The 40/125 Forex Trend Trading Method

October 28, 2017 03:48 PM
Cutting your losses short and letting your winners run is a common bromide of trend trading, but takes a plan and the discipline to follow it.

Strategy Rules
To trade the 40/125 Forex Trend Trading Method, place a 40- and 125-day SMA on a daily price chart. Include a standard, 12/26/9, MACD indicator on the daily price chart. Also include the 14-day ATR on the daily price chart to calculate your stop loss level.

For longs:
When the 40-day SMA crosses above the 125-day SMA a setup is signaled, if

The MACD crosses signaling an upward trend at the same time, and

Price trades above a previous high, then

Enter the trade with two times the 14-day ATR as the stop loss point.

For shorts:
When the 40-day SMA crosses below the 125-day SMA a setup is signaled, if

The MACD crosses signaling a downward trend at the same time, and

Price trades below a previous price low, then

Enter the trade with two times the 14-day ATR as the stop loss point.

Your stop loss should be adjusted daily based on the two times ATR metric.

Once the trend gains your total risk you can scale into a second position equal to one half your original risk. If the trend continues then scaling in helps magnify the return (see “Multiplying earnings,” above).

As of this writing, the trade is still viable, and because we calculate the stop loss level daily, the stop scales higher as the trade accrues profits.

A Word on Scaling In
Huge returns are intoxicating, so if you’re willing to risk a bit more to gain a larger return, then consider scaling in to a winning move. If your trade gains your initial risk then you can scale in half your original position to take advantage of a potential homerun. It doesn’t always work out but the potential return can be far greater for the slight increase in risk. Also, when you add to your position, you adjust your stop level, locking in the initial profits or moving your stop to a breakeven level.

The Danger of Apathy and Trading Complexity
It’s worth mentioning that the biases of herding and confirmation still pose as much a danger to you as the other traders who aren’t familiar with the term. Price trends can result in a type of apathy on your part as these biases seep into your trading decisions.

While being aware of them is powerful knowledge for exploiting forex price trends it remains a double-edged sword. Finding yourself under their spell will make it harder for you to act when the exit signal comes.

You have to remind yourself daily of their toxic effect, which is why some trend traders act too slowly when the trend comes to an end. The longer the trade goes in your favor it makes it increasingly difficult to take the appropriate exit.

In addition, the simplicity of the 40/150 method lends itself to another bias called the “complexity bias.” This is a human tendency to tinker with something that has been proven to work with the goal of making it even better or perfect.

This is why over-optimization is so common among system designers, who sometimes lose sight of the goal of designing a robust trading method in favor of a mythical Holy Grail.

If you find yourself deviating from the rules or changing the rules, then you’re committing the sin of taking the simple and making it complex. Worse, if you’re doing it in the middle of the trade you’re setting yourself up for unnecessary losses.

You might succeed every now and then but eventually it’s going to come back and bite you. It’s like running around in a dynamite factory with a lighted match; you might survive but you’re still foolish for doing it.

Test and customize according to your goals and to match your personality, but execute with discipline without being blind to your own biases.   

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About the Author

Billy Williams is a 20-year veteran trader and publisher of www.StockOptionSystem.com, where you can read his commentary and a report on the fundamental keys for the aspiring trader.