So what does the “lens” actually do ? Imagine that you have a system that trades a very simple entry like a moving average cross with a stop loss value of 50 pips and a take profit value of 50 pips. The perfect setup for the system is when there is a moving average cross and the market moves 50 pips towards the favorable side before moving 50 pips into negative territory. This is what we could call the system’s ideal trading condition. However if you analyze any moving average cross for the past 10 years and you determine the mathematical expectancy in terms of pips, you’ll notice that the actual movement varies greatly as market conditions change. Sometimes the system would be able to capture 100 pips, other times 20, other times 50. In the end, you find that the “ideal” condition for the system is fairly rare and when it appears it seems that it is failing to achieve its true potential. What we want to do is implement some type of adaptation technique such that those 50 pips do not remain constant but that they change with market conditions such that the probability of reaching an “ideal” condition becomes higher.
But how does the market change ? What makes a moving average cross in 2004 give only 20 pips and in 2008 give 300 ? What fundamental characteristic of the market changes ? Of course, this is not an easy question. An analysis of market properties over time related to the extent of movements reveals that the size of movements such as moving average crosses increases as volatility does. This means that if volatility grows, then the extent of our TP and SL should grow too to show us the “ideal” condition under current market conditions. This is the technique used on many of my trading systems which adapts a system’s parameters against changes in market volatility. This allows the systems to remain efficient and fit to the current market’s ideal trade while maintaining a very good degree of simplicity.
So the “lens” of a trading system can be market volatility, with this tool systems are able to “focus” on current market conditions and get a clear picture of what an ideal trade under the current market status would be. This adaptation proves to be vital for systems to survive to changes in the instruments they are trading as systems which maintain fixed parameters are like a camera with a fixed focus, once the picture changes they aren’t unable to determine what the image actually is.
It would be naive to say that volatility is the only actual parameter of the market that changes with changing market conditions but it is the easiest parameter we can measure that allows us to generate an adaptability criteria. Of course, other ways of adaptation which measure other aspects of the market such as “pattern shapes”, “length of trends/consolidations”, etc are also possible but their measurement is far more complex and doesn’t necessarily generate better results than those that arise from a simple volatility adapting criteria.
If you would like to learn more about adaptability and how you too can learn to build systems which adapt to changes in market conditions using volatility please consider buying my ebook on automated trading or joining Asirikuy to receive all ebook purchase benefits, weekly updates, check the live accounts I am running with several expert advisors and get in the road towards long term success in the forex market using automated trading systems. I hope you enjoyed the article !