As you can see from the GBPUSD chart, the market attempted 7 times to  head towards resistance of 2.000, only to stop and reverse somewhere in between and drift unexpectedly back down to 1.9700.  In such a constricted and volatile 300 pip range (with each leg up and down of uncertain length and duration), neither longs nor shorts could have much potential for profit, with the downside risk of stop out being greater. A few of our strategies did manage to breakeven in their attempts to go long or short, but others attempting pivot high or low breakouts hit their 150 pip stop losses when market reversed.

As you can see from the EURUSD chart, the market attempted 5 times to move up and break through resistance of 1.5900, but each break at or above that number could not be long sustained, and market headed south towards its 1.5700 support. A few of our strategies did manage to capture some of their profit (or at least breakeven), if they were generated near the low range of the channel (if going long), but there were others entering at the mid to outer edges of the range that could not find a grip either long or short .The market finally fall and break through the 1.5700 support on the downside but only on the last two days, not enough time for our shorts to show much of a profit for the month. Given that the month had an overextended period of  whipsaw ranges across all the dollar based currency pairs (except for USDJPY), we had a more than usual number of trend and breakout strategies being stopping out (at 1% stop loss each), all accumulating to this month’s current draw down figure.

If this month teaches a lesson, it is a very difficult one to implement in practice: try to stay out of whipsaw months. This is easier said than done.

No one knows for sure how long a whipsaw trading range can hold for any currency pair. Most successful mechanical trading systems work with either the trend or the breakout above/below ranges, and most of our systems are no exception to this. We have a few range trading systems, but they do not make a significant part of the mix because range trading over time can be very dangerous, with the large stop losses eroding the gains made by the smaller profit targets (note: range trade systems usually requires smaller profit targets and larger stop losses). Thus, given that most of our systems depend on their profitability from the market continuing its established trend or breaking out of its ranges, then the next best thing is to somehow avoid trading in market ranges, for attempting to trade the trend or breakout in extended market ranges can add up the losses. 

The Solution 

To the end of avoiding frequent trading during market range phases, we have created and applied a “Smoothing Filter” and “Smoothing Exit” to all our existing strategies, starting this month. This smoothing filter is designed to identify the larger trend of the market, either up or down, and also spot the market reversal or turning points. Once it identifies the larger trend, or pending reversal from it, then it filters out those trades that are attempting to initiate to trade according to their own logic, but outside the boundaries set by the filter. It is not a magic filter, but a scientifically tested one that significantly improves strategy profit factor across the board, back tested in the last 20 years. 

For example, this filter would have prevented us from getting into as many losing long and short EURUSD and USDCHF trades generated in the consolidation phase before the market turned direction. Though the EURUSD eventually did turn south (and USDCHF turned north) at the end of the month, for most of the month this was seemingly uncertain; however, this newly designed and back tested filter did detect the pending reversal (and market indecision) and would have prevented the trades from initiating during the dangerous consolidation phase.

We believe that going forward we will have more protection against future consolidation phases by detecting them earlier on and stepping aside. In addition, this smoothing filter has been converted into a smoothing exit and applied to many strategies, so that when the filter senses that the broad market is turning direction, and that the trade is moving in the opposite direction from the pending turn, it will exit from the trade with much less damage than from being stopped out.

This new exit version of the filter would have enabled many of our breakout GBPUSD trades this month to exit with just minor damage each of the seven times the market turned direction.

In sum, then, the newly created and implemented smoothing filter and exit act as the warning sign and life preserver for a dangerous swim zone: the smoothing filter will warn (and prevent) many strategies from entering in a chopping market condition in the first place, and if the plucky strategy does enter during this phase, then the smoothing exit will help limit the downside risk, bailing out the trade before a counter wave sinks it to the bottom.