In the book “Trading for a living” by Dr Alexander Elder states it pays for retail traders to design a system that will give signal relatively infrequently. This will save you a ton in fees and whip-sores. A trading system that trades infrequent doesn’t mean there will be no drawdowns or the system will always produce winning trades. Since there are fewer trends than ranges, a trend based system fits perfectly this criteria. It helps a lot if that system is simple to understand because it means it will be easy to stay discipline to.
The 7/21 System designed by Simon Brown is one such system, it tries to catch trends as they start, and ride for as long as possible. It uses 2 simple moving averages, the 7 & 21 simple moving average applied on close.
The system is works well with low volatility
- Major forex pairs
No so well with high volatility
- Minor or exotic forex pairs
- Single stock CFDs
- Crypto currency
To catch a trend what you need
- Indicators that the trend is starting
- The direction of that trend
- Where and when to enter
- Position sizing
- When to exit the trend
- When the starting trend fails
All of which need to be as objective and mechanical as possible.
Determine if a trend is start (Signal)
When the 7SMA crosses the 21SMA we have a signal that a trend is beginning. When the 7 crosses the 21 from below I have an indication an up trend is beginning, inversely with down trend. I need the market to confirm the trend before I enter.
I need the market to close higher (in the case on an up trend) or lower (in the case of a down trend) than where it closed when the crossed occurred.
When I have a confirmed signal, I enter at the open of the next candle, the speed of execution required depends on the timeframe. Longer timeframes are more forgiving of slow execution.
Position sizing and risk per trade
I subscribe to the 2% rule. I only risk 2% of my portfolio on any given trade. My position sizing is always such that only 2% of my portfolio is at risk.
I like to base my initial stop using the weekly Average True Range when I enter the trade, I base my position size on it.
Account size: R100 000
Max risk(2%): R2000
Position size: R2000/1000 = 2 contracts
Some brokers have a fixed cost per index point, in which case I would multiply the weekly ATR by the cost per point.
Because the system tries to ride the trend for as long as possible. The only exit there is, is at stop loss. The stop loss is the close below (in long positions) or above (in short positions) the 21 moving average. When that happens I exit at the open of the next candle.
When does a buy/signal fail
A buy/sell signal is regarded failed, if the moving averages cross again before the signal was confirmed.
An example of a short trade.
Example of a long trade.
- Very simple to understand and trade
- Rides this long bull bear markets for much
- Trades infrequently
- The two step entry reduces
- It can have an extended string of loosing trades, in a ranging market
- At times the close below/above 21 moving average can take you out of good trades, but that just the nature of the trading.