there is often an optimum RR somewhere in the range one to five. It's up to you to find that optimum so that you can calculate the TP for the setup tool.\r\n\r\nIn the first series on \"The Basic Setup\" I showed you how to bring together all the key components of a trade setup except the target price, TP. We have now come full circle, calculating an optimal risk/reward multiplier, RR, and therefore a TP that completes all the elements you need in the basic setup. Now with the basic setup in place you should be able to apply it to your preferred signal method and estimate an RR as input into a system of trades.\r\n\r\nPerhaps what you discover by measuring the results of your system under different RR values will lead you to calibrate the approach you have been using up until now, or even to change to a different signal method. That's all part of learning and trading.\r\n\r\nNone of these methods or ratios are permanent fundamental constants of the universe in the way that mathematical pi is. In fact you can expect RR and some of the signal filters to change over time and between markets.\r\n\r\nHowever if you apply your time and energy to investigating the trend and measuring the performance of your system rather than constantly second guessing every trade and whether you should take profits or move to break even, I believe you will be far better psychologically equipped to make profits in futures and forex. Micro managing trades will cause you to make so many mistakes you will lose confidence in your ability to trade anything. Aside from excess leverage, there is probably no greater impediment to trading than poor psychology and implementing a system will help you see that.\r\n\r\nIn our future stories I will apply the methods detailed above to calculating the optimal RR for other markets. I will continue to pick tricky examples, such as ambiguous trends or markets consolidating, because that's where I believe there is the most to learn.\r\n\r\n<br>\r\n<br>\r\n<br>\r\n#### Disclaimers\r\n\r\nAlthough the PagooLABS site is educational and does not advocate any position in a futures or forex contract, it is important to present the following disclaimers as additional information. Trading these markets can be risky and you must be aware of the following:\r\n\r\n**U.S. Government Required Disclaimer**\r\nCommodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results.\r\n\r\n** CFTC RULE 4.41 **\r\n\"These results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown.\"\r\n\r\n<br>\r\n<br>\r\n<br>\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n*[pi]: ratio of a circle's circumference to its diameter\r\n*[HA]: Heikin Ashi\r\n*[MA]: Moving Average over a specified period - 100 periods for eg\r\n*[EMA]: Exponential Moving Average - has a long 'memory'\r\n*[OHLC]: Open, High, Low, Close: the 4 key values for any bar on a chart\r\n*[bull]: An uptrending or rising market\r\n*[bear]: A downtrending or falling market\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[MR]: Maximum Risk\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[EURJPY]: The Euro - Yen cross currency: buying Euros priced in Yen\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[setup]: An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\r\n*[instrument]: A particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: Particular traded forex or futures contracts such as gold or USDJPY\r\n*[underlined text]: Congratulations! You have successfully hovered over text\r\n*[indicator]: A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\r\n*[indicators]: Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\r\n*[H4]: Chart of the four hour timeframe\r\n*[M5]: Chart of the five minute timeframe\r\n*[H1]: Chart of the one hour timeframe",
"image": null,
"html": "<hr>\n<h4><strong>Trading Systems Part 6 - Basic Manual Simulations in Forex and Futures</strong></h4>\n<p>We are going to apply the techniques discussed in the previous story to show how to simulate a particular market. What we are looking for is an optimal risk/reward multiplier, RR. In the real world, however, we more often find complications.</p>\n<p>I will be writing other stories on this topic because this is a major focus of our web site: <strong>Pagoo</strong> or <em>Playing A Game Of Odds</em>.</p>\n<p>However to begin, let's take an example where an optimal multiplier may not exist because we all want to remain sceptics about this whole approach. What do we do when our method does <em>not</em> work out easily?</p>\n<p>The <strong>first step</strong> is to find a chart you want to trade where a trend reversal has recently taken place. This means you can enter early enough to profit from the remaining trend. As noted earlier, you may have a notion of why that trend reversal is occurring. As a result you may have reason to believe the new trend is tradable. By 'tradable' I simply mean that the target price of the first <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> is achievable.</p>\n<p>For our purposes, let's take the S&P 500 where the market has been in a longer term uptrend from 2009 but suffered through a period of correction from 2014 through 2016. As you can see from the chart below, at <strong>point A</strong> a trend reversal takes place, made evident by the faster 100 period moving average, <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>(100), crossing above the <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>(200). You are free to choose whichever relevant <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> periods you prefer, or just use price action cycles, or use a regression line or whatever makes you confident the trend has changed. Crossing MAs is just an example I use here. Mistakes are allowed and you will see the outcome of those when you do your testing.</p>\n<p><img alt=\"Uptrend in SPX futures\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-UpT-20171012.png\" title=\"Uptrend in SPX futures\" width=\"90%\"></p><div class=\"clear-floating-cols-above\"></div><p></p>\n<p>We can readily see the S&P is in a solid uptrend but we did not know that at point A. In fact, all we knew was that the S&P had been uptrending for many years and had recently gone through a correction. For all we knew, the correction might have become deeper. Once the MAs crossed, we acted <em>as if</em> the uptrend had resumed. That's all we needed to know.</p>\n<h4>Pin bar example</h4>\n<p>For our first example of a system, let's use the pin bar <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>. It's a popular candlestick pattern and many traders already make use of it.</p>\n<p>The <strong>second step</strong> is to mark every hanging man candlestick on the chart. A hanging man candlestick pattern has a small head and a long lower tail. A bullish pin bar is just a hanging man with a prominent size and location to distinguish it, but that will be clearer as we work along. Each hanging man has been marked with a green arrow. Now let's filter out the candlesticks that do not meet our basic criteria for a pin bar:</p>\n<ul>\n<li>Ignore hanging men outside the range of the <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> cross: marked as red <strong>'OR'</strong></li>\n<li>Ignore hanging men which have <strong>n</strong>o <strong>r</strong>etrace with at least two previous red bars: <strong>'NR'</strong></li>\n<li>Mark the spikes which seem too extreme: <strong>'S'</strong></li>\n</ul>\n<p><img alt=\"Pin bars on S&P500 futures\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-UpT-PBs-20171012.png\" title=\"Pin bars on S&P500 futures\" width=\"90%\"></p>\n<p>That leaves five candidates that qualify as signals. The spike is disqualified partly because it is not preceded by several down bars and partly because the target price may be so far above today's market that achieving that <abbr title=\"target price\">TP</abbr> seems improbable - and probability is the name of the game. Pin bar #3 barely qualifies, but it does have two prior down days but is not as prominent as we would like. Pin bar #5 does not strictly qualify but is 'rejecting' the area below the <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>(100), which gives it a measure of confluence.</p>\n<p>Also note that if we lose the second trade we will be out of the market until we reenter for the third trade. During that period there was a big rally in our direction. There's an earlier engulfing pattern in the first week of December 2016 that we could add, but then we need to examine <em>all</em> engulfing patterns as entry candidates otherwise we would be selecting patterns based on hindsight. I will just keep this simple for now, but this is the sense in which I mean a pin bar <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> is not <em>complete</em>.</p>\n<p>The <strong>third step</strong> is iterative: starting at an RR multiplier of one, consider each trade in turn in the order it would occur in a live trade scenario. We will mechanically simulate what would transpire given our <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> and the calculated <abbr title=\"target price\">TP</abbr>. We will hold that position, opening no others, until it is either stopped out for a loss or triggers our <abbr title=\"target price\">TP</abbr> for a win.</p>\n<p>To show the mechanics, I indicate the risk of each trade in the table below, where the risk comes from the <abbr title=\"open price\">OP</abbr> of the following time period less the <abbr title=\"stop loss\">SL</abbr> given by the bottom of the pin bar. I always move the <abbr title=\"stop loss\">SL</abbr> a few points beyond the bottom of the pin bar so that my stops would survive a challenge at the same price as the pin bar low. I will count any final open position as a loss because I want to be as sceptical as possible in the simulation and I have no other way to handle it until it's closed or the trend ends.</p>\n<p>The starting conditions for this table are:</p>\n<ul>\n<li>A maximum risk of 2%, assumed to be $100,000 here</li>\n<li>A Risk Reward ratio of 1:1, or <strong>RR=1</strong>, so that the <abbr title=\"target price\">TP</abbr> is 1 x Contract Risk</li>\n<li>We are trading the ES mini S&P500 contract with a contract size or <abbr title=\"contract size\">CS</abbr>=50</li>\n<li>The columns are just the <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> parameters except for the final two result columns.</li>\n</ul>\n<table>\n<thead>\n<tr>\n<th>Trade#</th>\n<th><abbr title=\"open price\">OP</abbr></th>\n<th><abbr title=\"stop loss\">SL</abbr></th>\n<th>Risk</th>\n<th><abbr title=\"Contract Risk\">CR</abbr></th>\n<th><abbr title=\"target price\">TP</abbr> (1)</th>\n<th><abbr title=\"number of contracts opened\">CO</abbr></th>\n<th>Result</th>\n<th>Win/Loss</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td>1</td>\n<td>2078.60</td>\n<td>2049.70</td>\n<td>28.90</td>\n<td>1445</td>\n<td>2107.50</td>\n<td>1</td>\n<td>Win</td>\n<td>+1445</td>\n</tr>\n<tr>\n<td>2</td>\n<td>2133.30</td>\n<td>2112.70</td>\n<td>20.60</td>\n<td>1030</td>\n<td>2153.90</td>\n<td>2</td>\n<td>Win</td>\n<td>+2060</td>\n</tr>\n<tr>\n<td>3</td>\n<td>2281.80</td>\n<td>2266.50</td>\n<td>15.30</td>\n<td>765</td>\n<td>2297.10</td>\n<td>2</td>\n<td>Win</td>\n<td>+1530</td>\n</tr>\n<tr>\n<td>4</td>\n<td>2343.80</td>\n<td>2320.80</td>\n<td>23.00</td>\n<td>1150</td>\n<td>2366.80</td>\n<td>1</td>\n<td>Win</td>\n<td>+1150</td>\n</tr>\n<tr>\n<td>5</td>\n<td>2430.20</td>\n<td>2416.20</td>\n<td>14.00</td>\n<td>700</td>\n<td>2444.20</td>\n<td>2</td>\n<td>Win</td>\n<td>+1400</td>\n</tr>\n</tbody>\n</table>\n<div class=\"codehilite\"><pre><span></span>Total wins 5/5 $7585\n</pre></div>\n\n\n<p>We went over the risk limit by 3% on trade #2. A small amount is acceptable but in general avoid extra risk of more than 5%. Also note that we were able to open all trades because each trade reached its limit before the next <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> was reached. It's unusual to get five wins in a row but that is a consequence of the strong trend and the fact that we only required an RR of one. A low RR means the market was more likely to reach the <abbr title=\"target price\">TP</abbr>.</p>\n<p>The <strong>fourth step</strong> is to repeat the simulation, raising the value of RR by a small step. Let's run the simulation again, this time with an <strong>RR=2</strong>.</p>\n<table>\n<thead>\n<tr>\n<th>Trade#</th>\n<th><abbr title=\"open price\">OP</abbr></th>\n<th><abbr title=\"stop loss\">SL</abbr></th>\n<th>Risk</th>\n<th><abbr title=\"Contract Risk\">CR</abbr></th>\n<th><abbr title=\"target price\">TP</abbr> (2)</th>\n<th><abbr title=\"number of contracts opened\">CO</abbr></th>\n<th>Result</th>\n<th>Win/Loss</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td>1</td>\n<td>2078.60</td>\n<td>2049.70</td>\n<td>28.90</td>\n<td>1445</td>\n<td>2136.40</td>\n<td>1</td>\n<td>Loss</td>\n<td>-1445</td>\n</tr>\n<tr>\n<td>2</td>\n<td>2133.30</td>\n<td>2112.70</td>\n<td>20.60</td>\n<td>1030</td>\n<td>2174.50</td>\n<td>2</td>\n<td>Win</td>\n<td>+4120</td>\n</tr>\n<tr>\n<td>3</td>\n<td>2281.80</td>\n<td>2266.50</td>\n<td>15.30</td>\n<td>765</td>\n<td>2312.40</td>\n<td>2</td>\n<td>Win</td>\n<td>+3360</td>\n</tr>\n<tr>\n<td>4</td>\n<td>2343.80</td>\n<td>2320.80</td>\n<td>23.00</td>\n<td>1150</td>\n<td>2389.80</td>\n<td>1</td>\n<td>Win</td>\n<td>+2300</td>\n</tr>\n<tr>\n<td>5</td>\n<td>2430.20</td>\n<td>2416.20</td>\n<td>14.00</td>\n<td>700</td>\n<td>2430.20</td>\n<td>2</td>\n<td>Win</td>\n<td>+2800</td>\n</tr>\n</tbody>\n</table>\n<div class=\"codehilite\"><pre><span></span>Total wins 4/5 $11,135\n</pre></div>\n\n\n<p>Even though we were stopped out of one trade, we received double on the remaining four so our wins exceeded the results of the first simulation. We can conclude for this market under these counditions that holding out for an RR of two times risk is more profitable.</p>\n<p>Let's run the simulation again, this time with an <strong>RR=3</strong>.</p>\n<table>\n<thead>\n<tr>\n<th>Trade#</th>\n<th><abbr title=\"open price\">OP</abbr></th>\n<th><abbr title=\"stop loss\">SL</abbr></th>\n<th>Risk</th>\n<th><abbr title=\"Contract Risk\">CR</abbr></th>\n<th><abbr title=\"target price\">TP</abbr> (3)</th>\n<th><abbr title=\"number of contracts opened\">CO</abbr></th>\n<th>Result</th>\n<th>Win/Loss</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td>1</td>\n<td>2078.60</td>\n<td>2049.70</td>\n<td>28.90</td>\n<td>1445</td>\n<td>2165.30</td>\n<td>1</td>\n<td>Loss</td>\n<td>-1445</td>\n</tr>\n<tr>\n<td>2</td>\n<td>2133.30</td>\n<td>2112.70</td>\n<td>20.60</td>\n<td>1030</td>\n<td>2195.10</td>\n<td>2</td>\n<td>Loss</td>\n<td>-2060</td>\n</tr>\n<tr>\n<td>3</td>\n<td>2281.80</td>\n<td>2266.50</td>\n<td>15.30</td>\n<td>765</td>\n<td>2327.70</td>\n<td>2</td>\n<td>Win</td>\n<td>+4590</td>\n</tr>\n<tr>\n<td>4</td>\n<td>2343.80</td>\n<td>2320.80</td>\n<td>23.00</td>\n<td>1150</td>\n<td>2412.80</td>\n<td>1</td>\n<td>Win</td>\n<td>+3450</td>\n</tr>\n<tr>\n<td>5</td>\n<td>2430.20</td>\n<td>2416.20</td>\n<td>14.00</td>\n<td>700</td>\n<td>2472.20</td>\n<td>2</td>\n<td>Win</td>\n<td>+4200</td>\n</tr>\n</tbody>\n</table>\n<div class=\"codehilite\"><pre><span></span>Total wins 3/5 $8,735\n</pre></div>\n\n\n<p><strong>Step five</strong> is to compare our results. When we raise our <abbr title=\"target price\">TP</abbr> to three times our risk, the total profit falls compared to the case with two times risk.</p>\n<p>Because our wins fell compared to the previous round, we would normally turn to target that area 1 < RR < 3 and iterate in smaller steps to focus in on an optimal value of RR. This final <strong>Step six</strong> would result in an optimal RR.</p>\n<p>However, in this case, it's worth looking further since this market has been in a long term uptrend. In fact, the S&P 500 climbed over 25% in this same period and it seems that a win of only $11K out of $100K in funds is too low, even if we only risked 2%. Others who are 100% invested in the S&P stocks have made about 25%, but only if they close now. In contrast, we are fully cashed up. Still, 25% is better than 11% so let's see what is going on here.</p>\n<p>First, note that in the previous simulation with <abbr title=\"target price\">TP</abbr> set to two times risk, we won four times receiving twice our risk for each. So in total we made roughly eight times our maximum risk (4 wins x 2 x $2K), except for slippage cause by rounding down. So let's try to see if taking a trade with an <strong>RR=8</strong> will win:</p>\n<table>\n<thead>\n<tr>\n<th>Trade#</th>\n<th><abbr title=\"open price\">OP</abbr></th>\n<th><abbr title=\"stop loss\">SL</abbr></th>\n<th>Risk</th>\n<th><abbr title=\"Contract Risk\">CR</abbr></th>\n<th><abbr title=\"target price\">TP</abbr> (8)</th>\n<th><abbr title=\"number of contracts opened\">CO</abbr></th>\n<th>Result</th>\n<th>Win/Loss</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td>1</td>\n<td>2078.60</td>\n<td>2049.70</td>\n<td>28.90</td>\n<td>1445</td>\n<td>2309.80</td>\n<td>1</td>\n<td>Loss</td>\n<td>-1445</td>\n</tr>\n<tr>\n<td>2</td>\n<td>2133.30</td>\n<td>2112.70</td>\n<td>20.60</td>\n<td>1030</td>\n<td>2298.10</td>\n<td>2</td>\n<td>Loss</td>\n<td>-2060</td>\n</tr>\n<tr>\n<td>3</td>\n<td>2281.80</td>\n<td>2266.50</td>\n<td>15.30</td>\n<td>765</td>\n<td>2404.20</td>\n<td>2</td>\n<td>Win</td>\n<td>+12,240</td>\n</tr>\n<tr>\n<td>4</td>\n<td>2343.80</td>\n<td>2320.80</td>\n<td>23.00</td>\n<td>1150</td>\n<td>2527.80</td>\n<td>1</td>\n<td>skipped</td>\n<td>0%</td>\n</tr>\n<tr>\n<td>5</td>\n<td>2430.20</td>\n<td>2416.20</td>\n<td>14.00</td>\n<td>700</td>\n<td>2542.20</td>\n<td>2</td>\n<td>Win</td>\n<td>+11,200</td>\n</tr>\n</tbody>\n</table>\n<div class=\"codehilite\"><pre><span></span>Total wins 2/5 $19,935\n</pre></div>\n\n\n<p>Trade #4 was skipped because we still had trade #3 open and one of our rules is not to go over 2% risk. Not only did one trade win at RR=8 but we managed to win two trades.</p>\n<p>Almost $20,000 is a substantial profit for a $100,000 portfolio that never risked more than 2% per trade, although by trade #3 we were down potentially 6%. The system I have used above is one of the simplest. It uses a crossing <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> to detect trend reversal and just one type of candlestick, the pin bar, as a trade <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>. There's clearly huge potential for improvement.</p>\n<p>The gains took place over 16 months and the trend is not yet finished. As it finishes you can expect to surrender some of that profit as what appear to be retracements turn out to become trend reversals that trigger stops.</p>\n<p>At some point it will become clearer that the uptrend is over and either a period of consolidation or a downtrend ensues. At that stage you can stop opening positions on signals. Until then the system does need to book profits to pay for the coming losses, or you could stop now until the next uptrend starts. Whatever you do, you must be consistent so that you can evaluate your performance and make necessary adjustments for the next trend you trade.</p>\n<p>If we look at the chart, something we can only do in hindsight, we can see a number of pin bars have not yet had their lows retested and the chart is currently trading at all time highs. That means that <em>any</em> RR multiple would work, as long as we closed our position now to lock in those profits. But how do we approach this problem before the trading takes place?</p>\n<p>If we knew the path of prices from the outset with clairvoyence, but determined to only enter trades based on pin bar signals, pin bar #3 would be best because it has furthest to run without being stopped. Yet it is also possibly the weakest shaped pin bar on the chart: small, does not protude from surrounding bars, is in a tiny retrace, is far above the moving averages, and so on. A reasonable pin bar trader would reject it. A position opened on pin bar #3 and held until the last day of trading would yield almost 18x risk, or $27,390 here because of rounded down contract sizes ($765 x 2 contracts x 18). So the optimum RR for this leg of the <abbr title=\"An uptrending or rising market\">bull</abbr> market in the S&P would lie somewhere between RR=8 and RR=18.</p>\n<p>But you cannot know about this single pin bar in advance. When you see RR numbers going over five, stop and examine the situation further. Your entire simulation cannot depend on one outlier.</p>\n<p>This chart is typical of the S&P 500. It represents stocks that have risen consistently for a century. The growing companies that comprise the S&P together with general price inflation, cause the index to be in a solid uptrend. There is no guarantee this will last but with all time highs being posted daily, it's unlikely to end anytime soon.</p>\n<p>The current rapid rise we are witnessing is at the high end of its previous performance, comparable to the post Soviet Union <abbr title=\"An uptrending or rising market\">bull</abbr> market of the 1990s. This suggests that expecting an eightfold increase or more for a pin bar could be unrealistic for other periods. You need to go back further and run the same simulation in earlier time periods. This is the time to break out your programming talents, for those that have them. Even a spreadsheet would make short work of this data and the worksheets or programs could be reused on other markets and time periods.</p>\n<p>If you don't have the time or inclination to program a simulation, print out the charts and user a ruler to find where stops are triggered. Do rough calculations for the trade risk and <abbr title=\"target price\">TP</abbr> levels and avoid laboring over decimal places unless necessary for the market in question. The advantage is you will have a permanent record for your files.</p>\n<h4>Summary</h4>\n<p>To begin our exploration of systems, I have picked an easy chart, although it is absolutely current and has some tricky quirks. Most charts will not be so easy because very few markets at the present time trend so strongly without pause. When inflation picks up, commodity prices should resume their uptrend.</p>\n<p>When we turn to other markets that don't trend so strongly, we will see that there is often an optimum RR somewhere in the range one to five. It's up to you to find that optimum so that you can calculate the <abbr title=\"target price\">TP</abbr> for the <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> tool.</p>\n<p>In the first series on \"The Basic Setup\" I showed you how to bring together all the key components of a trade <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> except the target price, <abbr title=\"target price\">TP</abbr>. We have now come full circle, calculating an optimal risk/reward multiplier, RR, and therefore a <abbr title=\"target price\">TP</abbr> that completes all the elements you need in the basic <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr>. Now with the basic <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> in place you should be able to apply it to your preferred <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> method and estimate an RR as input into a system of trades.</p>\n<p>Perhaps what you discover by measuring the results of your system under different RR values will lead you to calibrate the approach you have been using up until now, or even to change to a different <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> method. That's all part of learning and trading.</p>\n<p>None of these methods or ratios are permanent fundamental constants of the universe in the way that mathematical <abbr title=\"ratio of a circle's circumference to its diameter\">pi</abbr> is. In fact you can expect RR and some of the <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> filters to change over time and between markets.</p>\n<p>However if you apply your time and energy to investigating the trend and measuring the performance of your system rather than constantly second guessing every trade and whether you should take profits or move to break even, I believe you will be far better psychologically equipped to make profits in futures and <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr>. Micro managing trades will cause you to make so many mistakes you will lose confidence in your ability to trade anything. Aside from excess leverage, there is probably no greater impediment to trading than poor psychology and implementing a system will help you see that.</p>\n<p>In our future stories I will apply the methods detailed above to calculating the optimal RR for other markets. I will continue to pick tricky examples, such as ambiguous trends or markets consolidating, because that's where I believe there is the most to learn.</p>\n<p><br>\n<br>\n<br></p>\n<h4>Disclaimers</h4>\n<p>Although the PagooLABS site is educational and does not advocate any position in a futures or <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> contract, it is important to present the following disclaimers as additional information. Trading these markets can be risky and you must be aware of the following:</p>\n<p><strong>U.S. Government Required Disclaimer</strong>\nCommodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results.</p>\n<p><strong> CFTC RULE 4.41 </strong>\n\"These results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown.\"</p>\n<p><br>\n<br>\n<br></p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"post": "Also. I think we need to take more factors into account when we go all in on the trend. Using just the ma cross will land you in heaps of trouble when the mkt starts to see saw.",
"html": "<p><p>Also. I think we need to take more factors into account when we go all in on the trend. Using just the ma cross will land you in heaps of trouble when the mkt starts to see saw.</p></p>",
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"post": "Hello Jono,\r\n\r\nTrue. See my other answer here.\r\n\r\nI constantly repeat in the story's text that the particular *method* employed here to determine trend and signals is not of great interest. More important is trading consistently with the system you have chosen.\r\n\r\nOne of the most important influences on the success of trading is the trader's psychology. The first step toward improving that is to have a system so traders have something objective to measure performance against. After that, it's another big step to improve the system and make it even more profitable.\r\n\r\nMost of the 95% of traders that fail in futures and forex do not follow a system with the required discipline. That seems to me to be the first problem to fix.",
"html": "<p><p>Hello Jono,</p><br /><p>True. See my other answer here.</p><br /><p>I constantly repeat in the story's text that the particular <em>method</em> employed here to determine trend and signals is not of great interest. More important is trading consistently with the system you have chosen.</p><br /><p>One of the most important influences on the success of trading is the trader's psychology. The first step toward improving that is to have a system so traders have something objective to measure performance against. After that, it's another big step to improve the system and make it even more profitable.</p><br /><p>Most of the 95% of traders that fail in futures and forex do not follow a system with the required discipline. That seems to me to be the first problem to fix.</p></p>",
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"post": "Ok I got through these 5 or 6 and yeah they explain how to them but dont we need a computer program? Gets boring when I have to repeat the same calcs on each chart.",
"html": "<p><p>Ok I got through these 5 or 6 and yeah they explain how to them but dont we need a computer program? Gets boring when I have to repeat the same calcs on each chart.</p></p>",
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"post": "I completely agree.\r\n\r\nBut we have to start with little steps first and then work our way up to full fledged machine learning. When we get to machine learning, we need a good feel for the characteristics we will put into the training step.\r\n\r\nThe idea here is that we can all see the big picture: the choice of trend and use of signals within the trend to place our trades. \r\n\r\nWith Metatrader and the APIs provided by brokers such as Interactive Brokers and TradeStation, it will be possible to extract much better information out of the data that will help us determine trend and signals.",
"html": "<p><p>I completely agree.</p><br /><p>But we have to start with little steps first and then work our way up to full fledged machine learning. When we get to machine learning, we need a good feel for the characteristics we will put into the training step.</p><br /><p>The idea here is that we can all see the big picture: the choice of trend and use of signals within the trend to place our trades. </p><br /><p>With Metatrader and the APIs provided by brokers such as Interactive Brokers and TradeStation, it will be possible to extract much better information out of the data that will help us determine trend and signals.</p></p>",
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"post": "The machine learning mentioned above interests me. Will you be explaining how to train a model to compute the trend?",
"html": "<p><p>The machine learning mentioned above interests me. Will you be explaining how to train a model to compute the trend?</p></p>",
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"post": "I am trying to work out a way to present this in a story that still makes sense given the depth of knowledge needed about programming and ML. Not everyone is ready for this but after exhausting all the simple ways of measuring trend and signals, perhaps there will be greater appetite. The plan is to work toward it gradually.",
"html": "<p><p>I am trying to work out a way to present this in a story that still makes sense given the depth of knowledge needed about programming and ML. Not everyone is ready for this but after exhausting all the simple ways of measuring trend and signals, perhaps there will be greater appetite. The plan is to work toward it gradually.</p></p>",
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"id": 47,
"title": "How to Build Your own Forex or Futures Trading System",
"slug": "trading-systems-part-5-systems",
"status": 2,
"publication_date": "2017-10-24T03:53:29Z",
"lead": "This fifth story in the series \"Introduction to Trading Systems\" brings together the setup, the trend, and signals, combining them into a simple trading system. The system we design here is only for teaching purposes and as we build it we explain how to substitute your own signals and trading style.",
"excerpt": "This fifth story in the series on Trading Systems combines the setup, the trend, and signals into a simple trading system.",
"poster": "SeanManefield",
"content": "---\r\n#### **Trading Systems Part 5 - The Basic Steps for Forex and Futures**\r\n\r\nA system is a strategy to open a sequence of positions in an instrument based on the same or similar signals. As soon as a new signal triggers, the next position is opened as long as the previous one has been closed.\r\n\r\nThe system designer will determine in advance whether to trade in a trending or sideways environment. Within that environment, all signals are to be executed whenever they occur with little or no discetion according to predefined rules.\r\n\r\nThe main purpose of your system is to be profitable with historic data. In general, but not always, your system must be as *complete* as possible. A complete system is one that has you trading 100% of the trend and spending as little time as possible on the sidelines watching the prices trend in your direction. Profitability always trumps completeness.\r\n\r\nIn Part 3 and 4 we briefly explored signals. A signal is a price pattern that triggers the opening of a position. The signal may be any of the examples I used in part 4 of this series or it may be your own favorite signal. You choose the signals based on all the assembled evidence supporting the signal's usefulness and profitability. To open the position you turn to the setup tools from our earlier series on \"The Basic Setup\".\r\n\r\n\r\n##### **What is not a system**\r\n\r\nIt is not a system just because you open a position in reaction to a signal. Every signal could fail. It starts to become a system when you are prepared for that possibility with a strategy to deal with it. Withdrawing to lick your wounds or changing to a different market where you \"might have more luck\" is not a system. If you have correctly identified the trend, you need to be ready to unemotionally open on the next signal, confident from your testing that the system wins over time.\r\n\r\n##### **A Martingale - A dangerous system**\r\n\r\nA martingale is a strategy where the risk is doubled after each loss in the hopes of paying off the previous loss(es) and reaching a profit.\r\n\r\nIt's a dangerous system that will almost certainly lose all the funds in your account. All it takes is five losses in a row starting at 2% of your capital before you have lost 62% and are unable to make the next double. If you risk all that remains on a 6th signal and lose, you are wiped out. As I pointed out in \"A Simple Setup\", five losses or more in a row are common enough that you should never risk more than 2%.\r\n\r\nThe next table summarizes your balance after each consecutive loss:\r\n\r\nRound | Risk | Cumulative Loss | Remaining funds\r\n-------|-------|-------------------|-----------------\r\n1 | 2% | 2% | 98%\r\n2 | 4% | 6% | 94%\r\n3 | 8% | 14% | 86%\r\n4 | 16% | 30% | 70%\r\n5 | 32% | 62% | 38%\r\n6 | 38% | 100% | 0%\r\n\r\nNotice how by the 4th loss you have risked 30% just to make 8% - assuming your normal risk/reward multiplier is 4 and your trade risk is 2%? That alone should keep you away from this train wreck. Even if you start with just 0.1% of your funds, a quick calculation will show that you will lose half your account after ten consecutive losses, with the next failed trade wiping you out.\r\n\r\nIt works wonderfully though if you have unlimited funds available to trading, which nobody has. Margin rules should prevent you carrying out this strategy before you are ruined, but you also will not be able to recover your original trade balance, as the doubling strategy had promised.\r\n\r\nIf you play a martingale regularly, you will sooner or later face ruin. It is *not a trading system*.\r\n\r\n\r\n#### Calculating the Target Price using Simulations\r\n\r\nWhen you place one trade on a particular instrument as we did in \"The Basic Setup\", you are free to choose a TP that seems achievable given the current price action. Perhaps you choose a nearby level or an overhead area of resistance. However when running a system without any discretion, the TP will be different for each trade and therefore the calculation of the TP must derive from elsewhere.\r\n\r\nThe easiest solution is to use a multiple of the risk of the trade, where the risk is OP-SL. For example, you could insist that all trades must achieve a double (or 2 x OP-SL) before being automatically closed out. This number is based on the **`risk/reward ratio`** (RRR) and clearly it matters. If the RRR is 1:2 then for every $1 risked, $2 is expected as the reward or win. In our simulations we are more interested in the **`risk reward multiplier`**, which is the inverse of RRR, and to refer to it I will be using the notation **RR**. In this case we might say the RR equals two (1:2 becomes 2/1, or 2).\r\n\r\nIf you set a value too high for the RR then many or all trades could fail as the SL gets triggered first rather than the faraway TP. If in turn it is set too low then the trade is more likely to win but the winnings may not be greater than losses from other failed trades. It is apparent that there is an optimal, Goldilocks level for the RR for each market and leg of the trend, not too high nor too low.\r\n\r\n![SPX Setup Example](/media/uploads/2017/basic_system_trading/Setup-EG-TP4x.png \"SPX Setup Example\"):R60\r\nFor example, as you can see in the adjacent chart, if we used an RR=4, we could calculate TP easily by adding four times the trade risk to the OP. The trade risk (TR) would be just the amount we would lose if the stops were triggered, or (OP-SL). Multiply that risk by four and add it to the open price and we would have the TP to use for the setup.\r\n\r\nFor each RR there is a total win or loss from the system when applied to a range of historic data on a particular market. This RR will be calculated by simulating the system using historic prices and trying different values for RR until an optimum is found. I will do an example in the next story.\r\n\r\nThe purpose of the simulation is to determine the optimal RR so we can calculate the TP in every setup. Of course, the RR is not some fundamental constant of the universe - we expect it to change over time and in different markets. However our simulations may show some RR levels are more stable than others. Or we may find minimum or maximum RR ratios for certain markets or trend situations. Either way, we will end up with an RR that we will automatically be applied to each setup in the sequence of trades that make up our system.\r\n\r\n#### Simulations\r\n\r\nThe rules for reacting to signals within a system are determined during design and testing. The testing will simulate the real world consequences of applying the signal to historic data.\r\n\r\nA simulation makes all the calculations you would in a real trade using real data *as if* you opened the position with your broker. Whether your simulated trade is stopped out for a loss or goes on to win at the TP depends on what happened in the real market with real historic data. You do not actually execute the trade with your broker, in fact your broker has nothing to do with your simulation. The simulation can be done with pen and paper or with a computer program if you have the skills. If you are so inclined, it's easiest to get started using a spreadsheet, however we will do it manually here.\r\n\r\nBut how to we get the RR for the market, timeframe and trend that we trade?\r\n\r\n![Simulation Flowchart](/media/uploads/2017/basic_system_trading/simulation-flowchart.png \"Simulation Flowchart\"):C80\r\n\r\nThe RR will be calculated by simulating the system using historic prices and trying different values for RR until an optimum is found. I will do an example further below.\r\n\r\nWe have a chicken and egg situation: we need to run a simulation of the system to calculate an RR value but the simulation requires an RR value to run. The solution is to run the simulation starting with a low *guesstimate* value and then rerun the simulation with progressively higher values and compare results. Each increment in the RR, or **step**, is a value we decide on. If an optimum is reached, we can use that value for RR and calculate TP for each setup.\r\n\r\nNormally you would start simulating with an RR of one, unless you have reason to believe your signal is so powerful that it wins most of the time. If that is the case, then you could start with RR=0.1. In order to win with such a low RR, you must win more than ten setups for every one you lose - not impossible but certainly cause for concern.\r\n\r\nNext, the RR value is raised by a certain amount called the step size. If you started with RR=1, the step size might be 0.5 or one because in the first run you want to locate the area that is most profitable by quickly testing across a wide range. Later on, you can always backtrack to zoom in with a smaller step size. It really helps if your testing is automated with a computer program otherwise it can become tediously repetitive.\r\n\r\nAs we run simulations over the historic data with progressively higher values of RR, we make a note of our profit or loss from the system. After we finish, we choose the RR that gave us the highest profit, if one exists.\r\n\r\nIn some cases we might discover that the system is a failure and no RR value yields a profit. We can discard those systems or send them back to the 'laboratory' for further testing. In other cases we might discover there is no optimum because the market is in a relentless trend. In such a case the best strategy would be to keep trying entries with no TP until we find one that does not get stopped out. This would be akin to buying the S&P in 1923 and not selling. Each attempt would cost us 2% of our capital but the first winner would beat all those losses.\r\n\r\nThe 1987 market crash, while huge at the time, is now just a distant wiggle in the charts and an excellent entry position. This is the famous equities buy and hold strategy, which was more popular in the 1990s than today. That's reasonable considering all recent positions from 1997 until 2009 have been stopped out by the dotcom crash and the 2008 credit crisis, unless they had an SL way below the market.\r\n\r\nWithin a system, any one signal might fail leaving you with a loss. But when you trade all valid signals during the course of the trend you are following a system. A successful system will win more than it loses, even if more trades resulted in a loss.\r\n\r\n#### Summary\r\n\r\nA system is a series of trades that our testing with historic data suggests will win over time. We need a method to establish an optimum risk/reward multiplier for the market we trade which we will calculate by simulating trades on the historic data and observing the outcome for different RR levels.\r\n\r\nIn the following stories in this series I will try to pick tricky examples to show what can go wrong in our testing. In some cases the market is in a strong trend, in other cases there is either a mild trend or you are tricked into thinking there is a trend when in fact there is none. The key here is experience. Each time you run a simulation on a new set of data you learn something new. We need to use these methods frequently so they become part of our trading tools.\r\n\r\nIn the next story in this series I will show you the mechanics of such a simulation.\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n\r\n*[HA]: Heikin Ashi\r\n*[MA]: Moving Average over a specified period - 100 periods for eg\r\n*[EMA]: Exponential Moving Average - has a long 'memory'\r\n*[OHLC]: Open, High, Low, Close: the 4 key values for any bar on a chart\r\n*[bull]: An uptrending or rising market\r\n*[bear]: A downtrending or falling market\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[MR]: Maximum Risk\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[EURJPY]: The Euro - Yen cross currency: buying Euros priced in Yen\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[setup]: An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\r\n*[instrument]: A particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: Particular traded forex or futures contracts such as gold or USDJPY\r\n*[underlined text]: Congratulations! You have successfully hovered over text\r\n*[indicator]: A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\r\n*[indicators]: Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\r\n*[H4]: Chart of the four hour timeframe\r\n*[M5]: Chart of the five minute timeframe\r\n*[H1]: Chart of the one hour timeframe",
"image": null,
"html": "<hr>\n<h4><strong>Trading Systems Part 5 - The Basic Steps for Forex and Futures</strong></h4>\n<p>A system is a strategy to open a sequence of positions in an <abbr title=\"A particular traded forex or futures contract such as gold or USDJPY\">instrument</abbr> based on the same or similar signals. As soon as a new <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> triggers, the next position is opened as long as the previous one has been closed.</p>\n<p>The system designer will determine in advance whether to trade in a trending or sideways environment. Within that environment, all signals are to be executed whenever they occur with little or no discetion according to predefined rules.</p>\n<p>The main purpose of your system is to be profitable with historic data. In general, but not always, your system must be as <em>complete</em> as possible. A complete system is one that has you trading 100% of the trend and spending as little time as possible on the sidelines watching the prices trend in your direction. Profitability always trumps completeness.</p>\n<p>In Part 3 and 4 we briefly explored signals. A <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> is a price pattern that triggers the opening of a position. The <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> may be any of the examples I used in part 4 of this series or it may be your own favorite <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>. You choose the signals based on all the assembled evidence supporting the <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>'s usefulness and profitability. To open the position you turn to the <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> tools from our earlier series on \"The Basic Setup\".</p>\n<h5><strong>What is not a system</strong></h5>\n<p>It is not a system just because you open a position in reaction to a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>. Every <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> could fail. It starts to become a system when you are prepared for that possibility with a strategy to deal with it. Withdrawing to lick your wounds or changing to a different market where you \"might have more luck\" is not a system. If you have correctly identified the trend, you need to be ready to unemotionally open on the next <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>, confident from your testing that the system wins over time.</p>\n<h5><strong>A Martingale - A dangerous system</strong></h5>\n<p>A martingale is a strategy where the risk is doubled after each loss in the hopes of paying off the previous loss(es) and reaching a profit.</p>\n<p>It's a dangerous system that will almost certainly lose all the funds in your account. All it takes is five losses in a row starting at 2% of your capital before you have lost 62% and are unable to make the next double. If you risk all that remains on a 6th <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> and lose, you are wiped out. As I pointed out in \"A Simple Setup\", five losses or more in a row are common enough that you should never risk more than 2%.</p>\n<p>The next table summarizes your balance after each consecutive loss:</p>\n<table>\n<thead>\n<tr>\n<th>Round</th>\n<th>Risk</th>\n<th>Cumulative Loss</th>\n<th>Remaining funds</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td>1</td>\n<td>2%</td>\n<td>2%</td>\n<td>98%</td>\n</tr>\n<tr>\n<td>2</td>\n<td>4%</td>\n<td>6%</td>\n<td>94%</td>\n</tr>\n<tr>\n<td>3</td>\n<td>8%</td>\n<td>14%</td>\n<td>86%</td>\n</tr>\n<tr>\n<td>4</td>\n<td>16%</td>\n<td>30%</td>\n<td>70%</td>\n</tr>\n<tr>\n<td>5</td>\n<td>32%</td>\n<td>62%</td>\n<td>38%</td>\n</tr>\n<tr>\n<td>6</td>\n<td>38%</td>\n<td>100%</td>\n<td>0%</td>\n</tr>\n</tbody>\n</table>\n<p>Notice how by the 4th loss you have risked 30% just to make 8% - assuming your normal risk/reward multiplier is 4 and your trade risk is 2%? That alone should keep you away from this train wreck. Even if you start with just 0.1% of your funds, a quick calculation will show that you will lose half your account after ten consecutive losses, with the next failed trade wiping you out.</p>\n<p>It works wonderfully though if you have unlimited funds available to trading, which nobody has. Margin rules should prevent you carrying out this strategy before you are ruined, but you also will not be able to recover your original trade balance, as the doubling strategy had promised.</p>\n<p>If you play a martingale regularly, you will sooner or later face ruin. It is <em>not a trading system</em>.</p>\n<h4>Calculating the Target Price using Simulations</h4>\n<p>When you place one trade on a particular <abbr title=\"A particular traded forex or futures contract such as gold or USDJPY\">instrument</abbr> as we did in \"The Basic Setup\", you are free to choose a <abbr title=\"target price\">TP</abbr> that seems achievable given the current price action. Perhaps you choose a nearby level or an overhead area of resistance. However when running a system without any discretion, the <abbr title=\"target price\">TP</abbr> will be different for each trade and therefore the calculation of the <abbr title=\"target price\">TP</abbr> must derive from elsewhere.</p>\n<p>The easiest solution is to use a multiple of the risk of the trade, where the risk is <abbr title=\"open price\">OP</abbr>-<abbr title=\"stop loss\">SL</abbr>. For example, you could insist that all trades must achieve a double (or 2 x <abbr title=\"open price\">OP</abbr>-<abbr title=\"stop loss\">SL</abbr>) before being automatically closed out. This number is based on the <strong><code>risk/reward ratio</code></strong> (RRR) and clearly it matters. If the RRR is 1:2 then for every $1 risked, $2 is expected as the reward or win. In our simulations we are more interested in the <strong><code>risk reward multiplier</code></strong>, which is the inverse of RRR, and to refer to it I will be using the notation <strong>RR</strong>. In this case we might say the RR equals two (1:2 becomes 2/1, or 2).</p>\n<p>If you set a value too high for the RR then many or all trades could fail as the <abbr title=\"stop loss\">SL</abbr> gets triggered first rather than the faraway <abbr title=\"target price\">TP</abbr>. If in turn it is set too low then the trade is more likely to win but the winnings may not be greater than losses from other failed trades. It is apparent that there is an optimal, Goldilocks level for the RR for each market and leg of the trend, not too high nor too low.</p>\n<p><img alt=\"SPX Setup Example\" src=\"/media/uploads/2017/basic_system_trading/Setup-EG-TP4x.png\" style=\"float: right;\" title=\"SPX Setup Example\" width=\"60%\">\nFor example, as you can see in the adjacent chart, if we used an RR=4, we could calculate <abbr title=\"target price\">TP</abbr> easily by adding four times the trade risk to the <abbr title=\"open price\">OP</abbr>. The trade risk (TR) would be just the amount we would lose if the stops were triggered, or (<abbr title=\"open price\">OP</abbr>-<abbr title=\"stop loss\">SL</abbr>). Multiply that risk by four and add it to the open price and we would have the <abbr title=\"target price\">TP</abbr> to use for the <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr>.</p>\n<p>For each RR there is a total win or loss from the system when applied to a range of historic data on a particular market. This RR will be calculated by simulating the system using historic prices and trying different values for RR until an optimum is found. I will do an example in the next story.</p>\n<p>The purpose of the simulation is to determine the optimal RR so we can calculate the <abbr title=\"target price\">TP</abbr> in every <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr>. Of course, the RR is not some fundamental constant of the universe - we expect it to change over time and in different markets. However our simulations may show some RR levels are more stable than others. Or we may find minimum or maximum RR ratios for certain markets or trend situations. Either way, we will end up with an RR that we will automatically be applied to each <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> in the sequence of trades that make up our system.</p>\n<h4>Simulations</h4>\n<p>The rules for reacting to signals within a system are determined during design and testing. The testing will simulate the real world consequences of applying the <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> to historic data.</p>\n<p>A simulation makes all the calculations you would in a real trade using real data <em>as if</em> you opened the position with your broker. Whether your simulated trade is stopped out for a loss or goes on to win at the <abbr title=\"target price\">TP</abbr> depends on what happened in the real market with real historic data. You do not actually execute the trade with your broker, in fact your broker has nothing to do with your simulation. The simulation can be done with pen and paper or with a computer program if you have the skills. If you are so inclined, it's easiest to get started using a spreadsheet, however we will do it manually here.</p>\n<p>But how to we get the RR for the market, timeframe and trend that we trade?</p>\n<p><img alt=\"Simulation Flowchart\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/simulation-flowchart.png\" title=\"Simulation Flowchart\" width=\"80%\"></p>\n<p>The RR will be calculated by simulating the system using historic prices and trying different values for RR until an optimum is found. I will do an example further below.</p>\n<p>We have a chicken and egg situation: we need to run a simulation of the system to calculate an RR value but the simulation requires an RR value to run. The solution is to run the simulation starting with a low <em>guesstimate</em> value and then rerun the simulation with progressively higher values and compare results. Each increment in the RR, or <strong>step</strong>, is a value we decide on. If an optimum is reached, we can use that value for RR and calculate <abbr title=\"target price\">TP</abbr> for each <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr>.</p>\n<p>Normally you would start simulating with an RR of one, unless you have reason to believe your <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> is so powerful that it wins most of the time. If that is the case, then you could start with RR=0.1. In order to win with such a low RR, you must win more than ten setups for every one you lose - not impossible but certainly cause for concern.</p>\n<p>Next, the RR value is raised by a certain amount called the step size. If you started with RR=1, the step size might be 0.5 or one because in the first run you want to locate the area that is most profitable by quickly testing across a wide range. Later on, you can always backtrack to zoom in with a smaller step size. It really helps if your testing is automated with a computer program otherwise it can become tediously repetitive.</p>\n<p>As we run simulations over the historic data with progressively higher values of RR, we make a note of our profit or loss from the system. After we finish, we choose the RR that gave us the highest profit, if one exists.</p>\n<p>In some cases we might discover that the system is a failure and no RR value yields a profit. We can discard those systems or send them back to the 'laboratory' for further testing. In other cases we might discover there is no optimum because the market is in a relentless trend. In such a case the best strategy would be to keep trying entries with no <abbr title=\"target price\">TP</abbr> until we find one that does not get stopped out. This would be akin to buying the S&P in 1923 and not selling. Each attempt would cost us 2% of our capital but the first winner would beat all those losses.</p>\n<p>The 1987 market crash, while huge at the time, is now just a distant wiggle in the charts and an excellent entry position. This is the famous equities buy and hold strategy, which was more popular in the 1990s than today. That's reasonable considering all recent positions from 1997 until 2009 have been stopped out by the dotcom crash and the 2008 credit crisis, unless they had an <abbr title=\"stop loss\">SL</abbr> way below the market.</p>\n<p>Within a system, any one <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> might fail leaving you with a loss. But when you trade all valid signals during the course of the trend you are following a system. A successful system will win more than it loses, even if more trades resulted in a loss.</p>\n<h4>Summary</h4>\n<p>A system is a series of trades that our testing with historic data suggests will win over time. We need a method to establish an optimum risk/reward multiplier for the market we trade which we will calculate by simulating trades on the historic data and observing the outcome for different RR levels.</p>\n<p>In the following stories in this series I will try to pick tricky examples to show what can go wrong in our testing. In some cases the market is in a strong trend, in other cases there is either a mild trend or you are tricked into thinking there is a trend when in fact there is none. The key here is experience. Each time you run a simulation on a new set of data you learn something new. We need to use these methods frequently so they become part of our trading tools.</p>\n<p>In the next story in this series I will show you the mechanics of such a simulation.\n<br>\n<br>\n<br>\n<br>\n<br></p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"url": "https://pagoolabs.com/stories/api/46/edit/?format=api",
"id": 46,
"title": "Examples of Signals in Forex and Futures Trading",
"slug": "trading-systems-part-4-examples-of-signals",
"status": 2,
"publication_date": "2017-10-24T03:51:27Z",
"lead": "This fourth story in the series \"Introduction to Trading Systems\" explores examples of simple signals: the MA cross, Pin Bars, Engulfing patterns and Heikin Ashi reversals.",
"excerpt": "This fourth story in the series on Trading Systems explores examples of simple signals: the MA cross, Pin Bars, Engulfing patterns and Heikin Ashi reversals.",
"poster": "SeanManefield",
"content": "---\r\n#### **Trading Systems Part 4 - Examples of Signals**\r\n\r\nThe [previous story](/stories/45/2017/10/24/trading-systems-part-3-signals/) described the class of triggers we call signals. In this story we will explore some simple examples of signals. Most of these you will be familiar with and they help to clarify the terms we use in the next story on systems.\r\n\r\nAs examples, we will discuss the following types of signals:\r\n\r\n- MA cross\r\n- Pin bars\r\n- Engulfing patterns\r\n- Heikin Ashi reversals.\r\n\r\n<a id=\"Moving-Average-Cross-signals\"></a>\r\n#### Moving Average Cross signals\r\n\r\nAn MA cross signal occurs of course when two MAs cross. One MA has a longer periodicity than the other meaning that it will be slower to react to the latest prices while the MA with the shorter time period will react faster. If the previous trend had been a bear market then prices would generally be below the two MAs with the faster MA closer to the real market prices than the slow MA.\r\n\r\n![MAs above prices in downtrend](/media/uploads/2017/basic_system_trading/EJ-D1-MA-DN-20171013-2.png \"EURJPY MA Downtrend\"):C80\r\n\r\nIn a bull market, the opposite occurs with the slow MA below the faster, and *both* below the actual rising prices. The two charts of EURJPY show different phases of a cycle, with the first above showing a downtrend with the MAs lying above and to the right, and the following chart showing an uptrend with MAs underneath.\r\n\r\n![MAs below prices in uptrend](/media/uploads/2017/basic_system_trading/EJ-D1-MA-UP-20171013-0.png \"EURJPY MA Uptrend\"):C80\r\n\r\nFor the slow MA to be above the faster MA in a bear market but below in a bull market they must have **crossed** over at some point when the trend reversed. This is point A in the charts. This crossover point is frequently used as either a trend starting point or even as an entry signal for actual trading.\r\n![MA Cross on USDJPY](/media/uploads/2017/basic_system_trading/USDJPY-MA-Cross-20171017.png \"MA Cross on USDJPY\"):R40\r\n\r\nWe could use a second set of MAs with even shorter periods, such as MA20 and MA8, as our *signal* while reserving the longer 100 period MA as an indicator of *trend*. While admittedly simple, such a trading system could in fact work, depending on how you tested and implemented it. If there is an advantage to using a more complicated system, you should find that out in the testing.\r\n\r\nThe setup itself is made complicated by the long period of time that evolves while a cross is taking place and the fact that because we are dealing with averages, the low probably does not occur in the same period as the cross. Instead find the lowest price of all the bars leading up to the cross starting from the last downtrend. During the downtrend, prices were higher. At some point they must have flattened out before turning up to create the cross. Sometime in that period a lowest price must have been set. Use that low for the SL. Refer to the accompanying chart of the S&P futures.\r\n\r\n![MA Cross Setup on S&P500](/media/uploads/2017/basic_system_trading/SPX-D1-UpT-MACross-Setup-20171019.png \"MA Cross Setup on S&P500\"):R60\r\n\r\nEven if you witness a cross forming during the period, it may or may not actually appear on the charts depending on the closing price of the bar that day. You can never be sure the cross will complete until the close of trading. The open price should be the open of the very first bar *following* the cross although you're free to enact some intricate open policy that involves a confirmation pattern. That policy emerges later from your testing.\r\n\r\nWith the SL and OP set you can easily calculate the number of contracts to open (CO). The TP would usually be based on some multiple of the risk (OP-SL) and I will discuss that important topic in the story on [testing systems](/stories/48/2017/10/24/trading-systems-part-6-simulations-on-systems/). With the OP, SL, TP and CO we have all the elements required for the setup based on a particular signal.\r\n\r\nTo summarize the MA cross signal:\r\n\r\n- In an uptrend, when the faster MA crosses from below the slower MA to above, open a long position.\r\n- In a downtrend, when the faster MA crosses from above the slower MA to below, open a short position.\r\n\r\nBut MA crosses are just one class of signals out of many. Let's look at a few more.<a id=\"Pin-Bar-Signals\"></a>\r\n\r\n\r\n#### Pin Bar Signals\r\n\r\nPin bars belong to a set of simple candlestick patterns, such as doji, hanging man or shooting star. These are sometimes called pin bars when they exhibit certain extra characteristics such as position, shape and size that dominate surrounding bars. There are many other candlestick patterns and we plan to run a future story on some of these and how to use them in a system.\r\n\r\n![Pin bar in an uptrend](/media/uploads/2017/basic_system_trading/OK-PB-20171013.png \"Pin bar in an uptrend\"):R40\r\nA pin bar is a candlestick with a small body at one end and a much longer tail. The key idea is that a particular area has been tested by the long tail and rejected. The market probed down into the support area, triggered the stops and instead of continuing in that direction, bounced right back. The open trades that did not trigger are now considered to belong to *stronger hands*: traders who are less likely to be stopped out next time.\r\n\r\n![Pin bar](/media/uploads/2017/basic_system_trading/Pin_Bar.png \"Pin bar\"):R40\r\nBy shape alone, a pin bar is like a traditional hanging man or shooting star candlestick, although most practitioners only accept a subset of such candles as true pin bars. A *true* pin bar must usually dominate the surrounding pattern and either indicate a resumption of the trend after a retracement or be at the bottom or top of the range in a sideways market. You should strongly avoid accepting every hanging man or shooting star as a pin bar signal. Critically examine the charts to see how often this pattern fails to work as a signal when it is against the trend.\r\n\r\nThe setup is straightforward - the SL should be just beyond the tail of the bar, and the OP could be the open of the next bar. Or you could set a stop-limit order to trigger you into the trade when the market price moves above the top of the pin bar head (for a long trade).\r\n\r\nWith the SL and OP set you can easily calculate the number of contracts to open (CO). As with the MA cross, the TP would usually be based on some multiple of the risk.\r\n\r\nUsing only a pin bar is not a complete system because if the setup is stopped out, it is rarely followed by another pin bar to signal re-entry. However it can be combined with other entry signals such as the engulfing or outside bar pattern to provide a more complete system, and we turn to that now.<a id=\"Engulfing-pattern-signals\"></a>\r\n\r\n\r\n#### Engulfing pattern signals\r\n\r\nAn engulfing pattern or outside bar is a two bar pattern where the second bar reverses direction and has both a higher high and a lower low than the first. In other words, the second bar encloses or *engulfs* the first.\r\n\r\n![Example outside bar in uptrend](/media/uploads/2017/basic_system_trading/OB-EG-20171014.png \"Example outside bar in uptrend\"):R40\r\n\r\nIf you think about it, this is similar to a pin bar except it plays out over two periods instead of one. On the first day (or period) the market continued its retracement against the trend. On the second day the market opened lower in a bearish sentiment and attempted to go even lower before surrendering to the upward trend in a wave of buying that sent prices higher than the open of the previous day.\r\n\r\n![Outside Bar](/media/uploads/2017/basic_system_trading/Outside_bar.png \"Outside Bar\"):R40\r\nAs with the pin bar, there is the strong sense that the area below has been tested and rejected. But testing and rejecting really only makes sense when the market is probing *against* the real underlying trend. When prices are moving with the trend there are multiple examples of engulfing patterns that never lead to any price reversals.\r\n\r\nThe setup is similar to the case of the pin bar - the SL should be just beyond the tail of the larger outside bar, and the OP could be the open of the next bar or you could set a stop-limit order to trigger you into the trade when the market price moves above the top of the outside bar (for a long trade). The TP and CO are as discussed earlier for the other signals.\r\n\r\nAs with the pin bar, it needs to be combined with several other signals to be a complete system. Together with the pin bar you might be able to catch at least one of the entry points in a trend but whether it's enough to offset losses would depend on what your historical tests will show.\r\n\r\nTo make the engulfing pattern and pin bar more complete, you could also add the Piercing Line pattern (or Dark Cloud Cover) as well as a number of two bar reversals that don't quite qualify as engulfing patterns.\r\n\r\nIn 24 hour forex markets, gaps at the open are not possible unless they happened in the final minutes of trading. For this reason, outside bars are less prevalent than two bar reversals where both bars have a common low but the second has a higher high. You might like to use these in addition to engulfing patterns if you are trading in forex markets.\r\n\r\nCandlestick patterns are a huge field and there is much to explore. Fortunately there are many sites on the web that cover all these patterns.<a id=\"Heikin-Ashi-Candlesticks\"></a>\r\n\r\n#### Heikin Ashi Candlesticks\r\n\r\nHeikin-Ashi (HA) is a different candlestick design that smooths out the shortest term fluctuations in each bar. Because HA bars are a different shape than the standard candlesticks, the technique is not very popular with traders. However there are solutions to most of these problems. HA is presented here as an example of an uncommon technique. Below, side by side are the same two sections of the chart of the S&P futures contract. The chart with the normal candles is to the left and on the right is the same chart using Heikin Ashi candles.\r\n\r\n<div class=\"clear-floating-cols-above\"></div>\r\n![S&P 500 with Normal candlesticks](/media/uploads/2017/basic_system_trading/SPX-D1-Normal-Section-20171020.png \"S&P 500 with Normal candlesticks\"):L45\r\n![S&P 500 with HA candlesticks](/media/uploads/2017/basic_system_trading/SPX-D1-HA-Section-20171020.png \"S&P 500 with HA candlesticks\"):R45\r\n<div class=\"clear-floating-cols-above\"></div>\r\nAll candlesticks are composed of the Open, Close, High and Low or OHLC. Heikin Ashi (HA) candlesticks are made up of averages of these four key values: haClose, haOpen, haHigh, haLow. Because the averages for the haOpen, haHigh and haLow are further averages of earlier candlesticks, each HA has a 'memory' in much the same way as an exponential MA. Here are the formulae so that you can see how the memory kicks in:\r\n\r\n Where t represents the current period, and t-1 the previous:\r\n haClose = (Open[t] + High[t] + Low[t] + Close[t]) / 4\r\n haOpen = (haOpen[t-1] + haClose[t-1]) / 2;\r\n haHigh = maximum of High[t] and haOpen;\r\n haLow = minimum of Low[t] and haOpen;\r\n\r\nSo the close is just the average of the current periods values but the others are all averages in some way of the earlier period, unless the current high is higher or the current low is lower than the average. It should come as little suprise that the HA reversals track an exponential MA cross of very short duration. ![SPX daily chart](/media/uploads/2017/basic_system_trading/SPX-D1-20171012-EMAvsHA.png \"HA vs EMA4/2\"):R35 The short period, or fast MA, uses EMA(2) with HLCC/4 as the value used in each period (if this is confusing then just use the normal close value).\r\n\r\nWhere they cross is often the same time period where HA changes direction, so we can use the MA cross as a proxy for HA when it's not available. For the long period, or slow MA, use EMA(4). Remember the bars must close before you can know whether the MA crossed in that period or not. It's much easier to visualize these reversals with HA so you would only use MAs if HA is not available in your charting software.\r\n\r\nIn fact, many of these signals are not independent of one another because they are based on the same four market numbers contained in OHLC. There are only just so many ways you can slice and dice four numbers so you will often end up with the same result from otherwise different indicators.\r\n\r\nHere is an example of the EURJPY downtrend chart shown earlier in the section on MA crosses, but this time using Heikin Ashi bars. ![Heikin Ashi chart of EURJPY daily](/media/uploads/2017/basic_system_trading/EJ-D1-MA-DN-HA-20171013.png \"Heikin Ashi chart of EURJPY daily\"):R55 In these charts, HA is displayed in red whenever the haClose<haOpen, and in green otherwise. A great advantage over normal candlesticks is HA highlights the runs in one particular direction, smoothing out the minor fluctuations that distract you from the bigger picture.\r\n\r\nTo be sure, HA candlesticks cannot replace the normal charts, but they are a great addition when you flick quickly between both. If your software allows multiple open charts, and most do, just set up the normal chart in one window and the Heikin Ashi chart for the same instrument in another.<a id=\"HA-signals\"></a>\r\n\r\n\r\n#### HA signals\r\n\r\nOne signal that is readily apparent is to open whenever a bar changes from red to green if the trend is up. You must not already have an open position and you will need to **wait until the first green bar is complete** at the end of the period. Because the bar has changed color, there must have been a low set during the change, either on the new green bar or one of the immediately preceding red bars. Just below that is where you place your stop loss.\r\n\r\nThe setup then is similar to the case of the MA cross. With the SL determined, the OP should be the open of the first bar *after* the green reversal bar (red in a downtrend). The TP and CO are as discussed earlier for the other signals. See [The Basic Setup](/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/) if you are unclear on any aspect of the setup tool.\r\n\r\n![Heikin Ashi chart of S&P500](/media/uploads/2017/basic_system_trading/SPX-D1-HA-rev-20171012-2.png \"Heikin Ashi chart of S&P500\"):C90\r\n\r\nAbove, in the Heikin Ashi chart of the S&P500 continuous futures contract, most of the HA reversals have been marked with a green check if they have not yet been stopped out, or a red cross if subsequent prices triggered the SL.\r\n\r\nEven in an uptrend it's possible to see that about half the reversals were successful and the other half failed. That's because the unsuccessful signals occur in areas of consolidation and involved much whipsawing causing many minor reversals. The successful signals on the other hand resulted in resumption of the trend and continued for some time before the next HA reversal down.\r\n\r\nIf you open a signal that eventually fails you will open the next signal, which should come after the series of bars that stopped out your trade. If that fails you will open the next, and so on. Eventually, unless the trend has changed, you will be in a position that has the lowest SL of all those earlier failed trades.\r\n\r\nYou can see this on the chart above in the troublesome area after point A. The first setup fails, triggered by the concerns over the UK Brexit vote. When the market resumes in the direction of the trend, a new HA signal is triggered, this time with a lower SL than the first setup. None of the bad HA setups that follow should impact the open position because its stop never gets triggered and one of the rules is to not open a second position.\r\n\r\nHowever if for some reason you did not enter on the first signal, the next occurs about six days later. It eventually fails, stopped out by the US 2016 election result. Before then however there are multiple signals to enter, all of which fail for the same reason, but none of which affect you because you already have an open position. The point is that many of the failed signals on a chart are irrelevant, you will be in the first one until that fails, if it does. If it wins it will of course need a TP to compensate for the losses.\r\n\r\nThe HA signal is complete in the sense that the trend cannot resume without you. It is not possible for the market to trade higher after a period of retracement without first signaling an HA reversal.\r\n\r\nWhat could go wrong is that the reversal bar could be very large and untradable, like the spike we talked about above for pin bars. In that case you will have to wait for a more reasonable sized correction. Large spikes usually, but not always, provide these later opportunities. In the meantime however, you could miss out on a substantial rally in line with the trend.\r\n\r\nAside from the huge reversal spikes, the only part of the trend that is not covered are the bars after the TP has been hit and before the next HA signal. If the next signal is higher than the TP, which can happen, then the trader will miss out on a portion of the trend.\r\n\r\nThe disadvantage of the HA is that it displays candlestick bars that are slightly different to the real bars - it is after all an averaging system. To correct this, use your software to show both charts, the normal one and the HA, side by side. Or better still, place one chart on top of the other and then flick between them so that you can see the signals and the original chart. In this series, whenever I can, I will try to place them side by side with the HA on the right. Also, the normal chart has the EMA4 (green) and EMA2 (gold) moving averages so that you can compare the signals with the HA chart.\r\n\r\nThis section has not done justice to Heikin Ashi which has its own set of candlestick patterns differing from the traditional ones. Candlestick tails (shadows) or their absence take on new meaning. If you are interested, there are many books and sites on the web that discuss this technique further.\r\n\r\n#### Custom Signals\r\n\r\nThese examples above illustrate how to create a setup around any custom signal. All that is required is a clear, unambiguous trigger to open a position starting at a particular time period with some condition specifying the open price. To open the position you use the setup tools from our earlier series on \"The Basic Setup\". Looking around the area the signal occurs, you should be able to identify the most appropriate SL level. The setup tools describe the number of contracts and your own simulation described in a later story determine the TP.\r\n\r\n#### Summary\r\n\r\nHere we discussed what qualifies as a signal and showed several different signals based on MAs, candlestick patterns and Heikin Ashi charts.\r\n\r\nNote, these are all simple signaling systems: there is nothing complex about a pin bar or crossing moving average. Taken by themselves they could lose more than they would win. However when combined into a system they become powerful trading tools.\r\n\r\nIn other stories and posts I may use different signals just to show how widely the system method can be applied. While it does not depend on any one signal strategy, every system needs at least one signal strategy in order to trigger opening a long or short position.\r\n\r\nThe problem with signals is that sometimes they fail and the setup is stopped out. By itself, all we can say is the signal was successful or unsuccessful. However if losses are accumulating in the account then you are faced with the very real prospect of being wiped out. We need the bigger picture to see if all the positions we have opened as a result of signals are winning or likely to win.\r\n\r\nNow we turn to [building our first system](/stories/47/2017/10/24/trading-systems-part-5-systems/). With all the building blocks in place - trend, setup and signal - it is just a matter of assembling them in the right order into a system.\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n\r\n*[HA]: Heikin Ashi\r\n*[EMA]: Exponential Moving Average - has a long 'memory'\r\n*[OHLC]: Open, High, Low, Close: the 4 key values for any bar on a chart\r\n*[bull]: An uptrending or rising market\r\n*[bear]: A downtrending or falling market\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[MR]: Maximum Risk\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[EURJPY]: The Euro - Yen cross currency: buying Euros priced in Yen\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[instrument]: A particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: Particular traded forex or futures contracts such as gold or USDJPY\r\n*[indicator]: A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\r\n*[indicators]: Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\r\n*[H4]: Chart of the four hour timeframe\r\n*[M5]: Chart of the five minute timeframe\r\n*[H1]: Chart of the one hour timeframe",
"image": null,
"html": "<hr>\n<h4><strong>Trading Systems Part 4 - Examples of Signals</strong></h4>\n<p>The <a href=\"/stories/45/2017/10/24/trading-systems-part-3-signals/\">previous story</a> described the class of triggers we call signals. In this story we will explore some simple examples of signals. Most of these you will be familiar with and they help to clarify the terms we use in the next story on systems.</p>\n<p>As examples, we will discuss the following types of signals:</p>\n<ul>\n<li>MA cross</li>\n<li>Pin bars</li>\n<li>Engulfing patterns</li>\n<li>Heikin Ashi reversals.</li>\n</ul>\n<p><a id=\"Moving-Average-Cross-signals\"></a></p>\n<h4>Moving Average Cross signals</h4>\n<p>An MA cross signal occurs of course when two MAs cross. One MA has a longer periodicity than the other meaning that it will be slower to react to the latest prices while the MA with the shorter time period will react faster. If the previous trend had been a <abbr title=\"A downtrending or falling market\">bear</abbr> market then prices would generally be below the two MAs with the faster MA closer to the real market prices than the slow MA.</p>\n<p><img alt=\"MAs above prices in downtrend\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/EJ-D1-MA-DN-20171013-2.png\" title=\"EURJPY MA Downtrend\" width=\"80%\"></p>\n<p>In a <abbr title=\"An uptrending or rising market\">bull</abbr> market, the opposite occurs with the slow MA below the faster, and <em>both</em> below the actual rising prices. The two charts of <abbr title=\"The Euro - Yen cross currency: buying Euros priced in Yen\">EURJPY</abbr> show different phases of a cycle, with the first above showing a downtrend with the MAs lying above and to the right, and the following chart showing an uptrend with MAs underneath.</p>\n<p><img alt=\"MAs below prices in uptrend\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/EJ-D1-MA-UP-20171013-0.png\" title=\"EURJPY MA Uptrend\" width=\"80%\"></p>\n<p>For the slow MA to be above the faster MA in a <abbr title=\"A downtrending or falling market\">bear</abbr> market but below in a <abbr title=\"An uptrending or rising market\">bull</abbr> market they must have <strong>crossed</strong> over at some point when the trend reversed. This is point A in the charts. This crossover point is frequently used as either a trend starting point or even as an entry signal for actual trading.\n<img alt=\"MA Cross on USDJPY\" src=\"/media/uploads/2017/basic_system_trading/USDJPY-MA-Cross-20171017.png\" style=\"float: right;\" title=\"MA Cross on USDJPY\" width=\"40%\"></p>\n<p>We could use a second set of MAs with even shorter periods, such as MA20 and MA8, as our <em>signal</em> while reserving the longer 100 period MA as an <abbr title=\"A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\">indicator</abbr> of <em>trend</em>. While admittedly simple, such a trading system could in fact work, depending on how you tested and implemented it. If there is an advantage to using a more complicated system, you should find that out in the testing.</p>\n<p>The setup itself is made complicated by the long period of time that evolves while a cross is taking place and the fact that because we are dealing with averages, the low probably does not occur in the same period as the cross. Instead find the lowest price of all the bars leading up to the cross starting from the last downtrend. During the downtrend, prices were higher. At some point they must have flattened out before turning up to create the cross. Sometime in that period a lowest price must have been set. Use that low for the <abbr title=\"stop loss\">SL</abbr>. Refer to the accompanying chart of the S&P futures.</p>\n<p><img alt=\"MA Cross Setup on S&P500\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-UpT-MACross-Setup-20171019.png\" style=\"float: right;\" title=\"MA Cross Setup on S&P500\" width=\"60%\"></p>\n<p>Even if you witness a cross forming during the period, it may or may not actually appear on the charts depending on the closing price of the bar that day. You can never be sure the cross will complete until the close of trading. The open price should be the open of the very first bar <em>following</em> the cross although you're free to enact some intricate open policy that involves a confirmation pattern. That policy emerges later from your testing.</p>\n<p>With the <abbr title=\"stop loss\">SL</abbr> and <abbr title=\"open price\">OP</abbr> set you can easily calculate the number of contracts to open (<abbr title=\"number of contracts opened\">CO</abbr>). The <abbr title=\"target price\">TP</abbr> would usually be based on some multiple of the risk (<abbr title=\"open price\">OP</abbr>-<abbr title=\"stop loss\">SL</abbr>) and I will discuss that important topic in the story on <a href=\"/stories/48/2017/10/24/trading-systems-part-6-simulations-on-systems/\">testing systems</a>. With the <abbr title=\"open price\">OP</abbr>, <abbr title=\"stop loss\">SL</abbr>, <abbr title=\"target price\">TP</abbr> and <abbr title=\"number of contracts opened\">CO</abbr> we have all the elements required for the setup based on a particular signal.</p>\n<p>To summarize the MA cross signal:</p>\n<ul>\n<li>In an uptrend, when the faster MA crosses from below the slower MA to above, open a long position.</li>\n<li>In a downtrend, when the faster MA crosses from above the slower MA to below, open a short position.</li>\n</ul>\n<p>But MA crosses are just one class of signals out of many. Let's look at a few more.<a id=\"Pin-Bar-Signals\"></a></p>\n<h4>Pin Bar Signals</h4>\n<p>Pin bars belong to a set of simple candlestick patterns, such as doji, hanging man or shooting star. These are sometimes called pin bars when they exhibit certain extra characteristics such as position, shape and size that dominate surrounding bars. There are many other candlestick patterns and we plan to run a future story on some of these and how to use them in a system.</p>\n<p><img alt=\"Pin bar in an uptrend\" src=\"/media/uploads/2017/basic_system_trading/OK-PB-20171013.png\" style=\"float: right;\" title=\"Pin bar in an uptrend\" width=\"40%\">\nA pin bar is a candlestick with a small body at one end and a much longer tail. The key idea is that a particular area has been tested by the long tail and rejected. The market probed down into the support area, triggered the stops and instead of continuing in that direction, bounced right back. The open trades that did not trigger are now considered to belong to <em>stronger hands</em>: traders who are less likely to be stopped out next time.</p>\n<p><img alt=\"Pin bar\" src=\"/media/uploads/2017/basic_system_trading/Pin_Bar.png\" style=\"float: right;\" title=\"Pin bar\" width=\"40%\">\nBy shape alone, a pin bar is like a traditional hanging man or shooting star candlestick, although most practitioners only accept a subset of such candles as true pin bars. A <em>true</em> pin bar must usually dominate the surrounding pattern and either indicate a resumption of the trend after a retracement or be at the bottom or top of the range in a sideways market. You should strongly avoid accepting every hanging man or shooting star as a pin bar signal. Critically examine the charts to see how often this pattern fails to work as a signal when it is against the trend.</p>\n<p>The setup is straightforward - the <abbr title=\"stop loss\">SL</abbr> should be just beyond the tail of the bar, and the <abbr title=\"open price\">OP</abbr> could be the open of the next bar. Or you could set a stop-limit order to trigger you into the trade when the market price moves above the top of the pin bar head (for a long trade).</p>\n<p>With the <abbr title=\"stop loss\">SL</abbr> and <abbr title=\"open price\">OP</abbr> set you can easily calculate the number of contracts to open (<abbr title=\"number of contracts opened\">CO</abbr>). As with the MA cross, the <abbr title=\"target price\">TP</abbr> would usually be based on some multiple of the risk.</p>\n<p>Using only a pin bar is not a complete system because if the setup is stopped out, it is rarely followed by another pin bar to signal re-entry. However it can be combined with other entry signals such as the engulfing or outside bar pattern to provide a more complete system, and we turn to that now.<a id=\"Engulfing-pattern-signals\"></a></p>\n<h4>Engulfing pattern signals</h4>\n<p>An engulfing pattern or outside bar is a two bar pattern where the second bar reverses direction and has both a higher high and a lower low than the first. In other words, the second bar encloses or <em>engulfs</em> the first.</p>\n<p><img alt=\"Example outside bar in uptrend\" src=\"/media/uploads/2017/basic_system_trading/OB-EG-20171014.png\" style=\"float: right;\" title=\"Example outside bar in uptrend\" width=\"40%\"></p>\n<p>If you think about it, this is similar to a pin bar except it plays out over two periods instead of one. On the first day (or period) the market continued its retracement against the trend. On the second day the market opened lower in a bearish sentiment and attempted to go even lower before surrendering to the upward trend in a wave of buying that sent prices higher than the open of the previous day.</p>\n<p><img alt=\"Outside Bar\" src=\"/media/uploads/2017/basic_system_trading/Outside_bar.png\" style=\"float: right;\" title=\"Outside Bar\" width=\"40%\">\nAs with the pin bar, there is the strong sense that the area below has been tested and rejected. But testing and rejecting really only makes sense when the market is probing <em>against</em> the real underlying trend. When prices are moving with the trend there are multiple examples of engulfing patterns that never lead to any price reversals.</p>\n<p>The setup is similar to the case of the pin bar - the <abbr title=\"stop loss\">SL</abbr> should be just beyond the tail of the larger outside bar, and the <abbr title=\"open price\">OP</abbr> could be the open of the next bar or you could set a stop-limit order to trigger you into the trade when the market price moves above the top of the outside bar (for a long trade). The <abbr title=\"target price\">TP</abbr> and <abbr title=\"number of contracts opened\">CO</abbr> are as discussed earlier for the other signals.</p>\n<p>As with the pin bar, it needs to be combined with several other signals to be a complete system. Together with the pin bar you might be able to catch at least one of the entry points in a trend but whether it's enough to offset losses would depend on what your historical tests will show.</p>\n<p>To make the engulfing pattern and pin bar more complete, you could also add the Piercing Line pattern (or Dark Cloud Cover) as well as a number of two bar reversals that don't quite qualify as engulfing patterns.</p>\n<p>In 24 hour <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> markets, gaps at the open are not possible unless they happened in the final minutes of trading. For this reason, outside bars are less prevalent than two bar reversals where both bars have a common low but the second has a higher high. You might like to use these in addition to engulfing patterns if you are trading in <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> markets.</p>\n<p>Candlestick patterns are a huge field and there is much to explore. Fortunately there are many sites on the web that cover all these patterns.<a id=\"Heikin-Ashi-Candlesticks\"></a></p>\n<h4>Heikin Ashi Candlesticks</h4>\n<p>Heikin-Ashi (<abbr title=\"Heikin Ashi\">HA</abbr>) is a different candlestick design that smooths out the shortest term fluctuations in each bar. Because <abbr title=\"Heikin Ashi\">HA</abbr> bars are a different shape than the standard candlesticks, the technique is not very popular with traders. However there are solutions to most of these problems. <abbr title=\"Heikin Ashi\">HA</abbr> is presented here as an example of an uncommon technique. Below, side by side are the same two sections of the chart of the S&P futures contract. The chart with the normal candles is to the left and on the right is the same chart using Heikin Ashi candles.</p>\n<div class=\"clear-floating-cols-above\"></div>\n\n<p><img alt=\"S&P 500 with Normal candlesticks\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-Normal-Section-20171020.png\" style=\"float: left;\" title=\"S&P 500 with Normal candlesticks\" width=\"45%\">\n<img alt=\"S&P 500 with HA candlesticks\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-HA-Section-20171020.png\" style=\"float: right;\" title=\"S&P 500 with HA candlesticks\" width=\"45%\">\n</p><div class=\"clear-floating-cols-above\"></div>\nAll candlesticks are composed of the Open, Close, High and Low or <abbr title=\"Open, High, Low, Close: the 4 key values for any bar on a chart\">OHLC</abbr>. Heikin Ashi (<abbr title=\"Heikin Ashi\">HA</abbr>) candlesticks are made up of averages of these four key values: haClose, haOpen, haHigh, haLow. Because the averages for the haOpen, haHigh and haLow are further averages of earlier candlesticks, each <abbr title=\"Heikin Ashi\">HA</abbr> has a 'memory' in much the same way as an exponential MA. Here are the formulae so that you can see how the memory kicks in:<p></p>\n<div class=\"codehilite\"><pre><span></span>Where t represents the current period, and t-1 the previous:\n haClose = (Open[t] + High[t] + Low[t] + Close[t]) / 4\n haOpen = (haOpen[t-1] + haClose[t-1]) / 2;\n haHigh = maximum of High[t] and haOpen;\n haLow = minimum of Low[t] and haOpen;\n</pre></div>\n\n\n<p>So the close is just the average of the current periods values but the others are all averages in some way of the earlier period, unless the current high is higher or the current low is lower than the average. It should come as little suprise that the <abbr title=\"Heikin Ashi\">HA</abbr> reversals track an exponential MA cross of very short duration. <img alt=\"SPX daily chart\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-20171012-EMAvsHA.png\" style=\"float: right;\" title=\"HA vs EMA4/2\" width=\"35%\"> The short period, or fast MA, uses <abbr title=\"Exponential Moving Average - has a long 'memory'\">EMA</abbr>(2) with HLCC/4 as the value used in each period (if this is confusing then just use the normal close value).</p>\n<p>Where they cross is often the same time period where <abbr title=\"Heikin Ashi\">HA</abbr> changes direction, so we can use the MA cross as a proxy for <abbr title=\"Heikin Ashi\">HA</abbr> when it's not available. For the long period, or slow MA, use <abbr title=\"Exponential Moving Average - has a long 'memory'\">EMA</abbr>(4). Remember the bars must close before you can know whether the MA crossed in that period or not. It's much easier to visualize these reversals with <abbr title=\"Heikin Ashi\">HA</abbr> so you would only use MAs if <abbr title=\"Heikin Ashi\">HA</abbr> is not available in your charting software.</p>\n<p>In fact, many of these signals are not independent of one another because they are based on the same four market numbers contained in <abbr title=\"Open, High, Low, Close: the 4 key values for any bar on a chart\">OHLC</abbr>. There are only just so many ways you can slice and dice four numbers so you will often end up with the same result from otherwise different <abbr title=\"Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\">indicators</abbr>.</p>\n<p>Here is an example of the <abbr title=\"The Euro - Yen cross currency: buying Euros priced in Yen\">EURJPY</abbr> downtrend chart shown earlier in the section on MA crosses, but this time using Heikin Ashi bars. <img alt=\"Heikin Ashi chart of EURJPY daily\" src=\"/media/uploads/2017/basic_system_trading/EJ-D1-MA-DN-HA-20171013.png\" style=\"float: right;\" title=\"Heikin Ashi chart of EURJPY daily\" width=\"55%\"> In these charts, <abbr title=\"Heikin Ashi\">HA</abbr> is displayed in red whenever the haClose<haOpen, and in green otherwise. A great advantage over normal candlesticks is <abbr title=\"Heikin Ashi\">HA</abbr> highlights the runs in one particular direction, smoothing out the minor fluctuations that distract you from the bigger picture.</p>\n<p>To be sure, <abbr title=\"Heikin Ashi\">HA</abbr> candlesticks cannot replace the normal charts, but they are a great addition when you flick quickly between both. If your software allows multiple open charts, and most do, just set up the normal chart in one window and the Heikin Ashi chart for the same <abbr title=\"A particular traded forex or futures contract such as gold or USDJPY\">instrument</abbr> in another.<a id=\"HA-signals\"></a></p>\n<h4><abbr title=\"Heikin Ashi\">HA</abbr> signals</h4>\n<p>One signal that is readily apparent is to open whenever a bar changes from red to green if the trend is up. You must not already have an open position and you will need to <strong>wait until the first green bar is complete</strong> at the end of the period. Because the bar has changed color, there must have been a low set during the change, either on the new green bar or one of the immediately preceding red bars. Just below that is where you place your stop loss.</p>\n<p>The setup then is similar to the case of the MA cross. With the <abbr title=\"stop loss\">SL</abbr> determined, the <abbr title=\"open price\">OP</abbr> should be the open of the first bar <em>after</em> the green reversal bar (red in a downtrend). The <abbr title=\"target price\">TP</abbr> and <abbr title=\"number of contracts opened\">CO</abbr> are as discussed earlier for the other signals. See <a href=\"/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/\">The Basic Setup</a> if you are unclear on any aspect of the setup tool.</p>\n<p><img alt=\"Heikin Ashi chart of S&P500\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-HA-rev-20171012-2.png\" title=\"Heikin Ashi chart of S&P500\" width=\"90%\"></p>\n<p>Above, in the Heikin Ashi chart of the S&P500 continuous futures contract, most of the <abbr title=\"Heikin Ashi\">HA</abbr> reversals have been marked with a green check if they have not yet been stopped out, or a red cross if subsequent prices triggered the <abbr title=\"stop loss\">SL</abbr>.</p>\n<p>Even in an uptrend it's possible to see that about half the reversals were successful and the other half failed. That's because the unsuccessful signals occur in areas of consolidation and involved much whipsawing causing many minor reversals. The successful signals on the other hand resulted in resumption of the trend and continued for some time before the next <abbr title=\"Heikin Ashi\">HA</abbr> reversal down.</p>\n<p>If you open a signal that eventually fails you will open the next signal, which should come after the series of bars that stopped out your trade. If that fails you will open the next, and so on. Eventually, unless the trend has changed, you will be in a position that has the lowest <abbr title=\"stop loss\">SL</abbr> of all those earlier failed trades.</p>\n<p>You can see this on the chart above in the troublesome area after point A. The first setup fails, triggered by the concerns over the UK Brexit vote. When the market resumes in the direction of the trend, a new <abbr title=\"Heikin Ashi\">HA</abbr> signal is triggered, this time with a lower <abbr title=\"stop loss\">SL</abbr> than the first setup. None of the bad <abbr title=\"Heikin Ashi\">HA</abbr> setups that follow should impact the open position because its stop never gets triggered and one of the rules is to not open a second position.</p>\n<p>However if for some reason you did not enter on the first signal, the next occurs about six days later. It eventually fails, stopped out by the US 2016 election result. Before then however there are multiple signals to enter, all of which fail for the same reason, but none of which affect you because you already have an open position. The point is that many of the failed signals on a chart are irrelevant, you will be in the first one until that fails, if it does. If it wins it will of course need a <abbr title=\"target price\">TP</abbr> to compensate for the losses.</p>\n<p>The <abbr title=\"Heikin Ashi\">HA</abbr> signal is complete in the sense that the trend cannot resume without you. It is not possible for the market to trade higher after a period of retracement without first signaling an <abbr title=\"Heikin Ashi\">HA</abbr> reversal.</p>\n<p>What could go wrong is that the reversal bar could be very large and untradable, like the spike we talked about above for pin bars. In that case you will have to wait for a more reasonable sized correction. Large spikes usually, but not always, provide these later opportunities. In the meantime however, you could miss out on a substantial rally in line with the trend.</p>\n<p>Aside from the huge reversal spikes, the only part of the trend that is not covered are the bars after the <abbr title=\"target price\">TP</abbr> has been hit and before the next <abbr title=\"Heikin Ashi\">HA</abbr> signal. If the next signal is higher than the <abbr title=\"target price\">TP</abbr>, which can happen, then the trader will miss out on a portion of the trend.</p>\n<p>The disadvantage of the <abbr title=\"Heikin Ashi\">HA</abbr> is that it displays candlestick bars that are slightly different to the real bars - it is after all an averaging system. To correct this, use your software to show both charts, the normal one and the <abbr title=\"Heikin Ashi\">HA</abbr>, side by side. Or better still, place one chart on top of the other and then flick between them so that you can see the signals and the original chart. In this series, whenever I can, I will try to place them side by side with the <abbr title=\"Heikin Ashi\">HA</abbr> on the right. Also, the normal chart has the EMA4 (green) and EMA2 (gold) moving averages so that you can compare the signals with the <abbr title=\"Heikin Ashi\">HA</abbr> chart.</p>\n<p>This section has not done justice to Heikin Ashi which has its own set of candlestick patterns differing from the traditional ones. Candlestick tails (shadows) or their absence take on new meaning. If you are interested, there are many books and sites on the web that discuss this technique further.</p>\n<h4>Custom Signals</h4>\n<p>These examples above illustrate how to create a setup around any custom signal. All that is required is a clear, unambiguous trigger to open a position starting at a particular time period with some condition specifying the open price. To open the position you use the setup tools from our earlier series on \"The Basic Setup\". Looking around the area the signal occurs, you should be able to identify the most appropriate <abbr title=\"stop loss\">SL</abbr> level. The setup tools describe the number of contracts and your own simulation described in a later story determine the <abbr title=\"target price\">TP</abbr>.</p>\n<h4>Summary</h4>\n<p>Here we discussed what qualifies as a signal and showed several different signals based on MAs, candlestick patterns and Heikin Ashi charts.</p>\n<p>Note, these are all simple signaling systems: there is nothing complex about a pin bar or crossing moving average. Taken by themselves they could lose more than they would win. However when combined into a system they become powerful trading tools.</p>\n<p>In other stories and posts I may use different signals just to show how widely the system method can be applied. While it does not depend on any one signal strategy, every system needs at least one signal strategy in order to trigger opening a long or short position.</p>\n<p>The problem with signals is that sometimes they fail and the setup is stopped out. By itself, all we can say is the signal was successful or unsuccessful. However if losses are accumulating in the account then you are faced with the very real prospect of being wiped out. We need the bigger picture to see if all the positions we have opened as a result of signals are winning or likely to win.</p>\n<p>Now we turn to <a href=\"/stories/47/2017/10/24/trading-systems-part-5-systems/\">building our first system</a>. With all the building blocks in place - trend, setup and signal - it is just a matter of assembling them in the right order into a system.\n<br>\n<br>\n<br>\n<br>\n<br></p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"id": 45,
"title": "Important Things to Know About Forex and Futures Trading Signals",
"slug": "trading-systems-part-3-signals",
"status": 2,
"publication_date": "2017-10-24T03:49:44Z",
"lead": "This third story in the series \"Introduction to Trading Systems\" explains a signal, the trigger alerting us to open a position in an instrument.",
"excerpt": "This third story in the series on Trading Systems explains a signal, the trigger alerting us to open a position in an instrument.",
"poster": "SeanManefield",
"content": "---\r\n#### **Trading Systems Part 3 - Signals**\r\n\r\nA signal is a price pattern trigger that opens a position. It might be a crossing moving average, a candlestick pattern such as a pin bar, or one of a host of other available indicators.\r\n\r\nA Signal then is a general *class* of market events that act like triggers. A Setup is a particular *instance* of a signal and includes all the trade data necessary to open that position.\r\n\r\nThe difference between signal and setup is much like the *concept* of dog versus a *real* dog. In your head you can imagine a dog and there is no chance of confusing one with a horse. But in the real world, dogs come in all shapes and sizes from cute little puppies to Great Danes. We still readily recognize a particular animal as a dog when it exhibits familiar dog-like qualities.\r\n\r\nIn the same way, signals are a class of triggers while setups are the real-world instance of those signals and provide the actual OP, SL, TP and CO you need to make a trade. You can use the terms interchangeably if you like which might result in some minor confusion, as long as you don't confuse either with a horse. When we talk about a signal, we imagine a reversal or some other specific trigger pattern. When we talk about a setup, we describe the particular SL and OP that surround that reversal, as can be seen in the annotated chart of the S&P below which uses a Heikin Ashi signal.\r\n\r\n![Signals vs Setup](/media/uploads/2017/basic_system_trading/SPX-D1-HA-rev-EG-signal-vs-setup-20171012.png \"Signals vs Setup\"):c95!\r\n\r\n\r\n** Open Only with the Trend **\r\n\r\nSo far we have discussed trend which I have argued will determine the direction of our trades. Since we only trade with the trend, we should ignore signals that trigger in the opposite direction. In a bull market we only open long. Since a computer program should in principle be able to flag opportunities on a chart, a signal must include all the rules you have decided to check before opening a trade. For example, if you only open pin bars in the direction of the trend then a pin bar at the top of a swing high is not a signal in an uptrend.\r\n\r\nWithin the trend we can use the setup tool to construct an OP, SL, TP and CS for *any* candlestick bar. Although I do not advocate your trying this, it explains why we discussed the setup first. The setup can be used anywhere, although probably not profitably. Since each bar has a low and a close, the low could be used as the SL and the OP would use the close of this bar or the open of the next. The number of contracts derives from risk (OP-SL). All we need to finish the setup is an optimal TP.\r\n\r\n** Support and Resistance **\r\n\r\nIf we applied such a strategy to every bar on the chart we could expect a disaster. There are too many whipsaw regions where stops would be constantly triggered. This naturally leads us to exclude most bars as open candidates for signals and instead concentrate on the small subset of bars where probability favors our trade.\r\n\r\n![Rejection & Support with a Pin Bar](/media/uploads/2017/basic_system_trading/Pin_Bar.png \"Rejection & Support with a Pin Bar\"):R40\r\nThe key to a good signal is that an area has been tested by the market and rejected. That's where we want to place our stops. The market may come back to test that area again and there is no guarantee our stops will hold. But that's also true everywhere on the chart. The one thing we know about an area of rejection is that it was tested at least once and the level held. Enough other traders entered in the direction of the trend before those levels were breached and that is an important defense of our trade in the future, raising the probability, however slightly, that our trade setup will succeed.\r\n\r\nAny pattern that tests and rejects an area of support is a *candidate* for a signal. Whether it's an acceptable candidate or not remains to be seen. Eventually you will decide on a small class of identifiable patterns that you will use as signals, all other patterns will be considered normal bars. Identifying areas of support (or resistance in a bear market) and how your signal exposes them will be your mission.\r\n\r\n** A Retracement Ending **\r\n\r\n![Retrace before Pin Bar](/media/uploads/2017/basic_system_trading/PB-OK-retrace.png \"Retrace before Pin Bar\"):L20\r\nWe might reasonably impose the extra condition that some kind of retracement occurred before the candidate signal. After reviewing all the historic data we might exclude from our signals any patterns that were not preceded by at least two periods of trading against the trend. This is a filter that *you* will decide for your own favorite signal. Trigger patterns that are not *prominent* in some way have not yet tested and rejected an area. The SL level you use must have a higher probability of surviving a retest than any normal bar.\r\n![No retrace before pin bar](/media/uploads/2017/basic_system_trading/PB-No-retrace.png \"No Retrace before Pin Bar\"):R40\r\n\r\n** Avoid Spikes **\r\n\r\nSometimes the stop loss level is so far away from the open price that the corresponding TP will lie somewhere far in the opposite direction. Reaching such a target price might seem improbable to an experienced trader. This might occur if our prospective SL is a large spike caused by some dramatic news that hit the market, in which case it may be better to wait for the next retracement to enter.\r\n\r\nIn the same way, avoid markets when major unexpected events are under way such as a war starting, the UK Brexit vote, or the USA 2016 election. Clearly there's nothing you can do to avoid these events if you are already in a trade and the unexpected is happening. But you should avoid plunging into a trade to take advantage of the volatility. Your stops will be highly vulnerable and the days following would be a much better trading environment.\r\n\r\n** No Waiting: Open According to your Trading Rules **\r\n\r\nDepending on your signal, you must open at the start of trading of the very next period OR wherever you tested in your simulations. If you wait for a better price you stand to miss out on the trade all together and all your testing results for the signal and system no longer apply. \r\n\r\nFor example, some setups fail and more of the trades that failed may have fallen to a 'better price' at the open than those that were successful, leaving you with positions in a greater proportion of losers. When this is true, your real trading results will underperform your tests results.\r\n\r\n** Only One Position at a Time **\r\n\r\nSince we do not want our total risk in this position to exceed 2%, never open a new trade when one is already open, except in other uncorrelated markets. If your trade is winning, other traders will be on the same ride as you. New signals occurring in the market at that time will be ignored by successful traders because they know not to amplify their risks with more than 2% of their risk capital, or whatever percentage they allocate to an open trade. That means you will be opening a trade where other traders are less likely to join in to help propel the price in your direction.\r\n\r\n![No Multiple Positions](/media/uploads/2017/basic_system_trading/SPX-D1-HA-rev-Single-Positions-20171012-2.png \"No Multiple Positions\"):R50\r\nThis is also true if there had earlier been a clear signal that you missed for some reason. The other traders whom you would like to join you in this trade are already in that earlier one. There are no secrets in the markets - if you can see a signal worth trading then so can many others. What may look like a pin bar to you could look like an engulfing pattern to another trader using a shorter timeframe. If the price moves up then another trader's MAs will cross. Momentum will also change, triggering even more traders to join the trade. So other traders may be following different signals to you but they may still be triggered to open in the same general area as your signal.\r\n\r\nTread carefully once you have open trades and always check the correlations between the markets you choose. If two markets are 100% correlated then you cannot have simultaneous positions in both markets. It would be as if you were trading the same instrument but with double the risk. For this reason, avoid trading in correlated markets until you have exited the other position. If you are unsure about correlation in general or whether two markets are highly correlated then it's best to just trade one market at any one time.\r\n\r\n<a id=\"Rules-and-Filters\"></a>** Rules and Filters **\r\n\r\nA signal then is a set of rules about when to enter a trade. On the one hand there are the mechanical rules that I discuss below, such as a pin bar must occur or an MA must cross. These are mechanical because they involve no discretion and arise straight from a pattern of market prices on the chart. On the other hand there are filtering conditions we might apply before we open a trade. For example:\r\n\r\n- the trade must be in the direction of the trend\r\n- avoid candles with huge spikes\r\n- a retrace should be of a certain percentage of the previous runup\r\n- the retrace should occur at some key level such as a **`fibonacci`** or support/resistance area\r\n- never open a trade if you are already open in this or a correlated market.\r\n\r\nYou might apply filters such as these after testing and observing their effects on the total profit of the system, as I discuss later. However, you the reader have a lot of fertile territory to improve on what we lay out here. Many filtering conditions will depend on the precise trigger you are using.\r\n\r\nA common set of filters are the momentum oscillators such as RSI and MACD. Filters tend to keep you out of trades, which is their purpose. However watch out in your testing to see if they add to or reduce your total wins. Helping you avoid bad trades is good, but keeping you out of good trades that win multiples of what you lose in bad trades is toxic.\r\n\r\n** Signal Coverage **\r\n\r\nFor a signal to be acceptable it must be immediately recognizable as the pattern you are seeking. Testing should already have confirmed that similar signals are profitable and it should have relatively complete coverage of the trend. \r\n\r\nBy *complete coverage* I mean that the signal will allow us to participate in the full run of the trend. If stopped out, we should receive another chance to enter via a subsequent signal. Buying at the bottom and selling at the top would of course be full coverage, if only such a thing were consistently possible. Missing the entire trend altogether would be zero coverage. We should prefer a signal that has better coverage because it's more likely to keep us in open positions during more of the trend.\r\n\r\nMoving average crosses and Heikin Ashi reversals are two examples having almost complete coverage, while pin bars depend on how often they occur in the relevant section of the trend.\r\n\r\n#### Summary\r\n\r\nThere are many different kinds of signals and traders have their own favorites. Since this is an education site, we are agnostic here about which signal you use. In the descriptions below, I will deliberately use the simplest signal I can find. My purpose is to describe *how* to go about building a system, not to advocate for any particular signal.\r\n\r\nIn other stories and posts I may use different signals just to show how widely the system method can be applied. A system does not require any one signal strategy but it does need a trigger in order to open positions. For this reason, you will have to select a signal method you are comfortable with.\r\n\r\nIt may well be that it does not matter in general what signal strategy you decide upon. What may be more important overall is how you apply it. I will discuss this further in the story about Systems.\r\n\r\nIn the [next story](/stories/46/2017/10/24/trading-systems-part-4-examples-of-signals/) I will discuss several common and not so common signal strategies: the MA cross, pin bars, engulfing patterns and the Heikin Ashi reversal. These are all just examples and you are encouraged to use whatever signal method you have been using to date.\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n\r\n*[HA]: Heikin Ashi\r\n*[MA]: Moving Average over a specified period - 100 periods for eg\r\n*[EMA]: Exponential Moving Average - has a long 'memory'\r\n*[OHLC]: Open, High, Low, Close: the 4 key values for any bar on a chart\r\n*[bull]: An uptrending or rising market\r\n*[bear]: A downtrending or falling market\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[MR]: Maximum Risk\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[EURJPY]: The Euro - Yen cross currency: buying Euros priced in Yen\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[setup]: An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\r\n*[instrument]: A particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: Particular traded forex or futures contracts such as gold or USDJPY\r\n*[underlined text]: Congratulations! You have successfully hovered over text\r\n*[indicator]: A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\r\n*[indicators]: Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\r\n*[H4]: Chart of the four hour timeframe\r\n*[M5]: Chart of the five minute timeframe\r\n*[H1]: Chart of the one hour timeframe",
"image": null,
"html": "<hr>\n<h4><strong>Trading Systems Part 3 - Signals</strong></h4>\n<p>A <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> is a price pattern trigger that opens a position. It might be a crossing moving average, a candlestick pattern such as a pin bar, or one of a host of other available <abbr title=\"Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\">indicators</abbr>.</p>\n<p>A Signal then is a general <em>class</em> of market events that act like triggers. A Setup is a particular <em>instance</em> of a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> and includes all the trade data necessary to open that position.</p>\n<p>The difference between <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> and <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> is much like the <em>concept</em> of dog versus a <em>real</em> dog. In your head you can imagine a dog and there is no chance of confusing one with a horse. But in the real world, dogs come in all shapes and sizes from cute little puppies to Great Danes. We still readily recognize a particular animal as a dog when it exhibits familiar dog-like qualities.</p>\n<p>In the same way, signals are a class of triggers while setups are the real-world instance of those signals and provide the actual <abbr title=\"open price\">OP</abbr>, <abbr title=\"stop loss\">SL</abbr>, <abbr title=\"target price\">TP</abbr> and <abbr title=\"number of contracts opened\">CO</abbr> you need to make a trade. You can use the terms interchangeably if you like which might result in some minor confusion, as long as you don't confuse either with a horse. When we talk about a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>, we imagine a reversal or some other specific trigger pattern. When we talk about a <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr>, we describe the particular <abbr title=\"stop loss\">SL</abbr> and <abbr title=\"open price\">OP</abbr> that surround that reversal, as can be seen in the annotated chart of the S&P below which uses a Heikin Ashi <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>.</p>\n<p><img alt=\"Signals vs Setup\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-HA-rev-EG-signal-vs-setup-20171012.png\" style=\"float: right;\" title=\"Signals vs Setup\" width=\"95%\"></p><div class=\"clear-floating-cols-above\"></div><p></p>\n<p><strong> Open Only with the Trend </strong></p>\n<p>So far we have discussed trend which I have argued will determine the direction of our trades. Since we only trade with the trend, we should ignore signals that trigger in the opposite direction. In a <abbr title=\"An uptrending or rising market\">bull</abbr> market we only open long. Since a computer program should in principle be able to flag opportunities on a chart, a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> must include all the rules you have decided to check before opening a trade. For example, if you only open pin bars in the direction of the trend then a pin bar at the top of a swing high is not a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> in an uptrend.</p>\n<p>Within the trend we can use the <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> tool to construct an <abbr title=\"open price\">OP</abbr>, <abbr title=\"stop loss\">SL</abbr>, <abbr title=\"target price\">TP</abbr> and <abbr title=\"contract size\">CS</abbr> for <em>any</em> candlestick bar. Although I do not advocate your trying this, it explains why we discussed the <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> first. The <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> can be used anywhere, although probably not profitably. Since each bar has a low and a close, the low could be used as the <abbr title=\"stop loss\">SL</abbr> and the <abbr title=\"open price\">OP</abbr> would use the close of this bar or the open of the next. The number of contracts derives from risk (<abbr title=\"open price\">OP</abbr>-<abbr title=\"stop loss\">SL</abbr>). All we need to finish the <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> is an optimal <abbr title=\"target price\">TP</abbr>.</p>\n<p><strong> Support and Resistance </strong></p>\n<p>If we applied such a strategy to every bar on the chart we could expect a disaster. There are too many whipsaw regions where stops would be constantly triggered. This naturally leads us to exclude most bars as open candidates for signals and instead concentrate on the small subset of bars where probability favors our trade.</p>\n<p><img alt=\"Rejection & Support with a Pin Bar\" src=\"/media/uploads/2017/basic_system_trading/Pin_Bar.png\" style=\"float: right;\" title=\"Rejection & Support with a Pin Bar\" width=\"40%\">\nThe key to a good <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> is that an area has been tested by the market and rejected. That's where we want to place our stops. The market may come back to test that area again and there is no guarantee our stops will hold. But that's also true everywhere on the chart. The one thing we know about an area of rejection is that it was tested at least once and the level held. Enough other traders entered in the direction of the trend before those levels were breached and that is an important defense of our trade in the future, raising the probability, however slightly, that our trade <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> will succeed.</p>\n<p>Any pattern that tests and rejects an area of support is a <em>candidate</em> for a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>. Whether it's an acceptable candidate or not remains to be seen. Eventually you will decide on a small class of identifiable patterns that you will use as signals, all other patterns will be considered normal bars. Identifying areas of support (or resistance in a <abbr title=\"A downtrending or falling market\">bear</abbr> market) and how your <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> exposes them will be your mission.</p>\n<p><strong> A Retracement Ending </strong></p>\n<p><img alt=\"Retrace before Pin Bar\" src=\"/media/uploads/2017/basic_system_trading/PB-OK-retrace.png\" style=\"float: left;\" title=\"Retrace before Pin Bar\" width=\"20%\">\nWe might reasonably impose the extra condition that some kind of retracement occurred before the candidate <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>. After reviewing all the historic data we might exclude from our signals any patterns that were not preceded by at least two periods of trading against the trend. This is a filter that <em>you</em> will decide for your own favorite <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>. Trigger patterns that are not <em>prominent</em> in some way have not yet tested and rejected an area. The <abbr title=\"stop loss\">SL</abbr> level you use must have a higher probability of surviving a retest than any normal bar.\n<img alt=\"No retrace before pin bar\" src=\"/media/uploads/2017/basic_system_trading/PB-No-retrace.png\" style=\"float: right;\" title=\"No Retrace before Pin Bar\" width=\"40%\"></p>\n<p><strong> Avoid Spikes </strong></p>\n<p>Sometimes the stop loss level is so far away from the open price that the corresponding <abbr title=\"target price\">TP</abbr> will lie somewhere far in the opposite direction. Reaching such a target price might seem improbable to an experienced trader. This might occur if our prospective <abbr title=\"stop loss\">SL</abbr> is a large spike caused by some dramatic news that hit the market, in which case it may be better to wait for the next retracement to enter.</p>\n<p>In the same way, avoid markets when major unexpected events are under way such as a war starting, the UK Brexit vote, or the USA 2016 election. Clearly there's nothing you can do to avoid these events if you are already in a trade and the unexpected is happening. But you should avoid plunging into a trade to take advantage of the volatility. Your stops will be highly vulnerable and the days following would be a much better trading environment.</p>\n<p><strong> No Waiting: Open According to your Trading Rules </strong></p>\n<p>Depending on your <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>, you must open at the start of trading of the very next period OR wherever you tested in your simulations. If you wait for a better price you stand to miss out on the trade all together and all your testing results for the <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> and system no longer apply. </p>\n<p>For example, some setups fail and more of the trades that failed may have fallen to a 'better price' at the open than those that were successful, leaving you with positions in a greater proportion of losers. When this is true, your real trading results will underperform your tests results.</p>\n<p><strong> Only One Position at a Time </strong></p>\n<p>Since we do not want our total risk in this position to exceed 2%, never open a new trade when one is already open, except in other uncorrelated markets. If your trade is winning, other traders will be on the same ride as you. New signals occurring in the market at that time will be ignored by successful traders because they know not to amplify their risks with more than 2% of their risk capital, or whatever percentage they allocate to an open trade. That means you will be opening a trade where other traders are less likely to join in to help propel the price in your direction.</p>\n<p><img alt=\"No Multiple Positions\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-HA-rev-Single-Positions-20171012-2.png\" style=\"float: right;\" title=\"No Multiple Positions\" width=\"50%\">\nThis is also true if there had earlier been a clear <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> that you missed for some reason. The other traders whom you would like to join you in this trade are already in that earlier one. There are no secrets in the markets - if you can see a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> worth trading then so can many others. What may look like a pin bar to you could look like an engulfing pattern to another trader using a shorter timeframe. If the price moves up then another trader's MAs will cross. Momentum will also change, triggering even more traders to join the trade. So other traders may be following different signals to you but they may still be triggered to open in the same general area as your <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>.</p>\n<p>Tread carefully once you have open trades and always check the correlations between the markets you choose. If two markets are 100% correlated then you cannot have simultaneous positions in both markets. It would be as if you were trading the same <abbr title=\"A particular traded forex or futures contract such as gold or USDJPY\">instrument</abbr> but with double the risk. For this reason, avoid trading in correlated markets until you have exited the other position. If you are unsure about correlation in general or whether two markets are highly correlated then it's best to just trade one market at any one time.</p>\n<p><a id=\"Rules-and-Filters\"></a><strong> Rules and Filters </strong></p>\n<p>A <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> then is a set of rules about when to enter a trade. On the one hand there are the mechanical rules that I discuss below, such as a pin bar must occur or an <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> must cross. These are mechanical because they involve no discretion and arise straight from a pattern of market prices on the chart. On the other hand there are filtering conditions we might apply before we open a trade. For example:</p>\n<ul>\n<li>the trade must be in the direction of the trend</li>\n<li>avoid candles with huge spikes</li>\n<li>a retrace should be of a certain percentage of the previous runup</li>\n<li>the retrace should occur at some key level such as a <strong><code>fibonacci</code></strong> or support/resistance area</li>\n<li>never open a trade if you are already open in this or a correlated market.</li>\n</ul>\n<p>You might apply filters such as these after testing and observing their effects on the total profit of the system, as I discuss later. However, you the reader have a lot of fertile territory to improve on what we lay out here. Many filtering conditions will depend on the precise trigger you are using.</p>\n<p>A common set of filters are the momentum oscillators such as RSI and MACD. Filters tend to keep you out of trades, which is their purpose. However watch out in your testing to see if they add to or reduce your total wins. Helping you avoid bad trades is good, but keeping you out of good trades that win multiples of what you lose in bad trades is toxic.</p>\n<p><strong> Signal Coverage </strong></p>\n<p>For a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> to be acceptable it must be immediately recognizable as the pattern you are seeking. Testing should already have confirmed that similar signals are profitable and it should have relatively complete coverage of the trend. </p>\n<p>By <em>complete coverage</em> I mean that the <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> will allow us to participate in the full run of the trend. If stopped out, we should receive another chance to enter via a subsequent <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>. Buying at the bottom and selling at the top would of course be full coverage, if only such a thing were consistently possible. Missing the entire trend altogether would be zero coverage. We should prefer a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> that has better coverage because it's more likely to keep us in open positions during more of the trend.</p>\n<p>Moving average crosses and Heikin Ashi reversals are two examples having almost complete coverage, while pin bars depend on how often they occur in the relevant section of the trend.</p>\n<h4>Summary</h4>\n<p>There are many different kinds of signals and traders have their own favorites. Since this is an education site, we are agnostic here about which <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> you use. In the descriptions below, I will deliberately use the simplest <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> I can find. My purpose is to describe <em>how</em> to go about building a system, not to advocate for any particular <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>.</p>\n<p>In other stories and posts I may use different signals just to show how widely the system method can be applied. A system does not require any one <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> strategy but it does need a trigger in order to open positions. For this reason, you will have to select a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> method you are comfortable with.</p>\n<p>It may well be that it does not matter in general what <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> strategy you decide upon. What may be more important overall is how you apply it. I will discuss this further in the story about Systems.</p>\n<p>In the <a href=\"/stories/46/2017/10/24/trading-systems-part-4-examples-of-signals/\">next story</a> I will discuss several common and not so common <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> strategies: the <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> cross, pin bars, engulfing patterns and the Heikin Ashi reversal. These are all just examples and you are encouraged to use whatever <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> method you have been using to date.\n<br>\n<br>\n<br>\n<br>\n<br></p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"id": 44,
"title": "What you Need to Know About Timeframes, Fundamentals and Reversals in Forex and Futures Systems",
"slug": "trading-systems-part-2-timeframes-fundamentals-reversals-and-retracements",
"status": 2,
"publication_date": "2017-10-24T03:47:29Z",
"lead": "This second story in the series \"Introduction to Trading Systems\" investigates how timeframes and fundamentals affect the trend. We also look at how to distinguish retracements from trend reversals.",
"excerpt": "This second story in the series on Trading Systems investigates how timeframes and fundamentals affect the trend. We also look at how to distinguish retracements from trend reversals.",
"poster": "SeanManefield",
"content": "---\r\n#### **Trading Systems Part 2**\r\n\r\nThe [previous story](/stories/43/2017/10/24/trading-systems-part-1-introduction/) introduced trends and showed how to recognize them using higher-high and higher-low cycles, (HH-HL, or LH-LL in downtrends) and moving averages. Here we will look further into timeframes and fundamentals to see how they affect the trend.\r\n\r\nIn some cases a trend can be almost indistinguishable from a sideways pattern. Cases like this are to be avoided because if other traders in the market lack conviction why should you be so convinced? Trade another market and come back to this one when the trend is more obvious.\r\n\r\n<a id=\"shorter-timeframes\">\r\n#### Shorter Timeframes\r\n\r\nAnother alternative is to move your trading to a shorter time frame: what looks like a series of whipsaws going nowhere on the weekly, may look like a strong trend on the latest section of the H4 chart. Equally, you could move to a longer timeframe: what looks like a sideways market on the H4 may be just a small retrace forming in a steady trend on the weekly. Favor longer over shorter timeframes if you can.\r\n\r\nYour charting software usually allows you to choose between various timeframes. The common ones include:\r\n\r\n- one minute\r\n- 5 minutes\r\n- 15 minutes\r\n- one hour\r\n- 4 hours (H4)\r\n- one day (D1)\r\n- one week (W1) and\r\n- one month\r\n\r\nEach timeframe collapses all the trades for that period into one bar on the chart. The open and the close are the prices where the time period began and ended respectively, and the high and low are the trading extremes over the duration of the period.\r\n\r\nIn general you should aim to trade the daily. This allows you 24 hours to digest a single candlestick, which is often enough time to review the news. You will have several days at least between trades, enough time to recover from a failed trade as well as time to remind yourself after a successful trade that you are very much human. In ancient Rome a slave would whisper in Caesar's ear that he should *\"Remember, you are only a mortal!\"* while enjoying the adolation of the crowd during a victory triumph. A win is often a lot of money so never let success carry you away. It's just a trading system and sometimes it wins, sometimes it loses. A level head helps.\r\n\r\nHowever if the markets are trendless on the daily or weekly charts, you might consider trading shorter timeframes where a tradable trend may be easier to see. Consider the Gold futures contract where gold has been consolidating sideways on the weekly chart after falling from its 2011 European crisis highs.\r\n\r\nHere is how a longer timeframe (weekly) looks for the Gold continuous futures contract:\r\n![Gold Futures - no trend on the weekly](/media/uploads/2017/basic_system_trading/Gold-Wk-NoT-20171015.png \"Gold Futures - no trend on the weekly\"):C90\r\n\r\nThose little wiggles in the chart look insignificant on the weekly but on the H4 they display a tradable trend:![Gold Futures - H4 trending](/media/uploads/2017/basic_system_trading/Gold-H4-T-20171015.png \"Gold Futures - H4 trending\"):C90\r\n\r\nIn terms of the basic operation of your system, nothing much changes in your setup, signals and system as you move to a shorter timeframe, other than the points I discussed above about analysis and recovery time. But there are some notable differences with shorter timeframes you must be aware of:\r\n\r\n- Unless the system is automated or you have trading partners scattered across timezones trading the same system on the same portfolio, no human can trade 24 hours continuously without sleeping.\r\n- You cannot assume the best signals occur while you are awake.\r\n- You will therefore miss many signals.\r\n- News that shocks the daily charts will so overwhelm the shorter timeframe that your stops can slip disastrously. Your system could be thrown into deep losses. Of course, the opposite may happen as well and you win, but then you are limited to a four fold win. Except for the very best, many brokers will force you to carry all losses but will turn on a dime to share in any gains should you win more than you expected.\r\n- Bid/ask spreads and commissions become a bigger percentage of the trade.\r\n- Margin comes into play because you will be buying more contracts given the closer stops and therefore the lower risk - see the series on [\"The Basic Setup\"](/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/) for an explanation.\r\n\r\nChoose a timeframe that most suits your style, favoring longer over shorter timeframes where possible.\r\n\r\n\r\n#### The Fundamentals and Trend\r\n\r\nIf you trade a market you owe it to yourself to become familiar with its news and the fundamental influences that drive it. If the instrument is trading in a bull market you should know why. As it changes direction, ask what fundamentals have now changed? Are they likely to last long enough for a trade? Ask yourself the same question every day. This is your best early clue to a change in trend.\r\n\r\nIn a very important sense, the trend *is* the longer term fundamentals. If prices in the economy are inflating, gold, oil and other commodities will be rising in price. Currencies of countries with prices rising faster will fall against the currencies of countries with more stable prices. At present (2017), inflation is low and lower than many observers expected a decade ago. In consequence, prices for gold and oil are lower than their peaks set at a time when prices were expected to rebound. Of course, there are other reasons for the fall in some commodity prices but keep your eye out for if and when inflation starts to re-enter the system.\r\n\r\nThe fundamentals and the trend should be in sync, and if they are not then you should be cautious about trading that market until they are. Also, different timeframes have different fundamentals. A minor news conference or statement from the Bank of Japan might send the Yen in a new direction on the M5 chart but result in less than a blip on the daily.\r\n\r\nAs technical traders we are accustomed to the rubric that all news is already in the prices. There is a lot of truth to that but we should still be aware of the *major* fundamentals driving the trend, not the day to day press conferences or occasional burst pipe line. When the trend changes, the prices will reverse direction but it may just look like a deep retracement in the early stages. Knowing the major fundamentals and how that affects the markets you follow will help you spot a changed trend or paradigm shift sooner.\r\n\r\n\r\n#### Trend Reversals\r\n\r\n![Trend Reversal](/media/uploads/2017/basic_system_trading/UpT-Rev-EG-20171015.png \"Is the Trend Reversing?\"):R40\r\nIt is rarely clear when a previous trend is coming to an end and has begun to reverse direction. You could wait for a pattern of HH-HL or LH-LL to assert itself. Or you might wait for the faster (short timeframe) moving average to cross the slower. If you trade these markets you should have a good idea of the news in this area. What has changed in the fundamentals to cause this new market behavior? Does it look like these new fundamentals will be market drivers over the time horizen of your trades?\r\n\r\nIf you wait until a new trend is well and truly established, it may be too late to trade. These are normal issues that every trader has to grapple with. Follow rules that are consistent so that you can measure your performance and adjust if necessary.\r\n\r\n![Gold Short Pin Bar](/media/uploads/2017/basic_system_trading/Gold-D1-NG-Rev1-20171019.png \"Gold Short Pin Bar\"):C80!\r\nThere is a tendency for some traders to trade reversals because in looking at the charts, that's where the biggest gains cluster. ![Gold Short Pin Bar](/media/uploads/2017/basic_system_trading/Gold-D1-NG-Rev2-20171019.png \"Gold Short Pin Bar: Whoops!\"):R30 However, for long periods in a row, a trend can progress relentlessly in one direction. Based on probability alone, a series of smaller trades in line with the trend would be far more likely to succeed than guessing that one place where the trend finally ends. If you trade the trend then that last trade where the reversal triggered your stop would be a loss but all the earlier wins should offset that nicely. As you can see here above and to the right, what looked like a prominent pin bar in the Gold continuous futures contract, turned out to be one more bar continuing in the direction of the trend.\r\n\r\nThe one exception to this rule about not trading reversals should be those trading sideways markets, which I do not cover here.\r\n\r\nWhile it may not be clear for some time that a trend has reversed, evidence nonetheless accumulates pointing to that conclusion:\r\n\r\n- the fundamentals have changed\r\n- coming out of a previous downtrend the market puts in a higher low and a higher high\r\n- the moving averages cross, and\r\n- possibly a candlestick reversal pattern is evident at the low.\r\n\r\nAny one of these may not mean much but when several occur then its probably time to change over to a bullish strategy of buying the retracements. Evidence for a trend change applies equally at the start and at the end of a trend. Look to the much longer timeframe to see whether the new trend is likely to be a real trend reversal or a retracement.\r\n\r\n\r\n#### Retracements against the trend\r\n\r\nWithin the trend, retracements occur regularly. On the charts above you can see these retracements between each HH and HL. There are many reasons for why prices do not move steadily in one direction but it's apparent that traders have widely divergent views about the interpretation of events as they occur in markets. Perhaps you are yourself conflicted about which way a particular item of news will send prices. There are two views right there! Profit taking by traders on their winning positions could itself reverse prices for a time.\r\n\r\nEventually whatever was fundamentally driving the trend will reassert itself, the short term profit taking will stop and stronger hands will hold on. The net effect is more buying pressure than selling within a bull market. The retracement comes to an end and the trend resumes.\r\n\r\n![Setup after retracement](/media/uploads/2017/basic_system_trading/Ret-MA-EG-20171015.png \"Setup after retracement\"):R45\r\nAs you can see, this area where prices resume in the direction of the trend is an excellent place to enter a new position. We have a clear area where the market tested further price falls and for now rejected them. Retracements that signal a resumption in trend are valuable sources of the location of support and resistance areas. I will return to explore this area further in the next section on signals in Part 3.\r\n\r\nWhen a trend reverses, it is not clear until much later when prices cut through previous areas of support or resistance. However when a retracement reverses it is from a higher low in a bull market (or lower high in a bear market) and you continue to trade with the trend. The more time you spend with charts the less chance of getting the two confused.\r\n\r\n#### Summary\r\n\r\nTrade the longer timeframes whenever possible. They give you plenty of time to analyze the market and make the necessary pyschological adjustments you need to risk your money on a trade.\r\n\r\nEven technical traders should pay attention to the fundamentals as a guide to understanding the trend.\r\n\r\nDo not confuse reversals of trend with a retracement coming to an end. Check the history of the chart to see if the market is setting a higher low in what was a downtrend (or lower high in a previous uptrend).\r\n\r\nIn the [next story](/stories/45/2017/10/24/trading-systems-part-3-signals/) we will discuss how to receive a signal from the market. Signals are the heart of trading and typically include any special market price behavior that you have previously determined will trigger you to open a position. To do so, you will use the setup tools we have already discussed.\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n\r\n*[HA]: Heikin Ashi\r\n*[MA]: Moving Average over a specified period - 100 periods for eg\r\n*[EMA]: Exponential Moving Average - has a long 'memory'\r\n*[OHLC]: Open, High, Low, Close: the 4 key values for any bar on a chart\r\n*[bull]: An uptrending or rising market\r\n*[bear]: A downtrending or falling market\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[MR]: Maximum Risk\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[EURJPY]: The Euro - Yen cross currency: buying Euros priced in Yen\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[setup]: An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\r\n*[instrument]: A particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: Particular traded forex or futures contracts such as gold or USDJPY\r\n*[underlined text]: Congratulations! You have successfully hovered over text\r\n*[indicator]: A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\r\n*[indicators]: Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\r\n*[H4]: Chart of the four hour timeframe\r\n*[M5]: Chart of the five minute timeframe\r\n*[H1]: Chart of the one hour timeframe",
"image": null,
"html": "<hr>\n<h4><strong>Trading Systems Part 2</strong></h4>\n<p>The <a href=\"/stories/43/2017/10/24/trading-systems-part-1-introduction/\">previous story</a> introduced trends and showed how to recognize them using higher-high and higher-low cycles, (HH-HL, or LH-LL in downtrends) and moving averages. Here we will look further into timeframes and fundamentals to see how they affect the trend.</p>\n<p>In some cases a trend can be almost indistinguishable from a sideways pattern. Cases like this are to be avoided because if other traders in the market lack conviction why should you be so convinced? Trade another market and come back to this one when the trend is more obvious.</p>\n<p><a id=\"shorter-timeframes\"></a></p><a id=\"shorter-timeframes\">\n<h4>Shorter Timeframes</h4>\n<p>Another alternative is to move your trading to a shorter time frame: what looks like a series of whipsaws going nowhere on the weekly, may look like a strong trend on the latest section of the <abbr title=\"Chart of the four hour timeframe\">H4</abbr> chart. Equally, you could move to a longer timeframe: what looks like a sideways market on the <abbr title=\"Chart of the four hour timeframe\">H4</abbr> may be just a small retrace forming in a steady trend on the weekly. Favor longer over shorter timeframes if you can.</p>\n<p>Your charting software usually allows you to choose between various timeframes. The common ones include:</p>\n<ul>\n<li>one minute</li>\n<li>5 minutes</li>\n<li>15 minutes</li>\n<li>one hour</li>\n<li>4 hours (<abbr title=\"Chart of the four hour timeframe\">H4</abbr>)</li>\n<li>one day (D1)</li>\n<li>one week (W1) and</li>\n<li>one month</li>\n</ul>\n<p>Each timeframe collapses all the trades for that period into one bar on the chart. The open and the close are the prices where the time period began and ended respectively, and the high and low are the trading extremes over the duration of the period.</p>\n<p>In general you should aim to trade the daily. This allows you 24 hours to digest a single candlestick, which is often enough time to review the news. You will have several days at least between trades, enough time to recover from a failed trade as well as time to remind yourself after a successful trade that you are very much human. In ancient Rome a slave would whisper in Caesar's ear that he should <em>\"Remember, you are only a mortal!\"</em> while enjoying the adolation of the crowd during a victory triumph. A win is often a lot of money so never let success carry you away. It's just a trading system and sometimes it wins, sometimes it loses. A level head helps.</p>\n<p>However if the markets are trendless on the daily or weekly charts, you might consider trading shorter timeframes where a tradable trend may be easier to see. Consider the Gold futures contract where gold has been consolidating sideways on the weekly chart after falling from its 2011 European crisis highs.</p>\n<p>Here is how a longer timeframe (weekly) looks for the Gold continuous futures contract:\n<img alt=\"Gold Futures - no trend on the weekly\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/Gold-Wk-NoT-20171015.png\" title=\"Gold Futures - no trend on the weekly\" width=\"90%\"></p>\n<p>Those little wiggles in the chart look insignificant on the weekly but on the <abbr title=\"Chart of the four hour timeframe\">H4</abbr> they display a tradable trend:<img alt=\"Gold Futures - H4 trending\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/Gold-H4-T-20171015.png\" title=\"Gold Futures - H4 trending\" width=\"90%\"></p>\n<p>In terms of the basic operation of your system, nothing much changes in your <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr>, signals and system as you move to a shorter timeframe, other than the points I discussed above about analysis and recovery time. But there are some notable differences with shorter timeframes you must be aware of:</p>\n</a><ul><a id=\"shorter-timeframes\">\n<li>Unless the system is automated or you have trading partners scattered across timezones trading the same system on the same portfolio, no human can trade 24 hours continuously without sleeping.</li>\n<li>You cannot assume the best signals occur while you are awake.</li>\n<li>You will therefore miss many signals.</li>\n<li>News that shocks the daily charts will so overwhelm the shorter timeframe that your stops can slip disastrously. Your system could be thrown into deep losses. Of course, the opposite may happen as well and you win, but then you are limited to a four fold win. Except for the very best, many brokers will force you to carry all losses but will turn on a dime to share in any gains should you win more than you expected.</li>\n<li>Bid/ask spreads and commissions become a bigger percentage of the trade.</li>\n</a><li><a id=\"shorter-timeframes\">Margin comes into play because you will be buying more contracts given the closer stops and therefore the lower risk - see the series on </a><a href=\"/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/\">\"The Basic Setup\"</a> for an explanation.</li>\n</ul>\n<p>Choose a timeframe that most suits your style, favoring longer over shorter timeframes where possible.</p>\n<h4>The Fundamentals and Trend</h4>\n<p>If you trade a market you owe it to yourself to become familiar with its news and the fundamental influences that drive it. If the <abbr title=\"A particular traded forex or futures contract such as gold or USDJPY\">instrument</abbr> is trading in a <abbr title=\"An uptrending or rising market\">bull</abbr> market you should know why. As it changes direction, ask what fundamentals have now changed? Are they likely to last long enough for a trade? Ask yourself the same question every day. This is your best early clue to a change in trend.</p>\n<p>In a very important sense, the trend <em>is</em> the longer term fundamentals. If prices in the economy are inflating, gold, oil and other commodities will be rising in price. Currencies of countries with prices rising faster will fall against the currencies of countries with more stable prices. At present (2017), inflation is low and lower than many observers expected a decade ago. In consequence, prices for gold and oil are lower than their peaks set at a time when prices were expected to rebound. Of course, there are other reasons for the fall in some commodity prices but keep your eye out for if and when inflation starts to re-enter the system.</p>\n<p>The fundamentals and the trend should be in sync, and if they are not then you should be cautious about trading that market until they are. Also, different timeframes have different fundamentals. A minor news conference or statement from the Bank of Japan might send the <abbr title=\"The Japanese currency\">Yen</abbr> in a new direction on the <abbr title=\"Chart of the five minute timeframe\">M5</abbr> chart but result in less than a blip on the daily.</p>\n<p>As technical traders we are accustomed to the rubric that all news is already in the prices. There is a lot of truth to that but we should still be aware of the <em>major</em> fundamentals driving the trend, not the day to day press conferences or occasional burst pipe line. When the trend changes, the prices will reverse direction but it may just look like a deep retracement in the early stages. Knowing the major fundamentals and how that affects the markets you follow will help you spot a changed trend or paradigm shift sooner.</p>\n<h4>Trend Reversals</h4>\n<p><img alt=\"Trend Reversal\" src=\"/media/uploads/2017/basic_system_trading/UpT-Rev-EG-20171015.png\" style=\"float: right;\" title=\"Is the Trend Reversing?\" width=\"40%\">\nIt is rarely clear when a previous trend is coming to an end and has begun to reverse direction. You could wait for a pattern of HH-HL or LH-LL to assert itself. Or you might wait for the faster (short timeframe) moving average to cross the slower. If you trade these markets you should have a good idea of the news in this area. What has changed in the fundamentals to cause this new market behavior? Does it look like these new fundamentals will be market drivers over the time horizen of your trades?</p>\n<p>If you wait until a new trend is well and truly established, it may be too late to trade. These are normal issues that every trader has to grapple with. Follow rules that are consistent so that you can measure your performance and adjust if necessary.</p>\n<p><img alt=\"Gold Short Pin Bar\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/Gold-D1-NG-Rev1-20171019.png\" title=\"Gold Short Pin Bar\" width=\"80%\"></p><div class=\"clear-floating-cols-above\"></div>\nThere is a tendency for some traders to trade reversals because in looking at the charts, that's where the biggest gains cluster. <img alt=\"Gold Short Pin Bar\" src=\"/media/uploads/2017/basic_system_trading/Gold-D1-NG-Rev2-20171019.png\" style=\"float: right;\" title=\"Gold Short Pin Bar: Whoops!\" width=\"30%\"> However, for long periods in a row, a trend can progress relentlessly in one direction. Based on probability alone, a series of smaller trades in line with the trend would be far more likely to succeed than guessing that one place where the trend finally ends. If you trade the trend then that last trade where the reversal triggered your stop would be a loss but all the earlier wins should offset that nicely. As you can see here above and to the right, what looked like a prominent pin bar in the Gold continuous futures contract, turned out to be one more bar continuing in the direction of the trend.<p></p>\n<p>The one exception to this rule about not trading reversals should be those trading sideways markets, which I do not cover here.</p>\n<p>While it may not be clear for some time that a trend has reversed, evidence nonetheless accumulates pointing to that conclusion:</p>\n<ul>\n<li>the fundamentals have changed</li>\n<li>coming out of a previous downtrend the market puts in a higher low and a higher high</li>\n<li>the moving averages cross, and</li>\n<li>possibly a candlestick reversal pattern is evident at the low.</li>\n</ul>\n<p>Any one of these may not mean much but when several occur then its probably time to change over to a bullish strategy of buying the retracements. Evidence for a trend change applies equally at the start and at the end of a trend. Look to the much longer timeframe to see whether the new trend is likely to be a real trend reversal or a retracement.</p>\n<h4>Retracements against the trend</h4>\n<p>Within the trend, retracements occur regularly. On the charts above you can see these retracements between each HH and HL. There are many reasons for why prices do not move steadily in one direction but it's apparent that traders have widely divergent views about the interpretation of events as they occur in markets. Perhaps you are yourself conflicted about which way a particular item of news will send prices. There are two views right there! Profit taking by traders on their winning positions could itself reverse prices for a time.</p>\n<p>Eventually whatever was fundamentally driving the trend will reassert itself, the short term profit taking will stop and stronger hands will hold on. The net effect is more buying pressure than selling within a <abbr title=\"An uptrending or rising market\">bull</abbr> market. The retracement comes to an end and the trend resumes.</p>\n<p><img alt=\"Setup after retracement\" src=\"/media/uploads/2017/basic_system_trading/Ret-MA-EG-20171015.png\" style=\"float: right;\" title=\"Setup after retracement\" width=\"45%\">\nAs you can see, this area where prices resume in the direction of the trend is an excellent place to enter a new position. We have a clear area where the market tested further price falls and for now rejected them. Retracements that <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> a resumption in trend are valuable sources of the location of support and resistance areas. I will return to explore this area further in the next section on signals in Part 3.</p>\n<p>When a trend reverses, it is not clear until much later when prices cut through previous areas of support or resistance. However when a retracement reverses it is from a higher low in a <abbr title=\"An uptrending or rising market\">bull</abbr> market (or lower high in a <abbr title=\"A downtrending or falling market\">bear</abbr> market) and you continue to trade with the trend. The more time you spend with charts the less chance of getting the two confused.</p>\n<h4>Summary</h4>\n<p>Trade the longer timeframes whenever possible. They give you plenty of time to analyze the market and make the necessary pyschological adjustments you need to risk your money on a trade.</p>\n<p>Even technical traders should pay attention to the fundamentals as a guide to understanding the trend.</p>\n<p>Do not confuse reversals of trend with a retracement coming to an end. Check the history of the chart to see if the market is setting a higher low in what was a downtrend (or lower high in a previous uptrend).</p>\n<p>In the <a href=\"/stories/45/2017/10/24/trading-systems-part-3-signals/\">next story</a> we will discuss how to receive a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> from the market. Signals are the heart of trading and typically include any special market price behavior that you have previously determined will trigger you to open a position. To do so, you will use the <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> tools we have already discussed.\n<br>\n<br>\n<br>\n<br>\n<br></p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"post": "Got it! t.",
"html": "<p><p>Got it! t.</p></p>",
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"post": "Some of these charts show moving averages but you do not label them. The look like 100 and 200 period ma's. Is that correct? \r\nPS thanks for these articles btw it brings alot together.",
"html": "<p><p>Some of these charts show moving averages but you do not label them. The look like 100 and 200 period ma's. Is that correct? <br />PS thanks for these articles btw it brings alot together.</p></p>",
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"post": "The MAs here are 200 period (MA200) and the faster MA100 and are just used to emphasize the trend. In some cases, the time period when they cross is used to initiate trading with the trend for the simple system we cover here.\r\n\r\nHowever, there is no significance in general to the MAs. You do not need to use them at all. They are only used here to show one way in which an automated system can start opening on every signal. Before they cross, signals are either ignored or, if an opposite trend, positions are opened according to signals in the reverse direction. \r\n\r\nYou could use breakouts from a Donchian channel or any other signal you prefer. As far as we are concerned here, we are just trying to teach *how* to apply these tools, not which exact tools to use.\r\n\r\nHope that helps.",
"html": "<p><p>The MAs here are 200 period (MA200) and the faster MA100 and are just used to emphasize the trend. In some cases, the time period when they cross is used to initiate trading with the trend for the simple system we cover here.</p><br /><p>However, there is no significance in general to the MAs. You do not need to use them at all. They are only used here to show one way in which an automated system can start opening on every signal. Before they cross, signals are either ignored or, if an opposite trend, positions are opened according to signals in the reverse direction. </p><br /><p>You could use breakouts from a Donchian channel or any other signal you prefer. As far as we are concerned here, we are just trying to teach <em>how</em> to apply these tools, not which exact tools to use.</p><br /><p>Hope that helps.</p></p>",
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"title": "Building a Futures or Forex Trading System Using Trends",
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"publication_date": "2017-10-24T03:44:35Z",
"lead": "This first story in the series \"Introduction to Trading Systems\" explains what a system is and what you need to know about trends and signals so you will be able to build your own custom trading system.",
"excerpt": "This Introduction to Trading Systems explains what you need to know about trends and signals to help you build your own custom trading system.",
"poster": "SeanManefield",
"content": "---\r\n\r\n#### **Trading Systems Part 1**\r\n\r\nThis series shows you how to build a trading system. Within a system there is an almost limitless variety of buy and sell signals we could use, but here I purposely avoid advocating any particular method. That's because for many traders it's the system that is missing, not the ability to recognize a valid signal.\r\n\r\nBy learning how to build your own system you will have a trading method unique enough that you will be able to enter profitable positions hopefully before any advantage is arbitraged away by others. When enough traders play the same system, your entries, stops and targets would be discovered. Bigger players may find it profitable to bet against you, knowing that triggering your stops would allow them to enter in the same direction as you at a better price. By trading against you, the bigger players can reduce the profitability of your system and may even cause it to fail.\r\n\r\nFor that reason, I do not advocate you using any simple system outlined here. That's also true of just about any publically known system. It helps that there are so many systems out there, but what really helps is that so many beginning traders don't use systems at all. Instead, they make regular 'donations' to those who do, until their accounts are empty.\r\n\r\nWhat I present below is just for learning purposes. It should be easy to adapt this material to your particular trading style and favorite indicators, and I show you how.\r\n\r\nA system is simply a sequence of trades, all based on the same or similar **`signals`**. It is designed by carefully evaluating the historic data and the longer term charts. Any one trade might fail leaving you with a loss however a system covers multiple trades and the designer of a system looks for an approach where wins consistently beat losses.\r\n\r\n![Sample MA Cross System](/media/uploads/2017/basic_system_trading/SPX-D1-UpT-MACross-EG-20171019.png \"Sample MA Cross System\"):C100\r\n\r\nAbove is an example of a system, although it makes little sense at this point. Nonetheless, you can see that we have six setups on this chart where we could place an open trade based on the crossing of two **`moving averages`** (MAs). They are marked by little crosses below where the MA cross occurred, green for success and red for failure. I will explain this in detail later on but for now it just means that whenever the five period MA, MA(5), crosses above the MA(14) we will open a long position. There is nothing significant in these MA periods, they are just to illustrate a simple system. There is also a pair of longer term MAs, the MA(100) and MA(200), which are only shown to emphasize the trend since point A.\r\n\r\nThe point here is that our first setup failed, as did the 3rd and 4th. However, three of the six trades here were successful. If the TP were twice the risk then this simplistic system would generate three times the risk in wins (2 x 3 wins - 1 x 3 losses = 3), and therefore 6% of our risk funds (2% x 3). Of course, I have to explain why we should be long and not short after point A, why I chose twice the risk for the TP, what's this crossing MA all about and what happened to the right of the chart. I hope this series on systems will answer all these questions and more.\r\n\r\nIn many of the examples I deliberately use a simple MA cross to determine when the trend starts and sometimes even the triggers that prompt us into a trade. Although simple, if we can make a system work well with MAs then imagine what you can do with all your favorite indicators. Also, MA crosses are easy to explain and draw, so just what I need.\r\n\r\nDon't expect a system to be anything complicated. A system is *consistent*, and the easier to understand the better. A consistent system applies the rules in the same way on every trade setup. By being consistent, a system becomes testable. If we subtly change the conditions whenever we feel the normal human emotions of fear or greed, the system could fail but we won't know why.\r\n\r\nIf you have not used a system before it brings a major improvement for very little extra work.\r\n\r\nBefore we can discuss a trading system, I have some ground to cover on a few very important concepts. I have already posted a series on [**setups**](/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/) but we also need to discuss **trends** and **signals**. These two key topics will make up parts 1 to 4 of this series.\r\n\r\nWhile I have tried to keep this presentation simple, I imagine most readers would have already thought about many of these issues. Perhaps you have been trading a while but have become frustrated how often you are stopped out of trades that afterward move in your anticipated direction. For this reason, much of the jargon of trading is not covered here, or when it is covered, perhaps I pass over it too quickly. If you hover over underlined text, a brief explanation will pop up on many uncommon terms. Please alert us via a post in the comments section whenever something is unclear.\r\n\r\nAs you design your own systems I hope you will discuss your experiences on our forums. The best way to learn is to put your own ideas out there for discussion, get help and hopefully have your system improved by other members. Feel free to post replies to existing stories and, when you have enough points earned from posts, you will be able to post your own stories. Eventually you will be able to start and moderate your own forums when you have accumulated enough reputation.\r\n\r\nIf you have not done so already, I recommend that you first read through the series on [\"The Basic Setup\"](/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/). This current series on Systems relies heavily on material discussed there on the Open Price (OP), Stop Loss (SL), Target Price (TP) and Contracts Opened (CO).\r\n\r\nFrom [\"The Basic Setup\"](/stories/40/2017/10/24/the-basic-setup-part-3-risky-trades/) we will assume in what follows a risk capital of $100,000 and a risk per trade of $2000. Because your risk capital is almost certainly different, just divide or multiply the per trade amounts depending on your available funds.\r\n\r\nAfter reading this series on systems, you should know:\r\n\r\n- how to spot a trend\r\n- the difference between a setup, a signal and a system\r\n- how to use your preferred signaling method in a full system\r\n- how to measure the number of wins and losses and\r\n- how to test whether your system has worked in the past.\r\n\r\nEverything I have to say here on trading applies equally whether short or long. However the descriptions become tedious to read when every sentence has to be qualified with something like \"or sell if short\". For this reason, in most of what follows unless otherwise stated, I will assume an uptrend (or bull market) and long positions. This is just for convenience and does not imply that being long is preferable to being short.\r\n\r\n#### <a id=\"The-Trend\"></a>The Trend\r\n\r\nMarkets spend most of their time consolidating sideways. You could build a system around this fact alone but it's not what we will do here. Instead we will focus on trending markets because those are more likely to result in a winning trade. Also the market is more likely to move to a TP that is a greater distance from the open price than the SL.\r\n\r\n![Uptrend then Consolidate](/media/uploads/2017/basic_system_trading/consolidating-trend.png \"Uptrend then Consolidate\"):R40\r\nWhen favorable information first hits the market, prices start to rise to some higher level. The prices then either consolidate, or fall back if the rise was too high or too fast. But if the asset such as gold, oil, the S&P or some currency is now worth more to the market, why doesn't the market immediately jump to that new higher level? After all, who would sell below that level and who would not be buying? Both of those factors should push the price up to the new level immediately.\r\n\r\nSometimes markets *do* adjust quickly and when that happens politicians and traders on the losing side howl that something has gone terribly wrong. But in general prices adjust slowly for several reasons:\r\n\r\n- it's rarely clear at the time prices begin to move where that higher or lower stable price range lies\r\n- funds have to be moved out of other markets first and perhaps now is not the best time\r\n- the price rising is itself confirmation to other traders that the news is in fact bullish, so the initial price rise accelerates, sometimes overshooting\r\n- some traders may think that the initial price rise was sufficient for this piece of news and either take profits or short it.\r\n\r\nThere are many different players in every market each with their own competing perspectives. Some players are central banks with a policy to push, others are major corporations hedging against a product they have committed to deliver. Still other players may have misinterpreted the significance of the news.\r\n\r\nAll of these factors combine to slow down the movement in market prices as they adjust from the previous stable trading range to the new higher one. During that period of adjustment we have a trend.\r\n\r\n![Uptrend in SPX futures](/media/uploads/2017/basic_system_trading/SPX-D1-UpT-20171012.png \"Uptrend in SPX futures\"):C85!\r\nSome trends are obvious, such as the recent behavior of the S&P500 on the daily or weekly timeframe from 2009 to 2017, arguably longer (see above). Obvious trends display a clear rise or fall in prices as you look across the chart from left to right. Within a trend, retraces or cycles may occur but they should exhibit a reasonably clear pattern of higher highs (HH) and higher lows (HL) in a bull trend, and lower highs (LH) and lower lows (LL) when the market is bearish.\r\n<div class=\"clear-floating-cols-above\"></div>\r\n![Uptrend showing HH-HL](/media/uploads/2017/basic_system_trading/UpT-EG-20171015.png \"Uptrend showing HH-HL\"):R45\r\n![Downtrend showing LH-LL](/media/uploads/2017/basic_system_trading/DnT-EG-20171015.png \"Downtrend showing LH-LL\"):R45\r\n\r\n#### <a id=\"Moving-Averages\"></a>Moving Averages\r\n\r\nMoving averages (MA) are useful to help you visualize the trend. They work well in computerized systems that need a numeric computation in the absence of being able to visualize a chart.\r\n\r\nA moving average simply takes the current price in each period and averages it with the prices from a given *number* of previous periods. That number is called its **`period`** and represents an *historic* average. The MA cannot take into account the future because that is not known in the current period. As each new period trades, its price is added into the calculation of the average while the oldest price is dropped.\r\n\r\nIn that sense, the average *moves* along from oldest to newer prices. Exponential moving averages are similar but give greater weight to more recent prices and typically have a lower weighted memory of *all* previous prices.\r\n\r\nAlthough not necessary in a trading system, it is common for charts to have at least two MAs, a longer term one and another that's shorter and therefore faster reacting. Even price action traders who have no other indicators on their charts, often have a couple of MAs.\r\n\r\n![MAs below prices in uptrend](/media/uploads/2017/basic_system_trading/UpT-MA-EG-20171015.png \"MA Uptrend\"):R45\r\n\r\nAn MA averages out today's prices with prices from the past. In a bull market, the most current price will tend to be higher than in the recent past so the MA should be below where prices are trading. An MA that averages back over a longer period will tend to be further below and slower to react to changes in current prices because it is averaging over a larger number of earlier, lower prices. The latest, higher price has less effect on a longer average.\r\n\r\nTherefore we can refer to the longer one as the **slow** MA and the shorter as the **fast** MA.\r\n\r\n![MA Cross on USDJPY](/media/uploads/2017/basic_system_trading/USDJPY-MA-Cross-20171017.png \"MA Cross on USDJPY\"):R45\r\nIf a market is moving up smoothly, the shorter MA will lie above the longer. In a bear market the pattern is reversed with the MAs lying above the prices and the longer above the shorter. If the trend changes direction from bear to bull or recovers from a severe retracement (a correction), the faster MA will move up first and may cross the slower MA.\r\n\r\nThis is shown above on the chart for USDJPY. Whether they cross or not will depend on the period used for both MAs. For some traders, this triggers a signal to enter the market. There are many ways to trigger the opening of a market position, and crossing MAs is just one.\r\n\r\n#### Summary\r\n\r\nThe trend is an essential component of a trading system because trading against the trend is more hazardous and trades aligned with the trend have a greater probability of success.\r\n\r\nMoving averages are one tool that can help you identify trends and MA crosses help recognize trend reversals.\r\n\r\nIn the [next story](/stories/44/2017/10/24/trading-systems-part-2-timeframes-fundamentals-reversals-and-retracements/) I will discuss several aspects of trend following such as timeframes and fundamentals.\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n<br>\r\n#### Disclaimers\r\n\r\nAlthough the PagooLABS site is educational and does not advocate any position in a futures or forex contract, it is important to present the following disclaimers as additional information. Trading these markets can be risky and you must be aware of the following:\r\n\r\n**U.S. Government Required Disclaimer**\r\nCommodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results.\r\n\r\n** CFTC RULE 4.41 **\r\n\"These results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown.\"\r\n\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n\r\n*[HA]: Heikin Ashi\r\n*[MA]: Moving Average over a specified period - 100 periods for eg\r\n*[EMA]: Exponential Moving Average - has a long 'memory'\r\n*[OHLC]: Open, High, Low, Close: the 4 key values for any bar on a chart\r\n*[bull]: An uptrending or rising market\r\n*[bear]: A downtrending or falling market\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[MR]: Maximum Risk\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[EURJPY]: The Euro - Yen cross currency: buying Euros priced in Yen\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[setup]: An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\r\n*[instrument]: A particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: Particular traded forex or futures contracts such as gold or USDJPY\r\n*[underlined text]: Congratulations! You have successfully hovered over text\r\n*[indicator]: A calculated line, such as a Moving Average drawn on a chart, that is separate from the OHLC prices but often calculated from them\r\n*[indicators]: Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\r\n*[H4]: Chart of the four hour timeframe\r\n*[M5]: Chart of the five minute timeframe\r\n*[H1]: Chart of the one hour timeframe",
"image": null,
"html": "<hr>\n<h4><strong>Trading Systems Part 1</strong></h4>\n<p>This series shows you how to build a trading system. Within a system there is an almost limitless variety of buy and sell signals we could use, but here I purposely avoid advocating any particular method. That's because for many traders it's the system that is missing, not the ability to recognize a valid <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>.</p>\n<p>By learning how to build your own system you will have a trading method unique enough that you will be able to enter profitable positions hopefully before any advantage is arbitraged away by others. When enough traders play the same system, your entries, stops and targets would be discovered. Bigger players may find it profitable to bet against you, knowing that triggering your stops would allow them to enter in the same direction as you at a better price. By trading against you, the bigger players can reduce the profitability of your system and may even cause it to fail.</p>\n<p>For that reason, I do not advocate you using any simple system outlined here. That's also true of just about any publically known system. It helps that there are so many systems out there, but what really helps is that so many beginning traders don't use systems at all. Instead, they make regular 'donations' to those who do, until their accounts are empty.</p>\n<p>What I present below is just for learning purposes. It should be easy to adapt this material to your particular trading style and favorite <abbr title=\"Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\">indicators</abbr>, and I show you how.</p>\n<p>A system is simply a sequence of trades, all based on the same or similar <strong><code>signals</code></strong>. It is designed by carefully evaluating the historic data and the longer term charts. Any one trade might fail leaving you with a loss however a system covers multiple trades and the designer of a system looks for an approach where wins consistently beat losses.</p>\n<p><img alt=\"Sample MA Cross System\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-UpT-MACross-EG-20171019.png\" title=\"Sample MA Cross System\" width=\"100%\"></p>\n<p>Above is an example of a system, although it makes little sense at this point. Nonetheless, you can see that we have six setups on this chart where we could place an open trade based on the crossing of two <strong><code>moving averages</code></strong> (MAs). They are marked by little crosses below where the <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> cross occurred, green for success and red for failure. I will explain this in detail later on but for now it just means that whenever the five period <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>, <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>(5), crosses above the <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>(14) we will open a long position. There is nothing significant in these <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> periods, they are just to illustrate a simple system. There is also a pair of longer term MAs, the <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>(100) and <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>(200), which are only shown to emphasize the trend since point A.</p>\n<p>The point here is that our first <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr> failed, as did the 3rd and 4th. However, three of the six trades here were successful. If the <abbr title=\"target price\">TP</abbr> were twice the risk then this simplistic system would generate three times the risk in wins (2 x 3 wins - 1 x 3 losses = 3), and therefore 6% of our risk funds (2% x 3). Of course, I have to explain why we should be long and not short after point A, why I chose twice the risk for the <abbr title=\"target price\">TP</abbr>, what's this crossing <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> all about and what happened to the right of the chart. I hope this series on systems will answer all these questions and more.</p>\n<p>In many of the examples I deliberately use a simple <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> cross to determine when the trend starts and sometimes even the triggers that prompt us into a trade. Although simple, if we can make a system work well with MAs then imagine what you can do with all your favorite <abbr title=\"Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\">indicators</abbr>. Also, <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> crosses are easy to explain and draw, so just what I need.</p>\n<p>Don't expect a system to be anything complicated. A system is <em>consistent</em>, and the easier to understand the better. A consistent system applies the rules in the same way on every trade <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr>. By being consistent, a system becomes testable. If we subtly change the conditions whenever we feel the normal human emotions of fear or greed, the system could fail but we won't know why.</p>\n<p>If you have not used a system before it brings a major improvement for very little extra work.</p>\n<p>Before we can discuss a trading system, I have some ground to cover on a few very important concepts. I have already posted a series on <a href=\"/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/\"><strong>setups</strong></a> but we also need to discuss <strong>trends</strong> and <strong>signals</strong>. These two key topics will make up parts 1 to 4 of this series.</p>\n<p>While I have tried to keep this presentation simple, I imagine most readers would have already thought about many of these issues. Perhaps you have been trading a while but have become frustrated how often you are stopped out of trades that afterward move in your anticipated direction. For this reason, much of the jargon of trading is not covered here, or when it is covered, perhaps I pass over it too quickly. If you hover over <abbr title=\"Congratulations! You have successfully hovered over text\">underlined text</abbr>, a brief explanation will pop up on many uncommon terms. Please alert us via a post in the comments section whenever something is unclear.</p>\n<p>As you design your own systems I hope you will discuss your experiences on our forums. The best way to learn is to put your own ideas out there for discussion, get help and hopefully have your system improved by other members. Feel free to post replies to existing stories and, when you have enough points earned from posts, you will be able to post your own stories. Eventually you will be able to start and moderate your own forums when you have accumulated enough reputation.</p>\n<p>If you have not done so already, I recommend that you first read through the series on <a href=\"/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/\">\"The Basic Setup\"</a>. This current series on Systems relies heavily on material discussed there on the Open Price (<abbr title=\"open price\">OP</abbr>), Stop Loss (<abbr title=\"stop loss\">SL</abbr>), Target Price (<abbr title=\"target price\">TP</abbr>) and Contracts Opened (<abbr title=\"number of contracts opened\">CO</abbr>).</p>\n<p>From <a href=\"/stories/40/2017/10/24/the-basic-setup-part-3-risky-trades/\">\"The Basic Setup\"</a> we will assume in what follows a risk capital of $100,000 and a risk per trade of $2000. Because your risk capital is almost certainly different, just divide or multiply the per trade amounts depending on your available funds.</p>\n<p>After reading this series on systems, you should know:</p>\n<ul>\n<li>how to spot a trend</li>\n<li>the difference between a <abbr title=\"An instance of a signal ready for trading with values for the number of contracts and the Open, Stop and Target prices\">setup</abbr>, a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> and a system</li>\n<li>how to use your preferred signaling method in a full system</li>\n<li>how to measure the number of wins and losses and</li>\n<li>how to test whether your system has worked in the past.</li>\n</ul>\n<p>Everything I have to say here on trading applies equally whether short or long. However the descriptions become tedious to read when every sentence has to be qualified with something like \"or sell if short\". For this reason, in most of what follows unless otherwise stated, I will assume an uptrend (or <abbr title=\"An uptrending or rising market\">bull</abbr> market) and long positions. This is just for convenience and does not imply that being long is preferable to being short.</p>\n<h4><a id=\"The-Trend\"></a>The Trend</h4>\n<p>Markets spend most of their time consolidating sideways. You could build a system around this fact alone but it's not what we will do here. Instead we will focus on trending markets because those are more likely to result in a winning trade. Also the market is more likely to move to a <abbr title=\"target price\">TP</abbr> that is a greater distance from the open price than the <abbr title=\"stop loss\">SL</abbr>.</p>\n<p><img alt=\"Uptrend then Consolidate\" src=\"/media/uploads/2017/basic_system_trading/consolidating-trend.png\" style=\"float: right;\" title=\"Uptrend then Consolidate\" width=\"40%\">\nWhen favorable information first hits the market, prices start to rise to some higher level. The prices then either consolidate, or fall back if the rise was too high or too fast. But if the asset such as gold, oil, the S&P or some currency is now worth more to the market, why doesn't the market immediately jump to that new higher level? After all, who would sell below that level and who would not be buying? Both of those factors should push the price up to the new level immediately.</p>\n<p>Sometimes markets <em>do</em> adjust quickly and when that happens politicians and traders on the losing side howl that something has gone terribly wrong. But in general prices adjust slowly for several reasons:</p>\n<ul>\n<li>it's rarely clear at the time prices begin to move where that higher or lower stable price range lies</li>\n<li>funds have to be moved out of other markets first and perhaps now is not the best time</li>\n<li>the price rising is itself confirmation to other traders that the news is in fact bullish, so the initial price rise accelerates, sometimes overshooting</li>\n<li>some traders may think that the initial price rise was sufficient for this piece of news and either take profits or short it.</li>\n</ul>\n<p>There are many different players in every market each with their own competing perspectives. Some players are central banks with a policy to push, others are major corporations hedging against a product they have committed to deliver. Still other players may have misinterpreted the significance of the news.</p>\n<p>All of these factors combine to slow down the movement in market prices as they adjust from the previous stable trading range to the new higher one. During that period of adjustment we have a trend.</p>\n<p><img alt=\"Uptrend in SPX futures\" class=\"center\" src=\"/media/uploads/2017/basic_system_trading/SPX-D1-UpT-20171012.png\" title=\"Uptrend in SPX futures\" width=\"85%\"></p><div class=\"clear-floating-cols-above\"></div>\nSome trends are obvious, such as the recent behavior of the S&P500 on the daily or weekly timeframe from 2009 to 2017, arguably longer (see above). Obvious trends display a clear rise or fall in prices as you look across the chart from left to right. Within a trend, retraces or cycles may occur but they should exhibit a reasonably clear pattern of higher highs (HH) and higher lows (HL) in a <abbr title=\"An uptrending or rising market\">bull</abbr> trend, and lower highs (LH) and lower lows (LL) when the market is bearish.\n<div class=\"clear-floating-cols-above\"></div>\n<img alt=\"Uptrend showing HH-HL\" src=\"/media/uploads/2017/basic_system_trading/UpT-EG-20171015.png\" style=\"float: right;\" title=\"Uptrend showing HH-HL\" width=\"45%\">\n<img alt=\"Downtrend showing LH-LL\" src=\"/media/uploads/2017/basic_system_trading/DnT-EG-20171015.png\" style=\"float: right;\" title=\"Downtrend showing LH-LL\" width=\"45%\"><p></p>\n<h4><a id=\"Moving-Averages\"></a>Moving Averages</h4>\n<p>Moving averages (<abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>) are useful to help you visualize the trend. They work well in computerized systems that need a numeric computation in the absence of being able to visualize a chart.</p>\n<p>A moving average simply takes the current price in each period and averages it with the prices from a given <em>number</em> of previous periods. That number is called its <strong><code>period</code></strong> and represents an <em>historic</em> average. The <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> cannot take into account the future because that is not known in the current period. As each new period trades, its price is added into the calculation of the average while the oldest price is dropped.</p>\n<p>In that sense, the average <em>moves</em> along from oldest to newer prices. Exponential moving averages are similar but give greater weight to more recent prices and typically have a lower weighted memory of <em>all</em> previous prices.</p>\n<p>Although not necessary in a trading system, it is common for charts to have at least two MAs, a longer term one and another that's shorter and therefore faster reacting. Even price action traders who have no other <abbr title=\"Calculated lines, such as Moving Averages drawn on a chart, that are separate from the OHLC prices but often calculated from them\">indicators</abbr> on their charts, often have a couple of MAs.</p>\n<p><img alt=\"MAs below prices in uptrend\" src=\"/media/uploads/2017/basic_system_trading/UpT-MA-EG-20171015.png\" style=\"float: right;\" title=\"MA Uptrend\" width=\"45%\"></p>\n<p>An <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> averages out today's prices with prices from the past. In a <abbr title=\"An uptrending or rising market\">bull</abbr> market, the most current price will tend to be higher than in the recent past so the <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> should be below where prices are trading. An <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> that averages back over a longer period will tend to be further below and slower to react to changes in current prices because it is averaging over a larger number of earlier, lower prices. The latest, higher price has less effect on a longer average.</p>\n<p>Therefore we can refer to the longer one as the <strong>slow</strong> <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> and the shorter as the <strong>fast</strong> <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>.</p>\n<p><img alt=\"MA Cross on USDJPY\" src=\"/media/uploads/2017/basic_system_trading/USDJPY-MA-Cross-20171017.png\" style=\"float: right;\" title=\"MA Cross on USDJPY\" width=\"45%\">\nIf a market is moving up smoothly, the shorter <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> will lie above the longer. In a <abbr title=\"A downtrending or falling market\">bear</abbr> market the pattern is reversed with the MAs lying above the prices and the longer above the shorter. If the trend changes direction from <abbr title=\"A downtrending or falling market\">bear</abbr> to <abbr title=\"An uptrending or rising market\">bull</abbr> or recovers from a severe retracement (a correction), the faster <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> will move up first and may cross the slower <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr>.</p>\n<p>This is shown above on the chart for USDJPY. Whether they cross or not will depend on the period used for both MAs. For some traders, this triggers a <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> to enter the market. There are many ways to trigger the opening of a market position, and crossing MAs is just one.</p>\n<h4>Summary</h4>\n<p>The trend is an essential component of a trading system because trading against the trend is more hazardous and trades aligned with the trend have a greater probability of success.</p>\n<p>Moving averages are one tool that can help you identify trends and <abbr title=\"Moving Average over a specified period - 100 periods for eg\">MA</abbr> crosses help recognize trend reversals.</p>\n<p>In the <a href=\"/stories/44/2017/10/24/trading-systems-part-2-timeframes-fundamentals-reversals-and-retracements/\">next story</a> I will discuss several aspects of trend following such as timeframes and fundamentals.\n<br>\n<br>\n<br>\n<br>\n<br></p>\n<h4>Disclaimers</h4>\n<p>Although the PagooLABS site is educational and does not advocate any position in a futures or <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> contract, it is important to present the following disclaimers as additional information. Trading these markets can be risky and you must be aware of the following:</p>\n<p><strong>U.S. Government Required Disclaimer</strong>\nCommodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don't trade with money you can't afford to lose. This is neither a solicitation nor an offer to Buy/Sell futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed on this web site. The past performance of any trading system or methodology is not necessarily indicative of future results.</p>\n<p><strong> CFTC RULE 4.41 </strong>\n\"These results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown.\"</p>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"post": "You have used moving averages here but MACD indicator is more common. It has the advantage of having a momentum oscillator built in. Maybe you could show an fx market using a macd. Trends and all.",
"html": "<p><p>You have used moving averages here but MACD indicator is more common. It has the advantage of having a momentum oscillator built in. Maybe you could show an fx market using a macd. Trends and all.</p></p>",
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"id": 42,
"title": "Managing a Futures or Forex Trade with Margin and Target Price",
"slug": "the-basic-setup-part-5-manage-that-trade",
"status": 2,
"publication_date": "2017-10-24T03:35:01Z",
"lead": "What is the role of margin and how do we manage the trade setup so we can then sit back and let the trade work for us?",
"excerpt": "Learn how to trade Futures and Forex markets. Understand margin, trade management and position sizing.",
"poster": "SeanManefield",
"content": "---\r\n\r\n#### **Part 5 - The Conclusion of The Basic Setup**\r\n\r\n##### **Margin**\r\n\r\nBefore concluding our discussion of the basic trade setup I need to say a few words about margin. The stop loss being triggered is not the only reason your broker may close out your position. You will also be closed out if the remaining funds in your account, less the marked to market losses from a losing position, fall below a given amount. This amount is called the **`maintenance margin`** and it varies by contract as well as changing over time.\r\n\r\nEach day your broker will mark-to-market your open positions. It is as if you closed the position, recognized any gains or losses at the day's closing price, and then immediately reopened a fresh position at the same price without paying commissions. Those gains and losses accumulate in your account and, if negative, your account will fall in value. Each open contract has a maintenance margin requirement and you must keep at least that amount of funds in your account.\r\n\r\nThe exchanges and regulatory authorities set the minimum margin but your broker may set a higher percentage to protect itself and its other clients from losses arising from your account. It is your job to familiarize yourself with the **`initial and maintenance margins`** of all the instruments you trade.\r\n\r\nAt the current price of gold at around $1280/oz, a contract of 100 ozs would cost $128,000 if you paid the full price. However the current initial margin requirement per contract is only $4,300, or just under 3.5%. That means you need $4,300 in your account for every gold contract you open. The maintenance margin, which applies after you have opened the position, is around $3250 or 2.5%. Your broker may set a higher amount. If you only had two open contracts then you would not fall afoul of the margin requirement since you would have $98K still in your account even at the SL price. That's more than enough to cover the $6,500 maintenance margin (2 x $3250).\r\n\r\nHowever if you opened 20 contracts and your risk was $2000 per contract then at the SL price you would be losing $40,000 from your account leaving only $60,000. Since that is not enough to cover the $65,000 maintenance margin ($3,250 x 20 contracts) you would have already received a **`margin call`** from your broker. In many cases, they would automatically close the position in order to protect their firm and customers from losses occurring in your account.\r\n\r\nIt is important to recognize that your broker does not take into account your stop loss since the market may blow straight through it without pause. While you might think in terms of your risk being capped by the stop loss, your broker will instead be watching your available funds and the current value of your equity in the open position. This is more likely to cause a problem if the original dollar risk was small and you opened a large number of contracts.\r\n\r\nThe dollar risk gets smaller as you trade shorter timeframes. A typical setup on a 15 minute chart will almost certainly result in many more contracts than a setup from the daily chart. Those extra contracts may increase the risk of a margin call if there is a strong adverse price movement.\r\n\r\nAnother issue to be aware of is that if you trade frequently, the funds from your last trade may not yet have been settled. Although your account balance looks healthy, the funds from your previous trade are not yet available to cover the margin of a new position and the remaining available funds may not be enough to ward off a margin call.\r\n\r\nKeep a watchful eye on margin and avoid opening any position where your available funds only barely cover the initial margin. Your broker probably has tools to help you calculate initial margin so stay alert to ensuring a margin call will never trigger before your stop loss.\r\n\r\n\r\n##### **Managing the Trade**\r\n\r\n![Successful Gold Trade](/media/uploads/2017/a_basic_trade_setup/20171008-Gold-setup3.png \"Successful Gold Trade\"):R50\r\nAfter all our hard work in coming this far, how did the trade work out?\r\n\r\nThe trade was a winner! To the right you can see that the market blew straight up through our TP level and continued rising for quite some time before running out of steam. That's why we have TP levels. We don't know where the top of the market might be.\r\n\r\nThis trade was very profitable and the following table lays out the arithmetic that you can apply to any setup.\r\n\r\n<div class=\"clear-floating-cols-above\"></div>\r\n<a id=\"Profit-in-the-Sample-Gold-Trade\"></a>\r\n\r\n Profit in the Sample Gold Trade\r\n Maximum Risk:\r\n TF = $100,000 Total Funds (fixed)\r\n MR = TF x 2% Maximum Risk\r\n = $100,000 X 2%\r\n = $2,000 Maximum Risk\r\n Setup:\r\n TP = 1295.00 Target Price\r\n OP = 1260.75 Open Price (fixed)\r\n SL = 1251.40 Stop Loss\r\n CS = 100 Contract Size (fixed)\r\n Trade Risk:\r\n TR = OP - SL Trade Risk\r\n Contract Risk:\r\n CR = (OP - SL) x CS Contract Risk\r\n = (1260.75 - 1251.40) x 100\r\n = $935\r\n Contract Potential Win (CW):\r\n CW = (TP - OP) x CS Contract Win\r\n = (1295.00 - 1260.75) x 100\r\n = 34.25 x 100\r\n = $3,425\r\n Number of Contracts to Open = Max Risk / Contract Risk\r\n CO = MR / CR Contracts to open\r\n = $2000 / $935 Max Risk / Contract Risk\r\n = 2.14\r\n = 2 Contracts rounded down\r\n Total Trade Risk:\r\n TR = ContractRisk x Contracts=Total Risk of the trade\r\n TR = CR * CO\r\n = $935 x 2\r\n = $1870\r\n Total Potential Trade Win:\r\n TW = CW x CO Total Potential Trade Win\r\n = Win per Contract x Number of Contracts\r\n = $3,425 x 2\r\n = $6,850\r\n Risk/Reward (Win) Ratio:\r\n RRR = $1870 : $6850\r\n = 1 : $6850 / $1870\r\n = 1 : 3.66 Risk Reward Ratio\r\n RR = 3.66 Risk Reward Multiplier\r\n\r\nThe risk/reward multiplier (RR) of the trade was 3.66, meaning the potential win was 3.66 times the size of the risk. That's considerably better than the double I hinted at earlier in this series. Most important, we knew the risk and the potential win *before* we entered the trade. We are $6,850 richer for each $100,000 of available funds, ignoring minor carrying costs for the eight days until the target was reached. We achieved that win without risking more than 2% of the funds we allocated toward futures and forex trading. When you manage your setups and position sizing as I outlined above, futures and forex markets can be no more risky than the way many investors trade equity markets.\r\n\r\nSince the market continued to climb in a favorable direction, I appear to have left a lot on the table in this trade. You might have better ideas where to exit or you might observe another entry possibility following almost immediately, but that is not the purpose of this series of stories on basic setups.\r\n<br>\r\n\r\n#### **Summary**\r\n\r\nThis series of stories on the basic setup has covered a lot of territory and I will have more to say in future articles on many of the sub-topics mentioned above. For now you should have a good understanding of how to open a position and limit your risk while setting a target price compatible with your overall risk/reward ratio. You have learned:\r\n\r\n- How to limit the size of your trades to 2% of your risk funds or less.\r\n- How to only choose trades that have target prices that will result in wins greater than losses.\r\n- How to calculate the number of contracts you can open without risking more than 2%.\r\n- How to pay attention to your margin levels.\r\n- How to define a trade setup.\r\n\r\nWhat I have not yet described how to do in these stories is:\r\n\r\n- calculate the TP\r\n- identify a proper trade signal\r\n- [build a system](/stories/43/2017/10/24/trading-systems-part-1-introduction/) out of individual signals\r\n- lay out a setup in a forex instrument.\r\n\r\nI will be writing about these topics in the coming weeks, so stay tuned.\r\n\r\nTraders cannot guess the future. All we can hope for is to make sensible judgements about the trend and where support and resistance lie. Once we are comfortable with these important details, the next step is to adopt a strategy or system that is more likely to win over time. The [following stories](/stories/43/2017/10/24/trading-systems-part-1-introduction/) will lay out some of the elements of such a system.\r\n\r\n---\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n\r\n\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[instrument]: a particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: a particular traded forex or futures contract such as gold or USDJPY",
"image": null,
"html": "<hr>\n<h4><strong>Part 5 - The Conclusion of The Basic Setup</strong></h4>\n<h5><strong>Margin</strong></h5>\n<p>Before concluding our discussion of the basic trade setup I need to say a few words about margin. The stop loss being triggered is not the only reason your broker may close out your position. You will also be closed out if the remaining funds in your account, less the marked to market losses from a losing position, fall below a given amount. This amount is called the <strong><code>maintenance margin</code></strong> and it varies by contract as well as changing over time.</p>\n<p>Each day your broker will mark-to-market your open positions. It is as if you closed the position, recognized any gains or losses at the day's closing price, and then immediately reopened a fresh position at the same price without paying commissions. Those gains and losses accumulate in your account and, if negative, your account will fall in value. Each open contract has a maintenance margin requirement and you must keep at least that amount of funds in your account.</p>\n<p>The exchanges and regulatory authorities set the minimum margin but your broker may set a higher percentage to protect itself and its other clients from losses arising from your account. It is your job to familiarize yourself with the <strong><code>initial and maintenance margins</code></strong> of all the <abbr title=\"a particular traded forex or futures contract such as gold or USDJPY\">instruments</abbr> you trade.</p>\n<p>At the current price of gold at around $1280/oz, a contract of 100 ozs would cost $128,000 if you paid the full price. However the current initial margin requirement per contract is only $4,300, or just under 3.5%. That means you need $4,300 in your account for every gold contract you open. The maintenance margin, which applies after you have opened the position, is around $3250 or 2.5%. Your broker may set a higher amount. If you only had two open contracts then you would not fall afoul of the margin requirement since you would have $98K still in your account even at the <abbr title=\"stop loss\">SL</abbr> price. That's more than enough to cover the $6,500 maintenance margin (2 x $3250).</p>\n<p>However if you opened 20 contracts and your risk was $2000 per contract then at the <abbr title=\"stop loss\">SL</abbr> price you would be losing $40,000 from your account leaving only $60,000. Since that is not enough to cover the $65,000 maintenance margin ($3,250 x 20 contracts) you would have already received a <strong><code>margin call</code></strong> from your broker. In many cases, they would automatically close the position in order to protect their firm and customers from losses occurring in your account.</p>\n<p>It is important to recognize that your broker does not take into account your stop loss since the market may blow straight through it without pause. While you might think in terms of your risk being capped by the stop loss, your broker will instead be watching your available funds and the current value of your equity in the open position. This is more likely to cause a problem if the original dollar risk was small and you opened a large number of contracts.</p>\n<p>The dollar risk gets smaller as you trade shorter timeframes. A typical setup on a 15 minute chart will almost certainly result in many more contracts than a setup from the daily chart. Those extra contracts may increase the risk of a margin call if there is a strong adverse price movement.</p>\n<p>Another issue to be aware of is that if you trade frequently, the funds from your last trade may not yet have been settled. Although your account balance looks healthy, the funds from your previous trade are not yet available to cover the margin of a new position and the remaining available funds may not be enough to ward off a margin call.</p>\n<p>Keep a watchful eye on margin and avoid opening any position where your available funds only barely cover the initial margin. Your broker probably has tools to help you calculate initial margin so stay alert to ensuring a margin call will never trigger before your stop loss.</p>\n<h5><strong>Managing the Trade</strong></h5>\n<p><img alt=\"Successful Gold Trade\" src=\"/media/uploads/2017/a_basic_trade_setup/20171008-Gold-setup3.png\" style=\"float: right;\" title=\"Successful Gold Trade\" width=\"50%\">\nAfter all our hard work in coming this far, how did the trade work out?</p>\n<p>The trade was a winner! To the right you can see that the market blew straight up through our <abbr title=\"target price\">TP</abbr> level and continued rising for quite some time before running out of steam. That's why we have <abbr title=\"target price\">TP</abbr> levels. We don't know where the top of the market might be.</p>\n<p>This trade was very profitable and the following table lays out the arithmetic that you can apply to any setup.</p>\n<div class=\"clear-floating-cols-above\"></div>\n\n<p><a id=\"Profit-in-the-Sample-Gold-Trade\"></a></p>\n<div class=\"codehilite\"><pre><span></span>Profit in the Sample Gold Trade\nMaximum Risk:\n TF = $100,000 Total Funds (fixed)\n MR = TF x 2% Maximum Risk\n = $100,000 X 2%\n = $2,000 Maximum Risk\nSetup:\n TP = 1295.00 Target Price\n OP = 1260.75 Open Price (fixed)\n SL = 1251.40 Stop Loss\n CS = 100 Contract Size (fixed)\nTrade Risk:\n TR = OP - SL Trade Risk\nContract Risk:\n CR = (OP - SL) x CS Contract Risk\n = (1260.75 - 1251.40) x 100\n = $935\nContract Potential Win (CW):\n CW = (TP - OP) x CS Contract Win\n = (1295.00 - 1260.75) x 100\n = 34.25 x 100\n = $3,425\nNumber of Contracts to Open = Max Risk / Contract Risk\n CO = MR / CR Contracts to open\n = $2000 / $935 Max Risk / Contract Risk\n = 2.14\n = 2 Contracts rounded down\nTotal Trade Risk:\n TR = ContractRisk x Contracts=Total Risk of the trade\n TR = CR * CO\n = $935 x 2\n = $1870\nTotal Potential Trade Win:\n TW = CW x CO Total Potential Trade Win\n = Win per Contract x Number of Contracts\n = $3,425 x 2\n = $6,850\nRisk/Reward (Win) Ratio:\n RRR = $1870 : $6850\n = 1 : $6850 / $1870\n = 1 : 3.66 Risk Reward Ratio\n RR = 3.66 Risk Reward Multiplier\n</pre></div>\n\n\n<p>The risk/reward multiplier (RR) of the trade was 3.66, meaning the potential win was 3.66 times the size of the risk. That's considerably better than the double I hinted at earlier in this series. Most important, we knew the risk and the potential win <em>before</em> we entered the trade. We are $6,850 richer for each $100,000 of available funds, ignoring minor carrying costs for the eight days until the target was reached. We achieved that win without risking more than 2% of the funds we allocated toward futures and <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> trading. When you manage your setups and position sizing as I outlined above, futures and <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> markets can be no more risky than the way many investors trade equity markets.</p>\n<p>Since the market continued to climb in a favorable direction, I appear to have left a lot on the table in this trade. You might have better ideas where to exit or you might observe another entry possibility following almost immediately, but that is not the purpose of this series of stories on basic setups.\n<br></p>\n<h4><strong>Summary</strong></h4>\n<p>This series of stories on the basic setup has covered a lot of territory and I will have more to say in future articles on many of the sub-topics mentioned above. For now you should have a good understanding of how to open a position and limit your risk while setting a target price compatible with your overall risk/reward ratio. You have learned:</p>\n<ul>\n<li>How to limit the size of your trades to 2% of your risk funds or less.</li>\n<li>How to only choose trades that have target prices that will result in wins greater than losses.</li>\n<li>How to calculate the number of contracts you can open without risking more than 2%.</li>\n<li>How to pay attention to your margin levels.</li>\n<li>How to define a trade setup.</li>\n</ul>\n<p>What I have not yet described how to do in these stories is:</p>\n<ul>\n<li>calculate the <abbr title=\"target price\">TP</abbr></li>\n<li>identify a proper trade <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr></li>\n<li><a href=\"/stories/43/2017/10/24/trading-systems-part-1-introduction/\">build a system</a> out of individual signals</li>\n<li>lay out a setup in a <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> <abbr title=\"a particular traded forex or futures contract such as gold or USDJPY\">instrument</abbr>.</li>\n</ul>\n<p>I will be writing about these topics in the coming weeks, so stay tuned.</p>\n<p>Traders cannot guess the future. All we can hope for is to make sensible judgements about the trend and where support and resistance lie. Once we are comfortable with these important details, the next step is to adopt a strategy or system that is more likely to win over time. The <a href=\"/stories/43/2017/10/24/trading-systems-part-1-introduction/\">following stories</a> will lay out some of the elements of such a system.</p>\n<hr>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"post": "Thanks. This is a very clear explanation. I would like to see an example from fx just to see if the math works out the same.\r\nThe systems articles look long but I'll try to get them done over the w/e.",
"html": "<p><p>Thanks. This is a very clear explanation. I would like to see an example from fx just to see if the math works out the same.<br />The systems articles look long but I'll try to get them done over the w/e.</p></p>",
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"post": "Exactly! Another vote for fx pls.",
"html": "<p><p>Exactly! Another vote for fx pls.</p></p>",
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"post": "A story focusing on Forex is high on the agenda. Keep a look out!",
"html": "<p><p>A story focusing on Forex is high on the agenda. Keep a look out!</p></p>",
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"post": "the systems series is better than this setup imo. more depth on setups vs signals. i am reevaluating my existing strategy atm. this could get interesting.",
"html": "<p><p>the systems series is better than this setup imo. more depth on setups vs signals. i am reevaluating my existing strategy atm. this could get interesting.</p></p>",
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"submit_date": "2017-11-03T00:59:04Z",
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"post": "Light weekend reading haha.",
"html": "<p><p>Light weekend reading haha.</p></p>",
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"submit_date": "2017-11-03T01:09:00Z",
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"id": 41,
"title": "How Many Contracts to Open in a Futures or Forex Trade",
"slug": "the-basic-setup-part-4-risky-contracts",
"status": 2,
"publication_date": "2017-10-24T03:31:45Z",
"lead": "How do we calculate the risk per contract and how does that lead to position sizing?",
"excerpt": "Learn how to trade Futures and Forex markets. Calculate how much to risk per contract and learn about position sizing.",
"poster": "SeanManefield",
"content": "---\r\n\r\n#### **How much to risk on each contract - Basic setups Part 4**\r\n\r\n\r\nLet's return to our [earlier trade](/stories/40/2017/10/24/the-basic-setup-part-3-risky-trades/) where we are now ready to allocate $2000 toward a long gold trade. How many contracts can we buy for $2000? To calculate this we need to determine the amount we risk losing per contract, and then divide that into our $2000. The amount we risk per contract is the amount we would lose by opening one contract at OP and getting stopped out at SL.\r\n\r\n\r\n##### A simple stock market example: MSFT\r\n\r\nIn order to see more clearly the direction these calculations are going, let's consider a typical example you might be more familiar with from the world of stocks. The usual contract size for stocks is 100, so at today's price of around $76 per share for Microsoft (MSFT), a full lot of 100 shares would cost $7,600.\r\n\r\nIf we only had $10,000 to invest in this trade then we could only buy one 'contract' of 100 shares. Two contracts would cost more than $10K (I am ignoring **`odd lots`** for this example). The only difference in futures and forex markets is that the contract size varies between different instruments. Also, to keep things simple I ignore **`margin`** rules here.\r\n\r\n Example of a simple trade in the stock market: MSFT\r\n OP = 76 (Open Price)\r\n CS = 100 (Contract Size)\r\n Cost of 1 'contract' = OP x CS\r\n = 76 x 100\r\n = $7,600\r\n Amount to invest = $10,000\r\n Number of 'contracts' = Funds / contract cost\r\n = 10,000 / 7,600\r\n = 1.3\r\n Contracts rounded down = 1 (Ignore odd lots)\r\n\r\n\r\nEvery financial contract traded on an exchange will specify the contract size. You must be familiar with the contract sizes of the instruments you trade. The following table lists just a few of the contract sizes for common instruments:<a id=\"common-contract-sizes\"></a>\r\n\r\nInstrument code | Description | Contract Size\r\n-----------------|:-------------------:|---------------\r\nGC | Gold | 100 ounces\r\nQO | Gold mini | 50 ounces\r\nMGC | Gold micro | 10 ounces\r\nSI | Silver | 5,000 ounces\r\nHG | Copper | 25,000 pounds\r\nCL | Crude oil | 1,000 barrels\r\nHO | Heating Oil | 42,000 US gallons\r\nSP | S&P 500 | $250 x S&P500 index\r\nES | S&P mini | $50 x S&P500 index\r\nEURUSD | Euro FX | 100,000 euros priced in USD\r\nUSDJPY | Yen FX | 100,000 USD priced in Yen\r\nAUDUSD | AUD FX | 100,000 AUD priced in USD\r\nZW | Wheat | 5,000 bushels\r\nPB | Pork Bellies | 40,000 pounds\r\nZT | 2 yr Treasury Note | 2,000\r\n\r\nAs you can see from this small selection of futures and forex instruments, there are wide variations in contract sizes.\r\n\r\nNote that the forex contracts listed above are traded in the very liquid 24 hour interbank market. There are similar contracts with different symbols and sizes traded on the [CME](https://institute.cmegroup.com/markets/fx). For example the Australian dollar futures contract is traded on the CME under the base symbol AD.\r\n\r\nWhat is important from the table above for our example trade in gold is that one contract of gold specifies 100 ounces with one ounce costing about 1260.75 at the open. So the price quote from an exchange that you see reported in the media is for one unit, but you will need to calculate the value or risk of a whole contract. For example, when the gold price moves up or down $1, an open contract has changed in value by $100 ($1 x 100 ounces).\r\n\r\n<a id=\"Dollar-risk-of-one-contract\"></a>\r\n#### **Dollar risk of one contract**\r\n\r\nTo calculate the dollar risk of one contract, simply subtract the SL from the OP and multiply that answer by the contract size, because that's how many units we will need for one contract. If you are shorting, the SL will be higher than the OP and you will need to subtract the OP from the SL. In other words, calculate the absolute difference between the open and stop loss prices. For our example above:\r\n\r\n Risk per Gold Contract for the Sample Trade\r\n OP = 1260.75 Open Price\r\n SL = 1251.40 Stop Loss\r\n CS = 100 Contract Size\r\n CR = (OP - SL) x CS Contract Risk (absolute value)\r\n = (1260.75 - 1251.40) x 100\r\n CR = $935\r\n\r\n\r\nEarlier we calculated the amount we could invest in the trade without risking more than 2% of our available risk capital. Given $100K to invest, we have $2,000 available for this trade. Finally we can readily calculate the number of contracts to buy:\r\n\r\n Number of contracts = ($ at risk) / (risk per contract)\r\n = 2000 / 935\r\n = 2 contracts\r\n Cost of position = $1870 from: 2 contracts x $935\r\n\r\nWe cannot buy a partial contract so we need to round the final result down to a whole number. Rounding up will cost more than the $2K we are prepared to risk. It is important to stay close to the $2,000 and two contracts only risks $1870. That's not bad but if we lose this trade and the next one rounded down to only 1 contract then it becomes that much harder to regain a profitable position: we need to consistently win more than double the amount we lose. Consider buying more mini contracts, where available, if they help you stay closer to the $2,000 risk limit.\r\n\r\nWhile the numbers above apply to trading gold, the calculations are almost identical for most futures and forex instruments. You will need to insert the proper contract size and adjust for the quote currency if it is not your local currency. For example, the USDJPY contract opens a position in 100,000 USD and is priced in Yen. I will discuss these differences in a separate story on forex trading.\r\n\r\nWe now have all the elements in place to make the trade: the open, stop loss, target price and the number of contracts. All of these elements ensure the trade never risks more than 2% of our risk funds. To place the trade you will need to be familiar with the software your broker provides. Trading software from MetaTrader, which is widely used, accepts all the key variables in one panel.\r\n\r\nSoftware from Interactive Brokers on the other hand provides greater flexibility for those who want it, breaking the trade up into the three constituent orders:\r\n\r\n- a limit or market order for x number of contracts, representing the main trade\r\n- a stop order at your SL, bracketed as a ONO (One Cancels the Other) with:\r\n- a limit order at your TP.\r\n\r\nIf either the limit or the stop gets triggered, the order executes and immediately cancels the other pending close order. With this method, you can have trailing stops, partial enters, partial exits, and almost any other combination you prefer. For example, you can have the stop trigger but only to then place the close order with a limit attached to help you get a better price. Of course, it may then fail to protect you if the limit is outside the market. The software your broker provides is a major tool and you must become familiar with how to enter and exit trades smoothly and proficiently before you risk any of your capital in a live trade. Practice in a demo account until you are 100% comfortable.\r\n\r\nIn the [final story](/stories/42/2017/10/24/the-basic-setup-part-5-manage-that-trade/) in this series, I discuss some important considerations about margin calculation. I will also make a few points about managing the above gold trade.\r\n\r\n---\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[instrument]: a particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: a particular traded forex or futures contract such as gold or USDJPY",
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"html": "<hr>\n<h4><strong>How much to risk on each contract - Basic setups Part 4</strong></h4>\n<p>Let's return to our <a href=\"/stories/40/2017/10/24/the-basic-setup-part-3-risky-trades/\">earlier trade</a> where we are now ready to allocate $2000 toward a long gold trade. How many contracts can we buy for $2000? To calculate this we need to determine the amount we risk losing per contract, and then divide that into our $2000. The amount we risk per contract is the amount we would lose by opening one contract at <abbr title=\"open price\">OP</abbr> and getting stopped out at <abbr title=\"stop loss\">SL</abbr>.</p>\n<h5>A simple stock market example: MSFT</h5>\n<p>In order to see more clearly the direction these calculations are going, let's consider a typical example you might be more familiar with from the world of stocks. The usual contract size for stocks is 100, so at today's price of around $76 per share for Microsoft (MSFT), a full lot of 100 shares would cost $7,600.</p>\n<p>If we only had $10,000 to invest in this trade then we could only buy one 'contract' of 100 shares. Two contracts would cost more than $10K (I am ignoring <strong><code>odd lots</code></strong> for this example). The only difference in futures and <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> markets is that the contract size varies between different <abbr title=\"a particular traded forex or futures contract such as gold or USDJPY\">instruments</abbr>. Also, to keep things simple I ignore <strong><code>margin</code></strong> rules here.</p>\n<div class=\"codehilite\"><pre><span></span>Example of a simple trade in the stock market: MSFT\n OP = 76 (Open Price)\n CS = 100 (Contract Size)\n Cost of 1 'contract' = OP x CS\n = 76 x 100\n = $7,600\n Amount to invest = $10,000\n Number of 'contracts' = Funds / contract cost\n = 10,000 / 7,600\n = 1.3\nContracts rounded down = 1 (Ignore odd lots)\n</pre></div>\n\n\n<p>Every financial contract traded on an exchange will specify the contract size. You must be familiar with the contract sizes of the <abbr title=\"a particular traded forex or futures contract such as gold or USDJPY\">instruments</abbr> you trade. The following table lists just a few of the contract sizes for common <abbr title=\"a particular traded forex or futures contract such as gold or USDJPY\">instruments</abbr>:<a id=\"common-contract-sizes\"></a></p>\n<table>\n<thead>\n<tr>\n<th>Instrument code</th>\n<th>Description</th>\n<th>Contract Size</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td>GC</td>\n<td>Gold</td>\n<td>100 ounces</td>\n</tr>\n<tr>\n<td>QO</td>\n<td>Gold mini</td>\n<td>50 ounces</td>\n</tr>\n<tr>\n<td>MGC</td>\n<td>Gold micro</td>\n<td>10 ounces</td>\n</tr>\n<tr>\n<td>SI</td>\n<td>Silver</td>\n<td>5,000 ounces</td>\n</tr>\n<tr>\n<td>HG</td>\n<td>Copper</td>\n<td>25,000 pounds</td>\n</tr>\n<tr>\n<td>CL</td>\n<td>Crude oil</td>\n<td>1,000 barrels</td>\n</tr>\n<tr>\n<td>HO</td>\n<td>Heating Oil</td>\n<td>42,000 US gallons</td>\n</tr>\n<tr>\n<td>SP</td>\n<td>S&P 500</td>\n<td>$250 x S&P500 index</td>\n</tr>\n<tr>\n<td>ES</td>\n<td>S&P mini</td>\n<td>$50 x S&P500 index</td>\n</tr>\n<tr>\n<td>EURUSD</td>\n<td><abbr title=\"The European currency\">Euro</abbr> FX</td>\n<td>100,000 euros priced in <abbr title=\"United States Dollar\">USD</abbr></td>\n</tr>\n<tr>\n<td>USDJPY</td>\n<td><abbr title=\"The Japanese currency\">Yen</abbr> FX</td>\n<td>100,000 <abbr title=\"United States Dollar\">USD</abbr> priced in <abbr title=\"The Japanese currency\">Yen</abbr></td>\n</tr>\n<tr>\n<td>AUDUSD</td>\n<td><abbr title=\"Australian Dollar\">AUD</abbr> FX</td>\n<td>100,000 <abbr title=\"Australian Dollar\">AUD</abbr> priced in <abbr title=\"United States Dollar\">USD</abbr></td>\n</tr>\n<tr>\n<td>ZW</td>\n<td>Wheat</td>\n<td>5,000 bushels</td>\n</tr>\n<tr>\n<td>PB</td>\n<td>Pork Bellies</td>\n<td>40,000 pounds</td>\n</tr>\n<tr>\n<td>ZT</td>\n<td>2 yr Treasury Note</td>\n<td>2,000</td>\n</tr>\n</tbody>\n</table>\n<p>As you can see from this small selection of futures and <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> <abbr title=\"a particular traded forex or futures contract such as gold or USDJPY\">instruments</abbr>, there are wide variations in contract sizes.</p>\n<p>Note that the <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> contracts listed above are traded in the very liquid 24 hour interbank market. There are similar contracts with different symbols and sizes traded on the <a href=\"https://institute.cmegroup.com/markets/fx\">CME</a>. For example the Australian dollar futures contract is traded on the CME under the base symbol AD.</p>\n<p>What is important from the table above for our example trade in gold is that one contract of gold specifies 100 ounces with one ounce costing about 1260.75 at the open. So the price quote from an exchange that you see reported in the media is for one unit, but you will need to calculate the value or risk of a whole contract. For example, when the gold price moves up or down $1, an open contract has changed in value by $100 ($1 x 100 ounces).</p>\n<p><a id=\"Dollar-risk-of-one-contract\"></a></p>\n<h4><strong>Dollar risk of one contract</strong></h4>\n<p>To calculate the dollar risk of one contract, simply subtract the <abbr title=\"stop loss\">SL</abbr> from the <abbr title=\"open price\">OP</abbr> and multiply that answer by the contract size, because that's how many units we will need for one contract. If you are shorting, the <abbr title=\"stop loss\">SL</abbr> will be higher than the <abbr title=\"open price\">OP</abbr> and you will need to subtract the <abbr title=\"open price\">OP</abbr> from the <abbr title=\"stop loss\">SL</abbr>. In other words, calculate the absolute difference between the open and stop loss prices. For our example above:</p>\n<div class=\"codehilite\"><pre><span></span>Risk per Gold Contract for the Sample Trade\n OP = 1260.75 Open Price\n SL = 1251.40 Stop Loss\n CS = 100 Contract Size\n CR = (OP - SL) x CS Contract Risk (absolute value)\n = (1260.75 - 1251.40) x 100\n CR = $935\n</pre></div>\n\n\n<p>Earlier we calculated the amount we could invest in the trade without risking more than 2% of our available risk capital. Given $100K to invest, we have $2,000 available for this trade. Finally we can readily calculate the number of contracts to buy:</p>\n<div class=\"codehilite\"><pre><span></span> Number of contracts = ($ at risk) / (risk per contract)\n = 2000 / 935\n = 2 contracts\n Cost of position = $1870 from: 2 contracts x $935\n</pre></div>\n\n\n<p>We cannot buy a partial contract so we need to round the final result down to a whole number. Rounding up will cost more than the $2K we are prepared to risk. It is important to stay close to the $2,000 and two contracts only risks $1870. That's not bad but if we lose this trade and the next one rounded down to only 1 contract then it becomes that much harder to regain a profitable position: we need to consistently win more than double the amount we lose. Consider buying more mini contracts, where available, if they help you stay closer to the $2,000 risk limit.</p>\n<p>While the numbers above apply to trading gold, the calculations are almost identical for most futures and <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> <abbr title=\"a particular traded forex or futures contract such as gold or USDJPY\">instruments</abbr>. You will need to insert the proper contract size and adjust for the quote currency if it is not your local currency. For example, the USDJPY contract opens a position in 100,000 <abbr title=\"United States Dollar\">USD</abbr> and is priced in <abbr title=\"The Japanese currency\">Yen</abbr>. I will discuss these differences in a separate story on <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> trading.</p>\n<p>We now have all the elements in place to make the trade: the open, stop loss, target price and the number of contracts. All of these elements ensure the trade never risks more than 2% of our risk funds. To place the trade you will need to be familiar with the software your broker provides. Trading software from MetaTrader, which is widely used, accepts all the key variables in one panel.</p>\n<p>Software from Interactive Brokers on the other hand provides greater flexibility for those who want it, breaking the trade up into the three constituent orders:</p>\n<ul>\n<li>a limit or market order for x number of contracts, representing the main trade</li>\n<li>a stop order at your <abbr title=\"stop loss\">SL</abbr>, bracketed as a ONO (One Cancels the Other) with:</li>\n<li>a limit order at your <abbr title=\"target price\">TP</abbr>.</li>\n</ul>\n<p>If either the limit or the stop gets triggered, the order executes and immediately cancels the other pending close order. With this method, you can have trailing stops, partial enters, partial exits, and almost any other combination you prefer. For example, you can have the stop trigger but only to then place the close order with a limit attached to help you get a better price. Of course, it may then fail to protect you if the limit is outside the market. The software your broker provides is a major tool and you must become familiar with how to enter and exit trades smoothly and proficiently before you risk any of your capital in a live trade. Practice in a demo account until you are 100% comfortable.</p>\n<p>In the <a href=\"/stories/42/2017/10/24/the-basic-setup-part-5-manage-that-trade/\">final story</a> in this series, I discuss some important considerations about margin calculation. I will also make a few points about managing the above gold trade.</p>\n<hr>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"post": "I am looking forward to an article from you on fx trading. I think in pips for risk. Is fx different.",
"html": "<p><p>I am looking forward to an article from you on fx trading. I think in pips for risk. Is fx different.</p></p>",
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"id": 40,
"title": "How Much Should you Risk on a Futures or Forex Trade?",
"slug": "the-basic-setup-part-3-risky-trades",
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"publication_date": "2017-10-24T03:29:31Z",
"lead": "How do we calculate the risk on each forex or futures trade? You will learn about risk management and how position size helps contain your risk.",
"excerpt": "Learn how to calculate the risk on each forex or futures trade. Explains risk management and position size.",
"poster": "SeanManefield",
"content": "---\r\n\r\n#### **How risky is a trade - Basic Setups Part 3**\r\n\r\nIn [earlier stories](/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/) in this series on \"The Basic Setup\", I presented an example gold trade along with the open, stop loss and target prices for a potential bullish setup. In this third part of the series, we discuss the risk we face should the gold price trigger our stop and cause us to exit the position for a loss. We will use this risk calculation to determine the number of contracts we will open in Gold.\r\n\r\nThis is what we have so far for our important **setup variables**:![Setup Variables](/media/uploads/2017/a_basic_trade_setup/20171008-Gold-setup4.png \"Setup Variables\"):R40\r\n\r\nKey variables | Price\r\n-------------------------------------------------------| ----------------------------------------\r\n<span style=\"color: #009;\">**Target price**</span> | <span style=\"color: #009;\">**1295.00**</span>\r\n<span style=\"color: #090;\">**Open price**</span> | <span style=\"color: #090;\">**1260.75**</span>\r\n<span style=\"color: #900;\">**Stop loss**</span> | <span style=\"color: #900;\">**1251.40**</span>\r\n\r\n\r\nWith this information we are almost ready to calculate the number of contracts to open. The math is fairly easy although it may seem unfamiliar at first. If you trade only a few markets (or **`instruments`**) you will soon be doing the calculations in your head. You can even write out a little table of risk amounts and contract sizes and keep it close at hand when examining a new setup.\r\n\r\n**Step one** is to determine how much money you have available to trade risky currencies and futures. Most of the extra risk compared to trading equities comes from the leverage that is available to you via your **`margin account`** with your broker. I will show you how to limit that risk, but these markets will always be subject to unexpected and sometimes extraordinary price movements. You need to protect yourself.\r\n\r\nSegregate the funds you have available for trading. You cannot reasonably expect to cover your living expenses until you are a successful trader and that may be months or years away. Keep your day job, keep your real estate separate and preferably maintain a bond and equity portfolio with another broker. On top of that you should allocate enough spare cash for emergencies over the next year at least. Whatever is left over, you might choose to allocate to your futures and **`forex`** trading.\r\n\r\nIf you are in any doubt, consult a licensed professional. They deal with issues like this all the time. Nobody online can know all the factors you face in assessing your risk profile: your age, your health, your sources of income, your need for emergency funds, etc.\r\n\r\nSo now you have an amount you can allocate to trading. It needs to be at least $10,000 to get started and preferably much more because you will only be risking a tiny amount of those funds on each trade. Since the probability of losing any one trade is greater than 50%, you cannot risk most of your funds on one trade or you will be wiped out very early in the game.\r\n\r\nIf all you can spare is $10K after following all these safety rules, you may find the forex market flexible enough for your needs. Even one mini S&P contract in the futures market requires US$4,500 margin just to get started. The forex market is less regulated and allows a smaller margin and a wider range of contract sizes. Carefully assess the risk first before committing funds because a higher margin protects both the brokerage and you.\r\n\r\nIf USD is not your currency, just substitute your own adjusted numbers below. The calculations are independent of the actual account currency you use until you get to market quotes and your available risk funds. Similarly if you are trading in USD, you will need to make adjustments when trading foreign markets where markets contracts are quoted in Japanese Yen or Euros. For example in forex trading, profits and losses may accrue in units of the **`quote currency`**. I will go into this in greater depth in a later story on forex trading.\r\n\r\n**Step two** is to determine how much to risk per trade or your **`position size`**. We calculated above the amount you can allocate to trading. There are many ways of approaching position sizing but the following lists common amounts to risk per trade given the trader's situation:\r\n\r\n- **Zero** - for an absolute beginner - please start a demo account and test everything first!\r\n- **1%** - after you have mastered the demo, and hopefully grappled with your own personality quirks\r\n- **2%** - after you have successfully survived several market shocks and have acted rationally and not emotionally to developments in the market\r\n- **5%** - only for experts with many years successful trading experience and a trading system that has proven itself through good markets and bad.\r\n\r\nIn general, proficient traders will risk no more than 2% of their **`available risk capital`** on each trade. That allows 50 losing trades in a row before you are wiped out (as long as you stick to 2% of the original sum and not 2% of what is left over - we can discuss that later).\r\n\r\nBut is it possible to lose 50 times in a row?\r\n\r\nWhile unlikely, it's not impossible and could happen purely by chance alone, just like throwing 50 heads in a row. Mostly such a low probability outcome would only occur if you trade against the trend, or panic, or trade low probability situations. A more likely outcome is to win more often than you lose but to not win enough to cover losses. Only a systems approach with proper money management could work to prevent that happening but that's the subject of the [next series](/stories/43/2017/10/24/trading-systems-part-1-introduction/).\r\n\r\nIf you find yourself losing more than 10 times in a row, stop what you are doing and investigate why. What trading rules are you breaking or what is really happening in the market? Perhaps the trend has reversed and you are stuck in the earlier way of thinking? Time for a sobre reassessment.\r\n\r\nThe difficulty is that you do not know the probability of a trade's success. You may see from a chart that some trades appear more probable than others, but you cannot see *how* probable. You cannot say for example, a certain trade is 50% likely to succeed. We can test historical patterns but the future is free to follow its own path. **`Black swans`** happen regularly enough that we should approach every trade with caution and humility.\r\n\r\nThere is no rule of nature that requires future prices to follow the same path as in the past. You must set up rules for your preferred strategy and stick to those rules. Following a system while those around you are losing their heads will help you score more wins than losses.\r\n\r\nWe can make our calculations easier here by assuming a trading portfolio of **$100,000** and using a trade risk of **2%**. That allows us up to $2000 to risk on one trade. Just divide by 10 if you have allocated $10,000 or multiply by 10 for each $1 million.\r\n\r\nIf we knew the risk on each contract, we could calculate how many contracts to open by dividing our total risk on the whole trade, $2000 in this example, by that risk per contract. It's like having $10 when apples cost $2 each and asking how many apples can we buy. That will be the subject of [Part 4](/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/) coming up next.\r\n\r\n---\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[instrument]: a particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: a particular traded forex or futures contract such as gold or USDJPY",
"image": null,
"html": "<hr>\n<h4><strong>How risky is a trade - Basic Setups Part 3</strong></h4>\n<p>In <a href=\"/stories/38/2017/10/24/basic-trade-setup-part-1-introduction/\">earlier stories</a> in this series on \"The Basic Setup\", I presented an example gold trade along with the open, stop loss and target prices for a potential bullish setup. In this third part of the series, we discuss the risk we face should the gold price trigger our stop and cause us to exit the position for a loss. We will use this risk calculation to determine the number of contracts we will open in Gold.</p>\n<p>This is what we have so far for our important <strong>setup variables</strong>:<img alt=\"Setup Variables\" src=\"/media/uploads/2017/a_basic_trade_setup/20171008-Gold-setup4.png\" style=\"float: right;\" title=\"Setup Variables\" width=\"40%\"></p>\n<table>\n<thead>\n<tr>\n<th>Key variables</th>\n<th>Price</th>\n</tr>\n</thead>\n<tbody>\n<tr>\n<td><span style=\"color: #009;\"><strong>Target price</strong></span></td>\n<td><span style=\"color: #009;\"><strong>1295.00</strong></span></td>\n</tr>\n<tr>\n<td><span style=\"color: #090;\"><strong>Open price</strong></span></td>\n<td><span style=\"color: #090;\"><strong>1260.75</strong></span></td>\n</tr>\n<tr>\n<td><span style=\"color: #900;\"><strong>Stop loss</strong></span></td>\n<td><span style=\"color: #900;\"><strong>1251.40</strong></span></td>\n</tr>\n</tbody>\n</table>\n<p>With this information we are almost ready to calculate the number of contracts to open. The math is fairly easy although it may seem unfamiliar at first. If you trade only a few markets (or <strong><code>instruments</code></strong>) you will soon be doing the calculations in your head. You can even write out a little table of risk amounts and contract sizes and keep it close at hand when examining a new setup.</p>\n<p><strong>Step one</strong> is to determine how much money you have available to trade risky currencies and futures. Most of the extra risk compared to trading equities comes from the leverage that is available to you via your <strong><code>margin account</code></strong> with your broker. I will show you how to limit that risk, but these markets will always be subject to unexpected and sometimes extraordinary price movements. You need to protect yourself.</p>\n<p>Segregate the funds you have available for trading. You cannot reasonably expect to cover your living expenses until you are a successful trader and that may be months or years away. Keep your day job, keep your real estate separate and preferably maintain a bond and equity portfolio with another broker. On top of that you should allocate enough spare cash for emergencies over the next year at least. Whatever is left over, you might choose to allocate to your futures and <strong><code>forex</code></strong> trading.</p>\n<p>If you are in any doubt, consult a licensed professional. They deal with issues like this all the time. Nobody online can know all the factors you face in assessing your risk profile: your age, your health, your sources of income, your need for emergency funds, etc.</p>\n<p>So now you have an amount you can allocate to trading. It needs to be at least $10,000 to get started and preferably much more because you will only be risking a tiny amount of those funds on each trade. Since the probability of losing any one trade is greater than 50%, you cannot risk most of your funds on one trade or you will be wiped out very early in the game.</p>\n<p>If all you can spare is $10K after following all these safety rules, you may find the <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> market flexible enough for your needs. Even one mini S&P contract in the futures market requires US$4,500 margin just to get started. The <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> market is less regulated and allows a smaller margin and a wider range of contract sizes. Carefully assess the risk first before committing funds because a higher margin protects both the brokerage and you.</p>\n<p>If <abbr title=\"United States Dollar\">USD</abbr> is not your currency, just substitute your own adjusted numbers below. The calculations are independent of the actual account currency you use until you get to market quotes and your available risk funds. Similarly if you are trading in <abbr title=\"United States Dollar\">USD</abbr>, you will need to make adjustments when trading foreign markets where markets contracts are quoted in Japanese <abbr title=\"The Japanese currency\">Yen</abbr> or Euros. For example in <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> trading, profits and losses may accrue in units of the <strong><code>quote currency</code></strong>. I will go into this in greater depth in a later story on <abbr title=\"Foreign Exchange including markets and trading\">forex</abbr> trading.</p>\n<p><strong>Step two</strong> is to determine how much to risk per trade or your <strong><code>position size</code></strong>. We calculated above the amount you can allocate to trading. There are many ways of approaching position sizing but the following lists common amounts to risk per trade given the trader's situation:</p>\n<ul>\n<li><strong>Zero</strong> - for an absolute beginner - please start a demo account and test everything first!</li>\n<li><strong>1%</strong> - after you have mastered the demo, and hopefully grappled with your own personality quirks</li>\n<li><strong>2%</strong> - after you have successfully survived several market shocks and have acted rationally and not emotionally to developments in the market</li>\n<li><strong>5%</strong> - only for experts with many years successful trading experience and a trading system that has proven itself through good markets and bad.</li>\n</ul>\n<p>In general, proficient traders will risk no more than 2% of their <strong><code>available risk capital</code></strong> on each trade. That allows 50 losing trades in a row before you are wiped out (as long as you stick to 2% of the original sum and not 2% of what is left over - we can discuss that later).</p>\n<p>But is it possible to lose 50 times in a row?</p>\n<p>While unlikely, it's not impossible and could happen purely by chance alone, just like throwing 50 heads in a row. Mostly such a low probability outcome would only occur if you trade against the trend, or panic, or trade low probability situations. A more likely outcome is to win more often than you lose but to not win enough to cover losses. Only a systems approach with proper money management could work to prevent that happening but that's the subject of the <a href=\"/stories/43/2017/10/24/trading-systems-part-1-introduction/\">next series</a>.</p>\n<p>If you find yourself losing more than 10 times in a row, stop what you are doing and investigate why. What trading rules are you breaking or what is really happening in the market? Perhaps the trend has reversed and you are stuck in the earlier way of thinking? Time for a sobre reassessment.</p>\n<p>The difficulty is that you do not know the probability of a trade's success. You may see from a chart that some trades appear more probable than others, but you cannot see <em>how</em> probable. You cannot say for example, a certain trade is 50% likely to succeed. We can test historical patterns but the future is free to follow its own path. <strong><code>Black swans</code></strong> happen regularly enough that we should approach every trade with caution and humility.</p>\n<p>There is no rule of nature that requires future prices to follow the same path as in the past. You must set up rules for your preferred strategy and stick to those rules. Following a system while those around you are losing their heads will help you score more wins than losses.</p>\n<p>We can make our calculations easier here by assuming a trading portfolio of <strong>$100,000</strong> and using a trade risk of <strong>2%</strong>. That allows us up to $2000 to risk on one trade. Just divide by 10 if you have allocated $10,000 or multiply by 10 for each $1 million.</p>\n<p>If we knew the risk on each contract, we could calculate how many contracts to open by dividing our total risk on the whole trade, $2000 in this example, by that risk per contract. It's like having $10 when apples cost $2 each and asking how many apples can we buy. That will be the subject of <a href=\"/stories/41/2017/10/24/the-basic-setup-part-4-risky-contracts/\">Part 4</a> coming up next.</p>\n<hr>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"url": "https://pagoolabs.com/stories/api/39/edit/?format=api",
"id": 39,
"title": "The Open Price, Stop Loss and Target Price of a Futures or Forex Trade",
"slug": "the-basic-setup-part-2-stop-loss-and-open-price",
"status": 2,
"publication_date": "2017-10-24T03:20:02Z",
"lead": "What are the key variables you need to know for each futures or forex trade? You will learn about the Open, Stop Loss and Target Price of the trade, along with how many contracts to open.",
"excerpt": "Learn how to trade Futures and Forex markets. Understand contract size, stop loss, target, take profit, margin, Basic trade setup, risk management, position size.",
"poster": "SeanManefield",
"content": "---\r\n\r\n#### **Where to Open, Where to Close - Basic Setups Part 2**\r\n\r\nIn this story I will show you how to open a long position in gold. You will learn the key data you need to lock down the potential risk and reward *before* opening the trade. Instead of opening a contract at today's price and then hoping for the best, we will dispassionately look over the chart of gold and determine our entry, a defensible location to place our stop loss and a reasonable target price given gold's recent **`price action`**.\r\n\r\nBy doing so we will have a trade with a defined risk (the difference between the open and the stop loss prices) and a defined reward (the difference between the open and target prices). Once the trade is opened, we will rarely revisit these key setup prices because to constantly second guess every price movement in the market will wear you out emotionally. You will be in no state to make a rational decision to either close out this position or open a new one. Instead, all this work must be done beforehand.\r\n\r\nIgnore price movements in open positions and instead focus your efforts on analyzing the longer term trends that drive the current price action you see in the charts. These trends arise from either longer timeframe charts or the fundamentals driving the market you are trading. For example, in gold the relevant fundamentals are the global risk environment, price inflation and movements in interest rates. There is enough there to keep you busy without becoming exhausted following minor price wriggles.\r\n\r\n####<span style=\"color: #090;\">The Open Price</span>\r\n\r\nThe current price at the close of the most recent trading on the chart was **$1260.75** in **`USD`** (United States Dollars). In general we will attempt to open at the start of trading of the next period immediately following the signal. We might set a limit order to ensure there is no huge gap but we have to be careful about trying to get a better price or we risk missing out on the trade altogether. The worst scenario is that we find ourselves 'chasing' the price as it pulls away from us. Never chase a price - walk away instead.\r\n\r\nIn this case we will accept the open price (OP) as set by the market on the next day. We hope to open our position at that price or lower. But before we commit our funds we need to know our target price, the stop loss and how many contracts to open.\r\n\r\n####<span style=\"color: #009;\">The Target Price</span>\r\n\r\nThe target price (TP), sometimes called the \"take profit\" price (and conveniently the same initials, TP), must be based on something more than your optimistic hopes for a successful trade. The first target appears to be the top of the range, about **$1295**. You will have to accept that for now but I have much more to say on this topic in a later story in this series. Later on, I will show how to derive the TP by applying a **`risk/reward multiplier`** to the risk of each trade, but for now I suggest we use *discretion* and set an appropriate TP from the chart alone.\r\n\r\nIt is essential to recognize that all traders have losing trades and your winners must at least compensate you for the losses. Some writers argue that because you have a 50% chance of the market going either up or down then you will win half the time. If that were correct you would need to target at least twice the amount you stand to lose.\r\n\r\nUnfortunately it is not so simple. We do not know the future so it may be true there is a 50% chance of the market going either way. However the market takes many paths to go up or down. Even in the 50% of cases where the market goes your way, there is also the possibility that before the market goes up it first falls enough to trigger the stop. Since the stop is closer than the TP, it is more likely that the SL gets triggered first. Afterwards the price might recover and hit your target, but without you along for the happy ride.\r\n\r\nFor this reason we should require more from a potential win than only double the risk. You must avoid any trade with a potential win less than double if you have only a 50% chance of winning. More on that later.\r\n\r\n![Gold daily chart](/media/uploads/2017/a_basic_trade_setup/20171008-Gold-setup2.png \"Stop Loss and Open Price\"):C90\r\n\r\n####<span style=\"color: #900;\">The Stop Loss</span>\r\n\r\nInstead of holding on to a losing position, with all the resulting emotional and financial distress, we are going to set a price where we will automatically close our position should the market go the wrong direction. By placing a stop loss (SL) on our trade we effectively limit the risk of the overall position.\r\n\r\nUnfortunately the SL is not a contract with your broker - why should they take a position off your hands that you no longer want? Instead the SL price being triggered will result in your position being placed into the market and other market participants will determine the price you receive for closing it out. In normal market conditions there is a mild amount of **`slippage`** and you may get closed out at a worse level than the SL you set. You should allow for that in the calculations below.\r\n\r\nHowever, occasionally the market may be **`illiquid`** as an unexpected dramatic event begins to unfold. In such circumstances there may be no one willing to take over your position at anything like the SL price you set when you opened. Although thankfully rare, such events happen often enough that you should heed the advice below about the maximum percentage of your funds that you invest in any one position. Although such a loss might be painful, if you follow this advice you will survive while all around you other traders are being wiped out.\r\n\r\nNow we are ready to discuss where to place our SL for this simple gold trade example. The key to choosing an SL is to locate an area where the market has recently tested a price and found **`support`** (or **`resistance`** if opening short). By choosing an area of support to place a stop in a long trade, you are raising the probability that your trade will also survive any renewed test from other traders. Note this does not provide any proof your trade will survive, it just raises the probability. As you will see, consistently trading higher probability scenarios will bring you out ahead of the game.\r\n\r\nFor our SL we could choose the low at point B, 1204.75, but that is far below our current open at point 'O'. It would be better to use the low of the retracement at about **1251.40**.\r\n\r\nAlthough this closer area is more likely to be stopped than the lower SL at point B, there is always the possibility of the market falling and triggering both stops. In the unfortunate event a stop at 1251.40 gets triggered we can sit out the potential fall in price back down to B. If a buy signal occurs there then we can open a new position without any of the additional risk of sitting in a losing trade, unable to take advantage of new market developments and unable to go short. There are other advantages to choosing the closer stop to do with **`leverage`** which I discuss below.\r\n\r\nMore to the point, you are not trying to be *right* about the market, you are just trying to win. To win you need to be opening positions in the same direction as the traders who are moving the market. If the market goes the wrong way for your trade then you chose incorrectly and you need to be out of that position as fast as possible. The nearby support area where you placed your SL is the only flexibility you allow the trade. Once breached, you should immediately cut your losses.\r\n\r\nNow that we have specified our open, stop loss and target prices for the sample gold trade, we need to turn our attention to the number of contracts to open. We will look at risk and contract sizes in the next story.\r\n\r\n---\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[instrument]: a particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: a particular traded forex or futures contract such as gold or USDJPY",
"image": null,
"html": "<hr>\n<h4><strong>Where to Open, Where to Close - Basic Setups Part 2</strong></h4>\n<p>In this story I will show you how to open a long position in gold. You will learn the key data you need to lock down the potential risk and reward <em>before</em> opening the trade. Instead of opening a contract at today's price and then hoping for the best, we will dispassionately look over the chart of gold and determine our entry, a defensible location to place our stop loss and a reasonable target price given gold's recent <strong><code>price action</code></strong>.</p>\n<p>By doing so we will have a trade with a defined risk (the difference between the open and the stop loss prices) and a defined reward (the difference between the open and target prices). Once the trade is opened, we will rarely revisit these key setup prices because to constantly second guess every price movement in the market will wear you out emotionally. You will be in no state to make a rational decision to either close out this position or open a new one. Instead, all this work must be done beforehand.</p>\n<p>Ignore price movements in open positions and instead focus your efforts on analyzing the longer term trends that drive the current price action you see in the charts. These trends arise from either longer timeframe charts or the fundamentals driving the market you are trading. For example, in gold the relevant fundamentals are the global risk environment, price inflation and movements in interest rates. There is enough there to keep you busy without becoming exhausted following minor price wriggles.</p>\n<h4><span style=\"color: #090;\">The Open Price</span></h4>\n<p>The current price at the close of the most recent trading on the chart was <strong>$1260.75</strong> in <strong><code>USD</code></strong> (United States Dollars). In general we will attempt to open at the start of trading of the next period immediately following the <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr>. We might set a limit order to ensure there is no huge gap but we have to be careful about trying to get a better price or we risk missing out on the trade altogether. The worst scenario is that we find ourselves 'chasing' the price as it pulls away from us. Never chase a price - walk away instead.</p>\n<p>In this case we will accept the open price (<abbr title=\"open price\">OP</abbr>) as set by the market on the next day. We hope to open our position at that price or lower. But before we commit our funds we need to know our target price, the stop loss and how many contracts to open.</p>\n<h4><span style=\"color: #009;\">The Target Price</span></h4>\n<p>The target price (<abbr title=\"target price\">TP</abbr>), sometimes called the \"take profit\" price (and conveniently the same initials, <abbr title=\"target price\">TP</abbr>), must be based on something more than your optimistic hopes for a successful trade. The first target appears to be the top of the range, about <strong>$1295</strong>. You will have to accept that for now but I have much more to say on this topic in a later story in this series. Later on, I will show how to derive the <abbr title=\"target price\">TP</abbr> by applying a <strong><code>risk/reward multiplier</code></strong> to the risk of each trade, but for now I suggest we use <em>discretion</em> and set an appropriate <abbr title=\"target price\">TP</abbr> from the chart alone.</p>\n<p>It is essential to recognize that all traders have losing trades and your winners must at least compensate you for the losses. Some writers argue that because you have a 50% chance of the market going either up or down then you will win half the time. If that were correct you would need to target at least twice the amount you stand to lose.</p>\n<p>Unfortunately it is not so simple. We do not know the future so it may be true there is a 50% chance of the market going either way. However the market takes many paths to go up or down. Even in the 50% of cases where the market goes your way, there is also the possibility that before the market goes up it first falls enough to trigger the stop. Since the stop is closer than the <abbr title=\"target price\">TP</abbr>, it is more likely that the <abbr title=\"stop loss\">SL</abbr> gets triggered first. Afterwards the price might recover and hit your target, but without you along for the happy ride.</p>\n<p>For this reason we should require more from a potential win than only double the risk. You must avoid any trade with a potential win less than double if you have only a 50% chance of winning. More on that later.</p>\n<p><img alt=\"Gold daily chart\" class=\"center\" src=\"/media/uploads/2017/a_basic_trade_setup/20171008-Gold-setup2.png\" title=\"Stop Loss and Open Price\" width=\"90%\"></p>\n<h4><span style=\"color: #900;\">The Stop Loss</span></h4>\n<p>Instead of holding on to a losing position, with all the resulting emotional and financial distress, we are going to set a price where we will automatically close our position should the market go the wrong direction. By placing a stop loss (<abbr title=\"stop loss\">SL</abbr>) on our trade we effectively limit the risk of the overall position.</p>\n<p>Unfortunately the <abbr title=\"stop loss\">SL</abbr> is not a contract with your broker - why should they take a position off your hands that you no longer want? Instead the <abbr title=\"stop loss\">SL</abbr> price being triggered will result in your position being placed into the market and other market participants will determine the price you receive for closing it out. In normal market conditions there is a mild amount of <strong><code>slippage</code></strong> and you may get closed out at a worse level than the <abbr title=\"stop loss\">SL</abbr> you set. You should allow for that in the calculations below.</p>\n<p>However, occasionally the market may be <strong><code>illiquid</code></strong> as an unexpected dramatic event begins to unfold. In such circumstances there may be no one willing to take over your position at anything like the <abbr title=\"stop loss\">SL</abbr> price you set when you opened. Although thankfully rare, such events happen often enough that you should heed the advice below about the maximum percentage of your funds that you invest in any one position. Although such a loss might be painful, if you follow this advice you will survive while all around you other traders are being wiped out.</p>\n<p>Now we are ready to discuss where to place our <abbr title=\"stop loss\">SL</abbr> for this simple gold trade example. The key to choosing an <abbr title=\"stop loss\">SL</abbr> is to locate an area where the market has recently tested a price and found <strong><code>support</code></strong> (or <strong><code>resistance</code></strong> if opening short). By choosing an area of support to place a stop in a long trade, you are raising the probability that your trade will also survive any renewed test from other traders. Note this does not provide any proof your trade will survive, it just raises the probability. As you will see, consistently trading higher probability scenarios will bring you out ahead of the game.</p>\n<p>For our <abbr title=\"stop loss\">SL</abbr> we could choose the low at point B, 1204.75, but that is far below our current open at point 'O'. It would be better to use the low of the retracement at about <strong>1251.40</strong>.</p>\n<p>Although this closer area is more likely to be stopped than the lower <abbr title=\"stop loss\">SL</abbr> at point B, there is always the possibility of the market falling and triggering both stops. In the unfortunate event a stop at 1251.40 gets triggered we can sit out the potential fall in price back down to B. If a buy <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> occurs there then we can open a new position without any of the additional risk of sitting in a losing trade, unable to take advantage of new market developments and unable to go short. There are other advantages to choosing the closer stop to do with <strong><code>leverage</code></strong> which I discuss below.</p>\n<p>More to the point, you are not trying to be <em>right</em> about the market, you are just trying to win. To win you need to be opening positions in the same direction as the traders who are moving the market. If the market goes the wrong way for your trade then you chose incorrectly and you need to be out of that position as fast as possible. The nearby support area where you placed your <abbr title=\"stop loss\">SL</abbr> is the only flexibility you allow the trade. Once breached, you should immediately cut your losses.</p>\n<p>Now that we have specified our open, stop loss and target prices for the sample gold trade, we need to turn our attention to the number of contracts to open. We will look at risk and contract sizes in the next story.</p>\n<hr>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"post": "I think finding a support/resistance area for profit taking makes most sense. Using some kind of average from a simulation seems fishy in comparison. I get your pt though. A proper support/res level requires human intervention. Not easy if you want a computer to get the levels for you I suppose.",
"html": "<p><p>I think finding a support/resistance area for profit taking makes most sense. Using some kind of average from a simulation seems fishy in comparison. I get your pt though. A proper support/res level requires human intervention. Not easy if you want a computer to get the levels for you I suppose.</p></p>",
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"post": "I can see how I can program S/R levels. A bit tricky but not impossible. Bigger problem is what if mkt is up in a break out situation and no overhead resistance is left.",
"html": "<p><p>I can see how I can program S/R levels. A bit tricky but not impossible. Bigger problem is what if mkt is up in a break out situation and no overhead resistance is left.</p></p>",
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"submit_date": "2017-10-30T06:31:33Z",
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"post": "The S&P is doing exactly that now and there is no resistance in sight. In times like this we need to fall back on historical patterns of breakouts rather than previous support and resistance levels.\r\n\r\nIn sideways markets, SR levels work well.",
"html": "<p><p>The S&P is doing exactly that now and there is no resistance in sight. In times like this we need to fall back on historical patterns of breakouts rather than previous support and resistance levels.</p><br /><p>In sideways markets, SR levels work well.</p></p>",
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"post": "this is great stuff but where does the take profit get set?",
"html": "<p><p>this is great stuff but where does the take profit get set?</p></p>",
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"post": "did u read the systems stories? they explain this great but i still want to see how to use support resistance areas to set tp.",
"html": "<p><p>did u read the systems stories? they explain this great but i still want to see how to use support resistance areas to set tp.</p></p>",
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"post": "This series on setups assumes a TP level is known beforehand. We relax that assumption in the [next series](/stories/43/2017/10/24/trading-systems-part-1-introduction/) on Systems and we show there how to use a simple simulation to automatically calculate a TP that works for many trades. Let us know if you have any questions.",
"html": "<p><p>This series on setups assumes a TP level is known beforehand. We relax that assumption in the <a href=\"/stories/43/2017/10/24/trading-systems-part-1-introduction/\">next series</a> on Systems and we show there how to use a simple simulation to automatically calculate a TP that works for many trades. Let us know if you have any questions.</p></p>",
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"title": "Setting up a Trade in the Futures or Forex Market - Part 1",
"slug": "basic-trade-setup-part-1-introduction",
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"publication_date": "2017-10-24T03:05:48Z",
"lead": "How do you set up a trade in either the forex or futures markets? You will learn how to measure the risk and potential reward of a trade before you open it and you will minimize the risk to just a small percentage of your portfolio.",
"excerpt": "Learn how to trade Futures and Forex markets. Understand contract size, stop loss, target, take profit, margin, basic trade setup, risk management, position size.",
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"content": "---\r\n\r\n#### **Basic Trade Setup Part 1 - Introduction**\r\n<div style=\"padding: 0 0 .1rem 0\"></div>\r\n\r\nA trade setup describes how to take a position in a market in order to profit from that market rising or falling. If for some reason (discussed later) you expect the market price to rise then you would open **`long`** by buying a number of contracts. If instead you expect the price to fall then you would open **`short`** by selling some contracts.\r\n\r\nIt may seem strange to sell first and buy later but it is just the symmetrical opposite of buying first and selling later. **`Short selling`** is also an important part of keeping **`futures`** markets liquid: how could you buy if someone else is not willing to sell? Also, a prime purpose of these derivative markets is to enable **`hedging`** and the offsetting of risks from other markets. Half the time that will require short selling.\r\n\r\nFor our purposes here, a trade setup is just a description of how you open that contract. It answers the following questions:\r\n\r\n- What is the **`open price`**?\r\n- Where is the **`target price`**, the price where you will automatically close out your position for a win?\r\n- Where is the **`stop loss`**, the price where you will automatically close out your position for a loss?\r\n- How many **`contracts`**?\r\n- What is the **`margin`** your broker requires from you to open and maintain your position?\r\n\r\nWhen you have finished this series of stories you will know how to only risk a specific percentage of your funds in each trade and how to calculate the number of contracts you need to do so. The material we discuss here is fairly basic, however it assumes a level of knowledge about charts, trading software and jargon that may be unfamiliar. Do not be discouraged by this, we all have to start somewhere. Most of the terms are common enough that a quick internet search should yield all the information you need.\r\n\r\nIf not, turn for help to our forums or the comment section under each story. If you want a special article on a topic you believe is important but not yet covered, make a post below and argue your case. If you can convince us the problem deserves its own story, we will be happy to oblige.\r\n\r\n\r\n#### **A Gold Trade Example**\r\n\r\nTo describe a setup, I am going to choose a reasonably simple example in a popular market: gold. Consider the following recent daily gold chart from April to August 2017. ![Gold daily chart](/media/uploads/2017/a_basic_trade_setup/20171008-Gold-setup1.png \"Basic setup\"):C90\r\n\r\nIf you remember the news at that time, there were ominous rumblings coming out of the Korean peninsula through July. War drums are usually bullish for gold because paper money often does not survive long when central governments are in turmoil.\r\n\r\nThe month long upswing from point B on the chart to O (for **O**pen) was followed by a six day downward **`retrace`**. Then, as the last trading session on the chart closed we can see that the **`candlestick`** of the day's trading was an **`outside bar`** enclosing the previous day's trading, and ending positively. Summarizing these developments to get a feel for market direction, we have:\r\n\r\n- The market is overall sideways, but currently trading in the middle of the range.\r\n- Since point A, the faster moving average (MA100) has crossed above the slower 200 day MA.\r\n- The current swing is up since point B.\r\n- the market has completed a week long retrace down.\r\n- The top of the sideways market is near points C and D, above the current price.\r\n- External global risk factors lean bullish on gold.\r\n- The previous trading session ended with a bullish reversal.\r\n\r\nI will get into all of these points more fully in a later story but for now I just want to walk through a basic trade setup with you. For our purposes here, let's just assume we have a bullish **`signal`**.\r\n\r\nWe will not be discussing **`brokers`** as your options vary widely by country. However there are many possibilities, from full service all the way through computer based online trading. Recently, since the 2008 financial crisis, many regulations have been tightened. Check the advertisements in your region and review the stories from other traders on the many social media platforms available to you.\r\n\r\nIn this story, I have presented a bullish signal in an example from the gold market. In the [next story](/stories/39/2017/10/24/the-basic-setup-part-2-stop-loss-and-open-price/) we will discuss *how* we will open a long position in gold. I will show you the key data you need to lock down the potential risk and reward before opening the trade.\r\n\r\n---\r\nCopyright (C) PagooLABS 2017. All Rights Reserved.\r\n\r\n*[SL]: stop loss\r\n*[TP]: target price\r\n*[OP]: open price\r\n*[CR]: Contract Risk\r\n*[CS]: contract size\r\n*[CO]: number of contracts opened\r\n*[USD]: United States Dollar\r\n*[AUD]: Australian Dollar\r\n*[Yen]: The Japanese currency\r\n*[Euro]: The European currency\r\n*[forex]: Foreign Exchange including markets and trading\r\n*[signal]: a price pattern in the market triggering the opening of a position\r\n*[instrument]: a particular traded forex or futures contract such as gold or USDJPY\r\n*[instruments]: a particular traded forex or futures contract such as gold or USDJPY",
"image": null,
"html": "<hr>\n<h4><strong>Basic Trade Setup Part 1 - Introduction</strong></h4>\n<p></p><div style=\"padding: 0 0 .1rem 0;\"></div><p></p>\n<p>A trade setup describes how to take a position in a market in order to profit from that market rising or falling. If for some reason (discussed later) you expect the market price to rise then you would open <strong><code>long</code></strong> by buying a number of contracts. If instead you expect the price to fall then you would open <strong><code>short</code></strong> by selling some contracts.</p>\n<p>It may seem strange to sell first and buy later but it is just the symmetrical opposite of buying first and selling later. <strong><code>Short selling</code></strong> is also an important part of keeping <strong><code>futures</code></strong> markets liquid: how could you buy if someone else is not willing to sell? Also, a prime purpose of these derivative markets is to enable <strong><code>hedging</code></strong> and the offsetting of risks from other markets. Half the time that will require short selling.</p>\n<p>For our purposes here, a trade setup is just a description of how you open that contract. It answers the following questions:</p>\n<ul>\n<li>What is the <strong><code>open price</code></strong>?</li>\n<li>Where is the <strong><code>target price</code></strong>, the price where you will automatically close out your position for a win?</li>\n<li>Where is the <strong><code>stop loss</code></strong>, the price where you will automatically close out your position for a loss?</li>\n<li>How many <strong><code>contracts</code></strong>?</li>\n<li>What is the <strong><code>margin</code></strong> your broker requires from you to open and maintain your position?</li>\n</ul>\n<p>When you have finished this series of stories you will know how to only risk a specific percentage of your funds in each trade and how to calculate the number of contracts you need to do so. The material we discuss here is fairly basic, however it assumes a level of knowledge about charts, trading software and jargon that may be unfamiliar. Do not be discouraged by this, we all have to start somewhere. Most of the terms are common enough that a quick internet search should yield all the information you need.</p>\n<p>If not, turn for help to our forums or the comment section under each story. If you want a special article on a topic you believe is important but not yet covered, make a post below and argue your case. If you can convince us the problem deserves its own story, we will be happy to oblige.</p>\n<h4><strong>A Gold Trade Example</strong></h4>\n<p>To describe a setup, I am going to choose a reasonably simple example in a popular market: gold. Consider the following recent daily gold chart from April to August 2017. <img alt=\"Gold daily chart\" class=\"center\" src=\"/media/uploads/2017/a_basic_trade_setup/20171008-Gold-setup1.png\" title=\"Basic setup\" width=\"90%\"></p>\n<p>If you remember the news at that time, there were ominous rumblings coming out of the Korean peninsula through July. War drums are usually bullish for gold because paper money often does not survive long when central governments are in turmoil.</p>\n<p>The month long upswing from point B on the chart to O (for <strong>O</strong>pen) was followed by a six day downward <strong><code>retrace</code></strong>. Then, as the last trading session on the chart closed we can see that the <strong><code>candlestick</code></strong> of the day's trading was an <strong><code>outside bar</code></strong> enclosing the previous day's trading, and ending positively. Summarizing these developments to get a feel for market direction, we have:</p>\n<ul>\n<li>The market is overall sideways, but currently trading in the middle of the range.</li>\n<li>Since point A, the faster moving average (MA100) has crossed above the slower 200 day MA.</li>\n<li>The current swing is up since point B.</li>\n<li>the market has completed a week long retrace down.</li>\n<li>The top of the sideways market is near points C and D, above the current price.</li>\n<li>External global risk factors lean bullish on gold.</li>\n<li>The previous trading session ended with a bullish reversal.</li>\n</ul>\n<p>I will get into all of these points more fully in a later story but for now I just want to walk through a basic trade setup with you. For our purposes here, let's just assume we have a bullish <strong><code>signal</code></strong>.</p>\n<p>We will not be discussing <strong><code>brokers</code></strong> as your options vary widely by country. However there are many possibilities, from full service all the way through computer based online trading. Recently, since the 2008 financial crisis, many regulations have been tightened. Check the advertisements in your region and review the stories from other traders on the many social media platforms available to you.</p>\n<p>In this story, I have presented a bullish <abbr title=\"a price pattern in the market triggering the opening of a position\">signal</abbr> in an example from the gold market. In the <a href=\"/stories/39/2017/10/24/the-basic-setup-part-2-stop-loss-and-open-price/\">next story</a> we will discuss <em>how</em> we will open a long position in gold. I will show you the key data you need to lock down the potential risk and reward before opening the trade.</p>\n<hr>\n<p>Copyright (C) PagooLABS 2017. All Rights Reserved.</p>",
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"post": "I like this as a kind of how to. I looked ahead into the systems stuff in the future chapters. Not having read those yet I can still see why setups are important info. The systems stuff is heavier going if you ask me. I wanna see some more. FX is the way to go.",
"html": "<p><p>I like this as a kind of how to. I looked ahead into the systems stuff in the future chapters. Not having read those yet I can still see why setups are important info. The systems stuff is heavier going if you ask me. I wanna see some more. FX is the way to go.</p></p>",
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"post": "Agreed.",
"html": "<p><p>Agreed.</p></p>",
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