Price filters in SAR trading - Gain or Pain!

There is always a struggle in mechanical trader’s mind as what kind of filter he should use on the sideways market to get away from whipsaws. Simple truth is "no filter value" can benefit in the long run. I personally  experienced the fact that most of the trades gets whipsawed even though the price filters are applied before reversing the trade. Whatever can be the filter value, but price will go there to kiss your SAR order and pull back:)

I hope many mechanical trading system followers would have experienced this.I definitely agree that few trades might survive from whipsaws due to application of price filters. But that's once in many trades. If you run the check with your old trade log, you will realise that there is no point in the fixed price filters.

They are actually a  pain to your mechanical trading system.How?

Look at the below table from my records.

Now, below is the small brief to understand the difference between the returns shown above.

Total trades in a year – 96

Say, we keep filter of 0.1% which is around 5 points per trade (considering average price of crude oil as 5000).So, when you place a order for reversal, you place 5 points above or below your actual SAR value.

Let us assume that we are reversing one short position into long with a loss. We place the order 5 points above the SAR level to enter into long position. One has to understand that we have straight away included loss of 10 points in the above trade. That is, we extend the loss of the existing trade by 5 points as well as we reduce the profit from the next trade also by 5 points with the lateral entry.

It is obvious that you are making loss of 10 points in every trade and if you zoom this calculation in to 1 year period, you lose 960 points ( 96 trades as i shown in table) in the name of filters. It is absolute 384% of returns you have lost by using filters. Even if your system do not generate any major gains for the year, if you would have saved this 384%, that is more than enough for any trader with any system.

Caution : My entire explanation is based on commodities and especially from my testing with crude oil. This cannot be considered as is for trading other contracts for eg, Nifty, without proper testing. And, my system is different and the effectiveness of filter might change among different trading vehicles.Check every contract you trade before making a decision.

My note # 1 : If one is already trading with filters, there is no need to immediately skip the filters. Try to reduce the filter size gradually. It can be flexible and worked based on some important TA levels placed around SAR price.This would work.

My note # 2 : I have stopped trading nifty and don't have the updated data. But I can do a approximate math with my experience in Nifty. If we assume that we execute around 75 trades in a year, then trading Nifty using a SAR system with 10 points of filter will lead to the invisible loss of  75x10x2 = 1500 points  which is 300% ROI. Am I correct?

Bottom line of this post is to highlight the invisible slow poison which dilutes your capital.So, keep a check on that!

Naked truth!

 One of the top turtle trader Curtis Faith writes as below.

// I won’t go into specifics here, but those of us who actually trade for a living know the names of many “famous traders” who are famous as “traders” but that don’t make money as traders. They make money selling new trading systems, seminars, home study courses, etc. Most of these so called “experts” can’t trade and don’t trade the systems they sell //

Very true!. I believe in this statement as it's a common sense.

Person who is proved right in trading will never try his hand in any other mode of income.He will desparetely pump all the available capital into his trading pool and always wish to grow big. If  he starts seeing some money using his own trading strategy, he will devote all his time only in improvising his trading method and he can't even think of any other activities to earn money. Trading is such kind of game which occupies your mind completely and not allow you to peek around.

Only when a trader gets frustrated by series of loss or not able to cope up with discipline to follow his own system, he looks for other derivatives of trading business to make money. It'll mostly work well for him.I can spot the trend and reversals exactly when am not in trading but i'll miss them if i am involved in trading.

So, absolutely there is no point in looking for free trading calls, following other's trading system or listening to trading strategists in media. Only way to excel is, listen and study everything whichever comes in your way for the sake of knowledge. Never follow anything blindly. Apply your mind over everything and try to build something on your own.

I always feel that one should create his own trading system or methodology. He can learn a lot in the process of discovering something on his own. Best phase in any trader's life is this R&D phase. Experience which he gains from this R&D phase is much more superior than any trading book written so far. None of the trading expert or book can teach him well than the own experience.

Newbies should always know this logic behind "experts" and "own study" well before losing their hard earned money.

Basic instinct!

Am sure all the traders might have experienced this.

When you decide to enter or exit a position, the very moment you think about it, there will be a flash of decision in your mind in a lightning speed. This is purely from your instinct. But, we always ignore that decision and go with the decision after many analysis which is mostly contrary to the instinct decision. Always the consequence go against your analysed decision but favoring the instinct decision which popped on first hand. We then curse our self for not following the instinct. Later, we used to do mind calculations, “if I could have followed that, I must be sitting on this much cash! Phew! I missed it!”. 

I experienced this many times especially on the option contracts before expiry. The moment I think about taking a option position on the expiry day or 1 day before expiry, I skip my instinct and go for the contrary position which always failed. If I could have taken all the positions as per my instinct, then I would have made more than 100% every time :)

It’s a simple logic. Brain is the best programmed software of mankind. Since the trading is in your blood and you think about it all over the day while eating, talking and even in sleep, your brain stores all the information you read, hear, discuss and your own analysis and keep it in the priority racks. It also stores all your past good and bad experiences from your everyday trading life. When you face the situation of decision making in trading, your brain do the quick analysis based on the experiences and link it with the information stored. It immediately trigger your instinct saying “go for this” or “ leave this”. But, we poor traders never listen to it and goes for own decision making after so called many analysis which mostly fails.

We all know why techincal analysis is so famous and getting you some money. Reaction of the mass crowd against particular price movement never changes. It may be another day or year, but the reaction of the traders at certain price levels after a specific move in any given contract, never changes. It’s a balance of greed and fear. TA captures this beautifully and generate signals at appropriate places to enter or exit. Core fundamental for any TA indicator is based on this concept only. You can take fibo, waves, RSI, MACD, Pivot or anything else.. you will understand this simple concept.

Combination of your basic instinct and sincere obedience to TA will never let you down!

--------------------------------------

Ok..why this post now! Because, my instinct saved me some 20k . I was carrying crude oil long positions which was actually bought at 4976 on Tuesday. My stop loss (SAR) for the same was at 4916. INR had a big role yesterday with its  volatile move, caused MCX crude prices not to run parallel along with its mother contract in dollar prices. After my buying at 4976, crude oil spurted to 5025 in a quick time but later fell heavily and exactly made low of 4916 i.e, at stop loss. After taking a support there, it again bounced to 4940-4950 and left me in a dilemma to take a decision whether I should reverse the position to shorts or to remain in the longs. As per TA, I can consider both option.

I can say either price has hit the stop loss so I should reverse or I can consider that stop loss actually gave the support to the price hence I should remain long. Price was swinging between 4920 to 4950 but it never came off. So, I didn’t reverse the position and closed the day with long position. After market is closed, I was thinking that I should have reversed to shorts as only due to  INR volatility, my stop loss was missed by a whisker!. If  INR was in the normal range, then prices should have gone way below the stop loss. Incidentally, the moment after our market is closed, I have seen that dollar prices were diving down heavily.

Next day, my stop loss has gone down to 4865. I am still in the long position and if I have to reverse to shorts today, I should wait for another 50 points from yesterday’s SAR. My instinct asked me to go for shorts when the prices going down below yesterday’s SAR and low i.e, below 4916 today and I responded to it. Lucky! Prices fell sharply and closed at 4855 yesterday and now it is trading at 4800.

If I skipped my instinct, loss of 55 points must be added to my wallet now.