Current Trading Strategy: Slow and Steady

There's a lot less daily drama and a lot more sitting on the sidelines in my forex trading these days, and so far it's a strategy that seems to be working. Because of the filters and meta-signals I've added to my trading system, it generates a lot fewer signals than it used to, since it's switched off during periods when it's likely to underperform. So in an average week I'll now make 2 trades or so, a lot fewer than the daily trades I used to make (and that ended up leading to some really nasty drawdowns late last year). I'm looking for smaller profits with each trade too, with my limit orders set at levels targeted for both trending and ranging price behavior.

This slow and steady strategy looks for a few high-probability trades and in the process filters out a lot of potential winners but also lots of losers, and seeks out modest profits across many different market conditions, with a focus on playing the likely daily range rather than hoping exclusively for profitable trends (which can be few and far between). And with the signal flipper I've added, there's a built-in ability to recognize when the core indicators aren't working and basically start fading my own signals.

Overall it's a slower, more patient, more boring and thus far, more successful approach to trading. So far this month I've placed three trades using this system and they were all winners, bringing in 31 pips in total profit. Again, not huge profits, but I'll take them over a drawdown anyday. The system also got the two trades before those right as well, making this a 5 trade winning streak. I'm under no illusion it'll last much longer, but I'm sure enjoying it while it does.

Signals and Meta-signals

If I had to categorize the different ways I've used trading signals in my brief forex career, I'd break them down into something like this:

1) I have no idea what a trading signal is, but I'm very eager to find out so I can get rich this year.

2) I'm trading with the first signals I read about in a book/website because someone said they work. But for some reason I'm not getting rich. In fact I've blown most of my account and if I'm going to preserve the rest I need a new style of trading - quickly.

3) I've discovered the psychological side of trading (the hard way) and am learning how to apply someone else's trading signals with discipline, rather than haphazardly whenever I need my trading fix.

4) I've begun to tweak the various off-the-shelf signals I've been using with my own variations and started using historical data and backtesting to determine which ones work best - if they work at all.

5) I've begun prospecting for my own trading signals using historical data and developing my own trading system that combines various signals with layered "and/or" logic. I end up focusing on this project obsessively for several months.

6) I discover (the hard way, as usual) that sometimes my trading system works well, and sometimes it's crap depending on underlying market conditions. To try and overcome this problem, I start exploring the idea of meta-signals, which monitor the performance of my trading signals and turn them on or off, or even reverse them, based on their recent track record.

So far the meta-signals I've developed act as trading filters, kill switches, and signal flippers. Others I've tried in the past but don't use currently are designed to weight competing signals based on their performance to determine which one is more likely to work. The basic principle is the same across the board: using internal feedback to fine-tune trading activity.

If you've been reading this blog much lately, you can probably tell #6 is the stage I'm in right now. Who knows, maybe it's the last signal-related stage before I start trading without any signals at all - though I can't imagine how I'd pull that off. I've found that meta-signals are as important as, if not more important, than the actual trading signals themselves. The reason is simple: they make my trading system work better. In fact sometimes I wonder if a really mediocre trading system could turn into a highly profitable one if the right meta-signals were attached to it.

So if you're ever frustrated with how your own trading system is performing, try running it through some meta-signals before trading it in for a new one. They might make all the difference.

My Signal Flipper

I had a pretty ugly run of failed EUR/USD short signals in the past month or so, so ugly that I stopped my manual trading entirely for a while and switched over to automated trades while I rethought my original strategy and tested out some new ones. One of the new strategies I considered seemed a little strange, since it called into question a lot of my assumptions about trading signals, but maybe strange enough to work. It's a signal flipper, which turns my short signals into long signals during periods when they're failing miserably.

The flipper is triggered when the success rate of my short signals falls below 40% over the previous 20 trades. So over the past several weeks, it would've converted almost all my short signals to long signals, and a steep loss to a profit (theoretically at least). The backtested results on a graph look promising, and most importantly they're consistent over a few years of price data: the flipper does what it's supposed to, even in periods outside the original timeframe I was worried about.

There are of course pros and cons to the signal flipper. The fact is, it doesn't really seem to add to the total profits - it just smooths out the earnings curve and dramatically reduces drawdowns, making it less likely I'll blow my account in the midst of erratic market behavior. For me this is a really big deal, since not only are drawdowns dangerous to the financial health of my trading career, but they make me call my whole trading system into question, resulting in low confidence and poor execution.

And as I mentioned, it calls into question certain assumptions about my trading signals. Frankly, when I create a short signal I want it to stay a short signal, not act as a long signal in certain market conditions. But that's what the principle of the trade flipper implies. It doesn't care what a signal's supposed to do, it just looks at what it's actually done for me lately and flips it short or long accordingly. Is that a good or bad thing? You tell me...but if it smooths out my trading performance and saves me from some nasty drawdowns, I certainly won't complain.

Related topics:
Creating Self-Tuning Signals
Your Worst Short Signals May Be Great Long Signals (and Vice Versa)

The Kill Switch is Working

I haven't been doing a lot of trading the last week or so, which given current market conditions turned out to be a very good thing. I recently added a new set of filters to my trading signals and they create very strict conditions for when I can enter certain trades - and for the past couple weeks they've been switched on most of the time. I just went back and looked at how my system would've performed without this new "kill switch" in effect and it wasn't pretty: in total it's saved me from over 150 pips in losses in a little more than a week.

How does it work? Well, part of the equation is the Bollinger Band filtering I wrote about recently. The rest of the equation involves some internal feedback that would only really make sense to me if I described it so I'll spare you the details.

Another question well worth asking is why my system would have performed so badly in the current conditions. If you've been watching the EUR/USD for the past several days you'll see why immediately: lots of very range-bound activity, with false breakouts and whipsaws that all seem to settle back into the same general price zone day after day. This is the type of market that would absolutely destroy my trading account if I let it - but with the new trade filters in place, that's less likely to happen. (I hope.)

Related topics:
The Quest for a "Kill Switch" Signal
Bollinger Band Trade Filtering
Creating Self-Tuning Signals

Easy Signal Tweaks to Boost Trading Performance

Happy holidays fellow forexers - hope your trading's going merrily. Before heading off for a week of no charts, no trading, and probably no blogging unless I get really bored, I thought I'd pass on a couple little tweaks I use with some trading signals that I've found can crank up their profitability significantly.

High/Low Breakouts

Take one of your usual signals and for the last trading period (hour, day, whatever) specify that the maximum or minimum price was higher or lower than the previous period's maximum or minimum. In some cases this type of breakout may point to a reversal, in others an accelerating trend in the same direction. How do you find out which? Backtest, backtest, and backtest!

Price Closed Up or Down

Take your usual signal and add the requirement that the previous period's price movement was up or down. For instance, if a moving average indicates a downward trend, specify that the price closed up in the last trading period. Backtest and see what happens to the performance. Then specify that the price moved down in the same period, and backtest that pattern.

I've found some of the most dramatic results occur when the trend indicator is pointing in one direction and the last period's price moved in the other direction. This is a good example of a simple divergence pattern that can be attached to just about any indicator.

Try out various combinations of these rules and see if they help boost your signal performance. They might not work for every indicator, but in my experience they'll definitely work for some.

Best wishes for a wonderful holiday and a happy (and profitable) New Year! And if you find yourself thinking about your next forex trade while opening presents, you may want to read this.

Related topic:
Signals aren't set in stone - so don't be afraid to fine-tune them

An Easy Signal Using Maximum Prices

This signal is basically the mirror image of the one using minimum prices I discussed yesterday, and while that one triggers short trades of the EUR/USD, this one signals long trades. While it's not the highest yielding signal you'll ever see, having these two complementary signals in your toolkit could make you a few pips now and then. Coincidentally, this signal just fired a couple days ago, predicting a long trade that made 64 pips on Monday, December 11.

Here's how it works:

Timeframe: Daily (24 hours)

Signal: If the previous trading day's maximum price is less than or equal to the closing price the trading day before that, a long signal is generated for the next trading day. So if it's the end of trading on Tuesday and Tuesday's maximum never exceeded Monday's closing price, a long trade would be signalled for Wednesday.

Tested out over 4+ years of data going back to September 2002, this signal would've generated 44 long trades (buying the EUR/USD pair) and 263 pips in profit after subtracting a 3 pip spread. Of those 44 trades, 25 would've ended positively, for 57% accuracy. If you combined this with the mirror-image short signal using minimum prices, you would've made a total of 81 trades and 769 pips in that time; not something I'd build an entire trading system around, but certainly worth keeping an eye out for when monitoring maximum and minimum prices.

I haven't tried these out on other currency pairs or timeframes, but I'll probably be testing them out with the GBP/USD soon.

Related topics:
An Easy Signal Using Minimum Prices
Signals Using Maximum/Minimum Prices

An Easy Signal Using Minimum Prices

This is an extremely simple short signal I came across while prospecting for new indicators to add to my EUR/USD trading system. Here's how it works:

Timeframe: Daily (24 hours)

Signal: If the previous trading day's minimum price is greater than or equal to the closing price the trading day before that, a short signal is generated for the next trading day.

These conditions occur disproportionately often during US weekends, with price gaps occurring between Friday's closing price and the minimum price in Sunday trading. So let's say it's the end of trading in the Sunday session. Sunday's minimum EUR/USD price never fell below Friday's closing price. Therefore, this signal indicates you should go short the EUR/USD on Monday.

I tested this little signal out on over 4 years of daily price data going back to September 2002, and in that time it would've generated 37 short trades (selling the EUR/USD pair) and 506 pips in profit after subtracting a 3 pip spread. Of those 37 trades, 23 would've ended positively, for 62% accuracy. Here's a chart of its performance:

So it's not the commonest signal, occurring less than once a month, and it doesn't yield gigantic profits. But on the other hand, it's extremely simple and has a fairly consistent track record, so it might be worth adding to your trading system.

So why does it work? (Keeping in mind that past performance doesn't guarantee anything, anytime, anywhere.) My theory is that it's a type of overbought signal - basically you're spotting a point when the market spikes upward without dipping back even slightly, and in those conditions a correction back downward becomes more likely the next day. This is especially true after the weekend break, when traders return to the markets anticipating a correction or reaction to the previous week's activity.

If nothing else I hope this gives you some ideas for creating your own signals using minimum price data. Stay tuned for a similar long signal using maximum prices...

Related topics:
Signals Using Maximum/Minimum Prices
Simplest. Signals. Ever.

Layering Your Trading Signals

One of the core features of my trading system is the layering of multiple signals into a single meta-signal. Rather than focus my attention on a few indicators, I decided to use every indicator that crossed my path that showed a positive return in backtesting. I then layered these with every other indicator on my trading menu so that if even if one wasn't firing, another one probably would be.

I'm not a programmer, so all my signals are generated via straightforward Excel functions. The syntax I use to construct my long and short meta-signals is based on the OR and AND functions, with an OR function at the highest level generating the final trading signal when any of the sub-signals have been fired. Here's what just one portion of the code looks like:

=IF(OR(AND(OR(J12=1,L12=1,H12=1,M12=1,N12=1,O12=1,Q12=1),
F12=1,AK12=0,T12=0,S12=0,AN12=0,AO12=0)...

In this long meta-signal, each number/letter combination represents a different sub-signal occupying a particular cell. A "1" represents a long sub-signal that's fired, and a "0" represents a short sub-signal that must be inactive in order for the long meta-signal to be activated. (More about that in my Trading by Process of Elimination post.)

By layering multiple signals into an automated meta-signal, you save yourself the headache of trying to decide which signal to pay attention to, sorting out contradictions between signals, and getting psychologically swamped by a dozen different indicators on your charts. It's a way to squeeze stressful decision-making and discretionary concerns out of the trading process by delegating them to a logical script. This allows you to focus more of your energies on refining that script by combining signals in different ways to achieve optimal results. And for me, that type of analysis has proved to be far more satisfying, and confidence-building, than biting my nails trying to make trading decisions without a consistent, logical process to guide me. It's not a strategy that will work for everyone...especially if you have an aversion to spreadsheets...but without it, my trading career would've ended a long time ago.

Related topics:
Trading by Process of Elimination
Designing a Trading System

Sometimes No Signals are Good Signals

Today was the best example yet of when following my trading system to the decimal point pays off. Yesterday I plugged in all the relevant data to generate today's trading signal. And my system, somewhat to my frustration, didn't generate either a short or long signal. As I always do when I don't get a signal I considered ways of forcing one, which is how my urge to overtrade currently expresses itself. But I decided it would be foolish to end a profitable week by breaking my own trading rules just to get in one last trade.

That rule-breaking trade would have been a long one, since that's what forcing a signal would've given me (I've done this before, can you tell?) This morning when I checked in on the EUR/USD out of curiosity I saw the results of today's Non-Farm Payroll announcement: a decline of around 100 pips. If I'd placed my undisciplined trade I would've started the weekend on an extremely bad note, having broken my trading rules and paid a high price as a result.

What I find intriguing is that my system avoided trading today, not because I've coded it to avoid high-volatility news events like the NFP, but based entirely on technical price analysis. I can't point to any one equation that made this decision for me, but I have to wonder if there was a specific price movement that signalled a period of dangerous volatility on the horizon. This mysterious region where technical analysis intersects with real-world news is fascinating, because I feel technical indicators can sometimes identify a safe or hazardous news trade before it occurs.

Or maybe it's my imagination - what do you think?

Signal saturation: a good problem to have. (Or, what to do with your overlapping signals)

I don't even know if I'd call this a problem - it's more of a confirmation that you're on the right track with your trading system. What I mean by signal saturation is when you add new and promising signals to your trading system, but they don't add much to the bottom line. I had this problem today with the Ichimoku indicators discussed over at Forex Project. Intrigued by their possibilities, I wrote up a few Ichimoku equations and backtested them on some EUR/USD data, and came up with what looked like excellent results. But then I plugged my new Ichimoku signals into my trading system, ran the same backtests and found they added only a few new pips to the results - and in a couple configurations, actually subtracted pips!

What's going on here? Well, it's a problem I encounter most of the time when trying to introduce new signals to my system: the existing signals are already covering that territory, so there's no additional trading edge to be gained. Or, to put it in a more positive light, the new signals are simply confirming the validity of your existing signals, since they overlap with them almost completely. Having two sets of signals that are saying the same thing certainly suggests you're doing something right. When I come across this type of signal saturation or overlap, I will usually just put the redundant signal in storage with my other backup systems, in case market conditions change someday and it's no longer redundant.

Another strategy for dealing with overlapping signals is interpret them as reinforcing each other: if two or more signals are in play, it's an even stronger trading indicator than one signal. So it's possible that the combination indicates an even higher-probability trade than a single signal, something you'll want to test out by statistically comparing the outcomes of single signal vs. multi-signal trades.

Yet another weird quirk of overlapping signals are the areas where they don't overlap. There are sometimes significant opportunities to be found in the 10% of disagreement between signals that agree 90% of the time. For example, some of my most powerful short signals are generated when two of my highly-correlated long signals part ways. For whatever reason, at these points of disagreement, the market tends to go the other way entirely and what's usually a long signal becomes a short one. One example I mentioned above is when those Ichimoku indicators were actually subtracting pips from my long trades.

You can get caught up in all kinds of explanations for why this happens, most of which will lead you nowhere - but the important thing is it happens. (But if you really want an explanation my personal theory is it's a form of divergence.)

So, to summarize: in the worst case, signal saturation is a minor annoyance. In the best case, it's a way to generate even stronger signals, and even some unusual new signals. If it shows up in your trading system, congratulations, you're on the right track!

Related topic:
Signals aren't set in stone...so don't be afraid to fine-tune them

Daily Forex Forecasts

I just came across a site called Forex Predictions which generates daily high/low price forecasts for a number of currencies. So if you're into trading based on daily ranges, an idea I've toyed with periodically, it might be worth a bookmark. My guess is it's applying the average daily range over a certain period (month, maybe?) to the previous day's closing price. Or something like that.

Here's their page with all the daily predictions for currencies like the Euro, Yen, Pound, Swiss Franc, Canadian Dollar, South African Rand, Thai Baht and various others, all calculated vs. the US Dollar:
Daily High/Low Forex Forecasts

Another handy feature is a little box you can install on your site with that day's high and low predictions. For instance, here's the Euro prediction box. Maybe I'll stick it in the sidebar one of these days.

My main quibble with the site is it doesn't provide data on the past performance of their predictions. So I definitely wouldn't take the forecasts at face value - I'd monitor them for a while to see how close they come to the real prices.

The Quest for a "Kill Switch" Signal

One of the things on my forex wish-list is an anti-signal that effectively blocks trades at difficult points in the market. I think of this as a "kill switch" that would turn off my entire trading system at times when the market's behaving so strangely that it's too dangerous to be trading. For example, my system tends to fare worst in situations where price is ranging through a fairly narrow channel and no clear long or short trend has emerged. In ranging markets, my signals keep looking for that next step up or down in price that would logically follow in a trending market, but which in a ranging market often turns into an abrupt reversal instead. So I'm always staggering along one step behind, and losing money on each reversal. Here's a good example of a ranging EUR/USD market that cost me a lot of money in May and early June of this year:

Essentially, then, I'm looking for an accurate way to detect ranging market behavior early on so I can disable my trend-based signals. A nice bonus, once I've gotten that switch built, would be to develop a whole new set of signals for ranging markets that would be activated by the same switch. (After all, as I noted in my process of elimination post, turning off one signal often means you're turning on another one.)

In some ways this may be a fool's quest, based on an impossible ideal: namely, that you can easily identify a ranging market and start making accurate trading decisions before it becomes a trending market again. So far all of the indicators I've tested have too much of a lag built in, and just as they come to the conclusion that the price is truly ranging, it heads off on an upward or downward trend. For instance, in the illustration above, the market suddenly began a major downtrend and sank around 400 pips by mid-June. If I had a kill switch operating, would I have been able to get my trending signals turned back on in time to turn a profit? I'm coming to the conclusion that one of the costs of having sensitive trending signals is having a high failure rate in ranging markets. As long as the market is trending more than it's ranging, you'll do OK, but you'll be in for some painful stretches along the way.

But enough theorizing. The fact is, I already have all kinds of kill switches built into my system that I'm just taking for granted. For instance, a stop-loss is essentially a kill switch. So are my signals that prevent any short trades when certain long signals are generated, and vice versa. So are situations where neither a long or short signal is generated.

I'd still love to find a quick way to detect ranging markets, though - so if you have one you're willing to share, please post it in the comments!

Related topic: Trading by the Process of Elimination

Exhaustion Signals - Profiting when the market is overbought or oversold

Some of the most effective signals I've integrated into my trading system are those based on the principle that the market will become exhausted and the price will begin rising or falling back towards its moving average after a strong upward or downward run. These signals go by various names - I prefer "exhaustion," because it's most vivid and immediately familiar, but terms like "overbought" and "oversold" are equally if not more commonly used. "Contrarian" or "correction" also apply, when used in this particular context.

Recent EUR/USD activity offers an excellent case study in a profitable trading opportunity in overbought conditions - as of this writing, I'm up over 100 pips on a short trade that caught the downtrend pictured in the daily chart to the left. After a major uptrend in the EUR/USD last week, the market is now correcting downwards, presenting a great chance to gather pips by going short.

There are a number of advantages I've found with these types of signals:

• They can be focused on a very specific moment during an uptrend or downtrend, and carefully tuned until they trigger trades at the optimal point in the trend. As a result they are more selective and precise than many other types of signals.

• They can be built around readily available chart indicators such as Bollinger Bands, moving averages, CCI signals, candlestick patterns, and highs and lows.

• When properly designed, they perform with a high degree of consistency. They never score 100%, of course, but then I've never come across a signal that does.

Drawbacks of exhaustion signals are that, well, sometimes the market doesn't get exhausted, and continues on its original course upward or downward. This is something you can expect to happen periodically, and it shouldn't be a surprise that it does - every signal has a failing, and this is the big one for exhaustion triggers. The key when designing these signals, as it is for any signal, is backtesting them extensively with historical data to determine their overall effectiveness and profitability over years of market activity. Only then will you have the confidence in them to execute trades consistently over a long enough period to see positive results.

Here are a few examples of exhaustion signals I use to trigger EUR/USD trades:

• If the market has seen a run-up of X pips over the past Y trading days, I sell the EUR/USD short (don't really feel like giving away my X and Y values today).

• If the previous day's closing price was below the upper Bollinger Band calculated over Z periods, and the high price from two days previous was above the upper Bollinger Band, I sell short. (I use a customized Bollinger equation to calculate my bands, and I'll just say it differs significantly from the standard default Bollingers you'll find in most charting software.)

• If the previous trading day's closing price was above the lower Bollinger Band calculated over Z periods, and the closing prices of the two days before that were below the lower Bollinger Band, I go long (buy) the EUR/USD.

Hopefully these will give you some ideas for designing your own signals for profiting from overbought and oversold conditions. If you have any exhaustion trading strategies you'd like to share, please feel free to post them in the comments.

Related topic:
A Nice Bollinger Band Trade

Signals Using Maximum / Minimum Prices

One type of signal you may find profitable to study is the behavior of maximum and minimum prices during a particular period of trading. I've found that some pretty reliable signals can be discovered by comparing maximums and minimums over time. What you'll need is an extensive set of historical price data and a willingness to test out various min/max iterations.

Just about the simplest signal to try is comparing the previous trading day's maximum or minimum price against the maximum or minimum for a selected preceding time period. What happens if the previous day's maximum exceeds the previous week's maximum? Or if the previous day's minimum drops lower than the previous week's minimum? How about the two preceding weeks, or the preceding month?

You can treat a given week's maximum or minimum the same way, for instance by comparing last week's max or min against the previous month's. Or try reducing the time scale and see what happens when the previous 15 minute period's max price crosses above the previous 4 hour maximum.

You get the idea - it really couldn't be more straightforward. Give it a try and I have a feeling you'll start discovering some profitable signals. Once you have, your next challenge is to trade them consistently - even after they've been wrong, which they inevitably will be every so often. Maximum luck to you!

Related topics:
An Easy Signal Using Minimum Prices
An Easy Signal Using Maximum Prices

Signals aren't set in stone - so don't be afraid to fine-tune them

The first forex signal I was ever introduced to was the Commodity Channel Index, or CCI. The CCI is the heart of Woodie's CCI system (yes, that's Woodie himself there with Barbara Bush), and my first forex broker recommended I try this straightforward trading method. So I did, just taking my account rep's word for it that it would work. He told me to set up the CCI with 5-minute periods and a range of 14 periods. So I did, again taking his word for it. At this point I really had no idea why 14 periods would be better than 10 or 20 periods, and I didn't know enough to ask, or to test out the theory that 14 was the magic number with historical data. And with that, I started trading Woodie's system, blindly accepting that this off-the-shelf strategy would work for me. Well, it didn't - or rather, I didn't know how to make it work.

At various other times, I've used similar standard set-ups of other signals. For instance, 5 and 20 period MAs, or 20 period Bollinger Bands. If asked why I was using these particular set-ups, the most honest answer I could've given was that "I read about them somewhere" or "Someone told me to do it this way." I had no personal experience or evidence to base my signal choices on, so I simply had to take other peoples' word that they would work. I don't think it was a coincidence that my trading results were poor. Very poor.

It was only later, when I'd begun using extensive historical data to guide my trading, that I really started fine-tuning and customizing my signals. For example, after trying to design a signal around 20 period Bollinger Bands with daily (24-hour) periods , I began testing out various other ranges of periods: 15 period bands, 12 period bands, 10 period bands, and so on. To my surprise, the most powerful signals were derived from 10-period daily Bollinger Bands - far more powerful than bands based on 20 periods, which I'd always understood to be the standard. Lesson learned! Likewise with moving averages - after extensive testing of many different periods, I found that a combination of 5 and 10 period MAs yielded the most significant results. Perhaps just as importantly, I also discovered that moving medians generated some very interesting signals as well. Now I've never seen a moving median mentioned anywhere outside my own spreadsheets, and had it not been for my new-found willingness to test, tweak, recalibrate and recalculate every potential signal, I don't think I would've ever stumbled on them.

Fine-tuning my signals in this manner also taught me that certain isolated events frequently emphasized in trading tutorials and chart-based trading systems were often less important that I'd originally assumed. For instance, a moving average cross, which certainly worth noticing, predicted a lot fewer trades than the ongoing relationship between two moving averages: how far one was from the other, whether the distance was increasing or decreasing, whether their more recent movements were in conflict or agreement with their longer term movements. I think focusing exclusively on chart-based trading led me to overemphasize single events at the expense of the total set of interactions between signals.

The lesson I hope I'm conveying amid all this rambling is that you shouldn't take anyone's word for it that a given signal will work at all, or will work better than other signals. All signals are just equations that someone else invented, and they can all be recalculated, tested, and retested with new parameters and different values. Think of signals as your employees. You wouldn't just take a new hire and put them straight to work - you'd spend some time getting to know them, training them for the tasks you expect them to carry out, and seeing how they perform in different situations. Signals work for you, and it's up to you to make the best use of their abilities.

Weighting your trading signals to improve performance

One strategy I've considered while designing forex trading signals is assigning a weight to each signal based on its overall performance in predicting market movements. Just as a weighted moving average assigns greater importance to more recent price data with the goal of improving its predictive accuracy, weighted signals would gain or lose importance versus other signals based on certain types of performance data.

In a trading system that relies on several different signals, weighting could help decide between conflicting signals and make trading predictions clearer, removing some of the confusion and uncertainty that are deadly to successful forex trading. Let's say you had a signal based on departure from a lower Bollinger Band that was shouting "Go long," and another signal based on long-term moving averages that was insisting, "Stay short"! Which one should you listen to? It's an ideal situation for signal weighting.

So, how would you go about weighting your signals in a way that's simple, easily understood, and most important, profitable? The best idea I've come up with so far, though I haven't actually put it into practice, is to determine the weight for each signal by calculating the average gain in pips for every trade it predicts. So maybe your long Bollinger Band signal historically yields an average gain of 10 pips per trade, while your short moving average signal yields 15 pips per trade. So, in theory, you could calculate that the moving average signal has 1.5 times the weight of the Bollinger signal, and therefore is the signal to follow.

When you're combining multiple signals to determine a trade direction, weighting can also help by giving you a total score based on the combined signals. Let's say you have three long signals with weights of 1, 1.5, and 3, and three short signals with weights of 1, 2, and 2. Adding up the long signals and then dividing by three for the average weight, you get a weighted score of 1.833, while your average score for the short signals is 1.667. So based on this technique, it looks like you should go long.

Another approach using weighted signals would be strictly additive - say you have 5 long signals adding up to a score of 8.5, and 3 short signals adding up to 10. While you've got fewer total short signals, they carry greater weight than the long ones, and so they win the trade.

These are just a few possible approaches to creating and interpreting your weighted signals. The key to determining the best weighting technique for your particular trading signals will be to test, test, and test some more using as much historical market data as you can get your hands on. Signals aweigh!

Your worst short signals may be great long signals (and vice versa)

This is an idea I keep revisiting as I try to design new signals - I'll often be trying to devise a short signal based on a range of indicators and historical data, and will, somewhat at random, come up with an appallingly bad signal. The sort of short signal that, if used consistently over a few years, would cost you thousands of pips. When I stumble on one of these stinkers, I always have to remind myself that what I may actually have on my hands is a great long signal. After charting its results as a trigger of long trades to determine its consistency, whether it has too many big drawdowns, and whether the results look unlikely to be some weird fluke, I may then put it into service on the long side.

I'm posting about this today because I just came across a signal that performs very badly as a short trigger: over 106 trades it lost 888 pips. I designed it using Bollinger Bands with a 10-day period, and it attempts to predict what happens if today's close was below the upper Bollinger, and yesterday's high was above the upper Bollinger. Turns out it's a terrible predictor of short trades, but it may just be a decent signal for long ones. Time to do some more testing...

Conflicting Trading Signals? Try a Tie-Breaker

If your trading system is anything like mine it will sometimes generate signals that conflict, telling you to go both long and short at the same time. Or alternatively, it may generate no signals at all, essentially saying "sit this one out."

For me this occurs most often in situations where the market has been ranging for a while and my formulas are having a hard time picking a clear trading direction out of the noise. Some people would decide to stay on the sidelines in these situations, concluding that there was insufficient information to make a clear prediction, and having the discipline to step back from their trading system when it's giving no clear signals. But not me. Since I have a tendency to overtrade - getting into the market even in ambiguous trading situations - of course I had to find a way to extend my system to resolve these types of "ties."

The solution was to run a bunch of backtests with the criteria "IF Long Signal = YES and Short Signal = YES" OR "IF Long Signal = NO and Short Signal = NO", show results of all hypothetical long and short trades. This gave me a pip value for whether the market tended to go long or short in these situations. As it turned out, when my signals are tied, the market tends to go long. So in essence I've forced a new long signal out of my system, and have also ensured that it will always provide a usable signal for trading.

Now I can indulge my desire to (over)trade every day and not miss any action, but in a way that's at least based on historical data. No more frustration over conflicting signals!

Creating Self-Tuning Signals: How Internal Feedback Can Improve Your Trading System

While trying to improve the performance of a trading system I was backtesting, I found myself wishing there was a way it could turn itself off, or at least improve its odds, when it was performing badly. If for some reason the current market dynamics didn't agree with my system, why not allow the system to recognize the adverse conditions and take a hiatus until the trends returned to behavior it could make sense of?

On other occasions, I wished for a feature that would track particularly good signal performance, and would trigger additional trades outside my primary signals because their trades were going so well in a particular direction.

Essentially, I was looking for ways to amplify good performances and cut short bad ones. So I created what I call monitoring signals or meta-signals, which keep tabs on how the primary trading signals are functioning and have the ability to turn them off, to trigger a trade in the opposing direction, or to trigger "bonus" trades in the same direction if the signals are performing optimally. Here's how they work:

One monitoring signal observes the performance of long trades generated by my forex system. If the past 5 days of trading have generated over 150 pips in profit, this feedback circuit automatically triggers another long trade on the sixth day. In my backtests I've found this meta-signal provides a significant boost to system profitability.

Another signal compares the performance of my long and short signals. It counts how many long vs. short signals have been generated on the past 5 trading days. If there have been more long signals than short ones, and if on the current day no long signal has been generated, it automatically triggers a short trade. The idea being that after a run of long signals in the market, it's statistically likely to rebalance itself with a downtrend. On the short side, I have another signal that performs exactly the same function, stepping in to trigger long trades after a run of short ones.

Some other types of meta-signals I've experimented with, albeit with variable results, have measured the slope of trading gains on a chart, and have excluded trades made when the slope of recent gains is either too gradual, or is negative. Another similar feedback signal measures the percentage of successful trades generated by a particular signal, and excludes trades made when its success over the past N trades has been under a certain percentage.

I could go on, but I'm sure you get the idea by now, and most of my other meta-signals have been variations on these basic themes. When designing a trading system, it's always good to keep in mind that in addition to having it analyze the forex market, you can also have it analyze itself.

Another Simple Long Signal for the EUR/USD

Here's a signal I came up with for predicting buy/long trades of the Euro-US Dollar pair. I've backtested it on almost 3 1/2 years of daily market data going back to September, 2002. In that time it generated 288 buy signals, making it a fairly selective indicator, at least by my standards. Remember, the fewer trades, the more you save on the spread.

The signal goes like this:

If the highest price on the previous trading day was more than 50 pips greater than the closing price, AND the highest price was NOT more than 130 pips above the closing price, then a long signal is generated for the next 24 hours, commencing at midnight Greenwich Mean Time. This is 4:00 PM in California, where I live.

Here's what it looks like in an Excel-style formula; obviously you'd need to tweak this to match the cells on your own spreadsheet:

=IF(AND(HIGH-CLOSE>0.005,HIGH-CLOSE<0.013),1,0)

In the testing period, this signal proved to be 59.72% accurate, and brought in 3865 pips before the 3-pip spread was taken into account. With spread costs, the total was 3202 pips. I reached this figure by counting all trades (288) then subtracting trades that occurred on successive days, since these would be rolled into the previous day's trade, saving on spread costs. I ended up with 221 trades x 3 pips, or 663 pips, which I then subtracted from 3865 for the final total of 3202 pips. So you're still left with a respectable pile of pips at the end of the day. (No, I didn't to figure out interest...I'll leave that to you.)

Here's a chart of its performance (before spread) over the ~ 3.5 year test period. One the left, vertical axis you see pips expressed as fractions of a dollar, where 1 pip = .0001, so .35 = 3500 pips.



You could also try combining this with other signals (such as the ones I described in this post) to see if you can boost its performance. Of course, I can't guarantee it'll continue to work in the future -- but it certainly was pretty reliable in the past. Good luck if you try it!

Simplest. Signals. Ever.

For anyone who thinks the search for trading signals is an arcane, arduous, and complicated one, here's some reassuring proof to the contrary. I set out to find the simplest signals I could, just to see if any actually existed. I was pleased to discover that they do -- at least, they do in my backtest. Whether they do in the future is a question for the future to answer.

Here's an example of two interconnected short and long signals I came up with while playing around with my daily Euro and Pound data:

Super Simple Long Signal
If the previous day's closing price is LESS THAN the average of the closing prices of the four days before the previous day, a long signal is generated. (Strange, isn't it, that the trigger is less rather than more than the previous average.)

Over 23 months of backtesting with the EUR/USD, this generated 277 trades yielding 1491 pips before spread costs, probably 1100 or so pips after spread costs, which can vary depending on your broker. You'll often get a series of days with the same signal, which allows you to consolidate them into a single trade, thereby saving on the spread costs of entering and exiting multiple times.

The overall success rate for this signal was 51.99%. Remember, you can have signals that have a success rate of well below 50% that will still turn a profit, because they're good at identifying the really important trades.

And on the short side, we have this formula:

Super Simple Short Signal
If no long signal has been generated, AND the previous day's close was greater than the closing price two days ago, then a short signal is generated. Note that this references the Super Simple Long Signal in order to exclude it, thus improving the signal's odds.

Over 23 months this signal generated 205 trades generating 1512 pips before spread costs. With spread costs factoring in, total profit was probably around 1100 pips, possibly more if you use a low-spread broker like Oanda. The overall success rate was 54.63%.

Here's a chart of the two signals combined performance over 23 months, totaling out at over 3000 pips before spread costs:



Note that it's a pretty nerve-wracking trajectory in places -- the trade-off for the simplicity of the signals is that they don't give a very consistent performance. But overall, they are profitable.

Incidentally, I tried them out on the GBP/USD pair with equally profitable results. Now, will they work in real life? Who knows...but good luck if you try them out!

Trading by the Process of Elimination

When I started creating and testing long and short trading signals, I discovered a whole class of signals that hadn't occurred to me previously. They're trading indicators generated by a process of exclusion or elimination: if long signals A, B, and C are NOT present, then by default a short signal is generated. What may not be immediately obvious when looking at a forex chart is that the absence of certain indicators can be just as important as their presence.

In some cases, the absence of some signals can amplify an opposing signal -- for example, here's the syntax of one Excel formula I've created that triggers a signal only if one long indicator is present while three short indicators are absent: =IF(AND(W572=1,Z572=0,Y572=0,K572=0), where 1 is a long signal and 0 is the absence of a short signal.

I could give a bunch of other examples, but you probably get the idea. So if you ever set out to design your own trading system, remember that you when you create a long signal, its absence may also be a short signal, and vice versa. Who knows how many pips this could add to your trades!