In Part 7 – What to expect…
There is a very simple trading strategy that can be applied to any market and any timeframe that you are trading. The strategy is based on the underlying principles of how trends in the market are defined. An up trend is defined as a series of higher highs and higher lows, while a down trend is defined as a series of lower highs and lower lows. The key to this strategy is identifying the transition from one trend to another.
A long trade would be initiated when the share forms a higher low and a higher high is confirmed at point G. Pyramiding and profit taking can be used in the same way as when trading short. This may seem a very simple strategy, and there are other far more complex strategies employed by many traders. Never underestimate simplicity. A trading strategy does not need to be complex to make money.
This strategy can be applied on a weekly timeframe, daily or any intraday time period you wish to trade. The strategy used in the following examples is based on exiting a long position or entering a short position when the share breaks below the previous trough and exiting a short position or entering a long position when the share breaks above a previous peak. No profit targets or pyramiding have been used and stop losses are set at the previous trough for a long entry and previous peak for a short entry. Figure 9.1 shows the strategy applied weekly to CBA, with the results in table 9.2.
When the share, shown by the black line, crosses below the red line, a signal to exit long positions and enter a short position is given. In this case, the share quickly reverses direction to stop out the short position, and a signal to go long is given by the share crossing the green line. Next signal is to go short when the share crosses down below the red line. Once again, the short signal is quickly stopped out. The long signal is then taken as the share climbs back above the green line, generating a strong profit before the next short signal occurring in May.
The share is now set up to break through the green line and give a signal to go long. The statistics show a profitable strategy returning approximately 16 per cent over 12 months, with a hit rate of 40 per cent and an edge ratio of 2.54. These figures show good gains to the trader and do not take into account the leverage available using CFDs. The percentage return could be up to 33 times this amount if using a 3 per cent initial margin. In all of the examples, the impact of brokerage and finance charges has not been considered.
This will reduce the return but the strategy will remain profitable.
The same strategy can be applied daily to CBA.
The first short signal was quickly stopped out before going long and picking up a strong gain. A profit was locked in with the next short signal, which again was a losing trade and stopped out, before taking a long trade for another profit.
The next short signal off the top was profitable and the strongest trade during this period of time with the exit of the short, setting up the next long trade. This long trade was stopped out for a loss, but the next long trade resulted in a good profit, before once again going short.
The share is now in an up trend, with the current position being a long trade. The statistics when trading daily are even better than when trading weekly. Both the hit rate and the edge ratio improve, resulting in higher returns.
The 12 per cent return is for six months, showing a raw gain of approximately 24 per cent p.a. without using any leverage. Add in the leverage and the returns could skyrocket to more than 400 per cent p.a. at a 5 per cent margin.
The strategy can also be applied on an hourly basis.
The first short trade delivers a strong profit with the rebound delivering a small profit on the long side as well. The next short trade is stopped out for a loss, while the long trade delivers another small profit.
The next short trade could have delivered a small gain, but once again is stopped out for a loss because no valid exit is provided to take profits. Then there is a period of trading long, then short, then long, losing money on every trade as the share oscillates backwards and forwards about its current level.
The current position is a long trade, with the stop loss sitting close to $45.60 to lock in a profit. Overall we can see once again a profitable strategy, with a return of 7 per cent in one month before any leverage was employed.
A 50 per cent win rate and a great edge ratio at 6.43 to 1 would deliver strong profits to any trader. The 7 per cent in a month is again before leverage and this strategy could deliver a cash on cash return of 140 per cent for the month.
When looking at five-minute charts the same strategy can again be used.
Here we are fortunate that CBA has a volatile day so it provides several trading opportunities to the trader. The first short trade initiated soon after open is profitable, then the consolidation results in two trades that lose money before the trend reverses and a profit is booked on the long side before the end of the trading day.
Overall, a profitable day occurred, with the trades delivering a 1 per cent return for the day without using any leverage. Add in the leverage using a 5 per cent margin and the return adds up to 20 per cent for the day. Be aware that execution of the strategy on shorter timeframes is far more difficult and requires not only close monitoring, but quick reactions when the signal is given to trade. Accurate execution is required to achieve the results shown here with a good hit rate and a very good edge ratio. Finance charges do not apply to intraday trades and brokerage charges have not been taken into account in this example.
I have traded the strategy myself on a wide variety of different instruments with good results. The key to ensure this strategy is profitable is to choose an instrument that trends strongly in the timeframe you wish to trade.
I wish you successful trading.
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