Left Brain Thinking II

BarroMetrics Views: Left Brain Thinking II

Thanks to all who left comments.

If I were answering the question, I’d split my answer into two parts:

  1. A risk management phase, then
  2. A trade management.

To understand why I have done the split,  it’s important to remember the function of the second third: it’s function is to deliver the method’s core profits.

The dilemma we face is: given our win rate, if we take profits too early, then in the long run, we’ll have a negative expectancy return; if we look to take profits too late, there may be no profits to speak of.

So, to find our way out the gordian  knot, we’ll turn to Expectancy Ratio, a cousin of our friend, Expectancy Return. (NB: The link has an explanation on use of the Expectancy Ratio, and shows the formula).

Figure 1 shows the Expectancy Ratio, and the expectancy data of two traders. Their results are identical except for their win rate. Both traders are looking for a 20% ROI. (For our purposes we can ignore the columns in green),

Now, let’s apply the  the Expectancy Ratio to a mock situation where the AUDUSD has made a low at .8034, and is currently trading at .8090. The price target for the second third is .8022. The question is should the traders take profits now, or should they look to manage the trade?

Based on Figure 1, Trader A can look to manage the trade; Trader B needs to exit.

Tomorrow we’ll look at why I say this.



Left Brain Thinking

BarroMetrics Views: Left Brain Thinking

Picture this:

  • You are short the AUDUSD.
  • You have exited 1/3 of your positions so that the remaining 2/3s, if stopped out, would be a ‘no-‘loss’.
  • You are looking to exit the second third at .8055.
  • Your stop is some 200 pips away, say .8258.
  • The AUDUSD gets to .8065 and bounces, what do you do?

I am coaching a couple of students who, on Friday, sent me their trade management plan for the AUDUSD shorts; they were preparing for this week’s trading. One did not even consider the possibility of a bounce; the other, took the view that unless his second third target was met, he’d take the stop i.e. either .8055 or .8258 whichever comes first.

What would you do? Send me a comment. 

Oh, let me provide some context:

  • The first third exit covers the loss on the remaining open positions at the initial stop level.
  • The second third exit is taken at a level assessed by the trader. It represents his core profit level. On exit of the second third, the stop on the last third is brought to breakeven.
  • The last third is exited on a trailing stop basis or on a change in trend pattern occurring in the trader’s timeframe.
  • Rational for the process:
  1. the first third is for protection;
  2. the second is where you derive the bulk of your ‘normal’ profits;
  3. the last is the ‘exceptional return’: more often than not you are stopped out at breakeven. But the time when you are not stopped out at breakeven, the times when you see a return of exceptional gains, these times make up for the breakeven stops.

    More after your comments.

    Time and Price Stats Window – Video

    BarroMetrics Views: Time and Price Stats Window – Video

    Sorin asked two questions:

    • Did I still have the Barros Swing Videos from 2010? Answer: Unfortunately no. We lost the masters when we changed servers.
    • Could I give an example of the time and price stats windows mentioned in Nature of Trends.

    That was a great request because most readers may benefit from the example. Here is the link to the video example.


    A couple of points to note:

    1. The example focuses on the window.
    2. When deciding on a  zone, I consider the items below which I did not consider in the video….
    • What is the trend of the timeframe I am trading? Is it likely to continue or change?
    • What are the other zones projections, do we have overlap? (actually I gave this a cursory examination in the video)
    • What are the maximum and minimum boundaries of the zones? If the optimum boundary is exceeded, but the maximum boundary is intact, will I still consider taking the trade? (Answer: Usually yes, though I may reduce position size – depends on the type of trend, and other aspects of the context).
    • Assuming a breach of the maximum boundary, what do I have to see to invalidate the zone and look for a new set? (Answer: usually a directional bar against the zone e.g. a bullish-conviction close above a sell zone). What do I have to see to consider the zone still valid? (Answer: usually a rejection bar; but normally a breach of the maximum boundary would mean I reduce my position size).

    Time and price stats windows provide the context for low risk, high probability zones for my trading. They may also serve your trading. I hope so.

    Trends II

    BarroMetrics Views: Trends II

    Let’s first look at the assumption I was referring to in the previous blog.

    Before I talk about the assumption, let’s first consider why we seek to label the type of structure an instrument may be in.

    For me it’s a matter of providing:

    • a strategy (i.e. a) long – or short, rotation or one timeframe,  b) where do I get in i.e. a zone), and 
    • a way of assessing my risk. 

    So, in a sideways congestion and in an uptrend,  may both provide a buy signal, but where we enter and the manner of entry (breakout or retracement) is a function of personality and the market structure.With that in mind let’s turn to the ‘assumption’.

    My friend assumed that all trends offer the same opportunity i.e. all trends are the same. In fact, of course, they are not.  If you consider Figures 1 & 2, both may be said to be trending but I’d find the trend in the USDJPY easier to make money in than the AUDUSD. Indeed, if you use a  breakout strategy, you may find that you’d be losing money trading the AUDUSD.

    One tool useful in this context is the Kaufman Efficiency Ratio. I don’t use the tool, but students who do use it, have given it 5-star ratings. 

    What tools do I use and how to I assess the trend? More on Monday.


    Turning to the competition.

    The key item here was my friend says he makes money in trends. The question I posed: what was a possible dangerous assumption? The answer I was looking for was ‘one strategy for all trends’. That is, he failed to distinguish between the different types of trends.

    The most popular reply (i.e. we can make money trading congestions) failed to take into account that by not trading congestion markets may mean he could be sitting on the sidelines for long periods, and may mean he may forgo opportunities, these would not cause losses. And, for this reason, I would not rate the ‘assumption’ as dangerous.

    No one came up with this so, the first 3 answers,  Shui Sing, Ryan and Paul will win a prize. In addition, I liked the answers from Michael, Sorin, Baz and Gassah. So, I’ll send you a copy as well.

    Congrats to all winners! The prize has been sent out. Let me know if you haven’t received it.

    Emotional Blind Spots II

    BarroMetrics Views:  Emotional Blind Spots II

    Today, I’ll look at the first question:

    if I have a system that makes money, why won’t that guarantee I become wealthy?”.

    My answer is having a robust system is necessary but insufficient to deliver a promise of success. 

    Trading success is comes from:

    Mind x Money x Method

    The mind delivers the mindset that delivers the discipline to execute the ‘rules’ of our plan, and to constantly achieve improvement; money balances risk of ruin with optimization of profitability; and method provides the process by which we determine whether the probabilities favour the entry and continuation of a trade.

    Notice the multiplication sign – it means that our trading returns are determined by the weakest link in the chain. Normally this will be ‘mind’.

    The reason is most traders focus on the the left brain when making trading decisions. And, if you understand the educational context, it’s little wonder. How often in trading have you heard: “To succeed, don’t trade emotionally!”.

    The problem is no decision can be made with emotion. This is true even if you are trading a computerised mechanical system. You don’t believe me?

    See what happens the next time you computerised computer system hits a deep and prolonged drawdown. I guarantee you that your emotions will be part of the decision-making process. Are you saying that ‘no matter what’, I have the discipline to stick with the system through thick and thin?!

    Problem is there are times when you do have to pull the plug (if only temporarily) because the conditions supporting the system have changed. If LTCM proved anything, it proved that risk management sometimes requires we stop trading.

    Finally your email indicated you were in a hurry to acquire wealth. You are looking at returns for 50% pa. A word to the wise.  Trading can make you wealthy, but only if you employ the power of compounding i.e. wealth will come in time.

    The best traders in the world focus on keeping their drawdowns small relative to their annual return. In trading, a consistent 12% per annum with a maximum drawdown of 4% is preferable to a 100% return per annum with  a 50% drawdown. The latter sails to close to the brink of ruin.

    Stats and Trading Plans

    BarroMetrices Views: Stats and Trading Plans

    Stats in a trading plan are little used by traders. Part of the problem lies in the perceive difficulties in learning the subject; part lies in the processing of data.

    The first problem is easily overcome: read ‘Statistics Without Tears‘ by Derek Rowntree. The book was published in 1981 and cost me US$5.00. It was one of the best buys I have ever made. For someone who was (is?) a dunce at maths, the book opened the world of statistics – the journey was effortless. The only maths involved was ‘plus, minus, divide and multiply’.

    The second problem was less easily solved. Gathering the data, inserting that into a spreadsheet to obtain the results, and maintaining the data set was a cumbersome process. Too cumbersome for many traders. Now, Market Analyst has come to the rescue.

    Figure  1 shows the EURAUD, 5-min chart with the stats for impulse (deep red) and corrective swings (light red). Obtaining the stats for 51 swings tool less than 10-mins. An easy and effortless process.

    So, how do I use the info?

    From the stats I derive the idea that, in this timeframe, a normal impulse move would be at least 30 pips. Overbought for me would be at least 53 pips. Hence if I am seeking to see an upswing, I’d like to see at least more than 30 pips (preferably nearer to 50).

    Figure 2 shows an impulse move into a Primary Sell Zone. The size of the move is 24 pips. Under this circumstances, all things being equal, I would forge taking a sell signal on the basis I’d expect to see another move up. Seeking at least a normal move has saved me many a time. Have I missed moves using this approach? Sure. But, on balance, I am ahead by not taking marginal trades.

    (A short note to advise that I won’t be posting on Friday)


    FIGURE 1 Stats


    FIGURE 2  EURAUD 5-min

    Risk Management IV

    BarroMetrics Views: Risk Management IV

    In this blog, I want to consider the elements of a robust trading plan.

    There is a correlation between the WinRate and timeframe a trader is trading and whether or not he is in a Flow Phase.

    There is an inverse correlation between the timframe being traded and the Win Rate. The shorter the timeframe, the higher the win rate. On the other hand, there is a direct correlation between the timframe being traded and the Avg $Win. The shorter the timeframe, the lower the Avg$Win.

    If you think about it, it makes perfect sense. If I buy the bid and sell the offer, there will be a high probability of my being able to do so; however my profit is limited to the spread.

    The scalping that was previously the domain of the locals is now the domain of the algos or quants. If you believe the press reports algo’s are rapaciously grabbing profits from you and I. The fact is algo funds, taken as a whole, have lost money 2012 and 2013.

    Why should this the case?

    Because the AvG$Loss is now exceeding the AvG$Win to the extent that it overcomes the 90% and over win advantage. Paul’s comment that he only looks at the Expectancy Return when the AVG$W and Avg$L are constant would mean that he would probably never use the formula. The fact is like most things in life, the Avg$W and Avg$Loss demonstrate the 80-20 rule.

    What is important about the Expectancy Return is the fact that it tells us the true state of our trading- you can’t B..lls..tt the numbers. And, with just a little effort, it tells us where we need to make the adjustments. …..

    Sorry Baz et all have run out of time – will continue next week.

    Trading Plans

    BarroMetrics Views: Trading Plans

    Through the years I have been asked: what would you recommend – a discretionary or mechanical trading plan?

    My answer has always been the same: “it depends on what best suits your personality and experience”. My preference is for a discretionary plan; but before I get into that, let’s define what I mean by the two terms.

    Mechanical: a set of trading rules that are always followed.

    Discretionary:  a set of trading guidelines that contains a guideline that says it’s OK to deviate from the guidelines. With this definition, I give room for my intuition to come into play. 

    The reason I added  ‘experience’ in the second paragraph is because for intuition to play a part, there must be an experiential foundation. The less experience we have, the more likely ‘intuition’ is merely a pseudonym for ‘into-wishing’.

    So, what sort of elements come into my ‘intuition’?  Bottom line, a trade must feel right.

    A great example of this was the trade I took as a day-trade on the GBPJPY last night. As a general rule, I avoid day-trading for reasons I won’t go into here. Indeed, I have a separate day-trading with a broker different to the ones I use for my ‘normal’ trading. In this way, I can quickly and easily see if my day-trading is profitable. 

    Turning to the GBPJPY yesterday:

    Figure 1 is a 12-month swing chart. The pattern at ‘A’ is what I call a Negative Development Buy signal where the minimum target is the Primary Sell Zone around 251 to 235. Currently we are at resistance zone 163.00 to 158.90.

    The Washington crisis has tended to result in relative Yen strength and relative Pound weakness.

    Figure 2 is a relative strength chart of the Yen and Pound. What we see is from Sept 20, the Yen has been rallying as has the Pound. But following the FOMC surprise, we have been seeing the Yen continue its rally with the Pound heading South to flat. (Figure 2). This normally suggests a down to sideways market. (Figure 2).

     That provides the context for the day trade. 

    Turning to the actual trade.

    • Looking at the 240-minute and 60-minute as the GBPJPY rallied to the Value Area High (VAH), I had a strong feeling we’d see a Death Zone trade setup. In other words, before the trade setup occurred in the 158.80 to 159.00 area, I had a strong feeling the GBPJPY would sell off from there. I have learned to respect these strong feelings.
    • Figure 3 shows the 240-minute chart.  
    • Figure 4 shows the 60-minute chart where a Negative Development Sell setup and trigger occurred – a failed push to new reaction highs (that takes place at resistance).
    • Figure 4 shows the entry, initial stop and target. My win rate says that my minimum reward:risk is 0.90:1 for day trades. I had better than this ratio in this case (about 1:1)
    • The exit was based on the fact that the high of the day at time of entry was 158.83, ATR at the moment is in the 130-140 range with a std deviation of 12. I expected at least a normal day’s range, so I estimated the low should be around 157.53 to 157.03. I took roughly the mid-point of the range. 
    • Once I had ‘the feeling’, I worked out my probable stop and range of entry points. Knowing my win rate, the entry zone calculation tells me the lowest price I can enter. In other words, I worked out my entry, stop and exit parameters BEFORE the signal took place. So that once I saw the signal, my brain ‘automatically’ executed the entry. 

    What’s important to note is I respected the ‘feeling’ and worked out what I would do IF my guidelines came into play. This was a classic case of left and right brain co-operation.


    FIGURE 1 12-M Swing


    FIGURE 2 Relative Strength


    FIGURE 3 240-minute


    FIGURE 4 60-minute

    Maximum Extension

    BarroMetrics Views: The Maximum Extension

    MH dropped me a line requesting I explain what I mean by ‘The Maximum Extension”. I am happy to oblige.

    In my approach, I look at three filters when assessing breakouts:

    • A time filter (Whole Point Count [WPC])
    • A momentum filter (Line Change Count [LCC])
    • A price filter (Maximum Extension [ME])

    (The WPC and LCC are concepts I read about in a course by Trend Dynamics).

    The ME seeks to identify the maximum price in a breakout that will still preserve the probability of a change in trend pattern. Or put in another way, as long as we don’t have acceptance beyond the Maximum Extension, the possibility remains that a breakout will turn into a change in trend pattern. One key element for the ME to come into play: there needs to have been a trending market before the breakout occurs.

    Let’s look at an example:

    In Figure 1:

    • we have the 12-month swing of the cash S&P. 
    • the ME is coming it at 1758. 
    • a monthly bar exhibiting a bullish monthly close above 1758 would suggest the breakout is genuine. 
    • until then, there are a couple of clues that a ‘3-Drives to a High’ CIT is more likely: the volume and ATR are less at  A than at the current breakout B (Figure 2).
    • a bearish-conviction close below  1447 would trigger the Upthrust CIT.


    FIGURE 1 12M Swing S&P


    FIGURE 2  Monthly S&P