Wednesday, January 9, 2013

Creating a trading system VI - Stops, targets and winrate

Tick Scalping

The above shows results of a 10t stop vs 1t profit. Entry is above any bar thats a potential signal bar regardless of color. If the bar triggers very quickly after signal bar closes and before a stop limit entry can be placed, we can place a limit order at the trigger price.

Profit target is +1t, risk is 10t. A 3t move beyond signal bar is sufficient to fill the target unless there is slippage, in which it takes a few more (trade #7; below b13).

Clearly, its very simple to get a high win rate. The larger your stop in comparison to your target, the higher your chances of a successful trade. However, such an approach has a few drawbacks

  1. Your theoretical maximum profit is limited to bars per day minus one ticks. Practically speaking, your maximum profit is probably around half the number of bars per day.
  2. Although your win rate is high, a 1tf or 2tf usually means your 10 prior wins will be wiped out. This gives a very severe drawdown potential, one you may not be able to stomach.
  3. Results may be inconsistent. You may have a day with 30t profit on a choppy day or a 30t loss.
  4. A large portion of your winnings go towards commissions.
  5. This is a very inefficient system to squeeze profit out of the markets. By taking only a tick profit out of a 70t+ move (trade #7), you give up the biggest moves in a chart.
However, this is a great way to experimentally determine the desired stop for large moves in a new instrument. For example, the large move triggered off b17 (trade #7) had a maximum adverse move of 2t. By collecting the adverse move against a large set of trades, you can determine a reasonable stop for large moves, i.e. if 80% of large moves have a MAE of less than 5t, then you could use 5t as a stop size.

But why can't you simply use 10t since its never been violated today? The reason is simple. Today, we only had 1t target. If we every plan to take a large profit target, our stop may have been hit on at least the first two trades today. A 10t stop would set us back twice the amount of a 5t stop. Until we can accurately pick out the large moves successfully, a smaller stop will protect our account better. 

One day's MAE is insufficient data to determine a reasonable stop. We would need to trade in all kinds of markets, fast and slow, news, large and small bars, choppy and sharp trends and so on. A one year data is probably good enough. However, after 40 samples, the chances of a dramatic result shift are unlikely and we can start using our provisional MAE +1t as a stop. 


  1. Hi, Cad, so all these trades are based on specific patterns only like 1Rev/1PB/A2, or assume that all trades have the same stop ticks? and may I ask what does "MAE" stand for?

    thanks so much.

    1. MAE is maximum adverse excursion and thats the maximum price moves against your entry.