As 90-95% of new forex traders lose money within the first 3-6 months this article helps to guide new forex traders by asking 5 questions that the forex trader needs to know prior to back-testing their forex system.
Let us jump right in...
1. What data type are you using (or going to use)?
I know this sounds strange, especially if you have experience from another market such as stocks as their generally is only one type of data source available. However, in the forex market you can have up to 4 different data types: bid, ask, mid and indicative. Each have their own little nuances.
If you would like to know more about the data types then visit the article written about the perils of indicative prices. As this will save me from having to repeat the information again and boring those who've already read it.
So, if you know you have indicative prices then you know you're in for some good results! However, if you have any of the other three you need to be careful on how stop and limit orders are placed.
As an example: If we had bid price history and we were looking to place a buy entry stop at 0830 EST according to the day's high, then we know that the bid price will not accurately reflect what the actual price of our order should be. You would have noticed that if you placed a buy entry stop at the exact same price as that of the day's high you would have entered prematurely - you would have entered 4 or 5 pips before the high or the low of the day was touched (the exact same amount as the spread your broker offers!).
This leads me into the next most important question...
2. What spread is your broker offering on the currencies you are bask-testing?
You need to know this as this can help you set your slippage settings on each currency.
As our example in question 1 pointed out. We found that our buy at the day's high method did not exactly work because we bought at the BID PRICE high, not the ASK PRICE high - the price that we need when we place our order TO BUY.
Therefore, we enter in a slippage setting representing the spread that would be exhibited by this trade on this currency.
But knowing at what price to buy is only half the problem... how do we know what quantity to buy?
3. What margin does your broker offer?
If we know at what price to buy our currency at we need to inform our broker on what quantity to buy to fulfill the order. We only know what quantity to buy by the margin that the brokerage firm offers.
Most brokerage firms offer 100:1 leverage, however, some firms offer mini accounts with 200:1 leverage, others only 50:1 leverage.
Find out the margin required.
4. What restrictions does your broker impose?
Now, I don't just mean margin and spread restrictions as I have mentioned above. These are important in their own right, what you need to find out are the details.
This is probably the most important question of all as the fine line between success and failure can be found in the details. Now you can have this questioned by one of two ways: 1. You can find out through experience (generally the most expensive way unless done through the demo account!); or 2. You ask your broker (the cheapest and best way).
Why is this so important? I hear you ask. Well let's say you have a system that trades any gaps that might form on Sunday at 1700 EST, but your broker does not open until 1730 EST. You either need to factor this restriction in to your system, or move onto another system completely. Or, you may have a system that has 10 pip stops, but you find out that your broker will only let you place 15 pip stops from your initial entry price. Once again you will need to change your system to see whether it still performs well, or throw out your system (or change your broker)!
In fact one of the most devastating restrictions imposed by FXCM is that they do not accept stop entry orders if price never happens to trade at your entry stop price! FXCM will honor and "take the loss" of your OPEN stop positions, but if the liquidity is not there and price has shot straight through your stop price then you will miss out. This can have disastrous effects on your system results as you are left wondering on trades where you made good returns - "Would FXCM have got me in?". You may want to read of some of the quirks I use when placing entry stop orders on FXCM that could be of huge benefit to you to help you possibly get around this problem.
The restrictions by your broker are only half your systems' success, you also need to find out about another more important restriction... yourself. This leads me to the final point...
5. What restrictions do you have?
This is a vitally important question. Most people test their systems and fall in love with the results but find when they trade their system they have lost their account and that most of the best signals occurred while they were sound asleep!
As the forex market is a 24 hour market, you need to put into place restrictions in your system that will be realisticly conducted by you during the course of a normal trading day. There is no use operating a trailing stop method that changes your stop points during times when you are asleep and cannot possibly do so.
I hope this article has made you aware of some of the important things that need to be known prior to testing your system.
Article written by Ryan Sheehy from Currency Secrets.com. Where you will find reviews on forex data vendors, signal providers, brokers, and popular forex resources, along with more quality articles... all for f*ree!
Thursday, January 4, 2007
Bollinger Bands Explained
What are they? Bollinger Bands are a pair of trading bands representing an upper and lower trading range for a particular market price. A market price or currency pair is expected to trade within this upper and lower limit as each band or line represents the predictable range on either side of the moving average. The lines are plotted at standard deviation levels above and below the moving average. This trading band technique was introduced by John Bollinger in the 1980.
Why use them? Bollinger Bands can be very useful trading tools, particularly in determining when to enter and exit a market position. For example: entering a market position when the price is midway between the bands with no apparent trend, is not a good idea. Generally when a price touches one band, it switches direction and moves the whole way across to the price level on the opposing band. If a price breaks out of the trading bands, then generally the directional trend prevails and the bands will widen accordingly.
Key features of Bollinger Bands:
1.A move originating at one band tends to go all the way to the other band.
2.Sharp moves tend to happen when the bands contract and tighten towards the average,
when the price is less volatile. The longer the period of less volatility then the
higher the propensity for a breakout of the bands.
3.When there is a breakout of the band, then the current trend is usually maintained.
4.A top or a bottom outside the band that is followed by a top or a bottom inside the
band indicates a trend reversal
Configuration and Confirmations
The most commonly used and hence default bands are drawn 2 standard deviations away from a 20 period simple moving average. This is for intermediate-term analysis. However, the number of periods and standard deviations can be varied. John Bollinger himself states "Choose one that provides support to the correction of the first move up off a bottom. If the average is penetrated by the correction, then the average is too short. If, in turn, the correction falls short of the average, then the average is too long. An average that is correctly chosen will provide support far more often than it is broken."
The Chart below is a 4-hour chart depicting the EUR/USD pairing. You can see that while the price generally remains within the band, there are a number of breakouts, particularly when the bands are in a narrow range. Some breakout trends are not sustained and the price action is quickly restored to within the band range. If the breakout does represent a real market shift then a continuation of this trend is generally upheld and the Bollinger bands automatically widen to accommodate this.
Bollinger Bands should be used as a measure together with other measures, most notably the Average Directional Index (ADX), RSI and Stochastic indicators.
The 15 Rules of Bollinger Bands
1.Bollinger Bands provide a relative definition of high and low.
2.That relative definition can be used to compare price action and indicator to
arrive at rigorous buy and sell decisions.
3.Appropriate indicators can be derived from momentum, volume, sentiment, open
interest, inter-market data, etc.
4.Volatility and trend have already been deployed in the construction of Bollinger
Bands, so their use for confirmation of price action is not recommended.
5.The indicators used for confirmation should not be directly related to one another.
Two indicators from the same category do not increase confirmation. Avoid
colinearity.
6.Bollinger Bands can also be used to clarify pure price patterns such as M-type;
tops and W-type bottoms, momentum shifts, etc.
7.Rice can, and does, walk up the upper Bollinger Band and down the lower Bollinger
Band.
8.Closes outside the Bollinger Bands can be continuation signals, not reversal
signals--as is demonstrated by the use of Bollinger Bands in some very successful
volatility-breakout systems.
9.The default parameters of 20 periods for the moving average and standard deviation
calculations, and two standard deviations for the bandwidth are just that,
defaults. The actual parameters needed for any given market/task may be different.
10.The average deployed should not be the best one for crossovers. Rather, it should
be descriptive of the intermediate-term trend.
11.If the average is lengthened the number of standard deviations needs to be
increased simultaneously; from 2 at 20 periods, to 2.1 at 50 periods. Likewise, if
the average is shortened the number of standard deviations should be reduced; from
2 at 20 periods, to 1.9 at 10 periods.
12.Bollinger Bands are based upon a simple moving average. This is because a simple
moving average is used in the standard deviation calculation and we wish to be
logically consistent.
13.Be careful about making statistical assumptions based on the use of the Standard
deviation calculation in the construction of the bands. The sample size in most
deployments of Bollinger Bands is too small for statistical significance and the
distributions involved are rarely normal.
14.Indicators can be normalized with %b, eliminating fixed thresholds in the process.
15.Finally, tags of the bands are just that, tags not signals. A tag of the Upper
Bollinger Band is NOT in-and-of-itself a sell signal. A tag of the lower Bollinger
Band is NOT in-and-of-itself a buy signal.
-----------------------------
By TodayFX
-----------------------------
Article Source: ActionForex.com
Why use them? Bollinger Bands can be very useful trading tools, particularly in determining when to enter and exit a market position. For example: entering a market position when the price is midway between the bands with no apparent trend, is not a good idea. Generally when a price touches one band, it switches direction and moves the whole way across to the price level on the opposing band. If a price breaks out of the trading bands, then generally the directional trend prevails and the bands will widen accordingly.
Key features of Bollinger Bands:
1.A move originating at one band tends to go all the way to the other band.
2.Sharp moves tend to happen when the bands contract and tighten towards the average,
when the price is less volatile. The longer the period of less volatility then the
higher the propensity for a breakout of the bands.
3.When there is a breakout of the band, then the current trend is usually maintained.
4.A top or a bottom outside the band that is followed by a top or a bottom inside the
band indicates a trend reversal
Configuration and Confirmations
The most commonly used and hence default bands are drawn 2 standard deviations away from a 20 period simple moving average. This is for intermediate-term analysis. However, the number of periods and standard deviations can be varied. John Bollinger himself states "Choose one that provides support to the correction of the first move up off a bottom. If the average is penetrated by the correction, then the average is too short. If, in turn, the correction falls short of the average, then the average is too long. An average that is correctly chosen will provide support far more often than it is broken."
The Chart below is a 4-hour chart depicting the EUR/USD pairing. You can see that while the price generally remains within the band, there are a number of breakouts, particularly when the bands are in a narrow range. Some breakout trends are not sustained and the price action is quickly restored to within the band range. If the breakout does represent a real market shift then a continuation of this trend is generally upheld and the Bollinger bands automatically widen to accommodate this.
Bollinger Bands should be used as a measure together with other measures, most notably the Average Directional Index (ADX), RSI and Stochastic indicators.
The 15 Rules of Bollinger Bands
1.Bollinger Bands provide a relative definition of high and low.
2.That relative definition can be used to compare price action and indicator to
arrive at rigorous buy and sell decisions.
3.Appropriate indicators can be derived from momentum, volume, sentiment, open
interest, inter-market data, etc.
4.Volatility and trend have already been deployed in the construction of Bollinger
Bands, so their use for confirmation of price action is not recommended.
5.The indicators used for confirmation should not be directly related to one another.
Two indicators from the same category do not increase confirmation. Avoid
colinearity.
6.Bollinger Bands can also be used to clarify pure price patterns such as M-type;
tops and W-type bottoms, momentum shifts, etc.
7.Rice can, and does, walk up the upper Bollinger Band and down the lower Bollinger
Band.
8.Closes outside the Bollinger Bands can be continuation signals, not reversal
signals--as is demonstrated by the use of Bollinger Bands in some very successful
volatility-breakout systems.
9.The default parameters of 20 periods for the moving average and standard deviation
calculations, and two standard deviations for the bandwidth are just that,
defaults. The actual parameters needed for any given market/task may be different.
10.The average deployed should not be the best one for crossovers. Rather, it should
be descriptive of the intermediate-term trend.
11.If the average is lengthened the number of standard deviations needs to be
increased simultaneously; from 2 at 20 periods, to 2.1 at 50 periods. Likewise, if
the average is shortened the number of standard deviations should be reduced; from
2 at 20 periods, to 1.9 at 10 periods.
12.Bollinger Bands are based upon a simple moving average. This is because a simple
moving average is used in the standard deviation calculation and we wish to be
logically consistent.
13.Be careful about making statistical assumptions based on the use of the Standard
deviation calculation in the construction of the bands. The sample size in most
deployments of Bollinger Bands is too small for statistical significance and the
distributions involved are rarely normal.
14.Indicators can be normalized with %b, eliminating fixed thresholds in the process.
15.Finally, tags of the bands are just that, tags not signals. A tag of the Upper
Bollinger Band is NOT in-and-of-itself a sell signal. A tag of the lower Bollinger
Band is NOT in-and-of-itself a buy signal.
-----------------------------
By TodayFX
-----------------------------
Article Source: ActionForex.com
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