Trading Forex Using A Breakout System

This is an article from http://theforexarticles.com/2007/10/24/trading-forex-using-a-breakout-system/.

Trading forex breakouts is one of the more basic trading strategies, but nevertheless it can deliver excellent profits. Just because a system is easy to follow does not mean it cannot produce consistent profits as breakout trading is a method used by some of the most successful forex traders around.

It's based around the whole premise that if a currency pair is trading in a very tight range for a sustained period of time, then eventually it will break out of that range and more often than not it will continue moving in the direction of the breakout.

This means that to make consistent profits you need to firstly identify instances where a currency pair is trading in a narrow range, and then place buy and sell orders at or slightly outside the current range to catch the breakout when it happens.

Furthermore if you want to look for the optimum set-up then you can use technical indicators to help you. My own method is to use a weekly 30 minute chart displaying 15, 50 and 100 period exponential moving averages.

When the price starts trading in a narrow range and all three of these EMA's have flattened out and also currently lie within this range, then this to me is the perfect breakout set-up. Why?

Well because with all three EMA's flat, something's got to give. It's like a volcano waiting to erupt. Once the breakout occurs, you could get a very big movement because the longer term EMA (100) can trend for a very long time so you could get a big points haul if this EMA follows the price and moves outside of the current trading range.

As regards targets and stop losses, I personally use the current trading range to determine where I place my stops so if I go long at the top of the range, then my stop loss will be at the bottom of the range. This is only really an emergency stop as most of the time the breakout will follow through and not go anywhere near this stop loss. My target price is usually the same number of points away as the stop at the very least.

The best thing about this system is that it works pretty well across many different time frames, plus not only does it work well for trading forex markets but it's also an equally good system for trading other financial instruments as well.

New High Breakout Over 21 days

A popular trading strategy among stock traders is to look for some sort of price breakout from current ranges or limits. For example, if a stock has been trading in between clearly defined resistance and support levels for the last few weeks and then it breaks through and close above the resistance level traders might buy or take a ‘long’ position in the stock, as illustrated in the chart below (click to enlarge).

Another way, which is easier, to determine price breakout is to look at the previous ‘n’ periods (for example 21 days) and wait for the price to make a new high within this period. When this happens, it is generally believed that there is renewed strength in the stock, and so traders would look to take a long position in the stock.

Once a long position has been taken, we could set the initial ‘stop loss’ level using the Average True Range indicator. The good thing about this indicator is that we could also use it to ‘trail’ the position as it starts to make a profit, and it also provide clear exit points for the position should the price start to come back down again. The chart below explains what I am trying to say in a much clearer way (click to enlarge).


Note that the ATR Trailing Stop indicator has 2 parameters which need to be defined (i) the time period and (ii) the multiplier. In this example, I have used 21 days as the time period and a multiplier of 2; I will refer to this indicator as ATR[21,2x].

Our system entry and exit rules are as follows.

System Rules for New High Breakout over 21 days:

• Open a long position in a stock when its price makes a new high over the last 21 trading days.
• Exit position in a stock when its price closes below the ATR[21,2x] trailing stop.

There are multiple parameters that could be varied in this system, including:

• Time period ‘n’ for measuring the breakout range (e.g. 10, 21, 50, 100, 200, etc.)
• Time frame of the chart: intraday, daily, weekly, monthly, quarterly or yearly
• The 2 parameters of the ATR Trailing Stop indicator

Instead of using the ATR indicator as the trailing stop, we could have used any other trailing stop indicator, such as other volatility-based stop loss, Count Back Lines, and Bear Range Exit just to name a few.

Changing any of these parameters could significantly affect the performance of the system. Therefore, it is important to determine the effects that each parameter have on the system in order to achieve the optimal performance.

I will discuss the performance of this particular system in a future post. Stay tuned!

Moving Average Crossover - SMA[100] & SMA[200]

Stock Market trading systems are usually constructed from one or more technical indicators and are used in such a way that gives clear signals to the trader or investor regarding the entry and exit points of a trade.

By far, the most well known and used technical indicator in the stock market is the moving average (MA). So, a good starting point in reviewing trading systems is to look at something that involves using the moving average(s) in some way.

In fact, the 100-day simple moving average (SMA-100) and 200-day simple moving average (SMA-200) crossover system will be discussed here. Why use the 100-day and 200-day periods? I believe that’s an excellent question, and it is the sort of questions that traders should be asking themselves all the time. But for now, the answer is because they are widely used by everyone out there including traders, investors and analysts.

Our system entry and exit rules are as follows.

System Rules for Moving Average Crossover - SMA[100] & SMA[200]:

• Open a long position in a stock when its MA-100 indicator crosses over its MA-200 indicator.
• Exit position in a stock when its MA-100 indicator crosses under its MA-200 indicator.

This is illustrated by the chart below (click to enlarge):



There are multiple parameters that could be varied in this system, including:

• Method of calculating MA: simple, exponential, weighted, etc.
• Period of the shorter (faster) MA
• Period of the longer (slower) MA
• Chart timeframe: intraday, daily, weekly, monthly, quarterly or yearly
• The exit condition could also be altered, such as using a trailing stop loss to lock in profits
  

Changing any of these parameters could significantly affect the performance of the system. Therefore, it is important to determine the effects that each parameter have on the system in order to achieve optimal performance.

I will discuss the performance of this particular system in a future post. Stay tuned!