Channel Breakout with 20-Tick Barrier

So far our channel breakout on the close stipulated that the close be one tick above the high or low of the previous 20 days. The one tick is sim­ply a barrier level beyond the 20-day trading range. Figure 5.6 uses a 20-tick barrier, instead of the 1-tick barrier. This number is arbitrary; you could certainly test other values. In this case, the decisive close above the barrier led to a strong rally.

156 Developing Trading System Variations

Figure 5.6 The 20-tick barrier for the March 1986 U.S. bond market contract. The thick line is the 20-day high. The narrow line is the 20-tick barrier.

Table 5.4 shows a summary of test results of the system using the volatility exit discussed in the previous section to provide continuity. The initial stop was set at $1,500 and $100 was allowed for slippage and commissions.

The net profit was essentially unchanged compared to the 20-day channel breakout with a volatility exit (see Table 5.3). However, this same profit was achieved with 26 percent fewer trades on average (141 versus 191). The average gain per trade climbed 21 percent, as you would expect with fewer trades. Thus, the main benefit of using a wider barrier is to reduce the total number of trades without hammering prof­itability.

Note how the results for the U.S. bond market improved from a loss to a profit when we went to a 20-tick barrier. This suggests that many big players are fading the market, say one to ten ticks beyond the previous high or low. Thus, there are many big sellers a few ticks above the previous day's high, and many strong buyers a few ticks below the previous day's low. Only when you clear through this interference does the price change become significant.

Table 5.5, page 158, shows the results of testing the 20-tick barrier system without any exits, and thus clarifies another aspect of the channel break-out system. Remember that not using any exits converts this sys-

Channel Breakout with 20-Tick Barrier 157

tern into a pure trend-following system, with symmetrical entries and exits. Thus, the 20-bar long signal is also the 20-bar short trade exit and vice versa.

The net profits with a barrier but without exits are 50 percent higher with 37 percent fewer trades than with an exit (compare Table 5.4). Surely the basic trend-following system is quite attractive. So it is fair to ask why we should have any exits with the channel breakout. The answer lies in the number of days the systems are in the market, and by implication in the potential risk exposure. If we do not use any exits, the 20-bar breakout system is always in the market. If we add an exit strat­egy, the system is out of the market some portion of the time. You can expect a reduction in exposure to market risk if the system is often out of the market.

Table 5.6 summarizes the number of days the 20-day channel breakout is in the market with and without an exit. Adding the volatility exit reduces the number of days the system is in the market by 58 per­cent on average. Thus, there is a significant reduction in potential risk when we add an exit to the channel breakout system. Your account could be earning interest when you are out of the market. Your interest in­come will also help to smooth out account equity.

Table 5.4 Results for the 20-bar channel with a 20-tick barrier and volatility exit.

						Maximum
						Intraday
		Number	Percent­	Win/	Average	Draw­
	Profit	of	age of	Loss	Trade	down	Profit
Market	($)	Trades	Wins	Ratio	(S)	(S)	Factor
British	24,588			1.69	no	-26,888	1.15
pound
Coffee	175,631			3.04		-22,605	1.98
Cotton	27,430			2.28		-18,595	1.25
Crude oil	^0,630			1.04	-366	-42,130	0.40
D-Mark	33,275			2.23		-7,813	1.46
Eurodollar	2,250			1.92		-2,900	1.34
Gold	31,610			2.87		-25,640	1.38
Japanese	53,950			2.08		-9,550	1.60
yen
U.S. bond	29,925			2.46		-20,113	1.49
Wheat	-5,250			2.17	-38	-15,650	0.89
Total	332,779	1,410
Average	33,278			2.18		-19,188	1.29

158 Developing Trading System Variations

Table 5.5 Results for the 20-bar channel with a 20-tick barrier and no exit

Market	Profit ($)	Number of Trades	Percent­age of Wins	Win/ Loss Ratio	Average Trade ($)	Maximum Intraday Draw­down ($)	Profit Factor
British	101,644			3.75		-25,544	1.69
pound
Coffee	220,100			5.46	1,508	-25,224	2.37
Cotton	43,345			2.94		-15,310	1.41
Crude oil	-1 7,320			1.40	-315	-29,020	0.68
Deutsche	49,900			2.66		-10,163	1.64
mark
Eurodollar	2,150			2.78		-7,225	1.19
Gold	-6,320			2.14	-83	-56,940	0.92
Japanese	74,575			3.40		-12,813	1.81
yen
U.S. bond	44,400			4.50		-19,825	1.69
Wheat	-12,581			1.87	-143	-29,494	0.79
Total	499,893
Average	49,989			3.09		-23,156	1.42

Note that the average maximum intraday drawdown was $19,188 with the volatility exit, versus $23,156 without any exits. Thus, there was also a 17-percent reduction in average drawdown by adding the exit strategy, but this could have occurred purely by chance. Thus, the pri-

Table 5.6 Adding an exit decreases the number of days a system is in the market

Market	Days in Market, No Exits	Days in Market, Volatility Exit	Percentage Difference
British Pound	4,028	2,322	-^2
Coffee	2,945	1,932	-34
Cotton	4,568	2,948	-35
Crude oil	2,732		-68
Deutsche mark	4,605	1,904	-59
Eurodollar	1,643		-83
Gold	4,110	1,713	-83
Japanese yen	3,838	1,645	-58
U.S. bond	3,005	1,196	-57
Wheat	4,816	2,287	-60

Average

3,629

1,711

-58

Channel Breakout System with Inside Volatility Barrier 159

mary benefit of expanding the barrier is to reduce the number of days the system is in the market.

Ideally, you should base the width of the barrier on market volatil­ity. A fixed barrier may be too far away to trigger trades within the usual range of daily volatility. For example, the 20-tick barrier is too wide for the Eurodollar market. A volatility-based barrier will respond to market action and provide a more consistent barrier across all markets. The next section discusses the effect of using a volatility-based variable barrier in­stead of a fixed barrier.