Currency Secrets

1. What type of data are you using (or going to use)?

I know this sounds strange, especially if you have experience from another market such as stocks as their generally is only one type of data source available. However, in the forex market you can have up to 4 different data types: bid, ask, mid and indicative. Each have their own little nuances.

If you would like to know more about the data types then visit the article written about the perils of indicative prices. As this will save me from having to repeat the information again and boring those who’ve already read it.

So, if you know you have indicative prices then you know you’re in for some inflated results! However, if you have any of the other three you need to be careful on how stop and limit orders are placed.

As an example: If we had bid price history and we were looking to place a buy entry stop at 0830 EST according to the day’s high, then we know that the bid price will not accurately reflect what the actual price of our order should be. You would have noticed that if you placed a buy entry stop at the exact same price as that of the day’s high you would have entered prematurely – you would have
entered 4 or 5 pips before the high or the low of the day was touched (the exact same amount as the spread your broker offers!).

This leads me into the next most important question…

2. What spread is your broker offering on the currencies you are back-testing?

You need to know this as this can help you set your slippage settings on each currency.

As our example in question 1 pointed out: we found that our buy at the day’s high method did not exactly work because we bought at the BID PRICE high, not the ASK PRICE high – the price that we need when we place our order TO BUY.

Therefore, we enter in a slippage setting representing the spread that would be exhibited by this trade on this currency.

But knowing at what price to buy is only half the problem… how do we know what quantity to buy?

3. What margin does your broker offer?

If we know what price to buy our currency at we need to inform our broker on what quantity to buy to fulfill the order. We only know what quantity to buy by the margin your brokerage firm offers.

Most brokerage firms offer 100:1 leverage, however, some firms offer mini accounts with 200:1 leverage, others only 50:1 leverage.

Find out the margin required.

4. What restrictions does your broker impose?

Now, I don’t just mean margin and spread restrictions as I’ve mentioned above. These are important in their own right, what you need to find out are the details.

This is probably the most important question of all as the fine line between success and failure can be found in the details.

Now you can have this questioned by one of two ways:
1. You can find out through experience (generally the most expensive way unless done through the demo account!); or
2. You ask your broker (the cheapest and best way).

Why is this so important?

Well let’s say you have a system that trades gaps that might form on Sunday at 1700 EST, but your broker does not open until 1730 EST. You either need to factor this restriction into your forex system, or move onto another system completely. Another example might be that you may have a system that has 10 pip stops, but your broker will only let you place 15 pip stops from your initial entry price. Once again you will need to change your system to see whether it still performs well.

In fact one of the most devastating restrictions imposed by FXCM is that they do not accept stop entry orders if price never happens to trade at your entry stop price! FXCM will honor and “take the loss” of your OPEN stop positions, but if the liquidity is not there and price has shot straight through your stop price then you’ll miss out. This can have disastrous effects on your system results as you are left wondering whether the trades that made good money would have been executed!

The restrictions by your broker are represent half of your system’s success, you also need to find out about one other more important restriction… yourself.

5. What restrictions do YOU have?

This is a vitally important question.

Most people test their system, fall in love with the results, but find when they trade their system they’ve lost their account and that most of the best signals occurred while they were asleep.

As the forex market is a 24 hour market, you need to put in place restrictions that will be realistically conducted by you during the course of a normal trading day. There is no use operating a trailing stop method that changes your stop points during times when you are asleep and cannot possibly do so.

I hope this article has made you aware of some of the important things that need to be known prior to testing your system.

Tags: Forex Trading

This entry was posted on Sunday, May 15th, 2005 at 7:33 pm and is filed under Forex Trading. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.