The Most Fun Part of Trading

Happy Wednesday!

Do you like talking about trading systems?

Because I have a confession: I love new trading systems. 

I can still remember my first trip to Vegas and I can still remember the excitement we had planning out which speakers we were going to see at the Las Vegas Forex Convention Show Extravaganza.

And I was embarrassingly excited for each new speaker and each new presentation.

That really hasn't changed much over the years.

Anytime I read about a new system in a trading magazine or hear a new speaker talk about her new system, I still feel a wave of anticipation. Even if that system or speaker lets me down, I still can't wait for the next one.

How do you feel about it? Do you love new systems, too? 

If you do, you're in luck. I have a whole bunch of research that I'd like to share (for free).

That being said, I fully understand that one of the best parts of trading is the actual profit. Of course it is. 

But the journey toward making that profit, the path we commit to, the systems we trade, might be the most fun part of all. 

If you're interested in talking about systems, then, by all means, get on my email list. You can sign up for free by going here: https://www.scottwelsh.me/free-ebook                           

I'm still posting each week, but the systems will only be in the emails. 

I'm going to start it off by sharing one of the very first trading systems I ever built starting next Wednesday. I'll actually talk a little bit about that system tomorrow on the weekly Thursday YouTube video.

Happy trading!

Scott

The Neglected Element of Trading Success

Your trading system won't make money.

It won't, that is, if you don't like it. 

When we're looking for a trading system, we spend a lot of time looking for the magical system and we spend zero time wondering if we like it.

I get a lot of emails about trading.

I'm asked about systems and robots and indicators and money management.

No one ever tells me what they like. 

For example, a trader will email me and tell me he's looking for a trading system. He'll then list a few of his goals for trading. Then, knowing I trade three different robots live in the market, he'll ask me which one I recommend.

And that's the key moment. 

Because it doesn't matter what I recommend. In fact, my recommendation may be the one thing that keeps him from making money with that particular system.

The thing that matters most, the thing that will make him successful, is answering this question:

What do you like?

The style you choose has to be the right style for you. Otherwise, it will most likely fail.

If tennis player Rafael Nadal played a different style, if he played only on fast surfaces and tried to serve-and-volley every point, he probably wouldn't be ranked in the top 100. Maybe not even in the top 500. 

Nadal is a defensive player, maybe the best defensive player of all time, and his success is based on playing that style on slow surfaces.

Doing the opposite would be disastrous.

The same is true for trading. 

Even if you have a system that will make money in the long run, if it trades in a way you don't like, it will only lose you money.

How?

Because if you hate the way it trades, you'll get out of winning trades early ("I better get out before it loses another one") and quickly just give up altogether ("I knew it was going to lose again--forget this!"). 

The winners are no longer winners and the losers take you out of the game. Voila, a successful system becomes a failure.

So how do we choose a style we like?

The first answer is: you already know what you like. Don't listen to anyone else and listen to your heart. How do you like to trade?

But sometimes we get so bogged down with trading advice that we can't see past our own confusion. How do we pick our style then?

It's easy. Concentrate on the losers.

How do you like to lose? Or, more specifically, what type of losing trade doesn't bother you so much?

For example, a trend following system loses pretty quickly. A breakout should work right away, and if it doesn't, then a trend following system will rapidly stop itself out. 

Is that okay with you? Would you mind a bunch of small losing trades (knowing a big winner is coming)?

Or would you rather avoid seeing losing trades as much as possible? If losing makes you angry, depressed, and a bad decision-maker, then you need a style that doesn't put you through that very often.

A system without any stoploss at all might fit the bill. Or possibly a system with a "negative" risk/reward. Either one of those will only have a small amount of losers, and that might be exactly what you need. 

If you want to trade, obviously you need to find a good system. But there are lots of those.

If you want to be successful long-term, you need to find a trading style that you dearly love. 

Once you do that, success is just around the corner.

 

To follow the performance of all the robots you can go here: https://www.scottwelsh.me/performance-tracking/

"The Greatest Strategy of All Time" (Breakout) Course is now available. You can find it here: https://www.kajabinext.com/marketplace/courses

Get the Heron Course here.

Get the Weekly Pivot robot (which is inside the 50% on Purpose Course) here.

My website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

My Big Points blog is here: https://www.scottwelsh.me/big-points-blog/.

Follow me on Twitter @swelsh66.

 

Is This Chart Too Good to be True?

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A quick note. It's literally just been confirmed that I'll be speaking live at the Festival of Traders next Tuesday, August 7th. There are eight speakers and I'll be presenting at 6 pm EST. Register here: http://www.tigersharktrading.com/2018festivaloftraders.htm?src=180807welsh. Hope to see you there! Now, on to the newsletter...
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You know how I feel about too good to be true.

I believe that life can be really good and really true. It doesn't have to be bad to be reality. 

However.

Over a year ago, I was messing around with some testing on the Fair Value style. My preferred chart at the time was 15-minute and my preferred instrument was Forex. 

But I decided to branch out just for fun.

And that's where this crazy chart came from.

Before I share the results, it's important to know that there are so many things wrong with this chart.

For one, it's on a Daily chart. Well, that's not really "wrong" but it's not the timeframe I spent dozens of hours on. 

For another, it's a Long-Only chart. Everyone knows we should trade in both directions, so that, of course, makes this research suspect.

For a third reason, it doesn't use a stoploss. That simply makes it way too risky. (Warren Buffett would never take a trade unless he had a firm stoploss, right?)

Fourth, it's the Australian Dollar futures contract. What kind of a person would trade the @AD anyway?

Fifth, it doesn't trade very much. It didn't take a trade in 2009 and sometimes it only trades once a year. No one trades like that.

So, you see, this is a ridiculous chart, and that's why I've done nothing with it. I've just let it sit quietly on my Tradestation platform and take its ridiculous trades.

A short time ago, on a lark, I checked in to see how bad it's been doing. 

Whoa.

Here's the Tradestation Performance Report:

https://www.screencast.com/t/IULfi1FQ

A few things about that Report.

One, the win % is 98.04%! Get out of town with that garbage. 

Two, it makes $39,516 over that past 16 years and only has a max drawdown of -$3,970. That's a 10:1 profit to drawdown ratio. 

And check out the Annual Returns:

https://www.screencast.com/t/g0MdCbvKmC4

No losing years. More than that, on a hypothetical $7,800 account (twice the max drawdown), there are 4 years where we would have made 50% or more on our money. 

And that's all with a 98% win rate. 

What do you think about that? Is it preposterous? Stupid? Too good to be true?

Or is it something that should be traded immediately with real money?

Tomorrow, on the weekly YouTube video, I'm going to go over this ridiculous system in detail and give all the settings.

Hope you can join me.

You can subscribe here if you're interested: https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

To follow the performance of all the robots you can go here: https://www.scottwelsh.me/performance-tracking/

"The Greatest Strategy of All Time" (Breakout) Course is now available. You can find it here: https://www.kajabinext.com/marketplace/courses

Get the Heron Course here.

Get the Weekly Pivot robot (which is inside the 50% on Purpose Course) here.

My website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

My Big Points blog is here: https://www.scottwelsh.me/big-points-blog/.

Follow me on Twitter @swelsh66.

 

Should We Trade in Both Directions?

It's an easy mistake to make.

I know. I've made it.

When developing a trading system, it's only logical to think that we should trade in both directions. Markets clearly go up and down. Why would anyone forego delicious profit by only focusing on one direction?

Furthermore, rational thinking would dictate that a system isn't robust if it only trades one way. If we only take long trades, for example, then we're probably curve-fitting.

No, if we're going to have a system that's viable long-term, we need to be trading both sides of any market. And not only that, we need to have the same rules for both. Otherwise, once again, we're just curve-fitting and asking for trouble. 

Right?

Well...

A few weeks back, we looked at how basic, free indicators can beat the market. But in those examples, we only went Long. 

Was that a mistake? 

In a more recent post, we saw that RSI was the best indicator for trading the ES. It beat the market for the holding period we talked about and it beat the other indicators. But, again, it only went Long. 

For that reason alone, it's reasonable to conclude that we should throw that research out. If we want a truly trustworthy system, we need to go Long and Short.

I might have been trying to pull one over on you.

So here is what happens when we get more "robust". I applied the same rules to the ES (60 day holding period, 1 contract, default RSI settings) and used the same rules (RSI goes up into Overbought, RSI closes down below Overbought, enter at open of the next day). 

Here's a picture of that entry: 

https://www.screencast.com/t/3VYAmpuupx

So how did the Short trades work out?

From 1998-2018, we lost over $65,000. Report here: https://www.screencast.com/t/wQVr5sr6H6

Keep in mind that the exact same rules for Long trades beat the market easily: https://www.screencast.com/t/lNzFm6fl

Yikes. 

Logic demands that we must trade both sides of the market and use the same rules to do so. The research tells us something else.

The Long side of the market and the Short side of the market are not the same. 

And they need to be treated very differently.

But does this only apply to the ES? We'll take a look at some other instruments in the YouTube video tomorrow.

To follow the performance of all the robots you can go here: https://www.scottwelsh.me/performance-tracking/

"The Greatest Strategy of All Time" (Breakout) Course is now available. You can find it here: https://www.kajabinext.com/marketplace/courses

Get the Heron Course here.

Get the Weekly Pivot robot (which is inside the 50% on Purpose Course) here.

My website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

My Big Points blog is here: https://www.scottwelsh.me/big-points-blog/.

Follow me on Twitter @swelsh66.

 

 

The Terrible Danger of a Good Risk to Reward Ratio

Everybody knows there's no Holy Grail in trading.

Except, of course, there is. 

While there may not be a system that qualifies as the Holy Grail (debatable), smart people will tell you that a concept is Grail-like.

And that concept is risk to reward

Just recently, I listened to a webinar that told us that very thing. 

In the webinar, many different systems were discussed. The point was: the system we choose isn't that important. 

What was truly important, they said, is that our reward must be much larger than our risk. 

The key to being a successful trader is having profits that are 2-10 times larger than the amount of our stoploss. That way, even if the win rate is only 50%, our profits will always outweigh our losses.

Risk to reward is the key to everything. It's the Holy Grail. 

Great. All our problems are solved. 

We just need a system that wins 50% or more and has profits, say, 2-3 times larger than our losses. No problem.

Except there's a problem. 

There's a huge danger to having a "good" risk to reward ratio. 

The first problem is the winning percentage itself. 

To trade a system with a reward far outpacing the risk, the truth is that the win percentage isn't going to be 50%. It's most likely going to be a lot lower. 

Typically "good" risk to reward systems have win percentages that drop down into the 25% range. 

Yikes.

Do you know what it's like to trade a system that wins about 25% of the time? Have you ever tried it? 

It's not great.

If we win 25% of the time, that means we lose 75% of the time. That's a lot of losing. That means almost every day of our trading life is going to be spent looking at our accounts going down. 

And when we go on losing streaks (streaks of small loss after small loss), it can get pretty depressing pretty fast.

And when it gets depressing, it's easy to think we'll never get a winner again.

And if we feel like the winner will never come, we might feel like quitting on this loser of a system.

Which means, of course, that we'll miss the next big winning trade.

Which means, bringing it back full circle, we get the nasty combination of a low winning percentage and profits that aren't bigger than our losses (because we just missed the huge winner).

That's a losing proposition.

There's another sneaky problem to seeking the magical risk to reward.

If we believe what the experts tell us, then we won't accept anything less than our winners being bigger than our losers. 

By accepting that concept as law, we might actually be guaranteeing we'll never be successful. 

Here's the thing, risk to reward isn't the Holy Grail. There are many systems that work WAY better with a "bad" risk to reward ratio. 

For example, remember our little indicator experiment on the ES? Remember how we put basic indicators on a chart and found out off-the-shelf indicators beat the market? 

Well, very recently I ran a comprehensive test on targets and stops on the ES using the default Stochastics settings. I took the basic Stochastics entry we talked about in those posts and then tested for the best target and the best stoploss. 

My brand new computer is pretty fast and the test still took an hour (over 100,000 tests). I tested a wide range of possibilities. 

Now if risk to reward is the Holy Grail, the test results should show a target that is many times larger than the stoploss, right?

That's not what happened. 

The top results all had a target that was much smaller than the stop. In fact, the best results had the stoploss being 5 times larger. 

Completely opposite to what we're told. 

You know what else?

I scrolled all the way through the top 200 results. Do you know how many target/stop combinations in the top 200 had a "good" risk to reward ratio? 

Zero.

Not one of the top 200 results had a target bigger than the stop.

So, if we only accept a reward bigger than our risk, we face the danger of turning a winning system into a losing system (or at least a barely profitable one). 

The "bad" risk to reward beat the market. The "good" risk to reward didn't come close.

The bottom line? A positive risk to reward is great if you can get it. Trend following uses this concept and I love trend following.

But a "good" risk to reward can be very hard to trade. And there are plenty of systems that work better with a reward far less than the risk.

We'll talk more about that in tomorrow's YouTube video.

To follow the performance of all the robots you can go here: https://www.scottwelsh.me/performance-tracking/

"The Greatest Strategy of All Time" (Breakout) Course is now available. You can find it here: https://www.kajabinext.com/marketplace/courses

Get the Heron Course here.

Get the Weekly Pivot robot (which is inside the 50% on Purpose Course) here.

My website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

My Big Points blog is here: https://www.scottwelsh.me/big-points-blog/.

Follow me on Twitter @swelsh66.

 

 

The Burning Question: Do I Need to Re-Optimize my System?

If you've ever optimized a system and then traded it live, you're familiar with the question that never quite leaves the back of your mind:

Do I need to re-optimize?

Of course, when things are going wonderfully, this question never seems to come up. When money is pouring in, the only question that comes up is whether you're a genius or a super genius.

(Hint: the answer is always super genius.)

But when things go poorly, or weirdly, then we're right back where we started. 

Is my system acting this way because it needs new inputs?

The first scenario to bring this doubt into play is losing. Losing always causes the worst of everything. When the system loses, obviously something is wrong. And that something needs to be fixed. 

That's where the max drawdown number comes in.

If the system has gone through a losing streak that's greater than the max drawdown, then something bad is going on. The market might have changed or the testing wasn't thorough enough. Either way, it's time to stop trading live and look again at the settings. 

In short, if a system has blasted through the previous max drawdown number, it's probably time to re-optimize. 

But that's not the only time the question comes up. 

Sometimes it comes up when things aren't necessarily going badly. Sometimes it comes up when the system appears to be acting strangely.

Case in point: my USDJPY Hornet robot. 

On paper, nothing really bad is happening. It had a great start to the year and since has tapered off. As I write this, it's at about break-even for the year. Clearly, that's nowhere near the max drawdown number.

(In addition, my Hornet took a full loss on a Sunday open when the spread widened to borderline criminal levels. Some of my Lifetime Members never got that stoploss, so they're doing better this year than I am.)

But the USDJPY has been doing something odd for the past few months: it hasn't been trading very much.

And when it doesn't trade very much, it's not going to make very much money--hence the ho-hum performance. 

So, if it's not trading as much as I'd expect, we're back again to the magic question. 

Should I re-optimize it?

The emotional answer is: Yes, re-optimize it! Re-optimize it every day of the week and twice on Tuesday until profit starts flowing again!

But we probably need to look a bit closer first.

For one, my USDJPY Hornet was trading quite often not that long ago. In November 2017 it traded about every other day and in December 2017 it did the same. 

And in January 2018, it traded nearly every day. 

That's three straight months of active action, the most it had seen since 2016. 

So it's not like it's been dormant for a long time. 

In addition, there have been periods like this in the past. November through April 2017 was similar. May 2013 through September 2013 was even more similar. 

And there have been many three-month periods that have seen bigger losses than have been seen recently. 

Last, I don't think that inactivity is necessarily a sign of danger for a system.

Value investors can go years and not see levels tasty enough for them to trade. 

Trend followers can also go several months without seeing a single entry.

If prices aren't dropping low enough, no one would say we need to stop being value investors or change our ways. 

If prices aren't breaking out, we wouldn't say trend following is dead and we need to change everything. 

Well, actually, people say trend following is dead all the time, but they've yet to be correct. 

So what's the bottom line?

If a system is racking up a massive drawdown, it's time to take a look.

If a system is a little more inactive than is preferable, then it's time to stay calm and watch it trade for several more months.

Of course, no one likes to sit around and watch their system not trade.

And I'm one of those people. 

If the lack of trading continues throughout the rest of the year, it might warrant some attention. 

In the meantime, I'll be watching closely. Very closely.

 

To follow the performance of all the robots you can go here: https://www.scottwelsh.me/performance-tracking/

"The Greatest Strategy of All Time" (Breakout) Course is now available. You can find it here: https://www.kajabinext.com/marketplace/courses

Get the Heron Course here.

Get the Weekly Pivot robot (which is inside the 50% on Purpose Course) here.

My website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

My Big Points blog is here: https://www.scottwelsh.me/big-points-blog/.

Follow me on Twitter @swelsh66.

The Surprising Indicator Beats the Market Best of All

During the past several weeks, I've tested fifteen different indicators and price action entries.

I've tested MACD, Momentum, moving average crosses, Stochastics, RSI, Key Reversals, and Outside Bars (just to name a few). 

A lot of them beat the market. 

But, to finish our discussion, I wanted to talk about the Indicator that performed best of all.

And it might surprise you. It did me.

The #1 performing indicator was...

Keltner Channels. 

Were you expecting that?

As I've done throughout our discussion, I just used the off-the-shelf settings. I didn't optimize any of the indicators or price action entries.

That being the case, here's how the Keltner Channel "strategy" works (using the standard inputs of length 20/ATRs 1.5).

When price closes above the Keltner Channel, we go Long when price moves 1 tick above the high of the bar that closed above the channel.

Here's what that looks like:

https://www.screencast.com/t/Jr3042ONQMl

Then we hold for 60 bars. 

Well, not exactly.

I did the smallest bit of optimizing for this one. I just had to see.

As it turns out, the Keltner Channel entry works best if we hold for 57 bars. Considering that's almost exactly the same at the holding period we've been using, I thought that would be okay. 

Here are the results.

If we used 1 contract on a hypothetical $25k hypothetical account, from 1998-2018 we'd have a profit of $106,762 and a total return (no compounding) of 427%. 

See the report:

https://www.screencast.com/t/dPjdFxRE

If, on the other hand, we bought-and-held 1 ES contract from 1998 until 6/27/18, we'd only have $73,055 of profit and a 292% return:

https://www.screencast.com/t/ZSM0FHEaMM

Of course, as you peruse the reports, you see that the Keltner Channel also had WAY less drawdown. We could double our trade size using the Keltner Channel and get twice the profit for the same drawdown as buy-and-hold. 

Pretty amazing. 

After all of the testing, the Keltner Channel indicator beat all other indicators and the market.

Who knew?

Maybe it's time for all of us to get some Keltner Channel in our lives.

 

To follow the performance of all the robots you can go here: https://www.scottwelsh.me/performance-tracking/

"The Greatest Strategy of All Time" (Breakout) Course is now available. You can find it here: https://www.kajabinext.com/marketplace/courses

Get the Heron Course here.

Get the Weekly Pivot robot (which is inside the 50% on Purpose Course) here.

My website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

My Big Points blog is here: https://www.scottwelsh.me/big-points-blog/.

Follow me on Twitter @swelsh66.

 

Price Action v. Indicators: Which Works Better?

We now know that indicators have been given a bad rap.

Not only are they worthwhile, but they can beat the market easily.

And we also know that, when it comes to indicators, RSI is the winner (so far). 

But what about price action, though?

I've heard a lot of traders talk about how price action is the only truth in trading. Again, I tend to agree.

Indicators have complicated math based on price movements, of course, but why deal with the middleman? Instead of creating an equation for price action, why not just look at the thing itself? 

It seems to me that using price to determine entries would be superior to using a derivative indicator. 

To do our case study, however, we'll need to determine what we mean by "price action". 

For our testing purposes, price action will mean an entry signal based only on what's happened on the charts. 

Today, we'll look at one of my favorite price action patterns: the Key Reversal.

The official definition of a Key Reversal is: "A key reversal is a chart pattern that consists of a new low and a higher close than the previous bar. When a Key Reversal pattern occurs, a long entry order is placed for the next bar at open."

I like this because it appears to mean something important. 

If price goes lower than the previous Daily bar, then the market is dropping, signaling that a downtrend might be upcoming.

However, instead of continuing down, price abruptly reverses back up and, in fact, closes above yesterday's close. The market thought things were bad and then dramatically changed its mind.

To me, that's significant and is something we should be a part of.

Here's a picture of a Key Reversal. Notice on the bar with the red arrow how the low goes below the previous bar and then the close is higher than the previous close. We enter at the open of the next bar:

https://www.screencast.com/t/sMjIg9ZRE3

So, using the same parameters as we have previously (1 contract, 60 day exit, $25k account, ES, 1998-now), let's take a look at how price action performed.

Pretty well, it turns out.

Entering on a Key Reversal and getting out 60 bars later produced $64,934 of profit. This beat buying-and-holding the market by 143% (Key Reversal 259%, buy-and-hold 116%). 

Price action does appear to matter.

What about drawdown?

The close-to-close drawdown of the Key Reversal was -$40,594. Considering that's more than our hypothetical $25k account, that means we'd have to have a bigger account and the return percentage would drop. So that's not good.

But the Key Reversal max drawdown was still better than the buy-and-hold max drawdown of -$55,625. 

However, as you remember, the RSI close-to-close max drawdown was -$15,828 while producing $68,772 of profit.

RSI beat Key Reversal in profit and max drawdown. 

The top-ranked indicator (so far) is better than this type of price action.

But they both beat the market.

Is there a different price action pattern that might be the best yet? We'll find out in Thursday's YouTube video.

To follow the performance of all the robots you can go here: https://www.scottwelsh.me/performance-tracking/

"The Greatest Strategy of All Time" (Breakout) Course is now available. You can find it here: https://www.kajabinext.com/marketplace/courses

Get the Heron Course here.

Get the Weekly Pivot robot (which is inside the 50% on Purpose Course) here.

My website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

My Big Points blog is here: https://www.scottwelsh.me/big-points-blog/.

Follow me on Twitter @swelsh66.

 

 

 

 

Which Indicator is Best: Stochastics or RSI?

Last week we learned that indicators definitely do work

Putting an indicator on a chart (in this case, Stochastics), waiting for a signal, and then holding for a set period of time produced a substantial amount of profit and had less drawdown than buy-and-hold by a country mile. 

So, if the data shows that an indicator is an effective way to beat the market, the question now becomes: which indicator works best?

I've heard sentiment that one indicator is very much like another. Worrying about which indicator works best is counter-productive and a waste of time. 

For the most part, that's been my opinion, too. 

Now I'm not so sure.

For one, the calculations are all so different. I'm starting to think the math behind some indicators is more relevant than the math behind others. 

For another, the numbers show that some appear to work better. 

As I mentioned, the first indicator I ever studied was Stochastics. That's why I used it in last week's case study.

But my favorite indicator is RSI. 

I love the way it trades. When RSI goes to Overbought or Oversold, it feels like it means something. I also like the way it works in real time. Emotionally, the RSI indicator seems to accurately depict market action.

It seems like a trading career could be based around using the RSI.

But is it true? Are my feelings misguided? Let's find out.

For reasons I've already outlined, we're going to stick with using the ES on the Daily time frame, and we're going to stick with a time-based exit. 

It makes sense that, if an indicator really works, we should be able to take a signal, walk away, and come back to see money in our accounts. 

So we're using a hypothetical $25,000 account on the ES on a Daily chart, Long signals only, one contract each trade (no compounding), and holding for about three months (60 days). 

Here are the results. 

From 1998-June, 2018, Stochastics (14 length/20 Oversold) produced $67,658 of profit with a close-to-close max drawdown of -$21,588. The win percentage was 71%

From 1998-June, 2018, RSI (14 length/30 Oversold) produced $68,772 of profit with a close-to-close max drawdown of -$15,828. The win percentage was 81%. 

[Remember, buying-and-holding the ES for the same time period had a max drawdown of over $55,000 and produced profits that were 300% LESS than what RSI achieved.]

Whoa. It appears my gut feeling was right. RSI does capture market action better than Stochastics and is a better indicator. 

RSI makes more money, has 26% less drawdown, and has a higher win percentage. 

However, RSI also produced less trades. Apparently it's harder for the ES to go into Oversold on the RSI. 

Stochastics traded 47 times in this time period while RSI only traded 27 times. If you like more trades, then that might make you lean toward Stochastics even though the overall numbers aren't as good. 

The bottom line: it looks like some indicators do work better than others on robust instruments like the ES. 

Which, of course, begs the follow-up question: does anything work better than RSI?

We'll look at that at tomorrow's YouTube video.

 

To follow the performance of all the robots you can go here: https://www.scottwelsh.me/performance-tracking/

"The Greatest Strategy of All Time" (Breakout) Course is now available. You can find it here: https://www.kajabinext.com/marketplace/courses

Get the Heron Course here.

Get the Weekly Pivot robot (which is inside the 50% on Purpose Course) here.

My website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

My Big Points blog is here: https://www.scottwelsh.me/big-points-blog/.

Follow me on Twitter @swelsh66.

 

 

Case Study: Do Indicators Really Work?

Full disclosure: I love indicators. 

I love that, years ago, a smart person saw something interesting in the markets and used smart-person math to numerically give us all a way to make money. 

There are ways to make money trading without an indicator, of course, but our minds are so undisciplined that most of the time we sabotage our own chances before we ever bank the profits. 

Indicators fix all that. 

They give us a definite mathematical entry and a definite mathematical exit. They give us logical reasons to make profitable trades and their calculations provide the discipline to execute properly. 

Just stand on the shoulders of mathematical geniuses and follow the indicators to the promised land. 

I love that. 

But indicators are taking a lot of heat lately. 

They're lagging.

They're based on math that's outdated.

They're a crutch only used by amateur traders. 

Is this true? Is it pointless to use indicators?

To answer, we're going to need some rules that make perfect sense. We're going to need rules that are so simple that the conclusion we draw is darn near inescapable.

Otherwise arguing about indicators is just a bunch of sound and fury signifying nothing. 

First, we need to use an instrument that's been around a while. Putting an indicator on bitcoin futures, for example, is not going to help us. So what's been around the longest?

The stock market.

But we can't pick individual stocks. That would be too biased. It could be argued that an indicator happens to work best on a particular kind of stock. 

No, we need the whole stock market. That incorporates a bunch of stocks and can give us a good picture. 

Second, let's use the futures market, specifically @ES. I suppose we could also use something like SPY, but I'll take the leverage of @ES instead. 

Third, let's only go long. The stock market has an upward bias, so let's use that and also stay very specific. The more variables we use, the less valid our conclusions. Plus, the long side of the market is very different than the short side, so we need to run those experiments separately. 

Last, what is the definition of "working"? If we say an indicator "works" what does that mean?

It means that if an indicator generates a Long signal, the market will go up. If we get a buy signal today, we should then be able to walk away and come back later and see a trade that's made money. 

If we put a stoploss in, we're tampering. We're saying that the indicator probably doesn't work that great, so let's put in a safeguard. That's a shaky signal.

If we put a target in, we're also tampering. We're saying that the signal doesn't have much strength, so we better get out before anything bad happens. 

If we're truly trying to find out if indicators work, then we need to keep it strictly black and white.

Get a signal, take the signal, and come back later and see profit. 

The question then becomes: how long should we wait? Should that signal last years?

I don't think that's a good test. The indicator was based on math that was intended to foreshadow an imminent change in our favor. I don't think any indicator was made to predict where we'll be five years from now. 

So how about three weeks? One week seems too short for this test. A month seems slightly too long. This is debatable, of course, but three weeks seems reasonable. It gives the indicator time to work while not forcing it to do too much.

Three weeks it is. If we find anything exciting, we can change this to a different time span and test some more. 

But that's not all we need. If we're going to believe in indicators, that indicator needs to give us signals that, if followed, beat the market. These signals should help us do better than if we just got in at the beginning and held for the next several years (or decades). 

If our famous indicator makers did their jobs, then those signals should do better than a trader who had no indicator at all. 

Finally, we need an indicator. I'm biased toward RSI and CCI, but the very first indicator I ever looked at was Stochastic, so that's where we'll start. And, to avoid any funny business, we'll just use the default settings given to us by George Lane himself (or C. Ralph Dystant). 

Those settings have a Length of 14 and an Oversold reading of 20.

Rules:

  1. Using a Slow Stochastic with a Length of 14, we're going to wait for price on the ES to go below 20 on a Daily Chart. 
  2. Then we're going to wait for the Fast stochastic line to cross over and close above the Slow stochastic line.
  3. Then we're going to hold the trade for 15 days (3 trading weeks) and exit at the open of the next bar. We won't count the entry bar. So that's 15 bars after the entry and then exit at the open of the 16th bar. 

Here's a picture of a winning trade from March 28, 2018: https://www.screencast.com/t/vLXYmS72x

What were the overall results?

Starting with a $20,000 (and including all trading costs such as slippage and commission), using a Stochastic indicator generated a profit of $56,039 and a close-to-close max drawdown of $15,091. The testing period was 1998 to June, 2018. The test used a trade size of 1 contract on every trade (no compounding). 

According to the Tradestation Performance Report, that's a return on initial capital of 280%. 

If we simply bought and held 1 contract of the ES during that same time period, we would only have achieved a return of 122%.

By the way, the max drawdown if we bought and held the ES would've been $55,625, which is more than 3 times as much as Stochastic's was and would have taken our whole account and shoved it down the toilet. 

The conclusion seems pretty clear: Indicators work. They provide a substantial edge over buy-and-hold.

Well, at least Stochastic does. 

But does it work only under those conditions? 

We'll find out in Thursdays YouTube video. 

To follow the performance of all the robots you can go here: https://www.scottwelsh.me/performance-tracking/

"The Greatest Strategy of All Time" (Breakout) Course is now available. You can find it here: https://www.kajabinext.com/marketplace/courses

Get the Heron Course here.

Get the Weekly Pivot robot (which is inside the 50% on Purpose Course) here.

My website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

My Big Points blog is here: https://www.scottwelsh.me/big-points-blog/.

Follow me on Twitter @swelsh66.