Fading False Forex Breakouts

In this article I will share a simple strategy that many professional traders use with a great deal of success. There are a lot of variations of this strategy that, combined with proper risk management, can give a particular trading system an edge.

Simple Trading Strategy

I run an fairly large introducing brokerage company. By observing the successes and failures of my clients and interacting with them, I am able to pick up on what successful traders use to make money and the mistakes that unsuccessful traders make to lose money. This is all backed up by hard numbers, since I am able to view the performance of my clients.

After talking to a lot of my forex clients, it became evident to me that they use pivot points quite a bit in their trading. Two particular areas that traders like to focus on is the previous day’s high and low.

A crowd usually has the psychology that if the previous day’s high is crossed up the general price move is up and they are more likely to buy than sell. The opposite is true for when the previous day’s low is crossed down.

To add to that many traders use the previous day’s highs and lows as their stops. So if the price crosses below the low traders will be stopped out and the price will drop. The opposite is true for the previous day’s high.

Taking this information into consideration, I feel that I will have an edge in the market by going long if the previous day’s high is crossed up and going short if the previous day’s low is crossed down. I feel that the price move will continue to go in the direction of the cross for at least a little bit.

Many traders however play this trade completely the opposite way. They look at these price points as support and resistance and they dollar cost down into their trades. In other words if the price crosses below the low of the previous day they will go long and add to their positions until their average entry price is lowered. It is for this reason that I give these trades a little wiggle room by placing my stops around 30 pips away.

By using this edge and back-testing it I have developed some simple rules.

Basic Rules for trading EUR/USD:

Price Action Strategy

To us a trading day is from 5pm EST to 5pm EST in forex.

1. Enter long on a stop order if the previous day’s high was crossed.

2. Exit on a limit if the trade gains approximately 10 pips. Exit on stop if the trade looses approximately 30 pips.

3. Enter short on a stop order if the previous day’s low is crossed down.

4. Cover your short position if the trade gains approximately10 pips using a limit order. Exit on a stop if the trade goes approximately 30 pips against you.

5. Only take the first high/low cross of the day.

Below is an example of an hourly chart.



Risk Control

With this strategy and any other strategy I discuss, it is critical to keep in mind the 2% rule. The 2% rule should supersede any rule of a system. The 2% rule states that you can never risk more than a certain percentage of your account on any single trade. In my case this is usually 2%, but certain traders like to kick the number up to 5%. Going above 5% in my opinion is an extremely bad idea.

Enhancements

The strategy that I described here is just a base for you to build on. There is a lot of proprietary information that I have to hold back. Putting in and testing out certain rules may enhance the system substantially. I will go through some examples.

Only take the trades in the direction of the overall trend. We back-tested a strategy very similar to the one I am describing here and a great majority of our loosing trades were short, while a great majority of our winning trades were long. Not so coincidentally the trend was primarily up during the period of our back-testing. I suggest using a trend indicator such as a moving average, trend candles tool in your software package (TopGun Software has this tool you can find more information on our website), trend lines or a parabolic SAR of some sorts.

Position Sizing Strategy

Since this system is very accurate, using an approach like the martingale that I described in my previous article will help you. Doubling the position after every losing trade may be a great idea. However it is imperative to never risk more than 2% of your account on any trade so positions should be sized accordingly. Pyramiding into the trades that go your way may enhance the performance quite a bit as well.

Place your entry stop orders a pip or 2 above or below the pivot level. By doing this you are ensuring that the price has actually crossed the pivot level.

Variations

There are numerous ways you can play around with this system to fit your style. Many traders like to straddle the opening price and go long if the price action moves a certain amount of pips above it and go short if it moves below it. Some traders like to keep this system on only during active market hours to ensure the necessary volatility. You can use other pivot points such as the midpoint and other support and resistance areas. What I described here to you is a simple time tested trading idea of trading around a price now it is on you to develop it into a system.

Execution Issues

It may be tough trading this system during heavy news hours or during a fast market. Spreads may widen out or you may get requited especially if you are trying to enter on a stop order. You may not get the best fills in this short term system. One approach that may be effective is to wait for the bar that crossed the key area to complete its move and than enter on the open of the next bar. You may leave a few pips on the table but at least eliminate some frustration.

Conclusion

What I described to you is a simple strategy that traders can use to be successful. A variation strategy was actually taught to me by a friend who was a former pit trader. By using various parameters and risk management tools you can turn it into a robust system. I recommend trading this only on the EUR/USD pair as other pairs seem to have a few too many spikes and the spreads are wider on them which eats into the profits. I would be interested in seeing variations of this approach you can email me. We use numerous strategies such as this and tools to try to enhance the performance of our clients. Our research department programmed in an approach similar to the one that I described above. Below is the Wealth-Lab report on the strategy. Keep in mind that we are overly conservative a back tested data is not indicative of future performance.

Below is a 7 months Intra day (hourly) Wealth-Lab back-tested report for you to look at. This report is based on a $100,000 account with the initial position size being 1 standard lot.

Alexander Nekritin is a professional trader with over 8 years of experience. His specialties include risk management and system development. Alexander is the CEO of www.forexyourself.com, which is a forex introducing broker and education company that helps suite client’s needs in forex trading. Alexander has a degree with a concentration in Investment Banking and derivative instruments from Babson College in Massachusetts. You can contact Alexander with further questions at alexn@forexyourself.com. Alexander conducts free seminars on Wednesdays at 9pm EST on risk management, strategy and trader’s psychology to register you can click this link: http://www.forexyourself.com/seminar.