My Trading Concept # 4
Confluence and development of trading system
(There are few links, visit those later after going through the end of doc, else you may miss out the full picture I am trying to paint here)
What I want to discuss today is the foundation stone of any successful trading strategy. Regardless, we buy or sell, there is always a seller for a buyer and vice-a-versa and both of them taking the action (buy or sell), with the assumption that they will make money – but only 1 of them will be correct (assuming both are trading on the same timeframe). Which side? The one who has the majority of the price-volume force. Visualize this as a Tug of War with un-even team-size. But the one with stronger price-volume force, will win.
So at the end of the trade, in this game of probability – where only one side can be correct (buyer or seller) – is the one who has The Force on his/her side.
The idea of confluence is to have a trade setup where the chance of your joining
The Force is higher –
But how?
Every different group of traders has a different technique:
- Few follow Pivot points (Fibonacci, Classic, Woodie’s or Camarilla)
- Few follow only Day High/Low, Previous Day’s High/Low , Value area High/Low, Market Profile etc
- Pinbar trading showing candle having long wick + High volume to show rejection
- Gann Fan / Gann Number traders
- Harmonic Pattern Traders, EW Traders
- Channel Breakout/ Break-out failure traders
- Traders following technical setup – and there we can have few thousands of setups considering the combination of indicators they are using
- Discretionary traders – who has some rules for entry /exit but left best to the discretion or price action they believe as correct for buying or selling
And the list goes on…..
And
The God-Father of all: The Smart Money
Consider yourself any one of this group (except being the Smart money) – your trade can and will win only if your buying or selling decision falls in the confluence with majority of the other traders in different of those above groups joining your side – and that will only happen if you Entry signal and direction (buy/sell) is close vicinity of the signals being generated by others. You will be in the majority group (Buyer or seller), overwhelming the other group with so much buying and selling pressure that you win the trade.
And let’s consider that still you will not be always right, but if you can get this right 5/10 times (yes only 50% time) with Risk Reward of 1.5 or more, your account balance will increase – this is generally my equation (50% win rate + 1.5 RR). But I do get most of my trade with 2 or 3R as I scratch my trade on the slightest hint of failure. As a matter of fact – power of confluence typically gives you an effective win-rate of +70%.
Now to do this (trading system with Confluence) – there are multiple recipes.
How you do this it is up to you – but let me share my strategic setup on how I develop a new trading system or have developed the winning one for me till now.
1. First be at the side of smart money – how? Check the trend on daily/weekly chart. I also track if FII/DII are selling or buying on EoD (For Nifty) – there are many places to check that. You can check the below link or NSE site to get provisional data:
http://craytheon.com/charts/fii_dii_nse_bse_trading_chart_graph.php
http://www.traderscockpit.com/?pageView=fii-dii-in-india
For Crude I use my Cash-Flow system (shall discuss on next section) to determine the money flow in the virtual way (not tracking real transactional volume as such).
I have won many contra (mostly on day trades) – but the majority of my winning trades are the one which are with the trends, especially almost 80 odd % of my positional win on Nifty since last 3 years were with the one with the trends.
If you are not sure about the trend (sideway market) – step aside from your screen and enjoy life outside trading. In fact that’s why we earn money.
2.
Find the Pivot points confluence (I don’t follow any particular type, I get the list of all). I have a paid membership at Traderscockpit.com (this was mostly to help me mostly with stock screening on cash section of trading). But they have many things apart from screening.
They have a beautiful presentation of pivot points. I mark the important one matching the other groups and also if there is anything on week pivot matching days level. (Below one for example purpose on past data, no intention of copy write infringement)
You also can do this based on excel. Below website can help you:
Pivot Trading
The point is, you can follow any Pivot calculation type.
My way is to find the matching levels one among all of those (so that I can net max of the Pivot traders in my Buy and Sell call)
3.
Find your timeframe – this is The Most Important Point.
The thumb-rule is, lower the timeframe, you need higher skill.
Think about this twice.
You definitely have members in your family and friends who does not know anything on technical analysis on trading. They will simply ring up the broker to buy some stocks when market crashes and hold it for 2-3 months or a year and then sell those with good profit. That is the magic of time.
Where all of us are in the trade to win money in fastest possible time, as if we are in some F1 race, but are we skilled enough for the lower TF?
If not, you will simply give away money. In Tom’s word you are just liquidity provider to others or a donner – who give away the hard earned money to other traders – losing both time and money.
We should develop skill first win with higher TF Trade, and then zeroing down to lower TF trades. In the day trade also you can explore with higher timeframe first (4 hours, 1 hours and then gradually narrowing down or 15 mins, 5 mins, 3 mins normal or Scalping trades.
4.
Find your position size. This is linked to your timeframe and overall trading capital (keep aside your R/R and Win rate aside for a while – think you don’t have a setup yet, so no idea on win rate).
Higher the timeframe will require Deeper SL and Higher Margin (overnight carryover margin). Lower TF will require small SL, so you can increase your Size.
There is also a human factor - I will discuss more on this later
5.
Find a technical setup - there are many on the net and as well I am discussing few of mine and will discuss remaining one as well. I will also discuss how to develop one of your own if you want something new. But purely on technical indicator – you need 2 things:
1. That generate entry/exit signal
2. The Filter – avoid the fake signals
Few indicators can be used differently for a different purpose on a different timeframe. For example – some of use RSI overbought to sell on the first sign of weakness of the trend, and few actually enters on Overbought on lower-time-frame to mark the beginning of a new strong trend.
I will save some energy here and let the vast repository of internet help you on indicators and how to combine those: but here is good starting point:
TradeCity
Putting everything together:
Now, when I start checking winning profitability of any of my setup (anything new I am developing even now), I typically do it with
just 1 or 2 lots Nifty or 10 lots of Crude Mini – Cause I want to lose minimum capital and I hate paper trading. I generally check below:
- The frequency – I simply cannot hit buy/sell on my wish. I need the signal generated from my technical indicators (point 5) along with some confluence
- What is the average profit (pips) I earn from my winning trades
- What is the pip size of SL (30 points,50 points,100 for overnight trade) to invalidate the Setup
- Identify, if this work best on Bullish Market or Bearish Market (Trending) or Sideways (you may hate it, but you need system for sideways market – generally 70% of the time market is on sideways as per common opinion and statistics)
Typically after testing for 2-3 months (I generally get both up and downtrend captured), I see the result. If the win-rate is > 50% and RR is anything above 1.5, this is a qualified system for me.
I don’t do Programming Back testing anymore these days, because it cannot capture the point of confluence and neither we can trade like a machine.Technically I am more than fit for a programmed back-testing as I am a programmer for last 14 years- and precisely that’s why I know where the machines fails.
Once the system is qualified – next step is testing. I test my system for a decent trade size (little higher than the validation setup) and check if I am capable of handling this without impacting the result in a negative way.
Once this is done – I own this system.
If one has not done this – I can bet that chances are pretty high that he or she will be a net losing trader, regardless he/she has been in the market for 5 months years or 5 years, or will become one in just matter of time.
It is tempting to ask “What is your trading system”? Don’t do that. Spend some time, learn the concept from scratch, and try your hand in trying something new. Fail Often, Fail First (with low position size, so that you don’t get bankrupt).
Yes, you can take idea of existing trading system from others on the internet, but tweak to see what is required to be altered to make it compatible with your Timeframe and Points of confluence.
My preferred one for confluence
For Nifty
1. Positional Setup (with Trend) : Trend+Weekly Pivots + Pullback till Dynamic R/S at 20 DEMA/50 DEMA/100 DEMA + Pinbar rejection day candle with high volume (optional) - this setup has given me back all my losses of my first 8 years of trading - I shall discuss this on Concept 5.
2. Positional Setup (Reversal System): Trend fatigue+ Weekly Pivots+ Pinbar Rejection with High Volume (Mandatory) - needs lots of guts to get in as sentiment will be outright bearish/bullish and you are going against the mass. Shall discuss on Concept 6 - I hardly could get in this on time, still practicing the right entry. But entered mostly on day 2 or 3 once little or more confirmation is in place.
Both of the above systems are for 9 to 6 guys - will discuss one of this tomorrow.
Nifty/Crude Intra Day Trade Setup
1. With trend : Cashflow System (will discuss) + Day Pivot confluence + Technical indicator showing Breakout failure on Contra - the one I use most of the time
2. Against Trend: Cashflow System (will discuss)+Divergence system (already discussed on last concept) + Daily Pivot points confluence.
Please note - on Intraday , I mostly trade breakout failures -
1. Bullish trend - I will try to enter long on failure of break of support on pullback
2. Bearish trend- I will try to enter short on the failure of a break-out of the resistance on upthrust.
Develop one successful trading strategy first – check profitability and practice it to own it. Scale up position size if you keep on hitting consistent win rate in the chosen market condition (bullish/bearish, trending). Then develop another (Overbought/Sol, expecting trade reversal) and then another (Sideways market) – that’s your square cut, Straight Drive and Pull Shots.
Finally – last picture will summarize everything for you. Trade with just 1-2 lot on higher TF till you graduate. Preserve capital and gain experience. Develop a System as a process and focus on process goal instead of hitting double century on debut. If you have freedom of time, check if that works on lower TF (as that will increase your trade frequency) – but only after your trade system is proven on higher TF.
Exception – There are few system only for lower TF (1 min, 3 min TF), don’t fall for those yet. Go for the universal one – which work across all TFs – those are easy one and gives you a feel of symmetry.
Ask yourself just one question – if you don’t have a system or process for making trading decision consistently to become a net winner with just 1 lot (Nifty or Crude Mini), what makes you believe that trading with bigger capital with multi-lot will let you make money in long term. 1 or 2 random win without a process will do more damage as you will do same again and blow it.
It has been a long post- but I have to sum up all my decade old learning - here it is.