Design of a EURUSD Donchian breakout strategy with proven statistical edge

This article appeared first on The Lazy Trader at http://www.the-lazy-trader.com/2012/11/eurusd-donchian-breakout-strategy.html

This article is about a Forex strategy that I designed for the EURUSD currency pair. In this exercise I would like to share with fellow Forex traders the concepts and ideas to take into account in order to design a "likely" long term profitable trading system. Steps to follow in the design process, and methods to find the answers to questions such as "Is there statistical evidence to believe this system has a positive edge?" or "How do I choose a reliable parameter set?" or more important yet "How do I know in the future that the system has possibly stopped working and shouldn't be used anymore?"

A simple strategy that beats most traders

I often find myself thinking about possible strategies and end up playing with historical data whenever I have the time. I like to come up with some experiments or simply have some fun enjoying the exercise of trying to design trading systems for different portfolio sizes and risk tolerances. Needles to say it is a tough exercise and most of the time I end up frustrated, but that's not the point for this article.

Measuring Portfolio's Performance

When browsing on the Internet for trading related content, we often stumble upon many websites that reflect some sort of historical performance, usually on a monthly basis. Sometimes we see impressive numbers that just look too good and we start doing the math in our head, calculating how much longer until we get rich with the returns achieved by those guys.

Trading with realistic expectations

A few days ago I had some emails back and forth with a reader talking about profit expectations when trading. Obviously I will protect his anonymity and I won't quote his exact words either so as not to make it personal. In the end, I believe it is valuable to share some thoughts with you folks, specially in this controversial topic as we can all benefit from a healthy discussion.

Portfolio Performance Analysis

With the arrival of options expiration yesterday, I finished the trading activity for 2012. The last position of the November expiration cycle, the  RUT 750/740 Bull Put spread expired worthless on Friday morning for full profit of $255. With this result, both trades on the November expiration cycle were profitable. The SPY 137/135 yielding $180 and the RUT 750/740 yielding $255, for a total of $435. On an initial balance of $13311 this month in the portfolio, it represents a performance of +3.27% before considering commissions.

Weekend Portfolio Analysis (11-11-2012)

The S&P500 started the week at 1414.02 and closed at 1379.85 on Friday for a -2.42% loss. And we finally left US elections behind. I had the opportunity to close the SPY 137/135 Credit Put Spread on Tuesday right before the sell off on Wednesday and this time I didn't hesitate, exiting for 0.14 debit. Could have exited for 0.11 debit but it is impossible to time exits perfectly all the time. Overall I'm glad that I closed the position for profit, and reduced my downside exposure right in front of the sell off that took place the following day.

November SPY Bull Put spread closed

The November SPY 137/135 Bull Put spread was closed today for 0.14 debit as follows:

BUY TO CLOSE 15 November SPY 137 PUT @0.31
SELL TO CLOSE 15 November SPY 135 PUT @0.17

Debit: 0.14 

Weekend Portfolio Analysis (11-04-2012)

The S&P500 started the week at 1410.99 on Wednesday and closed at 1414.20 on Friday for a small 0.2% gain. We had a solid bullish bar on Thursday and a strong start on Friday after the better than expected jobs report. I had the opportunity to close my SPY 137/135 Bull Put Spread for a debit of 0.11, which was much better than my plan of 0.15 mentioned in my analysis last week. Why didn't I close it then? Simple: I was too greedy. In the twelfth month of trading this system, trade by trade publicly disclosed on this website, I have realized that I'm usually more greedy than fearful. I could have closed the trade for 0.11 debit, I had time to do it for .12, .13, .14, .15 I had like two hours to close the spread for those prices and I didn't, only wanting and convinced that I could get a better exit.