Maximizing Investing Profits with a Mechanical Trading System

The 90% Rule – So Close to Target

We call one our 90% rule. That is basically designed for times that our mechanical objectives get within 90% or greater of full target. I can tell you without question we will never take a loss on a strategy that barely misses target. There is simply no reason to stubbornly wait out the next couple of ticks and in the meantime be willing to risk it all the way back to a full loss just because a calculated target just misses. We therefore in our minds know that if our objectives are $2.00 on a stock we will definitely have a stop adjustment if it gets to $1.80 or higher.

In fact, you might want a 50% rule. It is a good idea to ratchet up your stops (when long – opposite when short) when you get halfway to an objective. This doesn’t mean you should tighten stops so much that you get taken out repeatedly the moment it retraces even a slight amount, but it should be a level where you have some action plan built into your strategy. 50% and 90% or thereabouts are good levels to build some type of risk reduction into your plan and then some means of locking in profits. We always want to give our trades room to “breathe” – do not just get jumpy and head for the exits at the first sign of a entrancement. Going back to the concepts further up in this document, if you have a strategy that has put the odds in your favor, you have to let that strategy do its work. You need to give it the chance it needs – but ratcheting up stops (or down if short) is wise and still allows that trade room to roam and get your full objectives, while at the same time giving you the relief of cutting risks substantially and rewarding yourself for getting halfway there, and ultimately trading with a trade that you know is guaranteed to make a profit, rewarding yourself for the trade getting 90% of the way there.

What about “Key Levels?”

There are levels that markets just have a hard time passing, up or down. All support and resistance gets broken eventually so we don’t build strategies around these levels with the fear that they cannot be broken. If the case is that our profit objective requires one to be broken, then so be it.

However, you need to understand that much of trading is crowd psychology and though someone could put together a thesis on how there should be no difference between valuation of a market at 41.98 vs. 42.00 (the round number), it is a fact that traders, down to the individual basis, are the ones who are influencing these prices, and rightly or wrongly there is a lot of attention paid to key levels.

Now, you might think with all the electronic and program trading out there that these “robots” ignore these key levels but it is not difficult for any experienced trader, and therefore system developer, to realize that you have to respect these levels. So even as program trading starts to dominate many markets, they are building into these models these same behaviors.

What this means to you is that you need to know what levels “matter” in the markets you trade. It is different depending upon time frame and markets.

In the Forex markets, we always respect the “00” and the “50” levels, meaning 1.97”00” or 1.97”50” – this does not mean we do not exit the moment a market gets close. However, you can bet that if we have a set-up to buy at 1.9698, we are not going to enter that trade until it gets up and over 1.9700 and to 1.9702 or 1.9703. Same goes if we are heading short, and we get a set-up at 1.9754. We are not going short until the market breaks 1.9750, so 1.9748 for example.

Respecting key levels will add at least 5% or more to your win/loss ratio. It is measurable and can really make the difference.

The same case can be made in virtually all markets. Index futures? Pay attention on an intra day/day trading basis for example on the Russell e-Mini to the xxx.50 and xxx.00 levels. You’ll be amazed how often you will have a target that might be 830.10 and it will only get to 830. If it is close to a key level we adjust for it. Why make a market fight through a key level for an extra tick? Doesn’t seem worth the stress to us.

Same goes when setting stops. If we know day trading that the 829.”50” level should be watched and a sell stop is calculated at 829.60, you can be sure we’ll be lowering it down below the 829.50 level and instead more safely placing it at 829.40, assuming that the 829.50 level might be the area the support comes in. It is a key level.

Swing trading we wouldn’t pay much attention to the levels on that micro of a level. However, we would pay attention to the “5’s” such as 800, 805, 810, 815, 820 and even the round numbers like 806, 807, 808, and so on.

This is all just fine-tuning but it is that last thing you can do in your trading plan, it becomes total second nature, and it works across all markets whether stocks, Forex, futures, commodities, etc. It doesn’t matter. This is how you take a mechanical strategy, apply the art and experience to it and measurably improve your performance.

Never be afraid of support/resistance but be sure you at least acknowledge its existence and make small adjustments when you can – do not make large adjustments just to avoid facing down a key level, but small adjustments where you give up very little on the target or have to widen your stop just a bit make great sense.

Some of you might want to track and watch other Key Levels, such as Pivot formulas (of which there are several, all easily found by doing a basic Google Search or already built into your charting platform), Fibonacci levels (entrancements, projections, etc.), previous day highs, lows, closes, and so on.

What you don’t want to do is draw so many lines on your charts that you become paralyzed. Remind yourself that all levels will ultimately fall. They are not to be avoided, but they are to be respected. Nothing more.