The Finance Book Club

Have a toolbox - Use What Works for the Current Market Environment

Step #1: Determine the Trading Environment
Rules to Determining Trading Environment

Time to mess up your charts with indicators

1. Indicators suck, etc,
2. currency market obeys technical analysis particularly well, given its large scale and number of participants. (yes, 50% of the time!)
3. Every instrument is either ranging or trending, etc.
4. To detect ranging:
   1. ADX < 20
   2. Decreasing implied volatility - KL tracks short-term vs. long-term vol
   3. When short-term vol falls after a burst above long-term vol that’s a signal of return to range

Oh never mind there’s a graph

 

1. Risk reversals flipping between calls and puts. Far out of the money options should have the same nominative value but in practice they don’t as the market has some bias usually in one direction or the other. So risk reversals options can act like a sentiment indicator for FX
2. In ranges risk reversals tend to flip back and forth between favoring calls and puts

Since this information is actually valuable, you won’t find it anywhere but in expensive packages like the Bloomberg terminal.

 

1. To detect trending
   1. ADX > 20
   2. Momentum in trend direction as measured by RSI, MACD, stochastics
   3. Momentum index is less popular or reliable
   4. The best indicator says KL is a ‘perfect order’ of moving averages
      1. When 10, 20, and 50 day SMA are all moving upwards that’s a bull trend
      2. If the 100 day SMA and 200 day SMA are below the other averages
      3. Could check but I know what we’ll see - laggy signals

   5. Risk reversals should strongly favour either calls or puts

Step 2 - Determine the time frame for the trade

Intraday Trade (range) rules:

1. Use hourly charts to find entry and daily charts to confirm a range trade exists on the longer TF
2. Use oscillators to determine entry points within range
3. Look for short-dated risk reversals to be ‘near choice’
4. Look for reversal in osc (RSI/stoch at extremes)
5. Trade stronger when prices fail at key resistance
6. Use fib retracement points and MAs

Indicators used:
Stochastics, MACD, RSI, Bollinger Bands, options, Fib retrace levels (good grief)

Medium term range trade rules:

1. Use daily charts
2. Position for upcoming range trading opportunities or get involved in an existing range
3. Upcoming: look for high vol environments, where short-term vol is higher than long-term
   1. Look for reversion back to the mean

4. Existing: Use Bbands to identify existing ranges
   1. Look for reversals in RSI/stoch
   2. ADX < 25 and falling
   3. Look for medium-term risk reversals near choice
   4. Confirm with failure at key range resistance and bounce on key range support

5. Indicators: same

Medium-term trend trade rules:

1. Look for ranges on daily charts and use weekly charts for confirmation
2. Check for trending environment
3. Buy breakout/retracement scenarios on key fib levels or moving averages
4. Look for no major resistance levels in front of trade
5. Look for candlestick pattern confirmation
6. Look for MA confluence to be on same side of trade
7. Enter on break of significant high or low
8. Wait for volatilities to contract, ideally
9. Look for supporting fundamentals - a string of surprises or disappointments

Indicators:
ADX, PSAR, RSI, Ichimoku, Elliott waves, Fibonacci

Medium-term breakout trade rules:

1. Use daily chart
2. Look for contract in short-term vol to a point where it is sharply below long-term vol
3. Use pivot points to determine if a break is true/false
4. Look for MA confluence to support the trade

Indicators:
Bollinger, moving averages, Fibonacci

This is not the content I signed up for.

Risk Management

1. Simple but most important
2. risk/reward
3. Stop-loss orders - trailing stops are ‘particularly useful’ to lock in profits
4. Treat add-on trades as new positions
5. A stop loss allows you to know how much you’re risking at the time of trade
6. Two ways to place SL
   1. 2 day low method
      1. Place SL 10-20 pips below the 2-day low of the pair
      2. Move with each 2 day low

   2. PSAR

7. Practice emotional detachment
   1. Practice strategies independent of greed and fear
   2. Don’t marry a position

8. Know when to take a break
   1. Taking a few days off to clear your mind after a string of losses

1. Limit your losses.
2. Let your profits run.
3. Keep position sizes within reason.
4. Know your risk versus reward ratio.
5. Be adequately capitalized.
6. Don’t fight the trend.
7. Never add to losing positions.
8. Know market expectations.
9. Learn from your mistakes—keep a trade log.
10. Have a maximum drawdown

Good

Clemmo17,

I have to say; your thread is nothing but pure value. Thank you.

Much appreciated- please enjoy.

Chapter 8 -Technical Trading Strategy: Multiple Time Frame Analysis

1. Be selective
2. “Looking for opportunities to buy in an uptrend or sell in a downtrend can be far much (sic) more profitable than trying to pick tops and bottoms.”
3. Use daily charts to identify the trend and use hourly charts to find entries
4. Buy on dips of the RSI below 30 with the trend or when fib levels are broken
5. KL believes most traders are range traders because buying at the low and selling at the high is easy to understand

The rest of this chapter consists of examples that state basically what’s already been said

Chapter 9 - Technical Strategy: Trading with Double Bollinger Bands
KL believes one of the most useful indicators is Bollinger Bands. I used to think so too.


KL uses a pair of bands - one 20 period 2 standard deviation bands and one 20 period 1 standard deviation bands that produces something like in the chart above.

-don’t buy a bottom until the pair trades above the standard deviation band (so wait for a break of the inner bottom line)
-don’t sell a top until the pair trades below the std. Dev. band (so wait for a break of the top inner line)

Long rules:

1. Note the arrows - they’re between the first and second pairs of bands. Wait for that signal
2. Look for a close inside the inner bands
3. Enter long at close or at 5pm NY
4. Stop placed 50 pips below inner band edge
5. Close half when it moves by the amount risked; move stop on the remaining to initial entry price (breakeven)
6. Close remainder at 2x risk or trail the stop

Short rules (just invert)
But strangely she uses a different stop for shorts - only 30 pips. Why the difference?

In any case this is something we can test out.

Lien Double B-Band Strategy Test 1
I’m using EURUSD on D1 which seems like the classic KL type of instrument and timeframe. She uses two 20-period Bbands at 1 and 2 std devs. Here the inner (1 dev) bands are pink, the 2 dev ones are green. Ignore the centreline.

The first signal is to have price at the outer edge of the bands at point A. Then price closes below the upper 1 dev band at B. Then we enter on bar close. This produces a couple of nice wins where we take ½ off at C after 1x the risk (the distance from the initial stop to the entry point) and again at D after 2x the risk. Note that I’m using the fixed TP method, not the trailing one. Stellar performance so far.

KL doesn’t say if we should enter new trade signals while a current trade is underway, and in practice this would be dictated by our margin availability but let’s assume we are rich and can trade whatever we want.

It’s also not stated if we should require a close within the outer quarters (top or bottom quarter of the quartet) first before starting our signal hunt, which would filter out fast spikes which usually cause a close too far on the other side of the band to be a worthwhile trade.

We also need a way to handle situations where price lingers on either side of the division between quarter 1&2 or 3&4 without being particularly motivated (which causes disastrous sequences of losses in some cases - see below). However I’m going to assume we should not bother adding anything, as it was not mentioned, and it might filter out as many good trades as bad.

KL also doesn’t tell us how to handle bars that start inside the inner bands, pierce to the outside quarter and then return to close inside the band. That results in a bearish bar for a bull signal or a bullish bar for a bear signal, which I’m sure is not what’s intended.



Now I remember why I abandoned trading this way. A nasty loss at full volume for -100 pips because the signal is so strong. Price started in the outer quarter at A, closed inside the inner bands at B, very strongly, then reversed on a dime and continued with the trend. Without any other filters this system will catch nearly every strong retrace.

But that’s not the main problem - sometimes something like this can happen:


Occasionally a band will form in just the right (wrong) way usually during a consolidation that a cluster of trades takes place because price rides the edge of the band division but never breaks out. This can be catastrophic and it happened twice in 2020. Obviously some common sense rule will need to be added to avoid this. Maybe a few.

So how does it do after 2 years 1 year?

Losses (24) = -2176 pips
Wins (41) = +2054
Random.

Despite this I like some of the ideas behind this system and I think there is much to be gained from studying band systems like this.

1. If you enter after price has closed into a lower or higher quarter you are taking advantage of natural reversion and momentum combined. This is one of the few cases where an indicator actually gives you a leg up as it prevents you from selling too low or buying too high. If you can find a way to avoid the ‘bad knots’ this system would surely be profitable. One hint is that those knots of bad trades happen after a trend because the next phase is consolidation (ranging). So if you find some method of forcing price to move sufficiently again after a trend...
2. Maybe adding fundamentals to this is all that’s required to avoid those cases but I doubt it. This is a peculiarity of the double Bollinger.
3. The break-even rule actually doesn’t help this system, it hinders it, but the psychological harm of seeing a profitable position nearly hit the target and then revert can set you on tilt so I understand why people do it.

BBands can be used to check range or trend:
“When the pair is trading between the two lower or upper Bollinger Bands, it is in trend, and when it is trading between the first standard deviation Bollinger Bands, it is in range, as shown in Figure 9.6”

So one idea is to use the bands themselves and if you get two signals in a row inside the inner bands assume ranging is in effect and avoid adding new trades?

Using Double Bollinger Bands to Join a New Trend
Long rules:

1. Look for a close inside the inner bands, above the first std dev band (it looks like at least one candle must have its whole body above the band but she doesn’t explicitly state that)
2. Check if the last two candles were outside the inner bands
3. If so, buy at close or at 5pm NY
4. Stop set at +65 pips.

Short rules: inverse


I think there’s a typo in figure 9.8. She means both candles are below the band?

The confusing description here makes testing difficult. I am going to assume based on the short chart that we need to have two candles entirely inside the inner bands, and then enter on a third candle close that is above the first std deviation band. I also don’t know if I should reset after a completed trade, wait for price to hit a top band, etc.

I will test anyway, using the same time period but using USDJPY as per the example she showed. I’m not going to try to figure out the split/double-tap exits as I don’t think they’re beneficial anyway. TP is 50 pips away; SL is 65 pips away. The alert readers will note that KL is telling us to trade with a negative R:R!! OMG, bad naughty trader.

Right away I see that using a fixed pip stop is less than optimal. We get stopped out right before a big downtrend when the range expands.

Attached Image (click to enlarge)

Anyway, after a few of these ‘expansion’ losses, I’m out. This system could work if the details were worked out properly. KL is giving you just enough rope to hang yourself with, which is common to most trading book authors. Again, maybe the fundamental picture makes all the difference and when you combine them the magic happens, but I remain skeptical.

Chapter 10 - Technical Trading Strategy: Fading the Double Zeros
This chapter begins with the importance of the round-number levels again. Something I have seen no real evidence to support (no longer true thanks to Donnelly?) but to which KL adds nothing new or interesting.

Long: (invert for short)

1. Identify a currency pair that is trading below its intraday 20-period simple moving average on a 15-minute chart.
2. Enter a long position 10 to 15 pips above the figure (the round number).
3. Place an initial protective stop 20 pips below the figure.
   1. When the position is profitable by the amount risked, close half of the position and move your stop on the remaining portion of the trade to Breakeven.
   2. Trail your stop as the price moves in your favor.

This system you might already recognize and I’m quite optimistic about it as it’s basically our good old ‘anti-gunner’ system! The only significant change is she’s using a negative 3:1 R:R (hiss! boo!) ratio and she’s added a useless(?) MA. Let’s see!
I’m adding one rule that wasn’t specified - only one trade per direction per level will be opened until the first one is closed. So you can be both long and short but not have two longs open.

I start YTD USDJPY on M15 as instructed. There are no trades for a while because round-numbers mean nothing and have no effect on price, however eventually price decides to retrace as it must do and it breaks up through our 10-pip ‘buffer’ (dark khaki) rectangle; that is for a long trade it pushes up through the bottom and emerges on the top side. When price reaches the topside of the rectangle it triggers a trade for a profit at the other side of the ‘take-profit’ rectangle which is green. The bad SL 2:1 rectangle is twice as tall as the TP! That MA better keep us out of trouble!

When price (somewhat less temporarily) crosses the MA we flip the order of the rectangles, putting the green TP below and the red SL above with the buffer in between. Again - profit!

We move the rectangle setup at every ‘round number’ but you could use any regular division as long as it’s big enough to offset the cost of your spread/commissions. As I’m using 10 pip ‘round numbers’ and 10 pip rectangles I hardly even need the rectangles, but they might help keep things clear at first.

So after 100 trades how does it do?


22 losses @30 pips (20sl+10buffer) = 660 red pips
78(!) wins @10 pips = 780 green pips
Total win: 120 pips after 2 months
You find this slow? Just change the ra-ti-o!
Note the odds of getting a loss are a little more than ⅕ which lets you calculate your risk fairly accurately.
I’m sure you can think of ways to improve on this, but you almost don’t need to. And the best part is it’s super easy to automate. (coders - call me! We’ll get so rich!) Also, it works in ranges and trends, although it won’t follow a trend unless you use some kind of trailing which you shouldn’t.

So KL finally redeems herself; she’s batting .333 which is not bad for baseball, and actually it’s great for trading books too.

Chapter 11 - Waiting for the Deal

KL outlines a ‘London Open’ strategy.

1. The GBP trades most actively against the USD during the Euro/London hours. (in theory)
2. Captures the initial intraday move of the LON session
3. Exploits the perception that City traders are notorious stop hunters (aren’t they???)
4. KL speculates about why this works but let’s just be satisfied first that it does OK?!

Rules

1. Early European trading in GBPUSD begins around 1am NY Time, and we look

for the pair to make new range low of at least 25 pips above the opening price
(the range is defined as the price action between the Frankfurt and London
power hour of 6 GMT to 7 GMT NY Time).

1. Look for the pair to reverse and penetrate the high.
2. Place an entry order to buy 10 pips above the high of the range.
3. Place a protective stop no more than 25 pips away from your range high, or 35 pips.
4. If the position moves lower by 50 pips, close half of the position, move stop on rest to breakeven, and target three times risk, or 105 pips on the remainder.

Shorts:
1. GBPUSD opens in Europe and trades more than 25 pips above the high established during the Frankfurt to London power hour.
2. Wait for the pair to reverse and penetrate the low. When that occurs, place an entry order to sell 10 pips below the low of the range.
4. Place a protective stop no more than 25 pips away from your range low, or 35 pips.
5. If the position moves lower by 50 pips, close half of the position, move stop on
rest to breakeven, and target three times risk, or 105 pips on the remainder.

Since I now have a nearly 100% correlation between ‘good’ systems that take advantage of dumb momentum with no added frills (try it without the MA - does it matter?) I’m going to just go ahead and skip any chapters that are about other kinds of systems, ok? This is all I need or want (and also I feel terrible - like Covid terrible. No fever though) so I’m going to pack it in early. Feel free to note your objections!

Chapter 12
is a breakout strategy. It probably works but I’m tired of testing. I need an assistant. Also one functioning strategy is enough for a book. We aren’t going to get good at any of these if we try to trade them all at once.

Same with Chapter 13
a mean reversion strategy.

Chapter 14
another breakout strategy

Chapter 15
a channels strategy. You can tell KL got good grades in school. Maximum effort!

Chapter 16
a moving averages all pointing in the same direction idea - probably suboptimal but haven’t checked. “Low probability but high profit” trend-following in other words.

If you want the rules for these they will be in my footnotes.

Mate u doin excellent work
God bless you!!!

Cheers OwaisJam, thank you, it means a lot.

Chapter 17 - a Fundamental Strategy - pairing strong with weak
Ok, something different.

 

1. It’s not enough to simply pair a currency that is strong now with one that is weak now, you have to anticipate which ones will strengthen and weaken in the future
2. Again it all boils down to something like Du Toitian ‘relational analysis’ where you try to figure out what news story matters and how it’s connected to some upcoming event that matters. KL cites examples of ECB QE and following the direction of commodity prices.
3. And then the chapter ends as soon as it’s begun, rather unexpectedly. (??)

wish u a toast of lot of green pips

Clemmo could u plz share something that could help me understand gold fundamentals thank you

Chapter 18 - Fundamental Strategy - the Leveraged Carry Trade

1. The quintessential global macro trade says KL
2. Buy high yielding, sell low yielding
3. Differentials are small but it’s risk free!
4. They are just as risky as anything

How do they work?

Why do they work?

1. It’s all about the (difference in) interest rates!
2. Investors want higher interest rates - more more more

Carry trades work best during a specific attitude to risk - risk off - risk seeking, low risk aversion and they work worst during times of uncertainty. No carry trades in this current near future dystopia, friends. Maybe after the plague is ‘gone’.

Trade imbalances can cause a large trade surplus country’s currency to appreciate even when risk is off

The carry trade is long-term. Months, and years. You’re going to need a need a bigger account, sir.

hmm, gold fundamentals, eh?
I can only suggest you find a guy on Seeking Alpha (and normally I would never recommend anything from that site) but his name is Taylor Dart. He's a guru on mining, gold stocks, etc.

I wouldn't follow his equity trades, just the gold tips.

The thing about (spot) gold is it's at least as wild and unpredictable as any other commodity. It can trend for ages and then suddenly churn for weeks. That's why gold stocks might be a little more reliable, maybe? I know some people really like trading gold because of its wild volatility, but in my declining years I'm starting to appreciate less volatility.

Having said that, if I come across any books that are about precious metals trading specifically I will add one to the stack.