I recently came across a strategy I liked the sound of in a book called Winning Spread Betting Strategies. Its pretty a pretty basic strategy, very few indicators involved. I liked a lot of what they covered in this book, as the strategies they covered seemed to make sense and yield quite a good risk to reward ratio. My only criticism would be that they could have gone in to more detail in some parts.
The strategy is simply buying or selling support and resistance. We can use it in a up market if the price has started to consolidate side wards, likewise with a down market trend. And obviously we can use it when the market is generally just in a side wards trend.
However, unlike a lot of traders who advise waiting for a confirmation that price is heading in your direction, such as a certain candlestick, this system does not wait for that.
In this system we buy or sell the when the price is right or as close to major support or resistance as possible, hence giving us the best possible entry price. The theory is that if you are waiting for the confirmation you have already missed a lot of pips move in that direction, particularly when we are talking about the weekly time frame.
Another advantage it that you can set tighter stop losses, since a smaller move in the wrong direction when you enter right on the support is confirmation that the trade has turned sour and you should be out anyway.
I am going to use my software Forex Tester 2 to back test this strategy and see what kind of results we can yield.
What Markets will I be targeting?
I only trade Forex hence, I will be using this on currency pairs. The book mentions that this strategy can be used with stocks and indexes too.
What time frame will I use?
The time frame I will use is the weekly charts as they suggest in the book. We can expect trades to last a couple of weeks and most likely months.
We are looking for rectangular, flag patterns heading side wards in a channel with clear tested support and resistance lines. When price is trading right near or close to the top or bottom of that range, we take a trade.
Where to place the stop loss?
We will place our stop just behind the support and resistance so price has to break through to hit the stop. We know at this point we should not be in the trade anyway.
When to exit the trade?
Apart from the obvious of our stop loss being hit, we will need an exit plan for the trade also. Our price target is from the opposite top or bottom of the range. My exit plan will be to use a trailing stop once the price has made it half way to the target price. I will place the stop just below the low of the last two weeks.
If price breaks through our target we will then tighten up the trailing stop loss to be below the low of the previous week.
What risk to reward am I aiming for?
I am aiming for around 1:4 risk to reward ratio on average.
What lot sizes will I be using?
For the sake of testing I will just keep it simple.
Lets start back tEsTING!
The first set up I came across was on the EUR/USD weekly. Here is an example of the perfect rectangle trending sideways moving patters we are looking for. I took the trade at 1.2499 and set my stop at 1.2438 approximately 65 points away including the 4 point spread.
Distance between the top and bottom of the channel gives us a good risk to reward ratio as the top of the channel is our target. The below image is what happened two weeks later.
Price has taken a turn in our direct and has also made it half way to the target. I have now set my stop loss just below the low of the previous two weeks as planned. No profits locked in just yet. See below image for what is to come over the next weeks.
The trade continued in the right direction. I moved my stop again to the low of the last two weeks locking in 159 pips profit. As it is we’ve secured a risk reward ratio of 1:2 which is a good start. See image below for the unfolding of the next weeks.
On this occasion, instead of hitting the resistance and retracing, we see that price has broken through the resistance and is on its way up. This is not expected of every one of these trades but certainly is a bonus. What we do in this case once price meets that target or exceeds it is to place the stop tightly just below the high of the week previous week. In this case we have safely locked in 271 pips of profit.
Finally price dropped back a little and our stop was hit securing in a nice profit of 592 pips. Anyone trading full lots here would have secured $5924 with a risk of $650. In this case we secure a risk to reward ratio of 1:9 which is amazing for any trade. Granted, this trade panned out rather well and not all trades will turn out like this.
I tested this strategy manually from the beginning of 2001 until 2015 on 3 currency pairs; the EURUSD, the EURGBP and the USDJPY. The results are as below.
Total Trades – 112
Win probability – 56%
Average loss – $154
Average win – $397
I like trading this system because it offers you the opportunity to get in at the best possible price and limiting your downside risk quite considerably as it doesn’t wait for a reversal confirmation. However, all systems also have their down side. This one in particular leaves quite a lot to human judgement as opposed to completely strict rules. For this reason it can fall victim to human error also, both in choosing wrong entries and maybe not getting in when you perhaps should have through fear of wanting a better price.
In my example I obviously only showed you my successful trades. But as you can see from my winning probability of 55% there were almost an equal amount of losing trades. As long as your money is managed right and you aren’t risking too much of your account per trade this system should work well.
Make sure you have enough in your account that you can suffer a string of consecutive losses as this can always happen. In the long run however, you will be up.
The system is easy to follow. For any questions, critique or anything you would like to share please send me an email through the Contact Us section and I will reply as promptly as possible.