We maintain three parcelled cross trading strategies on Collective2: Artex, Jaypex and Montex. We’ll talk about them later.
Parcelled cross trading strategy is a forex trading strategy that evolved through the years of trying to follow thousands of qualified and non-qualified forex advisers. Some strategies tried were not suitable for our style of trading. I do not say that they were necessary bad. I am just saying that trading strategy needs to fit chief trader’s personality.
Some traders can bear huge draw downs before the market turns their way. I can’t. I can’t sleep if draw down exceeds my comfort zone which is tight since I wiped-out my entire forex trading account in 1997.
So as a rule, I don’t feel good trading without a stop loss. The first guiding principle of Parcelled cross forex trading strategy is to limit losses and draw downs as much as possible. We never risk more than 2% of portfolio value in one trade. One trade consists of four open positions. This way we can be wrong 5 times in a row and still keep the losses at manageable level. Without such money management one can lose entire investment account in one trade gone badly.
We are not too tight with stop losses as every currency pair needs to “breathe” before succumbing to a long term trend. When volatility is stronger than the trend we elect to stay on the sidelines. We do not take trades even if other indicators show an entry signal. We will have a chance to talk about the importance of patience later on in this series. We want in this place to express our contrairarian opinion to “Idiot-proof” trading strategies like Freedom Rocks.
In stable times Freedom Rocks strategy works well. Basically it consists of long opening of two correlated currency pairs like EURUSD and USDCHF for the long haul. Being inversely correlated and having positive interest rate differential usually one of the crosses will rise when the other is falling. When a cross comes to a top sell 1/10 of a position and at the same time when the other cross is at the bottom buy 1/10 of a position. Depending on the leverage you also multiply interest rate differential. You also make money each time you close a position.
In reality, this strategy depends on the behaviour of EURCHF cross. It works fine when EUR steadily rises against CHF as was the case from April of 2002 to July of 2007. If you traded the same strategy since July 2007 your account would have probably been erased. The wrong thing with described strategy is the omission of stop losses. Because in this strategy you play on crosses going astray and back, you can’t stop the one going down. You actually want it to, because you make money on swings.
But when EURCHF, which is a sum of EURUSD and USDCHF, starts going down, both your open long crosses start losing money. Apart from closing all the positions with a loss you have no remedy. You have no real measure when to close positions. There are no flawless “Idiot-proof” trading strategies. Whenever somebody introduces better “Idiot-proof” strategy somebody else makes a better idiot.
We are still at a stop loss discussion. No stop loss strategy may still be good for gamblers (Gambling trading style). You enter strong and have luck to double your investment in short time. You withdraw your initial investment and gamble with the rest again. Whenever you double your investment withdraw half and gamble some more with the “house money”. This may be good way to make money if it fits your personality. It is gambling, though, not investing.
Just to make sure that everybody is on the same song-sheet: A loss is realised. It moves no more. A draw down is unrealised, still in the open position that can be changed into plus if the market turns your way. Or make the loss bigger.
There is an easy way to avoid huge draw downs and exposure to loss without losing the upside potential. Your market analysis says to buy a cross with 30 pip stop loss. You opened this position. The market turns against you and stops you at minus 30 pips. Market falls 40 pips more before it turns your way. You wait the move to reach your stop loss point and enter the long position again. You did not miss the good thing that is moving up after falling. You escaped the bad thing, the draw down. Namely, if you didn’t exit at 30 pip stop loss, and in the meantime, when you are down 70 pips on your position, adverse information emerges. The market moves instantly 200 more pips against you and your entire investment account is at risk of erasure. You can succeed in making profit after humongous draw downs five or even ten times. Once you fail and all your investment is lost. I have seen many a trading systems reaching 20.000% or more in profit just to lose it all in a draw down, too big to handle.
It is already more info here than bite size. We will cover more in our next post.
