John Sweeney, Technical Editor of Technical
Analysis of Stocks & Commodities magazine, described
this analysis in his book Campaign Trading:
Tactics and Strategies to Exploit the Markets,
published by John Wiley & Sons.
A number of topics are covered, but the
foundation of the book is his MFE and MAE
analysis. MFE is the maximum profit level attained
while in a trade, whether the final outcome
was a profit or a loss. MAE is the opposite
measurement; what level of loss occurred
for each trade, whether profitable or a loss?
To understand this concept let’s look at
some simple examples of this analysis using a simple trend following system we will build
in The Fibonacci Trader.
We’ll walk through an example of a buy signal
on a 10-minute/50-minute/Daily plan of the June
T-bond contract using a system that has only one
rule: Buy on a “flip” of the Dynamic Trio Next;
Sell on a “flip” of the Dynamic Trio Next.
Why use the Next time frame for signals? The
shorter the time frame you use for observation the
more noise in the price movement about the tradeable
trends.
Most new traders gravitate to shorter time frames
because there is the appearance that risk can be controlled
in a tighter fashion, but more often than not
more losing trades are generated with the shorter
time frames making execution of a trading plan more
psychologically difficult by trading very frequently
the cost of slippage can mount up very fast. We’ll
be talk more about trading psychology at the end of
this Journal.
Looking at Figure 1 you can see that on Bar A the market closed above the Dynamic Trio Next,
which is the close of the 50-minute bar and therefore
flips, signaling a long position at 120-28. The
market rallied into the close with a nice kick off to
this trade. The next day the market trended higher
reaching 121-25 (Bar B) and then closing for the
session just off the high at 121-24.
After the strong close the market opened lower
the following day and at the close of the Next time
frame (the 50-minute bar) the Dynamic Trio Next
flips and the trade is exited at 121-10 (Bar C).
In this example the trade realized a profit
of 14 ticks (excluding commission and slippage,
something we will not ignore later), a Maximum
Favorable Excursion (MFE) of 29 ticks (Bar A to Bar B), and a Maximum Adverse Excursion
(MAE) of zero ticks. This was a fairly nice trade because
the trade was profitable did not experience any
temporary drawdown.
Moving onto Figure 2, we see a sell signal on
Bar A at 121-28, then the market edges higher to
122-05 (Bar B), but the market stalls and falls
sharply to 120-22 (Bar C) and we are smiling. The
market traces out a short term bottom with support
at the 120-24 level then gaps up the following day,
the Dynamic Trio Next flips, and the trade is exited
at a price of 121-10 (Bar D).
This particular trade had a realized profit of 18
ticks, an MFE of 38 ticks, and an MAE of –9 ticks.
Now that we understand how to measure MFE and MAE let’s take a look at this analysis over a month’s
worth of trades using a slightly more complicated
mechanical system.
This next system highlights a key feature of the
Fibonacci Trader that sets it apart from the other technical
analysis software. It is the ability to do multiple
time frame analysis. We’ll take advantage of this feature
with our next trading logic. We will still use the
10/50/Daily T-bond plan and the Dynamic Trio Next
for our entry and exit signals as in our previous examples,
but we will add an additional rule: The Dynamic
BP Step High will be our trend indicator. That
is to say, we will only take a buy signal to go long
based on the Dynamic Trio Next if the Dynamic BP
Step High is below the prices (the trend is up).
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