Trading Against the Forex Crowd in Volatile Currency Markets

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In our guide to FXCM Speculative Sentiment Index-based trading strategies, we discussed the “why trade against the crowd?” with a specific look to our SSI. This article covers the “how can we trade against the crowd?” with a closer look at the Breakout2 channel breakout strategy.

The Breakout2 trading system has been one of our more successful trading strategies in past years. We need to emphasize that past performance is not indicative of future results, but the strategy has historically done well in fast-moving markets with strong volatility.

Trading Rules for the FXCM Speculative Sentiment Index-Based Breakout2 Strategy

Automate the Breakout2 trading system via the FXCM Apps store

forex_crowd_breakout_trading_body_1a.png, Trading Against the Forex Crowd in Volatile Currency Markets

Buy Rule: Buy 5 lots when the currency breaks above its highest high of the past 24 hours.

Sell Rule: Sell 5 lots when the currency breaks below its lowest low of the past 24 hours.

Trade Filter: Breakout2 may only take short positions if the SSI ratio is at 1.22 or greater (55% of orders are long). It may only go long if the SSI ratio is at -1.22 or below (55% of open orders are short).

Profit Targets: Measure the 90-day Average True Range of the Pair. Place 4 limit orders every 0.5 ATR away from entry price.

Stop Losses: Measure the 90-day Average True Range of the Pair. Place 4 stop loss orders every 0.5 ATR away from entry price.

If long, place a trailing stop loss order at the 24-hour range low. If short, place a trailing stop loss order at the 24-hour range high. Note: the trailing stop will close the entire position if triggered regardless of whether any of the 4 ATR-based stops or limits are triggered.

Reviewing and Understanding the Logic of the Breakout2 System

Entries: Buys 5 lots when currency breaks its 24-hour high, sells 5 lots when it breaks 24-hour low: This is a high volatility strategy similar to our volatility-filtered Donchian channel breakout system. It does multiples of 5 lots so that it may scale out of orders. Like most breakout systems, it will more often do well when prices are breaking significantly higher or lower.

These are also the market conditions in which the trading crowd will most often be buying into weakness or selling into strength.

Thus the trades often have a stronger chance of success if they occur within larger market trends. i.e. we buy breakouts in an uptrend, sell breakdowns in a downtrend.

Filter: Can only buy if SSI at -1.22 or below (55% of traders are short), can only sell if SSI is at 1.22 or above (55% of traders are long): Breakout trades will often work best when they are in the direction of the larger trend. In other words, buying a topside breakout likely has a greater chance of success if done in an uptrend. Selling a breakdown is more likely to succeed in a downtrend.

SSI can tell us whether or not a currency pair is in an uptrend or in a downtrend—remember, most traders buy weakness and sell strength. If price is very volatile, we are more likely to see major breaks of support and resistance. Volatility likewise improves the performance of our benchmark channel breakout strategy.

Exits: Take the daily Average True Range of the currency pair for the past 90 days. Breakout2 places 4 stops and limits 0.5 ATR away from entry price. It places a fifth stop at the trailing 24-hour high or low. A trigger of the trailing stop will close the entire position.

Breakout2 uses a mix of fixed profit targets and stop losses that in our opinion improves its chances of overall success. Why a combination of both fixed and trailing profit losses/targets?

Breakout trading is often a lower-probability mode of trading. We offset the fact that positions are often unprofitable by employing a positive reward-to-risk profile and locking in a certain amount in profits without undue risk. That explains the fixed profit targets and stop losses.

The trailing stop is our way to allow the position to move in our favor without being closed out prematurely. If this is clearly the start of a much larger breakout, the trailing stop will keep us in the position for an extended period of time.

Automate the Breakout2 trading system via the FXCM Apps store

forex_crowd_breakout_trading_body_1a_1.png, Trading Against the Forex Crowd in Volatile Currency Markets

Strategy Tips and Resources – How We Use Breakout2

Not all market conditions suit the Breakout2 trading strategy, and as such there are definitely factors to keep in mind before taking any of its trade ideas.

Our research on the Donchian channel breakout system shows that it has historically done better during times of strong market volatility. How do we define volatile market conditions?

In our Weekly Strategy Outlook report, we cover market conditions with a special focus on volatility and prices in forex options markets. We report the “Volatility Percentile” of individual currency pairs, which tells us how much options traders believe the currency pair will move as compared to the past 90 days.

Our research shows that Breakout2 tends to do better when that number is at 50% or higher.

Our Forex Technical Analysis page shows a daily update of our Volatility Percentile figure:

forex_crowd_breakout_trading_body_Picture_38.png, Trading Against the Forex Crowd in Volatile Currency Markets

Past performance is not indicative of future results, but our experience shows that using the volatility percentile in conjunction with the Breakout2 strategy offers good trading ideas.

Automate the Breakout2 trading system via the FXCM Apps store

forex_crowd_breakout_trading_body_1a_2.png, Trading Against the Forex Crowd in Volatile Currency Markets

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

To receive the Speculative Sentiment Index and other reports from this author via e-mail, sign up to David’s e-mail distribution list via this link.

Contact David via

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