Keeping trading losses (very) small and catching trends

Posted by Bruce Levy on

One of the greatest parts of strategy automation is the ability to test your ideas right away.

The best strategies are not built by allowing the computer to find optimal parameters, but by the trader inputting the rules of a trading system based on their observations.

To run a winning system, one that you'd feel comfortable running in your sleep, or while at work, means you have a level of confidence in it's ability to operate without your supervision. 

In order to do this we'd want to know the system has a positive expectation of profit.

A positive expectation of profit simply means the program is expected to succeed given the current trend in performance.

I have been testing different types of stop and take profit methods to understand the dynamics of a profitable system. 

A program is a 33.33% win rate, with winners 3.76 times the size of the losers can be expected to produce positive value.


Avg Winner: $100

Avg Loser $26

Win rate of 33% = +$2859 Expected gain per month


At first glance you probably wouldn't think that winning only %33 of the time could work well, but in fact some of the greatest trend following systems have very low in rates; the money is made in catching the trends.

In order to succeed at this method you must allow the program to take more losers than you may be used to. You must also give away good profit in expectations of capturing great trends. 

Now what if we 'unlock' our winners by removing the static profit target? 

Backtests show that this method can indeed produce a positive return, but at the cost of a high win rate. In fact, the winners for a system with no static profit targets can be enormous and make up for dozens of small trades.

This leads me to focus my entry timing on finding out where the opportunity lies to capture a trend. This is where the volume profile comes into play.

The volume profile shows us areas where volume is low, or high and indicates to us how fast, or slow price will move through an area.

Figure 1.1 Euro Tick Volume Distribution

When price attempts to trade up to the Low Volume Zone in figure 1.1, we can see how trading interests declines. Traders of large size simply refuse to trade that area, this can create a vacuum, or air pocket. 

For the most part price will stay away from this area, however if price is to push up into this area on high volume participation, it is possible for price to pass through this area very quickly.

This is good to know because as a trend trade we can use this knowledge to our advantage. 

While the volume profile shows volume traded at price, it doesn't always show hidden areas that are covered by random trading action, that's why I developed the FTR Price Action Gap Indicator. It shows areas of Low Volume Development, without having to change time-frame and look inside the profile for areas of low volume. The FTR Price Action Gap Indicator shows traders, at a glance exactly where this low volume voids occur.

Use this knowledge of low volume zones to your advantage, if price trades into this area on increasing, or steady volume, it is possible for it to shoot through very quickly to the other side. This is great for trend traders interested in keep losses small while allowing winner to build, this information can give you a heads up as to what to expect when price runs into a level like this on your chart.

1 comment

  • Hey guys just testing out the comments section.

    AlgoTraderX on

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