About Trading Forex

FOREX international foreign exchange trading

Why is this presentation in English? • The vast majority of worthwile literature on trading is • • • •

written in English Almost all trading platforms are in English Terms, used in trading, come from English and often there is no meaningful translation available Most valuable resources on the internet are in English You need to get to grips with the correct terms in English to be able communicate with other forex traders abroad effectively

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Why there is a currency market in the first place? • Companies, institutions and people in general

need to be able to exchange money in order to be able to pay for goods from the foreign countries

• All of us are in fact investors on

•

the currency market since all of us hold some amount of currency. Currency holders invest in the economy of the issuer of the currency they hold There are free-floating and pegged currencies Forex trading - Mendel University [email protected]

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Quick quiz What is a market? Market is a huge amount of people. All markets are created when two or more people have an equal disagreement on value and an agreement on price.

“Price is what you pay, value is what you get.” - Warren Buffett Forex trading - Mendel University [email protected]

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What is a forex market • FOREX, or FX stands for FOReign • • •

EXchange FOREX is an OTC, or over the counter market: unlike equities, there is no centralized exchange for forex trading FOREX is a spot market: the trades are not settled up in the future (like futures or options) but rather immediately FOREX is an interbank market: the core players in the forex market are central banks, commercial banks and investment banks. The prices on the foreign exchange market are determined to large extent by these interbank participants Forex trading - Mendel University [email protected]

US Federal Reserve Bank

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What is a forex market • FOREX is the the largest and the most liquid market on the planet with $1.9 trillion daily trading volume.

• It is estimated that the

•

retail currency trading volumes total $25 to $50 billion a day, a tiny fraction of the $1.9 trillion-a-day currency market but not far off the $60 billion average daily turnover on the NYSE FOREX trades 24 hours a day, 7 days a week. Trading moves across borders and around the globe with the clock Forex trading - Mendel University [email protected]

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What is a forex market • 7 major currencies account for about 85% of

• • •

the daily trade volume: USD – US dollar, EUR Euro, GBP – British Pound, JPY – Japanese Yen, CHF – Swiss Franc, CAD – Canadian dollar, AUD – Australian dollar Major pairs traded on the forex: EURUSD, GBPUSD, USDCHF, USDJPY, USDCAD, AUDUSD. The most important currency in the world is USD Cross rates are pairs where neither of the two currencies involved is USD. For example: EURJPY, CZKJPY, AUDNZD London, UK, is the centre of FOREX trading, just as New York, NY, USA, is the centre of stock trading. The most prominent financial forex trading centers in the world are London, New York and Tokyo Chase Manhattan Bank, New York Forex trading - Mendel University [email protected]

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What is the difference between investing and trading in general? • Buy & hold = investing • The performance of trading systems is often • • •

measured against the “buy and hold” strategy Investing is only possible by buying the security Trading is an active effort – trades don’t last so long as the conventional investments do Trading = selling short & buying, too

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Gold standard and fiat money: Bretton-Woods system, 1944

• Bretton Woods Accord

established a fixed exchange rate regime in 1944, whose aim was to provide stability in the world economy after the 1930ies’ Great Depression and the World War II

• This accord fixed the exchange

rates of major currencies to the US dollar and set the price of gold to $35 per ounce. The accord required central bank intervention to maintain the fixed exchange rates

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Gold standard and fiat money: free-floating currencies, 1971 • The US Central Bank was required to exchange

dollars for gold, which eventually let to the demise of this system, when the demand for the dollar declined, as well as the gold reserves, forcing Nixon to stop the exchange of dollars for gold, effectively ending the system in 1971

Richard Nixon

• The Bretton Woods system ended on

August 15th, 1971, when US President Richard Nixon ended trading of gold at the fixed price of $35/ounce. At that point for the first time in history, formal links between the major world currencies and real commodities were severed

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Gold standard and fiat money • Almost every country in the world is on a system of fiat money • Money by itself is intrinsically useless - it is used only as a medium •

• • •

of exchange Commodities always possess some intrinsic value. Currencies do not. This is the most important difference between the commodities and the currencies Paper money is totally useless all by itself (50 mil. pounds robbery, money laundering) Currency value is entirely dependent on demand and supply Ithaca hours, Gresham’s law (bad money/good money)

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Got soybeans? 11

Bringing retail forex trading to life • Prior to 2000, retail forex

•

• •

trading was largely unknown to the public since there were almost no forex brokerages nor were they regulated Commodity Futures Modernization Act of 2000 has been approved by US Congress on December 15th, 2000 and signed into law by president Clinton on December 21st, 2000 Among others, this act allowed the CFTC (Commodity Futures Trading Commission) to regulate and oversee the Forex brokerages Historically, only big banks, institutions and big corporations were allowed to trade on forex – this has been changed Forex trading - Mendel University [email protected]

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Why forex is becoming so popular recently with retail investors? • The Chicago Mercantile Eschange (CME)

• • • •

introduced the E-Mini S&P and Nasdaq 100 contracts in 1997 and 1999 and stocks were going “forever” upward in the nineties, so retail investors were not interested in forex at that time. Well-established currency contracts were traded through CME BUT, In 2000, the stock market collapsed (dot com bubble), technology and other stocks tanked Retail forex brokers were ready to take orders online The trading hours are not limited. No sessions. Forex trades 24 hours a day, 7 days a week (Saturday and Sunday are weak days when almost no trading occurs) No opening gaps in forex

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Why forex is becoming so popular recently with retail investors? • Massive liquidity means getting in & out of • • • • • •

positions is not an issue Stops are guaranteed You pay only the spread, retail brokers usually offer Level II spread + several pips Zero commissions, almost no slippage Currencies don’t have accounting scandals or wayward CEOs Futures: problems with calculating continuous contracts Futures, options, stocks: lower leverage then forex Bank of Riyadh Forex trading - Mendel University [email protected]

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Quick quiz How many days do all the citizens of the Czech Republic need to work (to produce Gross Domestic Product) to make up for one day’s worth turnover on the forex market?

11.8 years. (2005 GDP of the Czech Republic = $161 billion, daily forex turnover = $1900 billion) Forex trading - Mendel University [email protected]

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Major currencies: USD - United States dollar • Issuer: United States of • • • • • •

America Currency: US dollar (USD, greenback) Most traded in: EURUSD, GBPUSD, USDJPY, AUDUSD, USDCAD, USDCHF, NZDUSD Central bank: U.S. Federal Reserve System – The Fed Chief monetary policy maker: governor Ben Bernanke (formerly Alan Greenspan) The Fed is the most influential central bank in the world Alan Greenspan retired January 2006 Forex trading - Mendel University [email protected]

Alan Greenspan 16

Major currencies: USD - United States dollar • Issuer: United States of • • • • • •

America Currency: US dollar (USD, greenback) Most traded in: EURUSD, GBPUSD, USDJPY, AUDUSD, USDCAD, USDCHF, NZDUSD Central bank: U.S. Federal Reserve System – The Fed Chief monetary policy maker: governor Ben Bernanke (formerly Alan Greenspan) The Fed is the most influential central bank in the world Alan Greenspan retired January 2006 Forex trading - Mendel University [email protected]

Ben Bernanke 17

Quick quiz What is the origin of the word “dollar”? It was a mid-16th century coin minted in the silver mine of Jáchymov (Joachimsthal), Czech Republic – “Joachimst(h)aler”. Later: German Taler, Flemish Daler – American dollar. Forex trading - Mendel University [email protected]

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Major currencies: EUR - Euro • • • • •

Issuer: European Union Currency: Euro (EUR) Most traded in: EURUSD, EURJPY, EURAUD, EURCHF, EURGBP Central bank: European Central Bank (ECB) Central bank governor: Jean-Claude Trichet Jean-Claude Trichet Forex trading - Mendel University [email protected]

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Major currencies: JPY – Japanese Yen • Issuer: Japan • Currency: Japanese Yen • • • •

(JPY) Most traded in: USDJPY, EURJPY, AUDJPY, CHFJPY, GBPJPY Central bank: Bank of Japan (BoJ) governor Toshihiko Fukui Often labelled “lifelong bureaucrat”. A boring old guy Forex trading - Mendel University [email protected]

Toshihiko Fukui

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Major currencies: GBP – British Pound • Issuer: United Kingdom • Currency: British Pound • • •

(GBP, cable, Sterling) Most traded in: GBPUSD EURGBP, GBPCHF, GBPJPY Central bank: The Bank of England (BoE) governor Mervyn Allister King Forex trading - Mendel University [email protected]

Mervyn A. King 21

Major currencies: CAD – Canadian dollar • Issuer: Canada • Currency: Canadian dollar • • •

(CAD, loonie) Most traded in: USDCAD Central bank: Bank of Canada (BoC) Central bank governor: David Dodge

David Dodge Forex trading - Mendel University [email protected]

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Major currencies: AUD – Australian dollar • Issuer: Australia • Currency: Australian • • •

dollar (AUD, aussie) Most traded in: AUDJPY, AUDUSD, EURAUD Central bank: The Reserve Bank of Australia (RBA) Governor Ian MacFarlane Ian MacFarlane Forex trading - Mendel University [email protected]

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Major currencies: CHF – Swiss Franc • Issuer: Switzerland • Currency: Swiss Franc • • •

(CHF, swissy) Most traded in: CHFJPY, EURCHF, GBPCHF, USDCHF Central bank: Swiss National Bank (SNB) Governor: Jean-Pierre Roth, Chairman of the Governing Board Forex trading - Mendel University [email protected]

Jean-Pierre Roth 24

Major currencies: NZD – New Zealand dollar • Issuer: New Zealand • Currency: New Zealand • • •

dollar (NZD) Most traded in: NZDUSD Central bank: Reserve Bank of New Zealand (RBNZ) Governor: Alan Bollard

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Alan Bollard

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Major currencies: CNY – Chinese Yuan • Issuer: People’s Republic of • • • •

•

China Currency: Chinese Yuan (CNY) Central bank: People's Bank of China governor Zhou Xiaochuan CNY is deliberately undervalued to prop up Chinese export – great opportunity to buy CNY now! Currently pegged to the USD Zhou Xiaochuan Forex trading - Mendel University [email protected]

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Quick quiz When one currency changes its value againts another currency, the pair quote changes. But what happens when the domestic currency changes its value compared to the domestic goods value? Inflation or deflation occurs. Forex trading - Mendel University [email protected]

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Bulls, Bears, Sheep and Hogs • Bulls make

money when prices are going up. Thus, a bullish market is an upward one

• Bears make

money when prices are going down. Thus, a bearish market is a downward one Forex trading - Mendel University [email protected]

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Bulls, Bears, Sheep and Hogs

hm s i ll bu

et k r a

bullish market in EURUSD from Feb/2002 to Jul/2002: trend following trading systems are making money Forex trading - Mendel University [email protected]

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Bulls, Bears, Sheep and Hogs bea

rish

mar ket

bearish market in EURUSD from Jan/1999 to Jul/1999: trend following trading systems are making money Forex trading - Mendel University [email protected]

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Bulls, Bears, Sheep and Hogs

are s go choppy market = rice ing p

re e h w no

choppy market in EURUSD from Mar/2004 to Sep/2004: mean reversion trading systems are making money Forex trading - Mendel University [email protected]

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Bulls, Bears, Sheep and Hogs • Sheep get trampled

under feet when bulls and bears make money because of their fear

• Hogs get slaughtered because of their frequent overleveraging and greed

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Technical analysis versus fundamental analysis

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Fundamental analysis: what moves currencies the most? • Unexpected events like war, hurricane etc. • Macroeconomic data: 1) Monthly non-farm payrolls report (NFP) 2) FOMC (Federal Open Market Committee) rate decision 4) Central bank governors’ speeches 3) Quarterly GDP data 4) ECB (European central bank), BoE (Bank of England), BOJ (Bank of Japan), BOC (Bank of Canada) rate decision meetings 5) Consumer Sentiment Indices Forex trading - Mendel University [email protected]

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Fundamentals - macroeconomic calendar

ECB rate decision

NFP Forex trading - Mendel University [email protected]

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Contrary opinion • Successful trader has to be able to fade mass psychology (COT report)

"Thus to be independent of public opinion is

the first formal condition of achieving anything great.“ - G. W. F. Hegel Forex trading - Mendel University [email protected]

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Commitment of traders - COT Weekly CFTC COT report consists of data for three groups: large hedgers (commercials), large speculators, small traders. COT commercials are usually right:

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Forex statistics: total ranges (volatility) sorted by daily range/spread

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Forex pairs: bid/ask spread in pips

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Forex pairs: monthly range in pips

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Forex pairs: daily range in pips

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Forex pairs: 15 min range in pips

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Forex pairs: daily range/spread

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Forex pairs: 15 min range/spread

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Forex pairs: trendiness (daily range / 1 min range)

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Margin and leverage leverage = position size / margin margin = minimum amount of money to be deposited with your broker to maintain a desired position size margin call = request to add money to your account to maintain the open position(s) return on margin, return on account

The margin required to control a position size of $100000: $25,000 $20,000 $15,000 $10,000 $5,000 $0

equities margin $25,000

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forex margin $250

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Margin and leverage leverage = position size / margin margin = minimum amount of money to be deposited with your broker to maintain a desired position size margin call = request to add money to your account to maintain the open position(s) return on margin, return on account

The position size (amount of money) you control with 1 dollar: $400 $350 $300 $250 $200 $150 $100 $50 $0

equities leverage 1:4

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forex leverage 1:400

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The anatomy of a forex quote • The currencies are always traded in two-way quoted pairs • In fact, everything is always traded in two-way quoted pairs:

= • You see, we have just created a quote: 1 COW = 2 PIGs, or: •

COWPIG = 2.0000 (read: 1 COW equals 2 PIGs) Two-way quote means that it works the other way round, too: PIGCOW = 0.5000 (read: 1 PIG equals 0.5 COWs) Forex trading - Mendel University [email protected]

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Quick quiz Can you give me an example of one-way quote? I bet you can’t since there are no one-way quotes in the world. Every quote (price) since the dawn of civilization is an expressed ratio between two values. Forex trading - Mendel University [email protected]

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The anatomy of a forex quote

EURUSD is trading at 1.2408 Bid, 1.2411 Ask Forex trading - Mendel University [email protected]

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The anatomy of a forex quote 1.2408/1.2411 • EURUSD = 1.2408 Bid, or

• • • • •

1 EUR / 1 USD = 1.2408 Bid, or 1 EUR = 1.2408 USD Bid 1.24 = big figure EUR is the base (unit) currency USD is the quote (price) currency EURUSD ask = 1.2411. If I BUY the EURUSD pair, I get the Ask price EURUSD bid = 1.2408. If I SELL the EURUSD pair, I get the Bid price Ask price minus Bid price = spread Forex trading - Mendel University [email protected]

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The anatomy of a forex quote: spread, slippage, liquidity and volatility

• Spread is the difference between the Bid and Ask prices • Spread changes with liquidity and volatility

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The anatomy of a forex quote: spread, slippage, liquidity and volatility

• Slippage is the

difference between the posted price and the actually filled price. Slippage seldom happens in forex market • The higher the volatility and the lower the liquidity, the higher the spread and the higher the slippage

low volatility

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high volatility

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pip, lot, minilot, overleveraging • One PIP or POINT it the smallest measure of price move, • • • • •

regardless of fractional representation: 1.2349 118.25 0.8235 1 LOT = 100000 units of base currency 1 MINILOT = 10000 units of base currency Overleveraged traders are called “hogs” Possible legal changes to prevent novice traders to go broke fast pending The major cause of beginner traders to fail is overleveraging (trading too many lots at once) Forex trading - Mendel University [email protected]

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Forex trade detailed EURUSD Bid: 1.2532 EURUSD Ask: 1.2535

EURUSD Bid: 1.2632 EURUSD Ask: 1.2635

1. I buy EURUSD and I pay 125 350 USD 2. Then I sell EURUSD and I get 126 320 USD 126 320 – 125 350 = 970 USD net profit after spread I buy 1 lot of EURUSD. I buy 100000 EUR, I pay 100000*1.2535 USD

I sell 1 lot of EURUSD. I sell 100000 EUR, I get 100000*1.2632 USD Forex trading - Mendel University [email protected]

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Intraday versus overnight positions • Intraday is any position opened • • •

any time after 5 pm EST and closed before 5 pm EST the next day Overnight is every position which is held thru exactly 5:00 pm EST (Estern Standard Time) Monday Friday You are credited to your trading account or you are charged from your trading account according to the currency pair you hold The percentage p.a. charged/credited depends on the currencies interest rates differentials in the pair you hold overnight Forex trading - Mendel University [email protected]

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Intraday versus overnight positions • You are credited to your

•

trading account if you are long the currency pair where the UNIT currency has a higher interest rate than the PRICE currency (GBPJPY: +20.5% p.a.) You are credited to your trading account if you are short the currency pair where the PRICE currency has a higher interest rate than the UNIT currency (EURGBP: +5.5% p.a.)

Five o’clock – time to collect the interest rate :)

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Intraday versus overnight positions • You are charged from your

•

trading account if you are long the currency pair where the UNIT currency has a lower interest rate than the PRICE currency (EURAUD: 9.7% p.a) You are charged from your trading account if you are short the currency pair where the PRICE currency has a lower interest rate than the UNIT currency (USDCHF: -10.65% p.a.)

Five o’clock – time to pay the interest rate :(

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Quick quiz Why do you think the 5:00 pm EST time has been selected internationally to represent the end of a forex trading day? Because, historically, it is the closing time for major US stocks, options and futures exchanges Forex trading - Mendel University [email protected]

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The topology of forex market

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Level II quoting

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Quick quiz What do you think the forex brokers live off? Primarily they live off of taking the other side of their clients’ positions. Also, they profit from the spread. Forex trading - Mendel University [email protected]

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Long and Short positions

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Hedge position

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STOP and LIMIT orders • STOP order: this or worse price – used for trend-following concepts • LIMIT order: this or better price – used for mean-reversion concepts

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Quick quiz Which price is better if we are selling short?

A B

Price A is better.

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Volume: trade volume, tick volume

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Forex market trading volume

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Timeframes • Tick-based charts versus • •

time-based charts The concept of time frames, each timeframe is a world onto itself Long-term, intermediateterm, short-term, intraday trades

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Timeframes – EURUSD monthly

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Timeframes – EURUSD weekly

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Timeframes – EURUSD daily

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Timeframes – EURUSD 240 min

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Timeframes – EURUSD 15 min

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Timeframes – EURUSD 1 min

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Timeframes – EURUSD 1 tick

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Timeframes – EURUSD 100 ticks

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Charting – open, high, low, close • Often referred to as OHLC • What is a session, 5pm – 5pm • Open is the first price that occured during the bar • High is the highest price • Low is the lowest price • Close is the last price

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Charting – Japanese candlesticks positive candle:

usually white, green or blue

negative candle:

usually black or red

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Charting – Japanese candlesticks

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Charting – western bars

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Charting – line on close

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Charting – Heikin-Ashi candles

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Charting – Point & Figure

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Charting – Renko

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Indicators - intro • There are thousands of various indicators, I will • • •

present only a handful of the most widely used ones Every indicator distorts the price action You may program your own indicators on most platforms Oscillators are normalized indicators, i.e. they oscillate between some predetrmined boundary values (for instance, 0 – 100) Forex trading - Mendel University [email protected]

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Indicators – moving averages (simple, exponential, weighted, triangular, adaptive...)

exponential ribbon

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Indicators – oscillators, RSI: relative strength index, OB, OS

overbought

oversold

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Indicators – oscillators: stochastic

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Indicators – Bollinger bands: SMA with 2 standard deviation envelopes

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Indicators – momentum: close – close[length]

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Indicators – Fibonacci retracements

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Indicators – probability map: normal range

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Indicators – your own: close – average(close, iLength);

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Indicators – your own:

Tradestation EasyLanguage programming code

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Price patterns: general principles • Patterns are only “civilized” trendlines • There are dozens of price patterns: rectangles, head and shoulders,

• • • •

double tops and bottoms, triple tops and bottoms, chinese double tops/bottoms, symmetrical triangles, right-angled triangles, broadening formations, wedges, diamonds, rounding tops and bottoms, shakeout tops and bottoms, flags, pennants, gaps, island reversals etc.... We will discuss only the most widely used ones here Price patterns are either bullish, bearish or continuation Price always breaks out from the pattern. Upside breakout or downside breakout Breakout from a price pattern should always be accompanied by a sharp rise of volume, this is especially true for the upside breakouts

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Support and resistance the sellers are stronger at the resistance level

resistance is a ceiling above the price action

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Support and resistance psychological issue: strong support and resistance are often found at or near round numbers (1.1800, 1.2000) support is a floor below the price action

the buyers are stronger

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Support and resistance certain moving averages often act as a dynamic support / resistance level

SMA – simple moving average Average(close, 100)

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Pivot points act as support / resistance levels • Pivot points are calculated from

the previous day’s high, low and close prices: R3 (resistance 3) = H - (2*(L - P)); RM3 (interim resistance 3) = (R2 + R3) / 2; R2 (resistance 2) = P + (R1 - S1); M4 (interim resistance 2) = (R1 + R2) / 2; R1 (resistance 1) = 2*P - L; M3 (interim resistance 1) = (P + R1) / 2; PIVOT (the pivot point) = (H + L + C) / 3; M2 (interim support 1) = (P + S1) / 2; S1 (support 1) = 2*P - H; M1 (interim support 2) = (S1 + S2) / 2; S2 (support 2) = P - (R1 - S1); SM3 (interim support 3) = (S2 + S3) / 2; S3 (support 3) = L - (2*(H - P)); Forex trading - Mendel University [email protected]

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Pivot points act as support / resistance levels R2 M4 R1

M3

pivot points often correspond with significant support and resistance levels during the day

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Price patterns: head and shoulders

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Price patterns:

head and shoulders – measuring objective

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Price patterns:

head & shoulders automatic software detection

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Price patterns: reverse H&S

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Price patterns:

reverse H&S measuring objective

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Price patterns: double top

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Price patterns: double bottom

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Price patterns: symmetrical triangle

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Price patterns: symmetrical triangle

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Price patterns: ascending triangle

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Price patterns: ascending triangle

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Price patterns: descending triangle

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Price patterns: descending triangle

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Bar patterns / candlestick patterns • There are hundreds of

the so-called “bar patterns” or “candlestick patterns”

• The bar patterns are -

classified as either: bullish bearish continuation

• The bar patterns are prone to computer assisted detection Forex trading - Mendel University [email protected]

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Bar patterns / candlestick patterns: automatic computer-assisted detection

software automatically detects preprogrammed bar patterns

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Trendlines Down trendline is always drawn across the highs, it represents the resistance

Up trendline is always drawn along the lows, it represents the support

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Trendlines:

automatic, computer-calculated trendlines

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Channels

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Elliott Wave Theory • Ralph Nelson Elliott

believed that the movement of prices could be predicted by observing and identifying a repetitive pattern of 8 consecutive waves, 5 one way and 3 the opposite way:

5

a

4

b

c

3 2 1

• Eliott wave theory has its advocates and opponents. In forex

market, it’s not much used nowadays. Objective rules programming based on Eliott Wave Theory is rather problematic Forex trading - Mendel University [email protected]

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Fancy an adrenaline? Then indulge in bungee-jumping.

A

f or s i line a n dr e

ga

s. r e l mb

Professional currency trading is a boring business... Forex trading - Mendel University [email protected]

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Black-box trading systems • • • •

•

Beware of the so-called black-box trading systems! There are lots of black-box trading systems ads all over the internet The vendors of black-box trading systems capitalize on inexperienced novices Never ever ever trade based on black-box system signals, you never know what might go wrong If you can’t backtest the system for yourself, then don’t ever trade such a system Forex trading - Mendel University [email protected]

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Trading systems and strategies: the power of computers • From the 1980ies, the widespread computer simulation and • •

•

backtesting accessibility have changed the markets considerably. The computing power is becoming ever more cheaper and cheaper. The markets have become evidently more efficient. As a result, every tiny inefficiency is quickly uncovered and capitalized upon Consequently, the successful trading tools from the past are no longer working today. It is not possible to design a profitable trading strategy without the use of a computer force any more Forex trading - Mendel University [email protected]

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Quick quiz Imagine you have $1 million in your account. Will you choose:

A) Trading system which makes 11 dollars profit 50% of the time B)

and loses 10 dollars 50% of the time, or Trading system which makes 11% profit 50% of the time and makes loss 10% of the account 50% of the time?

A is correct. - Trading system A will show a moderate yet steady equity growth: 11 – 10 = 1 dollar average profit every 2 trades - Trading system B will go broke eventually: 111% * 90% = 99.9% = 0.1% average loss every 2 trades Forex trading - Mendel University [email protected]

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Trading systems and strategies: the power of applied math • Forex market is ideal for

•

utilization of mathematical models-based trading systems. The massive proliferation of cheap computing power and high liquidity of the market makes forex very efficient nowadays Applied mathematics and financial statistics methods are widely and successfully used for professional trading systems development Forex trading - Mendel University [email protected]

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Trading systems and strategies: the power of computers The forex market is so efficient that, on the lowest level, the movement is resembling the Brownian motion – it is almost totally random: Plasmode 1 – randomly generated sample Forex trading - Mendel University [email protected]

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Trading systems and strategies: the power of computers The forex market is so efficient that, on the lowest level, the movement is resembling the Brownian motion – it is almost totally random: Plasmode 2 – randomly generated sample Forex trading - Mendel University [email protected]

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Trading systems and strategies: the power of computers The forex market is so efficient that, on the lowest level, the movement is resembling the Brownian motion – it is almost totally random: Plasmode 3 – randomly generated sample Forex trading - Mendel University [email protected]

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Quick quiz Choose between two trading systems: A) One that makes $9000 with 100% probability B) One that makes $10000 with 95% probability

B is correct. 0.95 * 10000 = 9500, which is more than 1*9000

Forex trading - Mendel University [email protected]

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Trading systems and strategies: precise rules programming

• Trading system = precise entry and • •

•

exit rules Trading strategy = trading system + particular market + particular time frame + position sizing/money management algorithm Trading systems may be based solely on strictly quantifiable facts. Thus, fundamental factors are not suitable for trading systems development To formulate and properly test the trading system, you need to be able to specify the rules precisely and program it into some trading platform. If you can’t program it yourself, you should hire a professional programmer -> Forex trading - Mendel University [email protected]

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Trading systems and strategies • Trading systems categories: – trend-following: moving averages, breakout models, continuation patterns... – mean-reversion: oscillator-based, false breakouts, reversal patterns... – seasonal: based on some intrinsic market cyclicity, like recurrent price fluctuations during the harvest season in soybeans (not much used in forex trading systems development) – neural networks-based: neural network takes a number of input variables and uses them to predict a taget, exactly as in regression. Neural networks may yield unrealistically good results in in-sample backtesting and at the same time fail miserably in the out-of-sample testing. The use of neural networks models should be done with caution and experience – genetic algorithm-based: these models may combine conventional trading techniques with a new approaches to try and find previously not-thought-of and unexpected yet extraordinary solutions. In trading systems development, genetic algorithms are used for 1) searching for a trading model, 2) searching for an optimal set of input parameters for the existing model, 3) doing both of the above simultaneously Forex trading - Mendel University [email protected]

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Trading systems and strategies: developing your own Holy Grail

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Trading systems and strategies: chart signals

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Trading systems and strategies: conventional versus genetic optimization

• Once you have programmed and checked your trading system, you should • •

optimize it to achieve the best linearity of the equity curve You should not optimize the system on NetProfit alone! Sane fitness functions include: – – – – – – – –

NetProfit/MaxDrawDown NetProfit/Margin VanTharp Expectancy PROM (Pessimistic Return on Margin) Ideal Profit Correlation Equity Curve Linear Regression Max Error Equity Curve Linear Regression StdDev Sharpe Ratio

• Conventional, exhaustive optimization is sufficient only for very low number •

of input parameters combinations Genetic optimization is not very likely to be fooled into the local maxima. The fitness landscape is shaped gradually Forex trading - Mendel University [email protected]

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Trading systems and strategies: genetic optimization

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Trading systems and strategies: genetic optimization, out-of sample and walk-forward testing

in-sample equity

Forex trading - Mendel University [email protected]

out-of-sample equity

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Trading systems and strategies: backtested equity curve

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Position sizing algorithms • You can achieve an exponential equity growth if you reinvest the profits •

rationally. The power of compound interest 8 pips a day: – – –

Max leverage: 1:100 One minilot for every whole $100 in an account Starting equity: $200

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Trading systems and strategies:

trader’s psychology – are you match tough? • One of the most important • •

aspects of system trading is trader’s own psychological ability to execute trades as intended The deadly emotions of fear, greed, regret and elation may undermine trader’s success Demo-account trading doesn’t prepare traders psychologically for live-account trading. Emotions involved in live-account trading are inimitable Forex trading - Mendel University [email protected]

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