Recaps, New Interviews, and Book Thoughts
I've been having several parallel trains of thought recently. After I go through a trading recap of August and September, I'll touch on the Best Loser Wins book again and how it ties into a fairly recent Chat With Traders interview.
Starting off with a trading recap, August was probably one of my best trading months recently. I would say trades during this month were near-perfect in terms of following my trading plan.
Although barely any pairs continued major trends, I was able to capitalize on momentum opportunities following my methodology of using the Darvas Box system and Average True Range metrics.
It was still a very simple approach to time my entries based on the box range breakouts. Once the trade is live, my stop loss and take profits are set based on the Average True Range (which I've now replaced with the Average Daily Range indicator).
I take a high-probability approach by setting my stop loss at 1x ATR and take profit at 2x ATR. With a bit of rounding, this usually keeps my reward-to-risk ratio somewhere between 2-3R. I am conscious of the risks associated with this.
By setting a take profit target of just 2x ATR, I require a higher win rate to be net positive (assuming position size remains static). The other issue is that I don't capitalize on larger trend movements that might take days or weeks to play out. This goes into my September's performance.
I ended September with a net loss. Fortunately, this loss was much lower than the gains I made in August. My poorer performance in September can be attributed to two key factors - a bit of overconfidence and a bit of experimentation.
Admittedly, I took more trades with sub-optimal entry signals. For example, I entered trades without waiting for an exhaustion signal on the 1-hour timeframe. I've since corrected this mistake by being more mindful of baking the immediate price action into my future entries.
The second factor was experimentation. After reading and writing a post on Best Loser Wins by Tom Hougaard, it got me asking myself - should I be trailing my trades instead? Would that actually be more efficient?
My thought process here is that I don't need to sustain a higher win rate in order to be net positive. Fewer, larger moves that play out can cover a series of losses that I take on. I really solidified this need to experiment after listening a Chat With Traders interview with Robb Reinhold.
This interview did a great job detailing Robb's experiment. I wouldn't do any justice summarizing it so I highly recommend listening to the link. In this episode, there were quite a few tidbits that really stood out to me:
- Most people over-emphasize picking the right instrument and timing the entry, which isn't as important as risk management (or at least that's my take on his thesis)
- If you pick stocks at random, you can still generate a return just by following a systematic risk management approach
- You can further optimize your trading performance by incorporating the entry and position sizing into your overall trading
Circling back to my September's performance, I changed my risk management parameters. I would enter trades with a stop loss set at 1.5x ATR, which I would trail by manually moving the targets on clear movement days. I define 'clear movement days' as the current bar closed with a clear high or low.
Keep in mind, I'm no longer setting an ATR-based take profit target now that I'm continuously trailing my stop loss by 1.5x ATR. This has led to a few observable changes in my P&L as well as my mentality.
Side note: the additional confidence of my performance in August also impacted how loosely I entered trades in September.
That said, overall observations detailed below:
- I had a lot more losing trades, but loss amounts were smaller because of the 1.5x ATR trailing stop function
- Winners were smaller because explosive moves would pullback and then stop me out
- Aggressive scaling required since the lower win rate forced me to have smaller entry position sizes
Overall, there was a certain amount of pain that came with returning the unrealized profits on your trades when trailing them. Efficiency wise, catching a major move can return 3-5x vs. taking profit at 2x ATR. However, a lot of otherwise profitable trades got scratched along the way because they don't turn into big moves.
Through this experimentation, efficiency wise, targeting 2x ATR seems better for me. I feel I'm playing a statistics game by targeting the highly probable outcome of hitting my take profits.
Sure, there are going to be plenty of moments where I only capture a fraction of the overall move. However, I am able to make up for it by putting on more size and achieve the same absolute P&L vs. scaling into a position that I need to hold for multiple days or weeks.
A final consideration is that maybe holding for longer is easier to optimize in other asset classes such as futures or stocks. In the CFDs space, holding costs is another component one must consider carefully.
As of now, I'll stick to what's working for me unless I have new developments.