Hoping for Whipsaws

Strange as it sounds, my current trading system has me looking forward to days with extreme price swings, or whipsaws, which I used to anticipate with dread. The key to this change in perspective was shifting my strategy from primarily trend-based trading to a system that looks for profits in ranging behavior as well. The result is that a whipsaw no longer looks like one of the nastiest patterns on the chart, but instead is a potential opportunity to grab some easy pips as the market swings within a semi-predictable range.

One essential part of my whipsaw-friendly strategy is a take-profit target of just 33% of the previous day's trading range in whatever direction I place the trade. Using a fairly modest limit order like this dramatically increases the chances that a wildly ranging day will also be a profitable one. By combining this take-profit strategy with a significantly wider stop-loss, my trades also allow for swings in the wrong direction that reverse and come back around to hit the take-profit a lot more often than they're taken out by the stop-loss.

Whether this strategy will work over the long-term is still an unanswered question (just like it is for any trading system) but results in both backtesting and live trading so far look good. I'll provide a periodic update on how the system's working (or not working) after it's logged some more live trades. Now bring on the whipsaws!

Improve Your Trading Odds - Aim Lower

One of the simplest ways to improve your odds as a trader is to get less greedy. Leave more potential money on the table and satisfy yourself with a smaller profit after each trade. After a bad run of trades in ranging market conditions, I've switched to a take-profit strategy that aims for just 33% of the previous day's trading range. It's far more likely to make money off of a whipsaw than my previous approach, and in combination with my signal flipper I have high hopes it'll improve my profitability and trading consistency over time. I can't exaggerate how much a run of bad trades can affect your confidence - but fortunately adjusting your goals and strategies, and seeing them work, can really help bring it back!

Risk/Reward Ain't Always What It Seems

It's very easy to get caught in the illusion that a tight stop-loss and a generous take-profit/limit order are going to earn you profits in that ratio. You know, setting your stop at 20 pips, your take-profit at 50 pips, and waiting for those consistent profits to start rolling in. This is a newbie error I made plenty of times before learning my lesson. What I've found since then is that a very generous stop-loss and a conservative take-profit strategy is often more consistently profitable.

A case in point: I'm currently running a GBP/USD trading system that features timed exits of around a week, take-profit at 100 pips, and stop-losses set at 300 pips. Yes, 300 pips. Sounds a bit weird, I know, but the key here is that those stop-losses almost never get hit. What's far more likely is that the price will advance 100 pips in that week, or the trade will time out if it doesn't (and sometimes with a profit). In fact, I could probably run the system without a stop-loss at all and the results would be similar, thanks to those timed exits - I'll have to backtest that notion soon, though the idea of trading without any stop-losses makes me nervous.

In general I've found that stop-losses work best for me in extreme emergencies, when the market is acting wilder than usual and hence could lose me more than usual. So for my trading style it makes sense to set them at the outer limits of the likely trading range, rather than squarely in the middle of the range where they're likely to get hit by a whipsaw or retracement.

Limit Orders or No Limit Orders?

One of the conundrums that I periodically wrestle with is whether to use limit orders (also known as take-profit orders) to exit my trades at certain pre-determined levels. Should I take profits at 50 pips? 60 pips? 75 pips? Usually I start wondering about limit orders anytime the price moves dramatically in the right direction and then falls back close to where it started (or whipsaws), leaving me fuming that I missed out on major profits and wasted a day of trading.

Not coincidentally, this happened yesterday, which is why it's on my mind. I had a EUR/USD short trade in place and when I checked in on it first thing in the morning it showed 30 or so pips in profit. On paper, of course. Then over the next several hours the EUR/USD price drifted back up and I actually ended the day with a small loss. In hindsight a limit order (set at the right level of course - in hindsight they're always at the right level) would've grabbed those profits. So clearly I should be using them, right?

The fact is, though, I only use limit orders in very rare circumstances. If I'm going to be traveling and won't be able to closely monitor my trade, I'll sometimes set a limit order at a very conservative level to exit the trade with some profit without my involvement. But these are uncommon, one-off circumstances. In regular day-to-day trading, I don't use limit orders because in all of my backtesting, the data indicates I actually make more by leaving trades open-ended, allowing the price to rise or fall as much as it wants without setting an artificial limit on where I'll exit. Of course, in situations like yesterday's, I end up seriously doubting this conclusion, and suspect my tests were flawed and that limit orders are the answer. And yet the data continues to support a strategy of (1) not taking profits at pre-set levels and (2) only exiting trades when a shift from short to long or vice versa is indicated. An additional benefit is that this saves on spread costs, since I don't enter as many trades.

One strategy I haven't tried, because it would be a huge pain to put together, is contextual limit orders fine-tuned to a particular signal. So if signal A goes off, a take-profit at 75 pips is indicated, whereas if signal B is triggered, a limit order of 50 pips is deployed, and so on. Since I currently have a few dozen signals at work, this strategy would be incredibly time-consuming, with no guarantee I wouldn't end up with the same conclusion: no limit orders.

On the other hand, I have found there is some additional profit to be made by using stop-loss orders. However, even this is not that significant an amount, and the levels where I set my stop-losses are only reached very rarely. So on most days, I might as well not have a stop-loss in place. That said, I absolutely need them in place, for my peace of mind if nothing else.

But to return to limit/take profit orders: if you're spending a lot of time agonizing about the best place to set them, consider the possibility that you might not need them at all.

Related topics:
Simply Your Trading
Figuring out where to set your stop-losses