By World Cup Champion Trader Rob Mitchell
The first couple million I made as a trader used a trading system that was only a couple lines of code. That was over 20 years ago. Now that I have had over 2 decades to refine that knowledge from that original signal, I will now share with you these concepts and how I have refined them to make the super trading systems that we use today to trade for high win percentages.
The Original System (yes, it still works today):
This concept is based on what I call the “Push-Pull.” One thing is working in one way or direction and the other is pitted against it such that the market gets “stretched.” The component that is not stretched out is the predictive one. The other component is statistically unlikely and poised to revert back to normal. When these two such things are in opposition, you are often ripe for movement in the opposing direction to the stretch. How did the system work? Back in those days, we traded on day charts. These days with volatility being what it is, we take advantage of these moves intraday mostly where we can trade multiple times daily and for high win rates historically. The concepts remain the same. Some of my students are trading this way 20-40 times per day. One of them told me the other day he is winning 92/93 trades in a week. This takes some refinement, of course, but the concepts stand the test of time. I’ll give you some resources for just this kind of refinement at the end of this article.
The original system looked at the monthly mid point; dividing the interval of the month in half. An 11 period moving average could split the market like this for practical purposes, since that interval is half the month. If the market is below that, then it may be poised to go up. If below it, then it is more likely poised to go down, given certain other conditions are met that we are calling the “squeeze” or the “Stretch.” This leads me to a couple rules we know to be generally true:
Market tenet #1: Order flow leads price movement.
Market Tenet #2: Cycle expansion comes before range expansion.
Market Tenet #3: Markets tend to trade to certain amounts of range expansion in a given interval (we call this “Probability to Extend”). You could also call this targeting. The difference being that Probability to Extend is constantly retargeting during the day “as you go.”
These three principles are just a few of many, but these main ones are at the core of most great trading systems.
Back in the early days, I didn’t know so much about the targeting part, and it didn’t matter so much as there was a bull market in those days. If you are missing this component, then when the market changes, it can be stressful (if not disasterous).
The second component of the original system was to look at market breadth as a leader of price action. Breadth is a form of order flow that is directional. So simply (and the system really was just these two lines of code), If you were below the midpoint and the breadth / order flow was rising, then buy. If it was above and order flow was declining, then sell. Then a couple lines of code for stop loss orders and that was it. So simple, yet so good as it allowed me to be and launched me into living life as a trader ever since.
In all my 20+ years of system development, I have never seen a complicated system or rule set work over time. The best trading systems tend always to be simple like this; often just a couple few lines of code. You can however take this idea further to make super systems by combining several (or more) uncorrelated systems each with its own probabilities. This opens the door for what I call probability stacking and this is exactly how you can get high win percentages as mentioned in the title of this article. A system designed this way will have an extremely low probability for failure because each component stands on its own resulting in a Super System. These are the methods we use these days and I am going to show you how to do this now. So, let’s now take a look at the 3 methods/principles mentioned above, each of which is independent and opens the door for probability stacking to make a “Super System.”
Order Flow leads Price Movement
In the chart below you will see two indicators. The top one, or the one in the second panel of the chart is called the Trapped Trader Oscillator. This tool takes a number of different metrics of order flow and combines them into a simple graphic that is easy to see and interpret with some simple patterns. The second tool we’ll combine with this, is the background colors on the chart. So, we will simply look for the color to be green for buys and red to sell. So, you will see a red bar on red to sell and a green on green bar to buy. These background colors are about 75% to continue for at least a bar and, the pattern I am about to show you called the “3 Dot Pattern” is also about the same 75%. Statistically when these are combined, you get 90% to continue; called “Probability Stacking.” I have marked the 3 dot pattern out for you on the chart (labeled “3D”); simply look for 3 lower or higher dots and then for price to go with that following. Note also the background colors as described.
Cycle Expansion Leads Range Expansion
If a market is moving sideways we often call it choppy. This is another way of saying the cycle is small. Markets with small cycling widths are choppy, but what is little known is the fact that as the cycle gets wider, it squeezes the market into expansion in range (which is ultimately what we trade for). Nobody wants to be trapped in a choppy market so this method has multiple benefits as it can help to keep you out of that chop. Based on our research, an expanding cycle predicts range expansion at about the 80% probability level without regard to anything else. If you add the Trapped Trader Oscillator that we discussed above, it goes generically to about 84%. If you combine other factors, then even higher. On the chart below I have pointed out the pattern that we call the “T2” pattern. It happens when the Smart Momentum (in the 3rd panel) is going down while price is going up. See the chart below for this pattern:
In the places where these two signals that I have shown you line up, you will get a stacked historical probability of greater than 90% to continue based on Bayes Theorem that we have covered in previous articles. Now let’s cover range expansion so we know how likely that is. This is called:
Probability to Extend
The probability to extend tells us that the market will extend its range during some parts of the day over others. Range expansion commences from the open of each day and then as it goes, the probability it will go further reduces. Also, if the market gets too far ahead of itself, it will often consolidate or reverse. This can often happen at key levels. For example, in the chart above you can see the market had moved 98 ticks into the period marked D. We know historically if this market goes 98 ticks on this chart, it is almost double normal, so a reversal or consolidation is likely.
The table below is for the Probability to Extend. We know for example that at the end of B period labeled on the table as AB, the market is 98% to expand by 157% of the already existing range. AB period was 65 ticks, so the prediction is to go 1.57 * .65 or 65 ticks plus .57 * 65 or 102 ticks. As we approach this number, we know we are in the land of diminishing returns and the market actually went to 98, or 4 ticks shy of that prediction. Once the market faded back up into its range, the chances for consolidation increased and the signaling system found some buys in there and then some later sells. Particularly early in the day however, this Probability to Extend could also add to our predictions on the signals that happened earlier on in the day; meaning the signals in C period. Due to this the probabilities were even higher (about 98% and then 93% historically) for those signals to continue.
Combining all these factors together, you are getting a generic stacked theoretical and historical probability to over 95%; thus a “Super System”. You might have noticed this article focused on win percentage as a key issue. My experience trading over the years has taught me that the single most important factor in trading is win percentage and those who focus on it and refine on that metric achieve the best results. This article has been about doing just that. If your win percentage as a trader is not where you would like it, and you are interested in learning more about the kinds of concepts in this article and many more, I encourage you to join us in the OilTradingRoom.com. You can also learn more about the tools and systems behind the concepts in this article through IndicatorSmart.com.
Rob is President of Axiom Research & Trading Inc. and the mother company to the OilTradingRoom.com, IndicatorSmart.com and ManifestingYourFuture.guru. Rob has been the largest Emini S&P trader in the world at various times and has won the prestigious Robbins World Cup Emini Trading Championship. He has been a trading system developer for nearly three decades. He is a proven researcher, trading educator, presenter, and mentor helping others to achieve their dreams as traders.