Putting the numbers to use

Now that we have the numbers, how do we apply them to trading? There are a few ways to incorporate this data. First, the process of forming a hypothetical track record, including profit/loss, MFE, MAE, and trade length, is a fundamental step toward refining trading rules. Profit targets can be determined based on typical favorable price movement, stop-loss points can be based on MAEs, and the types of trades that ultimately are not profitable can be identified.

In this case, the MFE analysis indicates trades that do not exceed 250 pips in open profit tended to be closed out at a loss. This leads to the idea of tracking breakouts beyond the previous week’s high or low and looking for reversals of the near-term trend if the 250-pip point is not broken. On the other hand, a move 250 pips beyond the close of the breakout bar implies a very strong trend.

Many of the trades with MFEs smaller than 100 pips had MAEs of more than 200 pips. This implies that during trading ranges false breakouts lead to solid moves in the other direction.

Finally, if the MFEs seem to shift, as they did in early 2005 (the two largest MFE for short trades occurred in January and April 2005), it could indicate a change in the trend. This type of analysis which provides concrete statistics about market behavior and trade characteristics — gives the most useful inputs for trading approaches.