Synthesizing Tharp and Alexander

[expiated]

Tharp writes…

Chuck LeBeau helped me make the link from the famous trader’s axiom “Cut your losses short and let your profits run” to the importance of exits. Think about it. Cutting losses short is all about aborting losses—exits. Letting profits run is all about exits as well. The entire axiom is all about exits.

Later he says…

Yet real money is made through intelligent exits which allow the trader to cut losses short and let profits run.

And again…

Contrary to popular opinion, much of your emphasis should be in the area of stops and exits.

But on the other hand, when listing his twelve steps to developing a system, his ninth step is to “ look for huge reward trades.” I’ve heard Scott Barkley refer to this as looking for the wide-open spaces. Yet, the only way to do this is to place at least a certain amount of focus on entries. In fact, Tharp writes…

If you decide to look for these trades, then your emphasis must be on (1) picking entry points from which the markets might make a huge surge, (2) choosing tight initial stops that make sense and that strictly limit your losses to a few dollars or even a few ticks, (3) being willing to leave your initial stop alone, even if it means letting a profit get away from you, and (4) being able to capture huge profits when they do come your way. When you elect to go this route, you are probably looking at a trading system with less than a 35 percent hit rate. However, it can still be very profitable despite the low percentage of winning trades.

I’m game for all of the above except that 35% hit rate—a winning percentage that would cause me to seriously question my ability to “get in tune” with the market, to use Tharp’s own words. (“In summary, people make money in the markets by finding themselves, achieving their potential, and getting in tune with the market.” – Van K. Tharp)

 

[expiated]

According to Tharp, entries receive more attention from most people than any other aspect of a trading system, but this attention is largely misplaced, often at the expense of the most critical aspects of a system.

Nonetheless, he states that if good timing can increase the reliability of your trading without changing its reward-to-risk ratio, then entry certainly deserves some of your attention.

It seems to me however that good timing has the potential to not only increase the reliability of one’s trading without changing its reward-to-risk ratio, but to actually increase its reward to-to-risk ratio.

No doubt, given the fact that so many entry techniques fail to evidence reliability much better than random—especially over 20 days or more—Tharp’s contention that you can make money with a random entry system is demonstrably true (as evidence by the success of numerous profitable traders whose win rates range in the neighborhood of 33%).

Yet, this suggests that if one’s entry techniques do evidence reliability much better than random, the amount of money generated via trading ought to be significantly better than mediocre.

Tharp closes this section of his book with a list of what the best entry indicators should include, which has prompted me to think about and clearly define my own entry criteria. So for me, the best entry indicators would include:

1. A painstakingly selected moving average that conveys extreme moves against major trends followed by bona fide reversals back toward the mean (the associated trendline).
2. A sufficient amount of liquidity/volatility to maintain substantial velocity/price action.
3. The occurrence of the above at predetermined zones of support or resistance as projected/forecast/predicted via an exhaustive statistical analysis of historical data reflecting typical price ranges in multiple time frames over an extended period of time.

I'm hoping the this criteria will indeed constitute an entry system significantly better than random.

 

[expiated]

Tharp spent an awful lot of time in Chapter 7 explaining all about setups, even though he states in the chapter’s summary: “Most people give overwhelming importance to the setups in their system. ln reality, about 10 percent of your efforts should be devoted to selecting and testing setups.”

And since I am trading foreign currency pairs rather than stocks, I felt much of what he included was not applicable to my situation anyway; and to be honest, the rest of what I saw in skimming the chapter did not interest me all the much either. I will leave William O’Neil’s “CANSLIM,” Warren Buffett’s “Value,” Motley Fool’s “Foolish-Four,” Perry Kaufman’s “Market Efficiency,” William Gallacher’s “Fundamental,” and Ken Robert’s models/approaches to others for testing and exploration.

I am a trader—not an investor—and an intraday trader at that. Consequently, the closest thing I’m likely to ever have to an entry setup is what I wrote the other day after skimming Tharp’s chapter on Entry or Market Timing (Chapter 8)…

Numerical Price Prediction (NPP) trade setup:
Predetermined zones of support or resistance as projected via an exhaustive statistical analysis of historical data reflecting typical price ranges in multiple time frames over an extended period of time.

However, just today I concluded a little exercise in which I closed in even more precisely on what I consider to be the single best moving average for conveying the ultimate direction in which an exchange rate is headed from an intraday perspective. So practically speaking, I am going to be perfectly happy entering positions anytime this indicator reverses direction during the London or New York sessions.

 

[expiated]

I will summarize everything Tharp had to say in the chapters about understanding expectancy, protecting your capital, and how to take profits in just three words—typical price range.

Numerical Price Prediction (NPP) uses the typical intraday price range to set stop losses and to minimize how much profit is given back. It uses the daily, weekly, and/or monthly prices ranges to maximize profits; and uses key, painstakingly selected moving averages (trend lines) to stay in trades for the duration as long as a run is (still) in progress.

 

[expiated]

Numerical Price Prediction (NPP) uses the typical intraday price range to set stop losses and to minimize how much profit is given back.

However, in actual practice, it is not the stop loss that triggers position exits, but rather, a reversal in the associated moving average/trend line, with the effect being that losses are virtually eliminated and the system results in a success rate in excess of 90%.

 

[expiated]

I don't see anything else in Alexander's book or Tharp's publication that interests me. So having taken a glance at what their text's had to say, what I have been left with is the following...

Numerical Price Prediction Protocol:

1. Use projected zones of support and resistance based on a statistical analysis of typical price ranges in multiple time frames over an extended period of time (using daily charts) to set predetermined levels where entering or exiting positions is likely to maximize the odds of the corresponding trades ending with success (i.e., maximize expectancy).
2. Once these levels are established, use the four- and/or one-hour chart configurations to recognize when potential trade setups are taking shape based on price evidencing structures/formations indicative of wholesale trend reversals (i.e., candlesticks "clearing the field").
3. As soon as a potential wholesale trend reversal has been confirmed/verified, use the five- and/or one-minute chart configuration to get a fix on the precise entry or exit points that will optimize each trade's profitability and the chances of its ultimately meeting with success.
4. Rather than exit the trade at predetermined take-profit targets, stay in the position (remain in the trade) until and unless the associated forecast model readings indicate that a given run has come to an end.
5. Rather than exit trades at a predetermined stop loss, do so as soon as the associated forecast model readings convey a reversal in the profit generating trajectory of price action.

 

[bookish]

Those methods are racist, because they all rely on colors.

Man I ain't racist. I got four black tires and a colored tv.

 

[expiated]

Having finally finished developing my trading system in its entirety, I now plan to look at a couple of educational resources on the topic and use them to help clarify why the methodology I've adopted is working.

I started with publications by Dr. Alexander Elder and Van K. Tharp because they were mentioned in a couple of entries posted on this forum. However, most of their information seemed to be geared toward trading stocks and general in nature.

Of greater interest to me personally are the resources I came across yesterday by a supposedly successful trader named Al Brooks. My impression is that he includes in his materials information dealing specifically with trading Forex. I began looking at a sample video Brooks made on Market Cycles which appeared to offer useful, concrete, practical, applicable information. So I will start there once I have enough free time to look at the presentation in its entirety...

 

[expiated]

Al Brooks

Interesting…Al was an eye surgeon before he got into the financial markets, so he applied the same approach to trading as he used in medicine—learn from people who are older than you (people who are already doing it), and read a lot of books. (The more you study, the more money you’ll make.) As a result, he was losing money for ten years…and paying thousands and thousands of dollars to authors, tutors and workshops for the privilege.

It wasn’t until he got rid of all the lines on his charts, looked at the charts, and did what they told him that he started making money. In other words, it was only after he started ignoring what everyone was telling him and learning on his own that he became profitable. This confirms for me the strength of my own (biblical) approach, which was to prove all things, examine what you read and hear every day to see if it is true, hold fast only to that which is good, and learn to discern—to rightly interpret—the signs of the times.

Al has found that the traders who become really, really profitable are the ones who write their own manuals and rewrite his stuff in their own personal way, the exact kind of approach I have taken and am continuing to take at this very moment.

One of his contentions is that the markets are in a strong breakout only 10% of the day. 90% of the day the markets are either in a channel or a trading range, meaning that there are reasons to buy and reasons to sell almost every minute of the day. Therefore, if you know how to read the charts, you can structure a reasonable buy and a reasonable sell any minute of the day.

I don’t agree with this 100%, but I get the gist of what he’s saying. It’s not all that different from what I posted just this past Thursday about conceptualizing exchange rates as moving as a belt or a strip rather than as a trend line, with “prices” swinging back and forth between the "banks" or shoreline of the corresponding “rivers” as they are swept along in the general direction of the current’s overall flow, thereby revealing an almost unlimited number of opportunities to compile profits throughout the day, provided one is able to interpret the charts accordingly.

Finally for this post...if Brooks believes he is looking at a trend and not a trading range, he always puts his stops below the bottom or above the top of the most recent breakout, depending on its direction. However my preference is to take profit during the initial formation of a pullback, and then reenter the position if appropriate following the next touch and go. But I will compare/contrast these two strategies in more depth later, after I view Al’s video on Market Cycles.

(The above was based on a "Desire to Trade" interview podcast I watched on YouTube.)

 

[expiated]

Kim Krompass is the first person I've seen demonstrate how to trade based purely on price action, and do so in a comprehensible manner. But this video made it clear to me that trading naked is not my thing for at least three reasons. This is not a critique of this particular style of trade. I'm all for everyone doing what works best for them. However, for me personally...

1. It seemed to take her a tremendous amount of effort just to walk away with 6 pips profit.
2. She missed a number of trades (breakouts) completely.
3. There was no apparent rhyme or reason as to why certain potential breakouts ended up not making (formulating) moves (going anywhere).

On the other hand, I find that plotting adaptive price price range envelopes and key moving averages on my charts reveals (in my mind) where statistical probability based on historical data suggests exchange rates are likely to stop and where the odds are highest that potential breakouts will actually follow through...