Creating a trading system I - A new beginning

From January 2013, I'll go through the steps of creating a new trading system to trade CL contract (oil futures.) My goal is to go through the steps of creating the risk management and trade management system for CL and publicly log all my trades, including experimental trades.

Initially, I will work on figuring out ideal stop sizes, scalp and swing targets and the system will run on SIM. As the system picks up consistency, I will start trading the system live.

This will serve as a template or guide for me and my readers to create their own price action trading systems on anything they may wish to trade.

Why CL?

From recent experience, I believe there may be a case for accelerated consistent profitability for new traders in CL compared to ES or any other equities contracts. CL also does not usually suffer from the lunchtime lull and traps that ES traders need to be wary of. CL does have its own dangers, namely slippage and whipsaw during news events. These are part of what makes stop size determination a bit harder on CL.

For the rest of December, I will attempt to describe my overall trading principles and the reason I believe they are universally applicable.

Risks of fBO

An fBO trade requires the highest amount of skill to swing and the least amount of skill to scalp. The reason is that fBOs are expected to give two legs but that's all. There is no expectation of a target. There is no expectation that the other end of the trading range would even be tested.

Since legs can be fairly complex and contain mini-legs, the end of an fBO move is highly subject to a trader's experience and judgement.

For example, the fbo trade below b37 today was expected to give two legs down and it did go sharply to b54. At this point, a trader needs to assess if there would be one more leg to the low of the day or a turn right here.

If the trader correctly guesses the price would turn and buy b54 or the HL at b60, then at b63, the question becomes: will this move end here or was this just a minor pullback in the larger trend down and is likely to result in another move down.

The complexity can be dealt with by assuming that every second push against the traders position forces an exit. For example, b37 sellers would exit above b54. b54 buyers would exit below b63 and so on. Such a strategy requires the trading range to be wide to be profitable. The trading range needs to be roughly the size of a day's move (8-10 points).

An opposing strategy is to trade every fBO as a trend and exit when the price takes out a stop beyond a swing point. This means b54 buyers would hold until their stops below b74 are taken out at b79. None of these are easy and fBO trades certainly need a scalp target since the potential for large swings is undefined.

Exiting early

Although I prefer to swing most of my trades till a trend terminates, sometimes its prudent to exit early. In general when the market is in a trading range, you cannot expect most trades to really break into a very strong trend and you may need to look to exit early.

A classic application of this rule is an fBO trade. Since fBO can only be expected to give two legs and the two legs may or may not take out any target (i.e. recent swing points or H/LOD), its often prudent to take a large open profit.


For example, today's fBO setup at b31 popped very high for a second leg up at b48. The theoretical swing stop is below the prior swing (b43) and when the price moves close to a potential target (b17H), it makes sense to exit early and re-enter on the expected deep pullback (eventually occurred at b65).  


One option is to exit on strength (inset image) or exit on the next tick against you (eventually below b51).  I prefer to exit on strength when a potential FF type setup shows up (inside bar b49 could act like FF).


Even on trend days, when the market makes a disproportionally strong move, you should expect an extended pullback, which could be either a quick deep pullback or an prolonged shallow pullback. If your swing stop and the price are very far (4+ points) its usually best to take an early profit rather than sit through what could be an prolonged, deep or complex pullback.  


A notable exception to this rule is the late trend, which rarely pulls back.