Article Highlights

  • Version 2.0 has two entry methods
  • Compared to Version 1.1, Version 2.0 is inferior in terms of expectancy and absolute returns
  • However, Version 2.0 is less vulnerable to choppy price action
  • The peak-to-trough drawdown on Version 2.0 is also much shallower
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Greetings, ladies and gents!

I finally finished developing Version 2.0, so here it is as promised. And in essence, it’s just an advanced (but profitable) version of Version 1.0.

And based on feedback from the previous versions, it seems like some people have difficulty understanding my trading rules when I used quasi-programming language.

And since the purpose of language is to communicate and not to obfuscate (*cough* politicians *cough*), I decided to switch to using simple English to lay down my trading rules.

Also, I just wanna let y’all know beforehand that Version 2.0 has two entry signals.

Entry Type 1 is essentially the same as the one used on Version 1.0 in that it is, as explained in My 2018 Trading Resolution, based on the trading principle/axiom that “all directional movements have an exhaustion point.”

As for Entry Type 2, it also uses the HHHL and LHLL patterns for entry signals. However, it also incorporates the trading principle/axiom that “a period of consolidation is usually followed by a period of expansion.” You’ll understand why when you see it later

Anyhow, below are the topics I’ll be covering today. This write-up is kinda long, so feel free to jump to the topic you want to see first, although it would make much more sense if you read everything.

Backtest Results

As usual, here are the assumptions/parameters for my backtests:

  • Starting account balance of $10,000.00
  • NZD/USD is at 0.7200, so value of 1 pip using 1 standard lot is around $7.20
  • Max risk per trade is 0.50% of starting account
  • Lot size varies; you’ll need the position size calculator
  • Testing period is from June 1-30, 2017
  • Tested on GBP/NZD’s 1-hour chart
  • Fixed spread of 12 pips assumed
Version 2.0 Equity Curve (Fixed 12-Pip Spread)
Version 2.0 Equity Curve (Fixed 12-Pip Spread)

Version 2.0 is inferior to Version 1.1 in terms of absolute returns and expectancy. However, I very much prefer Version 2.0 because it is significantly superior when it comes to capital preservation, given that the maximum peak-to-trough drawdown was only 2.58% on Version 2.0 whereas Version 1.1 had a painful drawdown of 5.40%.

Also, the equity curve has a noticeable upward tilt, even though the testing period (shown below) had prolonged periods when price action was range-bound.

GBP/NZD: 1-Hour Forex Chart
GBP/NZD: 1-Hour Forex Chart

In contrast, Version 1.1’s equity curve for the same testing period looks like this, showing how vulnerable Version 1.1 is to choppy market conditions.

Version 1.1 Equity Curve (Fixed 12-Pip Spread)
Version 1.1 Equity Curve (Fixed 12-Pip Spread)

The Core Patterns

If you’re new, then just know that this trading system uses patterns known as Higher Highs, Higher Lows (HHHL) and Lower Highs, Lower Lows (LHLL) to enter trades.

The HHHL pattern has the following elements:

  • The high of the recently closed candle must be higher than the high of the previous candle
  • The low of the recently closed candle must be higher than the low of the previous candle
  • The recently closed candle is designated as the signal bar

Pretty simple, right? Here’s an example to help you out:

The LHLL pattern, meanwhile, is just the opposite of the HHHL pattern, and it has the following elements:

  • The high of the recently closed candle must be lower than the high of the previous candle
  • The low of the recently closed candle must be lower than the low of the previous candle
  • The recently closed candle is designated as the signal bar

And here’s an example:

Definitions

Take note of the following since I’ll be using them constantly when explaining the rules of the system.

  • HHHL – Higher highs, higher lows candlestick formation
  • LHLL – Lower highs, lower lows candlestick formation
  • ATRH – 120-period average true range on 1H chart
  • SBar – signal bar or candle
  • Bar1 – the previous candlestick; the candle to the left of the signal bar
  • SL – stop loss level
  • TP – target profit level
  • Break – price level the pair needs to reach before you can move your SL to breakeven

Computing for TP, SL, Break

Before we move on, let me first teach y’all how to compute for our TP, SL, and Break. And yep, this version has a fixed TP and SL and you have to compute for both of ‘em. No worries, though, right? After all, if you’re interested in trading, then you also probably love numbers like me. Also, we’re only doing basic algebra. So if an elementary school student can do this, why can’t you?

Anyhow, also note that we’re applying real world conditions by taking spread into account in our calculations. And as I’ve mentioned since Version 1.0, this system is for GBP/NZD on the 1-hour chart and my assumption is that the broker has a fixed spread of 12 pips on GBP/NZD.

If going long:

  • TP = Entry – spread + (ATRH x 1.9)
  • SL = Entry – spread – (ATRH x 1.3)
  • Break = TP – (ATRH x 0.2)

If going short:

  • TP = Entry + spread – (ATRH x 1.9)
  • SL = Entry + spread + (ATRH x 1.3)
  • Break = TP + (ATRH x 0.2)

Long Position: Entry Type 1

  • If an LHLL pattern forms
  • And the lows of the four candles prior to the signal bar are higher compared to the low of the signal bar
  • Then set buy stop order at the high of the previous bar
  • After that, compute for and place the SL and TP
  • And make sure to remember when you can move your SL to breakeven
  • However, if a new LHLL pattern forms immediately after the previous one, reset everything based on the newer LHLL pattern
  • Moreover, if the buy stop order is not triggered within 12 hours, then cancel everything

Pretty easy, right? Okay, let’s try it out!

On February 28, 2017 at 6:00 pm GMT+2, we found the following LHLL pattern on GBP/NZD’s 1-hour chart.

We first checked to see if the lows of the four candles prior to the signal bar are higher compared to the low of the signal bar.

Since the lows of the four candles prior to the signal bar are higher compared to the low of the signal bar, we decided that this was a potential trade, so we wanted to place a buy stop order on the candle previous to the signal bar.

Okay, it’s time to compute. Here’s our given:

  • ATRH = 31 pips or 0.0031
  • Bar1 = 1.7250
  • Spread = 12 pips or 0.0012

Let’s compute for our Entry, TP, SL, and Break.

  • Entry = Bar1 + spread
  • Entry = 1.7250 + 0.0012
  • Entry = 1.7262
  • TP = Entry – spread + (ATRH x 1.9)
  • TP = 1.7262 – 0.0012 + (0.0031 x 1.9)
  • TP = 1.7309 (47 pips from entry)
  • SL = Entry – spread – (ATRH x 1.3)
  • SL = 1.7262 – 0.0012 – (0.0031 x 1.3)
  • SL = 1.7210 (52 pips from entry)
  • Break = TP – (ATRH x 0.2)
  • Break = 1.7309 – (0.0031 x 0.2)
  • Break = 1.7303 (6 pips away from TP)

However, a new LHLL pattern formed immediately after that.

We therefore have to recompute and reset everything based on the newer LHLL pattern. And here’s our new given:

  • ATRH = 32 pips or 0.0032
  • Bar1 = 1.7213
  • Spread = 12 pips or 0.0012

Let’s now compute for our new Entry, TP, SL, and Break

  • Entry = Bar1 + spread
  • Entry = 1.7213 + 0.0012
  • Entry = 1.7225
  • TP = Entry – spread + (ATRH x 1.9)
  • TP = 1.7225 – 0.0012 + (0.0032 x 1.9)
  • TP = 1.7273 (48 pips from entry)
  • SL = Entry – spread – (ATRH x 1.3)
  • SL = 1.7225 – 0.0012 – (0.0032 x 1.3)
  • SL = 1.7171 (53 pips from entry)
  • Break = TP – (ATRH x 0.2)
  • Break = 1.7273 – (0.0032 x 0.2)
  • Break = 1.7267 (6 pips away from TP)

And this time, our order got filled and we hit TP to boot. Yippee-kay-yay!

Long Position: Entry Type 2

  • If an LHLL pattern forms
  • And if another LHLL pattern forms inside the LHLL pattern
  • Then maintain orders on the older LHLL pattern
  • But also also set new orders based on the newer LHLL
  • However, if the buy stop order is not triggered within 12 hours, then cancel everything

Kinda confusing? Well, let’s say we saw this LHLL pattern below.

We check to see if the lows of the four candles prior to the signal bar are higher compared to the low of the signal bar. And as it turns out, they are, which means this is a valid signal.

We therefore place our buy stop order, as well as our TP and SL.

However, a new LHLL pattern later forms inside the original LHLL pattern. We don’t cancel our old orders. Instead, we place new ones based on the newer LHLL pattern.

And as it turns out, both were profitable trades.

Do note that there was another LHLL pattern, as marked below. However, the low of the signal bar of the LHLL pattern falls outside the bigger, original LHLL pattern. The LHLL pattern below therefore does not meet the criteria for Entry Type 2 and must follow the rules for Entry Type 1.

And yes, the LHLL pattern below meets the criteria for Entry Type 1, so we would have had three profitable long positions when GBP/NZD kicked higher later.

Short Position: Entry Type 1

Note: The rules for going short are just the mirror image of the rules for going long, so I won’t be giving examples… unless some of you make some noise in the comments section.

  • If an HHHL pattern forms
  • And the highs of the four candles prior to the signal bar are lower compared to the high of the signal bar
  • Then set sell stop order at the low of the previous bar
  • After that, compute for and place the SL and TP
  • And make sure to remember when you can move your SL to breakeven
  • However, if a new HHHL pattern forms immediately after the previous one, reset everything based on the newer HHHL pattern
  • Moreover, if the sell stop order is not triggered within 12 hours, then cancel everything

Short Position: Entry Type 2

  • If an HHHL pattern forms
  • And if another HHHL pattern forms inside the HHHL pattern
  • Then maintain orders on the older HHHL pattern
  • But also also set new orders based on the newer HHHL
  • However, if the sell stop order is not triggered within 12 hours, then cancel everything

Going Forward

I’m getting closer to achieving my goals for the trading system. In fact, I think I can start start forward testing the system by February.

However, there is still room for improvement, namely in terms of maximizing profit. My next objective is therefore to find a way to do just that without compromising Version 2.0’s superior capital preservation aspect.

Okay, time to get to work!

And as always, I enjoy getting your feedback. So if you have any suggestions, questions, or if just want to say “hi” then don’t be shy and write a comment down below!

Cheers!

Happy