Many
aspiring traders focus on setups and entries. I would say 90% of their
time is actually dedicated to perfecting entries. That is one way to
miss the forest for the trees. Back in the 1990’s, Tom Basso and Van
Tharp had already issued research conclusions on the relative
unimportance of entries in producing good trading results. Their “Coin
Flip” study showed that across 10 futures markets, a simple random entry
with a trailing stop made money.
Assuming
they did not cherry pick the situations for the test, is the relative
unimportance of entries still valid now? Does the random entry still
work or have the markets changed? We decided to answer that question
with a research project using current Forex data.
Tom Basso’s Coin Flip Study
In his book Trade Your Way..., Van Tharp explained how he and Tom
Basso came up with their idea to test a trading system using random entries:
"I
was doing a seminar with Tom in 1991. Tom was explaining that the most
important part of his system was his exits and his position-sizing
algorithms. As a result, one member of the audience remarked, 'From what
you are saying it sounds like you could make money consistently with a
random entry as long as you have good exits and size your positions
intelligently'”. – Van Tharp, Trade Your Way...
Here are the very simple rules Tom Basso used to test the viability of a random entry system:
1) Hypothetical $1 Million account →
this is required in order to simulate diversification amongst futures
contracts, withstanding margin requirements and drawdowns.
2)
Select markets that have more of a tendency to trend so at that time,
this meant commodities and futures markets. In particular, the markets
tested were Gold, Silver, US Bonds, Eurodollars, Crude Oil, Soybeans,
Sugar, Deutsche Mark, the Pound and Live Cattle.
3)
The exit is 3X Average True Range (10 day period) subtracted from the
close. The trailing stop can only get closer to the current market
price, not further away.
4) Position sizing strategy: risk 1% of equity per position
5) Selected markets must be liquid (so that trades can be entered and exited immediately with low slippage).
6) Always be in the market (so as soon as one trade closes, another is opened).
We
used these same rules to run simulations in MT4 with the help of our
resident programmer Craig Drury. We tested the six FX Major pairs along
with Gold from January 1st 2014 to June 30th 2016 (except for NZDUSD
which because of data errors, was tested only until the end of February
2016). Effectively, we tested the random entries through trending and
range bound environments over the entire test period. Unfortunately, MT4
doesn’t have a Monte Carlo generator so we had to do all the runs
manually (20 runs) and it was a lengthy process.
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