Tuesday, August 31, 2010

The Pain Index : A Measurement of How Hard it is to Trade a System from a Psychological Perspective

It is always said - with very good reason - that the biggest obstacle to trading systems profitably is the trader him or herself. There are many reasons why this is the case but perhaps the large amount of self-sabotaging, the inability to trade through draw down periods and the second-guessing about the profitability of different strategies is what makes unprofitable people turn their accounts into dust in the longer term. It is therefore interesting to ask ourselves if there is a way to measure this psychological hardship and estimate if a given system will or will not be difficult to trade from a mental stand point. It becomes clear that some systems - even if account wiping in the long term - are very psychologically easy to trade while systems that are very robust and long term profitable tend to be extremely hard to trade (and therefore almost never traded).

On today's post I will share with you my solution to this problem - the pain index - which is a measurement of how hard it will be - from a psychological point - to trade any given system. This scale gives us a quantitative way of comparing trading systems and it allows us to easily picture how easy or hard it will be to trade a given strategy in the long term. The lower the pain index, the easier a strategy will be to trade while strategies with a higher pain index reading will be excruciating and tremendously difficult to follow. Now bear in mind that the pain index does NOT tell us anything about profitability and there can be systems with extremely low pain index readings that will wipe accounts (as there are in real life), the pain index merely attempts to measure the psychological pressure on the trader rather than the ultimate effect on the account balance.

When attempting to come up with a measure to calculate how hard it is to trade a given system it became obvious to me that the most important factors were the maximum ten year draw down of a strategy and the maximum draw down period length. Trading systems with higher draw downs or longer draw down periods are harder to trade and the combined effect of these characteristics should be shown in any attempt to calculate the "pain" different strategies cause a trader. However it then became clear that both of these parameters do not have the same effect as deeper draw downs are much more important from a psychological point of view than longer draw down periods. Most traders would be able to bear a 1 year draw down period with a maximum draw down at 5% while doing the same thing with a 30% maximum draw down will be significantly harder.

After doing this analysis I came to the conclusion that maximum draw down should increase difficulty exponentially while draw down period length should do so linearly. Since the above introduces an exponential term I decided to use a logarithmic function (base 10) to normalize the pain index to values that would be between 0 and 10. The formula for the pain index calculation is shown below :

MD = maximum 10 year draw down as a percentage of account equity

MP = maximum 10 year draw down period length in years

pain index = 2*(Log( MD^2 * MP))

The scale goes from 0 to 10 since 0 is a hypothetical system that never loses (a system that would be extremely easy to trade, a system that doesn't exist) while 10 is a system that loses all trades within a ten year period except the last one which takes the account back into profit. So the easiest system to trade is a system that never loses while the hardest system to trade is a system that has a maximum draw down close to 100% and a maximum draw down period length close to 10 years (a system that would be effectively impossible to trade from a psychological standpoint).
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As you can see on the above graph which shows the evolution of the unnormalized (without the longarithm) pain index as a function of maximum draw down and draw down period length you can see how deeper draw downs increase the pain index rapidly while the duration of the draw down causes a linear increase. Now pay special attention to the fact that you can have systems with draw downs that can be extremely deep (even close to account wiping) but if their draw down period length is very small (just a few weeks or days) the actual pain index will be low. This is the reason why martingales and scalpers with very bad risk to reward ratios are so successful, even though these systems are dangerous to capital preservation and overall long term profitability they are extremely easy to trade from a psychological stand point since draw downs rarely happen and psychologically challenges will only come very sporadically (and perhaps when they happen the account will be wiped). It is fairly easy now to understand why these systems are tremendously dangerous, very easy to trade from a psychological perspective but extremely dangerous for account equity.

The obvious thing now was to take this new pain index measurement and calculate its value for several Asirikuy systems, risk levels and portfolios to see the actual difficulty to trade the different systems I use in live accounts. The results are actually very interesting and they do reflect the psychological difficulty in trading all these systems. Below you can see a scale showing several examples and their pain index values :

0 - system that never loses (does not exist)

2.59 - Watukushay No.2, Risk 1 EUR/USD

2.93 - Atinalla No.1 Portfolio (Risk 1 on all systems)

3.07 - Teyacanani, Risk 1 EUR/USD

3.60 - Watukushay No.5, Risk 1 USD/CHF

5.08 - Atinalla No.1 Portfolio (Risk 3 on all systems)

5.51 - Kutichiy EUR/USD Risk 1

5.79 - EUR/USD Turtle Trading System (original rules)

5.99 - GBP/USD Kutichiy Risk 1

6.71 - Kutichiy (EUR/USD, GBP/USD, USD/CHF, USD/JPY) (Risk 1 on all instances)

10 - system that loses everytime for ten years except on one trade that takes it to profitability

It is very interesting to see how this indexing falls in line with what we experience with the real live systems. The turtle trading system is extremely difficult to trade while systems like Teyacanani are far easier to use. Since this scale is logarithmic the pain index predicts that it is about 10 thousand times easier to trade teyacanani with a Risk = 1 setting than to trade the Turtle trading system on the EUR/USD. Shorter draw down periods and small maximum draw downs account for this difference. Of course we can also see the effect of increasing risk and how trading Atinalla No.1 on a Risk = 3 is almost 100 times worse psychologically than trading it from a Risk = 1 setting (due to the 3 fold increase in the expected maximum draw down). Overall it seems that systems with pain index levels above 6 start to become extremely hard to trade since they would put enormous psychological pressure on their use both through long and deep draw downs.

I hope that you can use this new pain index measurement to get an idea of how hard it will be to trade your systems from a psychological stand point, it will also help you understand why you have traded systems with unsound trading tactics in the past and how this is justified through the "small pain" that these unprofitable systems cause traders. This also shows that long term profitable systems - especially when aiming for yearly profits above 30% - are extremely hard to trade and why very few people actually achieve long term profitability from automated trading systems.

If you would like to learn more about automated trading and how you too can learn how you analyze systems in depth and come up with reliable long term profit, draw down and worst case scenario targets please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach automated trading in general . I hope you enjoyed this article ! :o)

Monday, August 30, 2010

Preserving Your Capital : Five Signals You are Taking Too Much Risk with Your Forex Trading

If you asked me what the most important aspect of trading is I would say : to preserve capital. This is something which is common to at least all the professional traders I know and something all new traders seem to lack. People new to forex trading like to trade their money like when they are gambling - the focus is to make money - while professionals trade so that they take the least possible risk on their capital (the focus is on preservation). I remember that when I was a new trader it was very hard to see when I was taking excessive risks, since the focus for new traders is in short term results, the real risk characteristics of the systems they use don't seem apparent until the market cashes on this risk and wipes the account or causes substantial losses.

On today's article I am going to give you some pointers that will let you know if you are trading with excessive risk. Certainly they won't cover all risky scenarios but you can be absolutely sure that if you feel identified with any of the signals highlighted below it is very likely that you will not be able to achieve long term profitability (at least until it is fixed) since you are taking a great exposure on your account which the market will eventually (with certainty) cash on. What are the red flags or signals that you are knee-deep into risky territory ? Keep reading to find out !

1. One loss has a significant emotional effect on you. When you are trading an account and a losing trade causes you any type of anguish, sadness or frustration it means that you are trading with a risk which is too high for you. One of the key ways to eliminate emotions in trading is to have short term results become meaningless to you from an emotional perspective, if a loss means something then it should be much smaller. Imagine that you had to burn a check for a given amount of money every single day. How small would that check need to be so that you could do it without any pain ? That is the maximum amount of money you should lose on each trade.

2. Your system has a historical ten year maximum draw down higher than 50%. When you are trading a system which in the past showed a maximum draw down higher than 50% it is very likely that this draw down will be much larger in the future. What happens here is that you are trading with a large enough risk so that your account will be wiped with a very good probability under evolving market conditions. The past - although a good guidance - should not be taken as if "the worst has already happened" always consider that a system will be able to double its maximum draw down in the future. As a rule of thumb you should reduce your risk so that the historical maximum draw down never reaches above 25%.

3. Your system cannot face twice the maximum number of historical consecutive losses. Also based on the above, the fact that a system has a given number of consecutive losing trades in the past does not mean that it will not have more in the future. It is undoubtedly possible and actually it happen rather frequently, that your system will face a "worse worst streak" in the future as market conditions evolve. You should always trade a system that can withstand twice the maximum number of past consecutive losses, otherwise you are assuming that the past already showed you the worst it could be, a rather naive assumption.

4. You cannot sleep. One of the easiest ways to recognize that you are using excessive risk levels in your trading is when you cannot sleep because you are thinking about the system you are using or the trades you have left open. If trading starts to mess with your sleep it is an absolutely clear and unequivocal sign that your risk level is way too high. As I said before, one of the keys to success is to make short term results meaningless and trading with low enough risk makes this a certainty.

5. You don't fully know your system or plan. Certainly a very risky element in trading is lack of knowledge about what you're doing. If you are trading in a certain way in which the long term profit and draw down targets are unknown then there is no way in which this system can be traded successfully over the long run. Trading a system or plan which has unknown profit and draw down characteristics is dangerous because you don't know the magnitude of the system's market exposure. It could cost you a significant portion of your account due to your lack of understanding.
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Definitely my experience has shown me that a trader who answers "yes" to any of the above signals will face very hard problems in the long term as there is ample road for disaster. The good thing here is that simple steps can be taken to correct all these problems, understand the systems you are using, analyze their profit and draw down characteristics and trade with lot sizes and short term results that become meaningless to you.

If you would like to educate yourself in the building and creation of automated trading systems that are likely long term profitable with realistic and sound profit and draw down targets please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach automated trading in general . I hope you enjoyed this article ! :o)

Sunday, August 29, 2010

The Indicator Series : The Awesome Oscillator - A Tool to Measure Momentum

On today's article we will be discussing a very interesting indicator which forms part of Bill Williams "chaos trading" theory in which several indicators are used to attempt to trade the markets profitably. This indicator- called the Awesome Oscillator - was developed as a means to get an idea about short term momentum on a given trading instrument. Within the next few paragraphs you will learn more about how this indicator's values are calculated, what it really tells us about the market and how we can use this information for the building of likely long term profitable automated trading systems. As a part of the "indicator series" this article will attempt to give you an idea about the essence of the indicator and the real nature of the information it conveys.

So what is the Awesome Oscillator about ? What makes it so awesome ? This indicator - usually plotted as a histogram - uses a very simple calculation to measure what we would call "market momentum". The indicator's value is obtained as the difference between a 34 and a 5 moving average calculated around the median price (which is the (high-low)/2 of each bar). Putting it simple, the values are obtained with this simple equation :

Awesome Oscillator = SMA(MEDIAN PRICE, 5)-SMA(MEDIAN PRICE, 34)

You might have also noted that the awesome oscillator contains red and green colors which depend on the increasing or decreasing nature of the values. If the last value is lower than the current values the current bar is green while the opposite case makes the bar red. To sum it up the awesome oscillator tells us if the 34 and 5 period average values of median price are coming closer or falling further apart. When the values are falling apart there is momentum (since short term price is - in average - moving away from the longer term average, when the values are closer then we have the opposite.
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It may now seem more evident how this indicator might be traded. We can build a system that trades the cross of the 0 line (which is equivalent to the simple moving average cross system of the 34 and 5 period MA values calculated on median price) or we can trade changes in direction (changes from red to green) to attempt to capture changes in momentum which may forecast an eventual cross of the moving averages. However the fact that the oscillator only gives us information about the momentum change taking into account a relatively small number of bars means that its success on lower time frames is bound to be very limited. When using this indicator on time frames lower than the daily you will see that it gives extremely confusing signals since the 34 and 5 median calculated moving averages cross a lot, something that makes the finding of an inefficiency quite hard.

Added to that is the fact that the awesome oscillator momentum "changes" (color changes from red to green) can happen during a single bar and therefore give a lot of fake signals. For this reason most people will advice to trade this indicator on three bar signals to gain a better perspective and eliminate signals that are simply spikes that might only "seem" like changes in momentum. By doing this we can gauge changes in momentum better and build a system that reacts quicker to changes in market direction. Exiting trades when the first opposite bar appears also seems to be a good exit strategy since usually this won't happen after the majority of the large move happens. Of course, the success of such an approach is bound to be minimal on lower time frames, again due to the inherent problems of the low period usage of the awesome oscillator on these charts.
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Above you can see a USD/CHF daily chart with some of the possible signals during the financial crisis which was a very trending period for this and other currency pairs. You can see here how the awesome oscillator would have captured moves with very good accuracy. Of course, the system is not going to be perfect and under conditions when the 34 and 5 MA comes close for large periods of time the system would suffer large amounts of losses (this is the system's market exposure so that it can get into this very good trades when they develop). The above mentioned signals also allow us to get back into trends after retracements, so they are definitely a necessary compliment since they help us fully exploit large runs without missing a large part (as if we only entered shorts above 0 and longs below 0).
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So as you see, the awesome oscillator is really not that awesome, it is simply a tool to measure momentum which compares the prices of two simple moving averages calculated on median price values. This information is bound to be useful for the development of a momentum based automated trading system, especially on large time frames - like the daily - where these signals are much more meaningful than on lower time frames when the low periods used by the oscillator will make the finding of inefficiencies extremely hard, if not actually impossible.

If you would like to learn more about automated trading and gain a true education in the development of likely long term profitable mechanical trading systems please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach automated trading in general . I hope you enjoyed this article ! :o)

Saturday, August 28, 2010

It's Really Much More than Staring at the Screen : Become a Trader the Active Way

There is a general myth in trading saying that anyone who stares at a trading screen long enough will start to gain some understanding about the underlying aspects of the market and how to trade it successfully. Many people spend a lot of time going through historical data and trading live demos so that this sort of "eureka moment" kicks in, a moment where finally everything starts to make sense and the person starts to just "see it clearly" and trading becomes an easy thing to do. Sadly trading is not something you can tackle this passively and obviously there are different degrees of success depending on how you face the challenge of becoming a long term profitable trader.

I have to be truthful with you and tell you that time and effort spent alone do not guarantee success in trading and that you could spend a decade trying to learn to excel at this job without achieving your first profitable year. Not only does this depend on the personal aptitude of the individual attempting to learn how to trade but it also depends on the way in which the forex educational challenge is taken. Some traders are exceedingly passive spending their time searching for someone who has developed something they can use to profit or just staring at the screen for days in an attempt to start to get a true understanding of price action.

It is important now to realize that success in trading comes from what you are doing and not from what anyone else in the world does so you should take an approach that exploits your potential and qualities and minimizes the expression of your defects so that learning how to trade can be an easier and a more rewarding thing to do.

When I talk to the few professional traders I know who have walked this road by themselves (from rookie to expert) it becomes obvious that the quickest and most rewarding way to become successful in trading is to do this the active way. This way of approaching trading is based on the building of knowledge from the ground up and the meticulous and careful analysis of trading experiences. When you get a demo or a live account and you start trading it you are acquiring a bunch of information both about yourself and the market and this information goes to waste most of the time as newbies neglect to fully analyze it. New people only like profitable results and the analysis of loses becomes a painful and seemingly unnecessary exercise since the idea most people have is "why focus on something that doesn't work ?".

Being an active trader is not something that requires a huge amount of effort as it requires quite the same - or perhaps even less - effort than the testing of the hundreds of different forum strategies and commercial systems that do not enrich the knowledge of the trader about the market or how to truly become profitable.

Finally what I always advice new traders is to take a very active approach to trading and to learn from every small bit of experience that you get. Keeping a trading journal is a very important part of this and doing statistical long term historical analysis of mechanical and discretionary strategies is also a huge part in the development of adequate expectations and understanding about how trading systems really work and how they can be used towards the success of each trader. Remember that every time you fail to do something because of lack of time/effort someone else will and that someone will reach the spot as a profitable trader you are missing.

Through the next few months I will try to write a series of posts on how an active trader trains and what practical exercise you can do to get yourself closer to a deep understanding of trading and how long term profitability can be achieved. Remember, it is really much more than staring at the screen, it is learning from your mistakes and squeezing all you can from every small trading experience on your way.

If you would like to lean more about getting an education in automated trading to develop your own algorithmic systems with realistic draw down and profit targets please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach automated trading in general . I hope you enjoyed this article ! :o)

Friday, August 27, 2010

Three Way (Triangular) Arbitrage in Forex : Does it Work ?

One of the most interesting ideas in forex trading comes from what would seem to be a fundamental market inefficiency that would seem very easy to exploit by most market participants. Three way arbitrage is a trading technique that seeks to exploit inconsistencies in exchange rates arising from trading activity, inconsistencies that supposedly lead to tradable market inefficiencies. On today's article I will write a little bit about three way arbitrage, what it is, how it is traded and what the potential rewards may be. I will tell you why I think this cannot be done successfully by regular retail traders and why the rewards - if any - would be much lower than those of a regular long term profitable trading system.

When we have a large group of currencies and all their combinations are available as different currency pairs there is a basic consequence that leads to the trading of several pairs being equivalent to the trading of some crosses. For example if you are buying 1 lot EUR/JPY it would supposedly be equivalent to going long an equivalent on the EUR/USD and going long one equivalent on the USD/JPY. The idea is that your profits are dependent on the EUR/USD and the USD/JPY exchange rates such that the USD exposure is canceled and your net exposure comes from the indirect relationship of the EUR with the JPY. The below graph better explains this idea (using the EUR/USD, GBP/USD and EUR/GBP) (the graph was taken from here, where the concept is also further explained).
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The three way arbitrate inefficiency now arises when we consider a case in which the EUR/JPY exchange rate is NOT equivalent to the EUR/USD/USD/JPY case so there must be something going on in the market that is causing a temporary inconsistency. If this inconsistency becomes large enough one can enter trades on the cross and the other pairs in opposite directions so that the discrepancy is corrected. Let us consider the following example :

EUR/JPY = 107.86
EUR/USD = 1.2713
USD/JPY = 84.75

The exchange rate inferred from the above would be 1.2713*84.75 which would be 107.74 and the actual rate is 107.86. What we can do now is short the EUR/JPY and go long EUR/USD and USD/JPY until the correlation is reestablished. Sounds easy, right ? The fact is that there are many important problems that make the exploitation of this three way arbitrage almost impossible.

The first problem is the trading cost. This three way arbitrage is based on taking very small profits from the market and as such it becomes extremely vulnerable to spread variations. A bad spread means that you will lose most of the profitability or that you will need to search for very large arbitrage gaps which are rare and often fall in line with news events when trading spreads are much higher and trading becomes much harder.

The second and biggest problem is execution. Not only will it be extremely hard to get into these orders without any slippage (since your profitability depends on it) but getting out might be even harder as you will be trying to squeeze a very small amount of profit from the market. These arbitrage opportunities are also searched by funds with ultra fast computers and direct connections to banking feeds and therefore the liquidity related to them will dry up terribly fast.

The simple fact when trying to trade three way arbitrage is that for a retail trader it will be almost impossible to profit given the amount of trading cost, the rarity of very good opportunities and the speed in which these opportunities "dry up" as traders with access to much faster computing power take advantage of them. In the end trying to exploit one of these trading techniques is bound to be MUCH harder than trading a simple long term profitable system since their profitability will depend on too many factors which the regular retail trader cannot control. As a matter of fact, the exploitation of every arbitrage opportunity greater than trading costs is something that banks and hedge funds do constantly, a practice that aids to keep exchange rates equalized also making these opportunities for retail traders practically nonexistent.

As always there is no "free lunch" in forex trading and success comes from knowledge and understanding and not from the exploitation of some "magical" trading system that no one else takes advantage of.

If you would like to gain an education around automated trading and learn how you too can make up your own systems with sound profit and draw down targets please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Thursday, August 26, 2010

Finally Some Real Competition for Metatrader 4 : FXCM's Strategy Trader

Through the past 4 years all of us have used the metatrader 4 platform for most of our automated trading Forex needs. Although this platform is not the only one available with such capabilities (tradestation and ninjatrader do this same thing) it is in fact the only one which is available to all retail traders since the platform is free to download and the live feed and historical data is also entirely free. A large part of Metatrader's huge success focuses on this free character which makes its use by people new to forex and aspiring traders a reality. This alone has generated a very large automated system sales industry, showing that the decision to make a platform and its price data freely available is indeed an excellent one. Up until now we didn't seem to have any alternatives with similar free character and the potential to become so massive but now we seem to have a new competitor that may want to take Metatrader 4 and 5 to the boxing ring. Today I will share with you some of my first impressions around this software and my opinions about its potential against the Metaquotes monopoly in retail automated trading.

So what's the name of this software ? The company who dared to fight the rule of Metaquotes in the retail forex industry is actually a broker in itself- FXCM - and the product they are using to compete with MT4 is actually a very young and still under development platform called Strategy Trader. The reasons why they developed this software seem to be both economical and technical since having a monopoly on a better-than-metatrader product would make them a must-use broker for many people and the fact that they have absolute control over the implementation means that they can better handle the straight through processing (STP) with their server implementation.

Is it really that good ? I have to say that I am surprised at many of the things that the people at FXCM seem to be getting "right" from the beginning with their software. It seems that they have really paid attention to what people want, not taking the position of metaquotes which simply turns a blind eye on anyone who wants to give some suggestions about the features and implementations within their platform. FXCM has actually already implemented many features that are obvious and that metatrader simply refuses to use. For example, FXCM has the ability to select ANY custom time frame and to create range bars and tick bars with ANY values. This is an obvious addition 99% of traders want and something Metaquotes has simply been "too lazy" to do.
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Another great advantage of the FXCM Strategy trader is the fact that the feeds are updated and the charts are created as a function of actual ticks taken from a server and not through one second updates as it is done in MT4 and 5. This allows you to have more precise charts and to have a more accurate picture of what is going on. Instead of just sending one package every second with whatever happened, the Strategy trader gets a package for every tick that happens. A feature which although harder to implement is far more robust for the end trader.

Regarding simulations - which I bet is what many of you want to know about - I have to say that FXCM has done a good job. Although the data is still reduced to one minute bars instead of ticks due to the practical size problems involving direct tick data for backtesting the fact is that there are several advantages. First of all, the data from the Strategy Trader is data from FXCM so the actual sources and reliability of the data are known from the beginning. Metaquotes does not disclose the source of their data and this makes it shady and more difficult to trust by traders all over the world. Another great advantage is the Bid/Ask data sources which means that actual spread values from real trading can be known with much better precision than with actual Metatrader data which simulates the spread.

Sure, the Strategy Trader is only in its infancy and it is still a much less stable, robust and of course used platform than Metatrader 4. However I think that FXCM has done a great job so far probably due to the fact that they have listened to what people want and they have created a platform to reflect this. In the future I would say that if FXCM continues with their efforts and decides to sell this platform to other brokers this might come to be the preferred industry standard over the currently more popular Metatrader series. I'll continue to follow up on its development and I'll share some future posts about my experiments with it in the future.

If you would like to learn more about automated trading and how you can gain a true education in the use and development of algorithmic trading systems please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Wednesday, August 25, 2010

How To Get Umaki : The Trader Builder

If you have been reading my blog recently you might be aware about the development of a trading tool I have built to use the metatrader 4 strategy tester as a "live" trading platform that would let us speed up the process of manual or discretionary system evaluation to a great extent. The tool allows us to use the visual backtesting feature of the strategy tester to trade on "live evolving charts" as we would trade the real market. You can read more about this tool and what it does here. On today's post I want to talk about the meaning of the word Umaki and how you can get this useful tool to increase the speed in which you learn to trade manually and understand the forex trading market.

What does Umaki mean ? Contrary to my general expert advisors which use words in Quechua or Nahuatl as their names (all experts of the Watukushay project use them) this trade-learning tool uses a word in Zulu, the language of a very well known group of Southern African tribes, to describe the EA. Umaki means "builder" in Zulu, I named it this way because I consider Umaki to be a "trader builder" a tool which can be used to get to successful manual trading much quicker - yet with a LOT of additional effort - in currency trading.

Why Zulu ? You might be asking. The reason for this is because of the way in which Umaki will be shared with all of you. Since Umaki does NOT have anything to do with automated trading but just with manual and discretionary trading I decided not to make it available within Asirikuy but to use it as a way to do something better.
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This is when I remembered the "Treasures of Africa" foundation one of my favorite charities dedicated to the protection and shelter of children in Tanzania. This foundation is run by a group of very dedicated and selfless Christians who attempt to do the impossible day after day to bring some hope into the heart of Africa. I have to say that the job they do is absolutely amazing and I have always greatly enjoyed to help them in as much as I can with what they need. I have to say that I also think the name of this charity is absolutely incredible, I can assure you that after you see their pictures you'll understand that diamonds are not the true treasures of Africa.

When I programmed Umaki it seemed like the perfect opportunity to help them and to do something to make the world better, even if it is only a grain of sand. If you want to get the Umaki EA to further develop your manual trading abilities please donate some amount of money (any amount you want) to the "Treasures of Africa" foundation. It would be absolutely great if you not only donated some money but also committed to the sponsoring of one of their children. Sponsoring a child is an absolutely wonderful endeavor and I can assure you that it is a true way in which you can make a difference to change some of the bad things happening around the world.

If you have made your donation or have started sponsoring a child please send me an email to ekans_(at)hotmail.com with a copy of your payment receipt and I'll be glad to send you the link to download the Umaki mql4 code along with a small set of instructions on how to use the EA. The download link and instructions will be sent to you within 24 hours after I receive your email. I believe that for people who want to become serious discretionary traders Umaki will be a very good tool and for everyone who sponsors a child rewards will go far beyond those of trading. Also remember that the donations you make to this charity are entirely tax deductible (at least under US law).
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If you however would like to learn more about educating yourself to be successful in automated trading please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Tuesday, August 24, 2010

Getting Years of Manual Forex Trading Experience in Only Weeks : The Umaki Trader Builder EA

Sure, we have all heard about the huge effort and thousands of hours that traders need to put into this business before they even start to turn a profit. One of the first thing that people new to the market first fight with is this inevitable need to acquire experience and the painful but real fact that demands this experience to be acquired through actual real trading, experience that needs to be taken by watching the screens and by losing money on the market (demo or live). If you want to become successful in trading then you will probably need to trade live for years before you actually come up with a true system (mechanical or discretionary) that has a positive long term statistical age and some - even remote - guarantee of bringing you stable profits. Is there any way to short-cut this road through effort ?

On today's post I want to discuss with you a way in which I believe that the time invested in trading can be exponentially reduced, reduced to the point where you will be able to gather a large amount of what would take years to get in just weeks or months. The catch however is that you will need to make the actual same effort so what we would change would be more precisely described as the "effort density" instead of the actual effort or time required. The solution I propose within this article will allow you to experience the markets in a much faster fashion, develop an excellent sense of discretionary trading and accurately evaluate your trading potential efficiently.

It occurred to me that the only way to gather true experience from the market is actually through trading a chart on the end of the right hand-side. Of course, evaluating discretionary strategies and developing a sense of the market when examining historical charts doesn't work very well because you are not taking or simulating decisions as you would in live trading - at least most beginners won't - and therefore it becomes primordial to be able to tackle the market in a "live" way.

Then I realized that there are simply no easily available tools that allow us to do this in a simple and quick fashion. It would be great if there was a way in which you could simulate live trading on a chart which had a controlled live evolution, a chart in which you could also place positions, keep track of you results and evaluate your performance when the test ended. However the closest thing we have - the visual strategy backtests in MT4 - do not allow you to take any positions and do not allow you to have an idea about the performance of a given discretionary trading style in the end.

My idea was then to develop an EA that would allow us to use the metatrader 4 visual backtester with the possibility to actually use it as a "live testing platform" in which we could actually take positions and evaluate the performance of a strategy in a live evolving, quickly moving right edge. This is how I created Umaki, the Trader Builder. This EA allows you to use a metatrader 4 visual backtest as a live market feed - only much faster - so that you can evaluate your discretionary strategies just like you would under live trading conditions (regarding chart movement and information available). (a picture of Umaki in action is shown below)
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If you want to evaluate a strategy over a statistically significant period of time (which is longer than 5 years) then Umaki provides you with the tools to do so. Simply place Umaki on the charts and use it to trade the system as you would in a real, live evoling market. You can then look at the backtesting results in the end and realize how your manual system would have performed over this entire period. Of course, Umaki is by NO MEANS a shortcut to effort but it allows you to study the forex market on your own time and develop trading skills and strategies when it is most convenient for you. Maybe you don't have the time to spend long hours within the week staring at live evolving screens but you do have a space of 10 hours during the weekend in which you can perform a ten year Umaki 4 hour run. As I said earlier, this tool allows you to increase the speed in which you evolve as a trader by increasing the effort density (much more effort in less time) and it will bring an experience as similar as possible to actual trading the real market.

Of course, a lot of honesty is required if this tool is to be used successfully (since the history of the market is anyway known) so you would have to take mechanical or discretionary decisions regardless of your knowledge of "future events". For example we all know that there was a huge EUR/USD drop in late 2008 due to the economic crisis but trading this simply because you know in hindsight is not honest and would defeat the purpose of Umaki. In the end it depends upon yourself to use the tool appropriately and to take the largest advantage from it by earning a "concentrated" live trading experience on a simulated "fast live evolving" trading platform. Also bear in mind that Umaki suffers from the limitations of the metatrader 4 backtester one minute interpolation problems so the evaluation of strategies with very low TP/SL values or on time frames below the 30 minute chart is NOT recommended in anyway.

For those of you who are curious and want to know how you can get this EA, don't worry, a post will come tomorrow just about that (also don't worry, I don't plan to sell it :o)) along with the meaning of this word. Anyone wants to take a guess ?

If you are not interested in discretionary trading or Umaki but you would like to learn more about automated trading and how you too can develop systems with sound profit and risk targets with a very good understanding about their logic and merit please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Monday, August 23, 2010

Easy Profit in Automated Trading, Logical Proof of its Nonexistence

Isn't hassle free profit from the forex market all we want ? Definitely the goal of every person that starts to look for an expert advisor - or most at least - is to find a trading system they can simply "set and forget", a trading system that just collects money from the market in a consistent manner with minimal or limited draw down. A "holy grail", so to speak. However, it becomes obvious after a while of being in this business that if it is too good to be true it probably is and that no trading system can provide the owner with profit without an effort to develop knowledge and understanding. However the fact that the other road seems plausible makes a lot of people continue to search for this nonexistent trading system, a quest that brings nothing but disappointment and financial loss for most new traders. On today's post I will be giving you a logic based demonstration that shows why easy profit in automated trading is impossible and why this search is meaningless and will never arrive at your intended result (a system that easily gets you money without any effort).

First of all we must understand the very basic aspects about logic based demonstrations. When we are faced with a given hypothesis there are several ways in which it can be demonstrated to be true. In mathematics this is done in several ways but one of them is of particular interest to my article. You can demonstrate that something is false if the assumption that it is true leads to absurd results. For example, let us test the hypothesis that the addition of two even numbers gives us an odd number (which is false).

Assuming this to be true :

n, m and k are integers (2n is the definition of an even number, 2k+1, the definition of an odd one)

2n+2m = 2k+1
2n+2m-2k = 1 subtract 2k from both sides
2(n+m-k) = 1 factor 2 out
2a = 1 since n, m and -k are integers their addition is another integer (a)

Since 2a is an even number by definition and it is said to be equal to 1, we have an absurd result. No integer times 2 is able to give us 1 as a result. The hypothesis has been proved false because the assumptions that it is true leads to absurd results.

When it comes to making money from a system without any effort we can do the exact same thing. Let us suppose that there is a system that generates a 200% yearly income which can be traded from 100 USD and used successfully by anyone who buys it. Looking into the sales of the most popular experts we could expect this system to be used by at least 30K people during the first 2 years. This means that 300K USD - assuming each person trades the minimum - will be traded within the first 2 years. After ten years the return of this system would have been 17714700000 which is around 17 billion which is above all other market participants for this same time period. If 300K USD were added each year (of course new sales), the results would be even more staggering nearing more than 100 billion USD.

After 20 years, results become even more absurd and the system is now making a return that would be equal to more than the volume available to be traded. That is, all other market participants would be losing money against this system. This reduces the result to absurd levels since the system's profits surpass the amount of money available from the market. In fact, all the money in the world roughly describes what this system would be making.

The conclusions of this thought experiment are therefore quite simple and straightforward. One of the following things must be true :
  • If a successful system exists that anyone can trade then there is an inherent - and quite small - volume limitation to its trading that will thereafter make it lose its profitability or its "tradable by anyone" character.
  • If a successful mechanical system exists then there must be strong psychological barriers that make it extremely hard to trade for most market participants
  • If a successful mechanical system exists then there is bound to be a maximum compounded yearly profit to maximum draw down limitation that forbids it from reaching the above scenario (a limitation on profits).
Through all my research and work I have found that it is certainly possible to have successful mechanical trading systems and I suspect all the above are in fact true statements. Systems that would be easily available for anyone to use would quickly lose this character as a function of volume and become hard to trade for some reason (psychological, increases in the maximum draw down to average compounded yearly profit ratio) and systems that are already successful are bound to be hard to trade or have an inherent profitability limitation that does not allow them to reach the above mentioned scenario.

In the end, logic is simply undeniable. The scenario portrayed before is an absurd outcome that cannot be reached and therefore limitations to its achievement must be contained within the systems themselves. Systems that may seem to show extremely high results must be volume limited and later become much less profitable and harder to trade while mechanical systems that are profitable in the long term are hard to trade by definition. The above logical reasoning also shows us that there is bound to be some form of profitability to draw down limitation which comes from the simple assumption that the above scenario must be avoided. In conclusion, there is simply no easy long term profit in automated trading.

As you see, the simple power of the "reduction to absurdity" logical reasoning allows us to gain a lot of information about the world of automated trading systems merely by the use of a very simple thought experiment. If you have any comments, suggestions, opinions or other similar reasoning exercises, please feel free to leave a comment !

If you would like to learn more about my journey in automated trading and gain a true education around this type of systems, their uses, limitations and possibilities please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Sunday, August 22, 2010

Yes, You ARE Looking for the Holy Grail : A Message for People New to Trading

It is very interesting to analyze the answers you get when you ask people what they are looking for and if they think that what they are looking for is the automated trading "holy grail". This mythical piece of code is an EA that does NOT exist which achieves "unbelievable" results. However despite the fact that most people will utterly deny that what they look for is the holy grail - they will always say they know the holy grail doesn't exist - when you analyze the answer to the question "what are you looking for in a trading system?" you will realize that the bast majority are indeed looking for this mythical piece of code. On today's post I will talk about the holy grail and new traders and especially the relative character of the definition of this term and why so many people are looking for it even if they categorically reject to be doing so.

What average yearly profit to max DD ratio do you consider realistically achievable ?


So what is this trading "holy grail" exactly ? Its definition is actually simple and yet very complex. In my mind a holy grail is a hypothetical system which achieves results superior to the highest achievable maximum draw down to average yearly profit ratio allowed by the market in real returns over the past ten years. This means that any system that can do better than how the best REAL trader has done within the past 10 years is the holy grail. The best way to measure this "better" character is by using the above mentioned ratio which compares profit to risk.

When we look at the performance of forex traders for the past ten years -and the best registered traders since then- we notice that any system that achieves an average yearly profit to maximum draw down ratio of 5:1 over a ten year period is in fact a holy grail (check my post on the Barclay index to learn more about REAL long term performance of forex traders). This means that - being realistic - a system that achieves a 100% yearly profit with only a 20% maximum draw down over ten years is a holy grail. A system that is extremely unlikely to exist due to the very nature of the markets and the long term limitations on performance it imposes.

When we then ask new traders what they are looking for the answers are actually quite interesting. As a matter of fact, the above mentioned realistically inferred holy grail becomes the "lower standard" of a given set of return figures that are inferred from short term results and "lore" rather than from actual long term real performance records and realistic expectations. The 100% yearly profit with 20% maximum draw down becomes something that new traders perceive can be "easily achieved" and things like a 20% monthly profit with a 5% maximum draw down start to become the "grail" targets.

As traders start to accumulate more experience and they get to know the market and the inherent limitations of profitability and draw down they start to lower these figures. A trader with one year of experience is bound to give a 5% monthly profit with a 5% maximum draw down as a realistic expectation while it usually takes traders 5-7 years to realize that the before mentioned grail of a 5:1 ratio of average compounded yearly profit to maximum draw down ratio taken from real performance data is actually the real "extremely hard to achieve" target.

So chances are that if you are a relatively new trader you are looking for a system which is quite unrealistic and your actual "holy grail" is way beyond the limits of what the market is willing to let you get. In the end, most traders are looking for holy grails, even if they believe they currently have "realistic" and sound expectations of draw down and profitability for their trading systems. If you would like to earn a true education in automated trading and learn how you too can design and build your own systems with realistic profit and draw down targets please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Saturday, August 21, 2010

Using Tick Volume in Forex : A Clear NVO Based Example

A week or so ago I wrote a post about tick volume in forex and how I believed it could be used for the development of long term profitable strategies. Inspired by a currency trader magazine article, I decided to explore this issue even further to discover if I was capable of coming up with some 10 year volume-based profitable strategies. Of course - as I had mentioned before - the first problem comes when you realize that tick volume is different between each broker and that some sort of normalization must be carried out before even attempting to come up with something useful. Within this article I will talk to you about how I sorted this obstacle and how I came up with my very first volume-based system with 10 year profitable results.

Evidently there is no such thing as true market volume in forex since the amount of money exchanged by all market participants cannot be accurately determined in an "of the counter" type of market. This lack of "true volume" information seems to doom forex traders to absolutely forget about using this information leaving them at a great disadvantage against stock and futures traders who do have access to centralized exchanges with very accurate live-updating volume information.

However tick volume - which simply measures the volume of ticks during a certain amount of time - has been shown to be proportional to true volume in systems where this data is available for comparison. In forex we have tick volume and this allows us to think about the building of systems based on this information. However a big problem is that each broker has different liquidity providers and for this reason the number of ticks as an absolute value becomes useless as each system would need to be tailor made to the data feed of each broker and this is just impossible to do since forex brokers do not let you access their 10 year data (or they haven't even been on the market for this long).

The best solution to the above problem is to use an NVO or normalized volume oscillator that portrays tick volume as a percentage of the tick volume values for the past X market periods. There are already several NVO indicators available for free for metatrader 4 and the one I like the most is available here. This indicators shows us volume in a -100 to 100 range where 0 represents the median volume value and -100 and 100 represent the lowest and highest volume values during the past X periods. Below you can see an image of the NVO together with the volume indicator (which just shows absolute tick volume values as a histogram).
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After we have this information it now becomes quite simple to design a strategy based on this NVO indicator. But how do we use volume ? The traditional way to use volume is to distinguish between different "reasons" for different "events" to happen in trading. Usually price action patterns, indicator signals, etc, can happen due to reasons that are not related to actual changes in market behavior. For example, you can have a shooting star candlestick pattern develop because of lack of liquidity and not because of an imminent reversal. What volume allows you to do is to eliminate all these "false" signals, since you are only entering positions after a signal that is meaningful happens. Meaningful in this case, means that it happens on high market volume (which we assume to be proportional to tick volume which is what we actually have).
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I designed a very simple system using a very simple candlestick pattern and the above mentioned NVO indicator. The results in simulations (Jan 2000 - Jan 2010, EUR/USD) were quite good with a system with an average yearly profit to maximum draw down ratio of 0.5:1 without any optimization or additional exit logic besides a simple SL and TP. What this strategy shows is simply that entries with very good mathematical expectancy values can be designed when using an NVO as a way to measure the meaningfulness of certain market signals (of course a strategy has to be designed with the use of volume in mind from the beginning, strategies like the ones used by Watukushay No.2 or Teyacanani don't actually benefit from an additional NVO based filter).
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Bear in mind that this does not mean that you should add an NVO filter to "every system" to attempt to improve its entries. This will most likely not work since anNVO is only useful as a way to aid in entry selection when the price pattern we are looking for benefits from this type of criteria. When a pattern is valid regardless of volume, the NVO becomes a problem and NOT a solution. Also most indicator signals do not get any improvements from the use of an NVO since their signals represent the conjunction of complex calculations done over price through significant periods of time. In the end if you want to design a system using an NVO you should plan this from the beginning, adding such a filter as an after thought is NOT going to work in the large majority of cases.

After a few weeks of hard work and development using normalized volume oscillators I can say that I have developed at least a couple of strategies that show long term profitable results on a basket of currency pairs. However we will see in time if such strategies are in fact able to avoid broker dependency due to the NVO implementation and therefore succeed in the long term. Tomorrow I will be releasing a few videos in Asirikuy dealing with volume as well as the actual logic and coding implementation of the above mentioned NVO strategy.

As always if you would like to learn more about automated trading and gain a true education in the development and understanding of these trading systems please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Friday, August 20, 2010

Six Steps to Become a Successful Forex Trader : A Short Guide for the Inexperienced Trader

Perhaps only a few other businesses in this world have such a steep learning curve as forex trading. Thousands of traders begin their journey towards becoming profitable every year and only a handful ever make it to what seems to be a very exclusive club of successful people. In my mind the fact that profitable traders are not that common makes this journey a lot harder for new people, if finding someone whose example you can follow is so dramatically hard, then the journey has to be repeated for each traded who wants to become profitable. It's an odyssey every time, time and time again. Then you also have a problem dealing with the actual achievement of profitability since the strategies and methods used by one person who achieved this goal may simply not work for another either for time availability or psychological restrictions.

Through the past few months I have been thinking if there is a straight "A to B" way in which new traders can achieve profitability, a set of defined and clear steps that will allow people to become profitable traders even if there is a total absence of another profitable trader's personal experience and advice. To solve this conundrum I have come up with what I consider the 5 main steps that a new trader needs to carry out to become a successful trader. Reflecting upon my experience as well as that of other people I know who went from inexperienced to profitable I can tell you that - even though the advice may sound too general - it does constitute a genuine and clear route towards success in the forex market.

1. Learn and understand all the basic information. It is absolutely important in order to succeed for traders to understand what in the world they are doing and what everything in the world of forex means. I cannot tell you how many times I have come up with people who have been involved with forex for even a year without knowing what a contract size represents, what "trading a lot" means or how you can calculate the amount of money to risk for a given stop loss size. The firs thing you need to do to become successful is to learn and understand all the basic aspects of forex trading.

2. Learn to program and run reliable simulations. Even for people who like to trade manual systems it is absolutely necessary to be able to run accurate simulations of the strategies one intends to use in real, live trading. When the advice of an already successful trader is missing it would take you months to test every single strategy and then years to learn its true potential. In order to understand what you are doing it is VITAL that you learn how to simulate system under past market conditions in a RELIABLE way to understand their true potential.

3. Know the profit and risk targets of ALL the systems you are trading. Nothing draws more traders into losses than their ignorance about the characteristics of the system they are trading. For any given strategy you are using you should be able to answer what the average yearly profit and maximum draw down values are expected to be. You should also have a very good idea about things like the number of consecutive losing months, the risk to reward ratio, the maximum length of a draw down period, etc.

4. Don't trade anything you do NOT FULLY understand. This is one of the most important things people new to forex need to learn. Black boxes are absolutely dangerous for new traders since they put a strong psychological pressure and uncertainty on the trader. The best way to fail in trading is to use systems which you do not understand which use trading tactics you are not familiar with. When you don't understand the reason why you are getting into a position besides "the robot entered a position" or "the blue line turned red" you are running into SERIOUS trouble. There is not a single successful forex trader I know who doesn't absolutely FULLY understand all the ins and outs of the logic of the system they are trading.

5. Reduce risk to the lowest possible level. New traders are like new bait in a shark tank. There is absolutely no doubt that in the beginning a huge amount of mistakes will be made and these will make capital losses important. The most important decision you can make is to make capital preservation a MUST. Do not think of your success as your account percentage profitability but think of your success as your maximum draw down to average YEARLY profit ratio. In the first few years achieving long term profitability will be HARD so make sure this process is as cheap for you as possible. Trade with the absolutely MINIMUM risk.

6. Make a commitment to the systems and strategies you decide to trade. New traders like to hop from one strategy to another without ever giving them a chance to succeed. If you have followed the above mentioned steps you have a very good idea about the profit and draw down characteristics of the system you are trading. If you absolutely understand what you are trading then there is no need to change the system unless it shows that it has become too risky. However you have adequate risk and profit targets so it will be easy for you to evaluate your system as time moves on and know if it is or if it is not following the draw down analysis you performed before.

Even though following the above mentioned steps - except perhaps the first one - will be really hard for new traders it is what - in my experience - has to be done in order to become successful. It is obvious that many problems and probably some financial loss will come along the way but the above steps give you strong safeguards that will not guarantee but increase your chances of success to a great extent. Most inexperienced people face account wipe outs and long term losses in trading and the bast majority never follow any of the above steps. If you follow them I can tell you that you will feel much more prepared and ready to tackle the challenge, even if it takes a huge amount of effort.

If you would like to learn more about my journey in trading and especially with automated trading strategies and gain a true education regarding this type of systems please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Thursday, August 19, 2010

New Review Methodology : Releasing my First Monthly EA Review Update ! :o)

Certainly there have been a lot of new expert advisors being released every month and writing a post review for each one started to seem like a huge task that didn't make a lot of sense since many of the trading system's being released don't even have the slightest hint of reliable evidence of profitability. Due to the fact that I consider reviews very important but due to the fact that I also consider that my written posts can be devoted to more practical and educational matters I have decided to give my reviews a total turn around, changing the way in which they are done and shared. On today's post I will be sharing these changes with you as well as the first monthly update of expert advisor video reviews :o)

The problem was actually very simple. There are many new expert advisors coming up every month and writing reviews for each one of them would have taken a lot of time and typing hand-stress. However stopping my reviews never seemed like a very good option because I consider that one of the most important aspects of my mission here in fxreviews is to inform others about my opinion regarding new trading systems and their merit (or more commonly the lack of it) in forex trading. I believe that many new traders have taken a lot of benefit from my views and the ways in which I review systems and for this reason I have decided to continue doing reviews, albeit in an entirely different way.

How will reviews be presented now ? From now on I will publish a monthly post in which I will include links to video reviews of most of the trading systems released that month. Each video will include the same material as my previously written reviews although now people will be able to follow me around the evidence and hear my opinion about the trading systems. Before recording the reviews I still perform my in-depth analysis of the systems and their evidence and I share it with you by going through each system's website on each one of the videos.

I believe that this new review-sharing mechanism is not only far easier from a technical point of view (when a lot of reviews need to be done) but it also allows traders to get the information faster and too see the problems and specific failures of the different trading systems in a much more straightforward manner. This also allows me to easily pinpoint links or other sources where people might find evidence relevant to the different systems (such as the free systems a scam system might be based on). As always my reviews will attempt to offer an unbiased perspective with evidence as the main focus of their findings.

This month I have reviewed several different trading systems. The review video links are highlighted below (please download the free divx video player here if you cannot watch the videos).

- Pip brains unbiased review

- 4xhotbot unbiased review

- Forex legend unbiased review

- Forex Onslaught unbiased review

- Forex Supersonic unbiased review

- NonameBot unbiased review

- FAMDrone unbiased review

- Forex Euro System unbiased review

- Forex Supreme Complexity unbiased review

- Forex Hippo unbiased review

- Forex JackHammer unbiased review

- Forex Set and Forget unbiased review

- Forex Outbreak unbiased review

- Forex Shockwave unbiased review

I hope you enjoy the reviews and consider them as good - or perhaps even better - than my previously written contributions. I definitely enjoyed making them and I believe they will do a great job at informing people about the general quality and extent of the evidence and actual potential for long term profitability that these systems have. As always, remember that my approach is based on the fact that the burden of proof is on the authors of trading systems and NOT on our live accounts. Please follow this link to learn more about how I review systems and what you should know about my methods.

Of course feel free to live any comments with any opinions, comments, suggestions, observations, etc :o). If would also like to learn more about my journey in automated trading and how you can gain a true education in this field to design your OWN systems based on sound trading tactics please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Wednesday, August 18, 2010

The Destructive Focus on Money : The Greatest Enemy of New Traders

In my career as a professional currency trader and through my whole experience with Asirikuy members I have been able to gain some great insights into how new and experienced traders think. There are several thought processes that seem to change from the time you start to trade to the time when you have your first profitable year and develop your first profitable system but I think none of them is so crucial as the evolution of your focus in trading. The way new people see trading and the way in which experienced profitable traders see it is absolutely and completely different. The main difference - if anyone asked me - is the focus in money. During the following few paragraphs I will attempt to explain a little bit how new experienced traders view their trading and how the view of professional traders is very different, focusing not on the money, but in the way in which this money is to be obtained.

Viewing things like a new trader is actually not very hard since we all have walked those steps. When you are beginning to trade the forex market you are hoping to "make it big", learn a lot, have small draw downs and huge gains. It is natural to think this way - perhaps due to all the hype - and most inexperienced traders enter the market with a sole focus : to make money. Although the objective of trading is to make money - for all traders - it is true that the main focus of new traders is the money and what happens to it, neglecting almost all other aspects of trading.

The difference here is that new traders don't know almost anything about trading in general. The bast majority don't have strong formations in economics, finances or statistics and they come from a wide variety of different backgrounds with the sole idea that they want to make money. The problem here comes when you see that there is a disconnection between the goal and the technique. New traders know they want to make money but they don't have the slightest idea of how this is made or how others who are successful actually achieve this. It is a world in which they are lost and where there doesn't seem to be any true guidance.

New traders also often come with pressures to gain money which may originate from different sources. They may be pressuring themselves to succeed, they may need the money to live from it, they may have a desperate financial situation, etc. In the end, new traders are simply people who don't have the slightest idea of what they are doing with the only idea that money is what they need to make.

Now the professional trader mindset is very different. Money is not actually the main objective but a consequence of succeeding at many other different aspects of trading. When you don't focus on the "money target goal" but on developing a statistically meaningful edges against the market, money comes to you as a consequence of your rational and sound based effort. Money comes as a consequence of succeeding at trading in general through analysis and understanding. Professional traders know that the most important thing is not to focus on making money but to focus on protecting capital and developing tools that guarantee long term statistical success under varied market conditions.
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The difference between both mindsets can be better explained through a simple example. Image there are two restaurant owners who just opened their businesses. One of them is an experienced restaurant owner while the other one is just on his/her first venture. The first restaurant owner knows that he/she must focus on developing a great menu, get some professionally trained staff and do some well planned advertising. The second restaurant owner rushes in with whatever menu he/she can get, employs half of his/her family and advertises everywhere he/she can. Five years after inauguration the first restaurant remains open while the second one filed for bankruptcy 4 years ago. The morale of the story, focus on the method and the objectives will take care of themselves.

In forex it is quite similar. Often I see Asirikuy members who are new traders focusing on using systems with higher risks and less understanding and evaluation while Asirikuy members who are professional traders focus a lot on the risk and develop an in-depth understanding of the strategies before even considering to use them. It is a matter of how things need to be done to get to a certain point, something which is sadly not known until you actually realize that making money in trading is a difficult goal to reach and it is only achieved in a consistent manner when the focus is on establishing the potential, reliability and robustness of methods and not by perusing an irrationally set money making goal.

If you would like to learn more about trading -especially automated trading - and gain a true education to achieve long term profitability please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Tuesday, August 17, 2010

Oh, My Bad Luck : The Perception of Luck and its Psychological Effect in Forex Trading

It is funny when you see how new traders talk about their first experiences in trading and what they believe happens when they start using a given system. Time after time I have found out people in forums saying that whenever they start to run a system it goes south and that this is merely a consequence of their terrible, terrible bad luck. As a matter of fact there are many reasonable explanations to these phenomena and a clear argument that shows us why most people are bound to start trading systems within draw down periods. Today I want to talk about this "luck" aspect of trading, why people get this perception about their own trading experience and the psychological effect it tends to have in the end.

So why do most systems go into draw down right after you start using them ? The answer to this question is surprisingly simple and tells us a lot about both trading systems and trader psychology. To understand why this is the case we first need to take a look into the way in which inexperienced traders select their automatic or manual trading systems. Usually the only thing new people care about is the slope of the equity curve and the fact that it is making money consistently, constantly and in great or moderate amounts during a period superior to 1 or 2 months. When a new trader sees this type of system he or she immediately wants to use it and set it up. After all, the system has been showing excellent results and why should this be different in the future ?
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The problem to those experienced in trading should now become more evident. New traders fail to understand that systems trade in profit and draw down cycles and that the only way in which a system can remain profitable in the long term is if those profitable periods are greater in magnitude than the draw down periods. However, they fail to grasp the fact that a system can still have very profitable periods and then strong draw down periods that wipe accounts. A general lack of focus on the reliability of simulations and the need to have long term reliable back testing results ends up with inexperienced traders only paying attention to very short term live tests that are statistically meaningless and only portray very short term trading results.

Additionaly- despite the actual long term profitability of a system- the existance of long consistently profitable periods makes the entering into draw down periods more likely since the market is waiting to cash on the system's exposure. So the more attractive the equity curve seems to new traders, the more likely it is to show a venture into draw down territory. In the end inexperienced traders will systematically select systems that have a high like hood to enter draw down periods and this will lead - in the bast majority of cases - to the above mentioned result. Every time you get a system, it seems to start losing money. Oh my bad luck.

However the solution is not to do the opposite and get into systems that are losing money (new traders tend to simplify things this way), the solution is to know the extent of the draw downs a trading system will get into, to have reliable long term trading simulations that can show us precisely what we should expect from the system. As always it is lack of understanding what makes new traders so bad at picking systems and even worse at being able to live through extensive and deep draw down periods (something that is bound to happen with any system). If you look for a system that consistenly makes profits and "seldomly loses" you are getting yourself into this game of picking losing systems and even worse, you are most likely to use systems with very unsound trading tactics and risk to reward ratios.

In the end, the "luck effect" - as I like to call it - has an important effect in trader psychology , ending up with traders losing all their "faith" in automated trading. People who time after time use systems with very nice equity curves only to find strong draw down periods sometime after will most of the time say "automated trading doesn't work" and they will completely quit the quest to achieve profitable trading using this type of systems. However it is important here to understand that what generates this "luck effect" is merely the general lack of in-depth analysis and the desperate search for a holy grail of automated trading. When new traders acquire some experience and they begin to see that the analysis and understanding of a trading system is vital for success, the luck effect immediately starts to vanish since draw down periods become a part of the business and not an undesirable evil.

Of course if you would like to gain a true education in automated trading and learn to design and use systems you can understand and have confidence in please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Monday, August 16, 2010

To Trade or Not to Trade : A Little Bit About Friday Trading

Can I disable Friday trading ? This is perhaps one of the most common questions I hear from people who try automated trading systems. Certainly the reason why most people are concerned with Friday trading can be easily understood but when you really look into the evidence people have to avoid trading this day of the week you will find that - for most systems - it is nothing more than a senseless superstition. What is so wrong and different about Fridays ? Should you avoid or not avoid Friday trading ? On today's post I will try to address these questions. I will first explore the reasons why traders avoid Friday trading and what the evidence actually says about trading the last day of the week, after that I will give you my conclusions about Friday trading and what you should do in order to know if you should or should not avoid trading Fridays.

What is the problem with Friday ? There are many reasons traders - especially new ones - give when you ask them why they are so reluctant to trade on Fridays. The first and most valid of these reasons is carrying positions over the weekend. Since traders know that getting a position through the weekend involves the risk of facing an unfavorable gap, they will attempt to avoid the carrying of positions in order to preserve their capital and avoid worse than stop loss trades. It is no mystery that if the market moves against you on a weekend and open up beyond your SL your broker will close your position at the next available price level which is - probably - much worse than your SL.
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Of course, the possibility of disaster changes depending on the trading strategy you are using. Systems that use 100-200 pip stops with a 1-2% risk will almost never lose a significantly large amount of money on a weekend gap (for systems like this the worst case I have found has been a 3-4% loss, just about two losing trades worth) while strategies that take huge risks on tight stops would run the risk of wiping the account on a large gap. For example, if you are trading a system with a 10 pip stop risking 10% (yes, there are systems that trade such an unsound money management) leaving a trade opened through the weekend is suicidal as a moderately large gap of 100 pips will wipe you out and an even larger gap of 200 pips can leave you owing money to your broker (yes, this is possible but I will discuss it on a later post).

The truth is that for all the systems I have tested that use sound trading tactics the largest loses due to weekend gaps have not surpassed a 3 consecutive loss count. It is also worth mentioning that the opposite effect (being on the right side of the gap) also happens with roughly the same frequency so in the end (over a long period of time) the effect of leaving trades over the weekend for these systems is almost the same as leaving trades open during any other day of the week.

Then we also have the fact that none of the systems I have ever tested and found reliable take any benefit from removing Friday trading. As a matter of fact- since Friday contains NFP releases and some other important news events- removing trading for this day of the week causes all the systems to lose a good part of their profitability, causing their net profits to go down and -even worse- damaging the average compounded yearly profit to maximum draw down ratio. Many important trending movements seem to begin on Fridays - with news as the catalyst- and for this reason removing Friday trading has never shown to bring positive consequences for any of the systems I trade.

In the end it seems that the removal of Friday from trading is more of an irrational fear caused by the psychological impact and "probable loss" from gaps than a good practice based on statistical evidence. When using systems that have sound trading tactics and modestly large SL and TP targets it has been evident that removing Friday trading has only detrimental effects on their long term performance. Of course if you would like to learn more about the development of sound trading systems and how you too can use, design and program your own systems based on realistic profit and risk expectations please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

Sunday, August 15, 2010

Trading the Noodle Soup : Discovering the Power of Guppy MA trading

I have always believed that the best trading techniques are the simplest ones. I have realized time after time that complexity is not always the key to success in forex trading and system development and that the use of very simple trading techniques that tackle fundamental aspects of market behavior brings us better results and -more importantly- far more robustness than the more "fancy" and complex trading techniques. One such trading technique which I have always found simple and very good at giving us a general picture of overall market behavior was developed by Daryl Guppy, an Australian trader. Within this article I will talk a little bit about the idea behind the GMA technique (Guppy Moving Averages) as well as its application for the development of successful systems.

The Guppy Moving Average method - which is how I believe it should be called - is nothing more than a simple template that puts certain indicators on the chart in the hopes that they will make trending price action much more evident and easier to handle. This method tells us to use the 30, 35, 40, 45, 50 and 60 slow moving averages and the 3, 5, 8, 10, 12 and 15 fast moving averages. The Guppy method teaches that the first group corresponds to the "long term trader behavior" while the short group corresponds to the "short term trader behavior". Guppy seems to have understood these moving averages as the representations of the behavior of short term and long term traders within the currency market.

Obviously when you look at a chart - especially at strong trending periods - through the Guppy lens, things seem to align perfectly with what you would expect and trending price action seems to become crystal clear. Below you can see an example of such a period on the EUR/USD. You can notice perfectly how the fast moving average group "collapses" when we are within the retracement of a long term trend while the slow group remains showing us overall trend direction. Guppy Moving Average charts have always reminded me of noodle soups (because of all the lines and their interactions) reason why when I trade with Guppy's indicator setup I like to refer to it as trading the noodle soup.
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However after you spend sometime studying the GMA and its actual use to create a real trading system which succeeds in time you will notice that it is not very straightforward to do. Although many websites on the internet talk about the GMA method, how to setup the charts and the general information given by the interaction of the moving averages none of them describes a real system which allows us to mechanically apply the GMA to obtain long term profitable results. As always it seems that all we have is some pretty noodle soups and no idea of how to interpret this information to arrive at a system that is able to exploit the information shown on the screen to our advantage.

It is fairly obvious that the GMA method is not without its problems and obviously this makes its mechanical application difficult at first. However after analyzing a lot of the characteristics of the GMA and the way the two groups of moving averages interact I was able to come up with a simple yet powerful system that allows us to exploit long term trading behavior within the daily charts in a mechanical way with precise sets of rules on several different currency pairs (ten year backtest of the EUR/USD shown below). This is indeed a fairly simple moving average based system (with the moving averages used by Guppy) that achieves profits in the long term (note that these simulations on daily charts are bound to very live/back testing consistent).
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The specifics of this trading system's rules will however remain hidden for the moment as I believe this idea and its results will form part of a future Currency trader magazine article and they will be further polished to become a future Asirikuy trading system. If you would like to learn more about my automated trading systems and how you too can design and build your own reliable strategies with sound risk and profit targets please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

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