Commodity Broker

Testing Methods to Find A Trading Plan

It was a long year, a great learning experience and a greater appreciation for the markets. Trading is not as easy as some would have you believe. Their goal is to sell you a product or collect fees.

I am thankful for being introduced into the commodities trading business by one of them, but even more thankful that I’ve learned a craft through hard work and perseverance without loosing my shirt. What has helped is a combination of a will to succeed and finding a trading plan that works for me. Sticking to it will be the true test of success. Sticking to it is the application of discipline.

It’s easy to get caught up in all the intrigue of striking it rich with all the opportunities commodities trading offers. Read the ads and articles in trading publications and magazines and you’ll see it for yourself. But if you work hard, plan the trade and trade the plan, and take a break every now and then, that hard work will pay off.

It started with trading options mostly because the thought of a high-risk futures contract was not something I was willing to risk being new to the markets. I spent way to many hours and money searching for something that did not exist . . . a Holy Grail type trading system or methodology that would bring about countless profits and a wealth of good fortune. But after many years of trading and hard work, something was discovered . . . a trading plan that works based on countless hours of testing and refining. That plan is the subject of this article.

The goal was to find a trading system that offers good signals based on sound technical indicators, test its ability to be profitable in the intended markets, and develop a plan that works according to my trading habits and comfort level. For some, this may be daytrading. For others, short-term to intermediate term on daily price bars. And for those with deep pockets and a great deal of patience, long-term trading (6-12 months). As for myself, any trade longer than 20 trading sessions is going to be very profitable or it’s a very bad trade, which meant I broke all my rules. A few years ago that may have been the case, but not today!

A trading plan must be tested and proven if one expects profitable results. It’s difficult to assess slippage when testing a plan on paper (or in my case, on the computer). It’s even more difficult to assess the necessary discipline that will keep you focussed. However, a disciplined trader coupled with a proven trading plan will help instill the confidence necessary to achieve success.

In my years of trading and 12-months of testing to-date, I have been able to witness market behavior and price action on a wide variety of markets during varying degrees of fundamental change. It is the fundamentals by which markets are driven and technicals by which they are traded. What I have learned is that testing my plan requires discipline to take every generated signal in all markets that can be afforded and to avoid the more volatile and expensive markets.

The analysis covered a wide variety of futures markets where a typical trade would last only 3 to 5-days with a few trades lasting 10+ trading days. I guess it makes me a short-term position trader. Several trades only lasted 2-days at best because price action must dictate a valid signal whether profitable or not over the next few days. Stop-loss was placed far enough away so spikes wouldn’t stop me out yet protect against a major move against my position.

Trading is a discipline, not art nor science. There is no room for emotions here. I use the technicals for good entry strategies, stop-loss placement, and adding to positions. Candlesticks can aid in warning of reversals. Divergence adds to that confidence that a reversal is eminent. Discipline, must be learned through testing and real money trades.

A system on its own should have the ability to at least perform profitably with enough cash backing up the inherent drawdowns. This is the problem with almost all-mechanical trading systems. Not enough available funds to continue trading during periods of large drawdown. The development of some simple rules have proven profitable by not waiting to be stopped out of a trade either by an initial stop loss point or a trailing stop.

Rule 1: Price action must dictate a valid signal upon the day of entry or the trade is exited on the open the following day.

This works very well at preserving capital. The type of price action that must dictate the valid signal is best described with candlestick patterns where a white candle is bullish and a black candle bearish. This article is not intended for the study of the various candlestick patterns, but it is those patterns that determine the validity of a signal. If the terms doji, star, harami, engulfing candle, falling window, and thrusting candle mean anything, then you will be able to understand Rule I’s application.

Candlesticks can be an asset to a trader’s arsenal if used to warn of an impending change. They are also useful as pattern entry signals if used properly with other technical indicators. I use candlesticks to do just that. An example would be if short a market and upon the day of entry and a bullish engulfing candle, rising window or thrusting candle occurred, then an order to exit the market on the open the following day would be placed. This would eliminate any second guessing or further losses if the market continued in the same direction against your position. The probabilities of the market moving back in your favor are much lower, although it does occur.

Other examples might be if a signal was generated to enter a market short based on a large bearish candlestick and the following day’s candlestick was a white harami or doji, the same exit criteria would be applied provided these patterns occurred near the high of the bearish candlestick. All other positions relative to the signaling candlestick would not invoke the exit criteria. If you are short a particular market and you get a bullish engulfing candle with higher lows and higher highs; it would invoke Rule 1 because the market could not break the previous low. This could indicate the correction or 'a' wave is not complete.

Rule 2: The breaking of short-term resistance/support on the close should be used to move stop to the projected extreme high or low pivot point (very close).

Stop loss points are used strictly to minimize large losses yet still leave room for small corrections inherent in the markets. A bullish engulfing candlestick 2-days in a row would be a good example if short the market. Breaking the highs set 3-6 days prior would be another example.

Not giving back all the gains made is what makes this rule valuable. However, it is more subjective than Rule 1 and should be applied cautiously. My system calculates the extreme high or extreme low pivot point, which is a projection of the next day’s extreme higher or lower trading range. If stopped out, likely a minor ‘b’ wave will form on a correction, which will allow you to get back into the trade. If not, entry can be taken when market breaks support, for example, if looking to short into the trend.

These rules are basic and should be easy to follow. The application of these rules can improve a trading system’s performance. Results show that these rules do preserve capital and therefore increase profitability. They are mechanical enough that emotion can be totally removed.

The trading plan - After one year of real- time testing (not back-testing), it has been proven that the addition of rules added to a mechanical trading system can increase the profitability and limit losses at times when markets are not trending. Trends only occur less than 20% of the time, so it makes sense to apply some rules to mechanical trading systems that only work well when markets trend.

This trading plan will be used in my money trades and will be profitable. To the extent of my testing is unclear. But the testing which brought this trading plan to life will reinforce the discipline necessary to succeed. I suppose many traders do not consider this vital step in their evolution to become successful traders and that will bring doubt and uncertainty into trading the mechanical trading system.