15 May The Power of Countertrend Trading
The Power of Countertrend Trading
May 15, 2019
Countertrend trading is in my blood.
The first trading books I ever read were books on Warren Buffett, and I became a convert like so many others.
His argument makes sense and it appeals to my sensibilities. Trends come and go and can be mediocre for years at a time. What never changes is this truth: everything comes back to Fair Value.
Find something that the emotional people have dragged away from proper value, and sit back and watch it violently correct right back to where it’s supposed to be.
It works now and it will keep working. What goes up must come down. Forever.
At least, that’s how the argument goes. And I loved that argument.
So when I learned about Pivot Points back in 2009 from my friend, Rob Booker, that fit in nicely with my value investing mindset. I’d traded stocks successfully for years and now I was going to do even better in Forex.
Pivot points were the key.
Because there is no useful fundamental analysis available in Fx (what’s the P/E ratio of the Australian Dollar??), Pivot Points gave us the Fair Value we need. These value yardsticks have been around for a hundred years and fortunes have been made by respecting their levels.
Pivot Points take the emotion out of the previous week’s trading and give us a reasonable value for the price of an instrument that week. It’s a static level that doesn’t change (unlike a moving average), and that’s an extremely effective tool.
In short, Pivot Points are a high probability level we can trade to. Wait for price to get silly, and then trade back to the weekly Pivot Point.
Here’s some data.
There have been approximately 364 Weekly Pivot Points created on the GBPCHF (the first pair I ever studied) since May 2012. Do you know how many of those 364 Pivots have seen price touch its level?
363. I checked.
There’s only one Weekly Pivot Point that hasn’t been hit in the past 7 years. In other words, 99.7% of Weekly Pivot Points get hit at some point in time. Apparently it’s true. Price loves to come back to Fair Value.
But there’s one more thing.
Price tends to come back to the Weekly Pivot fairly quickly–which makes sense. By the time traders get to Friday, they’re fried and emotional. They’re overreacting and ready to just get out of a position. And then they fly their helicopter to the Hamptons, calm down, and feel much better.
Come Sunday night or Monday morning, they’re over their madness and start putting the market back to reasonable levels. And that’s when the Weekly Pivot gets hit.
Again using the GBPCHF, since 2018 do you know how many Weekly Pivot levels were hit the same week they were created? 70.4%.
In past studies, this number always seemed to hover around the 98% level. In this recent study, that number was still very high.
So this week, we’ll look at a system that uses this universal truth. We’ll place bets on price moving back to the Weekly Pivot and we’ll use a high probability profit target to raise our percentages.
Here are the details:
- System: The Weekly Pivot System
- Philosophy Behind It: Price loves to revert to Fair Value, and it usually does so at the start of a trading week.
- Need Special Indicators? Yes, kind of. A Weekly Pivot indicator (available on most platforms) is nice, but can be manually calculated by adding last week’s high+low+close and dividing by 3.
- Special Caveat: We only take trades on Sundays and Mondays. We don’t trade Tuesday-Friday.
- Chart: Daily
- Instrument: Forex GBPCHF
- Long or Short? Both
- Entry: 1) Price must not have touched the Weekly Pivot level as of yet; 2) Price then moves 114 pips away from the Weekly Pivot; 3) Enter at exactly that level: 114 pips away (orders can be set ahead of time)
- Stop Loss: 110 pips
- Take Profit: 20 pips
- Trade size: 0.75 lots
- Hypothetical Profit: $40,753 (no compounding)
- Hypothetical Max Drawdown: $6,197
- Hypothetical account size: $10,000
- Test Period: 2003-2019
- Number of Trades: 748
Here’s the MT4 Performance Report.
It seems like our story about reverting to Fair Value is corroborated by the data. The profit to drawdown ratio is very nice.
In addition, by using a high probability target along with a high probability methodology, our odds are excellent. As you can see, the win rate is near 90%.
What’s the downside?
Not much. The biggest downside is when the market is in a savage trend. In those cases, price will storm away from the Weekly Pivot, we’ll get an entry, and price will continue dramatically in the same direction. Those type of stopouts can make us feel like our thesis is a stupid one.
But with a win rate that high, those thoughts might easily subside.
In our next email, we’ll look at what this system looks like if we compounded our gains and we’ll also look at a bigger target. But so far, this looks like trading back to Fair Value is promising.
Talk to you soon.
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It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.
HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.