A common sense approach to price observation

Buy when prices are going higher and sell when prices are
going lower. In a nutshell this is my goal when I am trading
the forex market. But the above statement of buying when
prices are going higher or selling when prices are going
lower may be too broad and therefore it may need some
guidelines and rules, this is where The 3 Duck’s Trading
System comes into play. The system will help you identify
buying opportunities in the direction of the last uptrend and
selling opportunities in the direction of the last downtrend.
The “ducks” in the title comes from the saying “to have all
your ducks lined up” an expression meaning to have
everything in the correct order. There are three ducks, the
first duck will help you to identify the last up or down trend,
the second duck helps to confirm the direction of the trend
and the third duck will help to identify buying or selling
opportunity in the direction of the trend.
This system involves using three different timeframe, a 4
hour chart (first duck), a 1 hour chart (second duck) and a 5
min. chart (third duck). A 60 period simple moving average
is applied to all three timeframes. That’s what I call keeping
it simple!

Back testing – I’m not a big fan
With comments like this one I often get a mixed response.
Back testing has its uses, but if a system buys when prices
are going higher and sells when prices are going lower I
don’t feel a need to back test the last twelve months or the
past 100 trades. What I will do is forward test the system in
real market conditions. The first phase of forward testing for
me would be to observe the system. I really want to see the
system working with the trend and doing what it is supposed
to do most of the time. I believe that if prices are going
higher there is a greater probability that they will continue in
that direction. The second phase would be for me to see
what I can do to make the system perform better, how can I
get this system working at its optimum? If I know what my
trading goals are i.e. x% per month or x% per year, what do
I need to do to give the system the best possible
opportunity of achieving these goals? How much should I
risk per trade? What size stop-loss should I use? what size
targets will work best for me? would it be best for me to
positional trade this system or would day trading this system
be better? When I have decided on the above I can forward
test the system again with these figures in place. After a
number of trades or over a period of time I can calculate my
win/lose ratio – what is my average winner compared to my
average loser? I will also calculate my probability of a
winning. Armed with these stats and with confidence in the
system I will then happily commit to it 100%, I will always
be keeping a close eye on my stats and looking for ways to
improve.

Risk versus Reward – It’s GOLDEN
“Let your winners run and cut your losers short” is what all
the trading books tell us. This statement is true, but with a
lot of trading statements you got to ask yourself, what does
this mean to me? For me it means having a positive risk
versus reward ratio. If I enter a trade with a 30 pip stop-loss
my projected reward must be greater than 30 pips, how
much greater does it need to be? Every trading opportunity
will be different but I would need at least one and a half
times my risk, which is 1 : 1.5, a trade with a 30 pip risk
must have the potential to gain at least 45 pips. I think
trading with anything less than 1 : 1.5 would be just like
playing tennis with my broker! Because The 3 Duck’s
Trading System trades in the direction of the trend it can
offer some great risk versus reward trades. Having a positive
risk versus reward ratio is one of the reasons I can stay
focused on my trading after a losing run, I know in the long
run I will come out on top.

Getting started
You can use most of the free charting packages to plot the
system on. You will need a 4 hour chart, a 1 hour chart and
a 5 min chart for each currency pair. For EUR.USD open the
4 hour chart and apply a 60 period simple moving average
(sma) like below:

You need to do exactly the same for the 1 hour chart and
the 5 min chart. You should now have three charts that look
something like this:

We now have three charts for the EUR.USD pair, we can
have a closer look at each chart starting with the 4 hour
then the 1 hour and finally the 5 min chart.
Note: Over the next few pages I will be using the words
“buying” and “up trend” to explain how this system works.
This system works for buying and selling opportunities.
Simply do the opposite for selling opportunities starting with
steps one, two and three. This system will work best
between the times of 7am – 4pm GMT. This system can be
applied to any currency pair just be careful to take into
account different currency “personalities”. All charts are for
demonstration purposes only.

The first duck
The 4 hour chart is our starting point, our first duck. We
need to find out if prices have been going higher or lower, is
the trend up or is it down? We can very easily and quickly
get the answer to our question: If the current price is above
the simple moving average on the 4 hour chart this will tell
us that prices have been going higher over a period of time.
We may be looking for buying opportunities, but firstly we
need to check our other two charts and make sure all our
ducks are lined up in the same direction.

The second duck
The 1 hour chart, our second duck is used to confirm what
the 4 hour chart is telling use. If the current price is above
the sma on the 4 hour chart it will also need to be above the
sma on the 1 hour chart. If the current price is above the 4
hour sma but below the sma on the 1 hour chart, that would
mean the two charts are not lined up in the same direction
and we would not be able to move on to step three.
However if the current price is above the sma on the 4 hour
chart and the sma on the 1 hour chart we could move on to
step three.

The third duck
The 5 min chart, our third duck is used for entries. What we
are really looking for on the 5 min chart is for prices to get
above the sma and move higher than the last high on the 5
min chart. For me to explain this system as clear as possible
let’s have a look at the chart below:

From this chart we can see that prices where below the sma,
then prices crossed above the sma, this would mean that all
our three ducks where lined up in the same direction. We
would now be looking to buy when prices move above the
last high (two candles to the left with lower wicks and two
candles to the right with lower wicks) on the 5 min chart.

Entries – A good entry makes a big difference
Buying or selling at the early stages of an up or down move
is very nice if you can do it. Some of my best entries and
most profitable trades using this system have come from
when the current price was above the sma on the 4 hour
chart and the sma on the 1 hour chart but below the sma on
the 5 min chart. Similar to the chart above, if you can then
enter a trade on the “first move” when prices move above
the 5 min sma and the last high, I think you will be
potentially catching the move in its early stages. You can
enter a trade when the open 5 min candle get above the last
high or you can wait unit you get a closed candle above the
high. The EUR.USD pair will pullback some of the time after
it has broken the high. It may be worth your while to wait
for a small pullback after it has broken the high, this will
allow you to enter the trade at a better price. As long as the
current price is still above the 5 min sma the potential trade
is still good. From the chart below we can see how prices
pulled back after it broke the high and then continued
moving up again.

GBP.USD is a different story! This pair will often break the
high or low and continue moving in that direction without a
pullback.

On the above chart we would be looking to sell when prices
cross below the last low and the sma on the 5 min chart.
Entering a position if the candle is open or closed really does
not make a huge difference on a 5 min chart in my opinion.
I will enter most of my trades when the candle is still open –
a HOT candle! After all I am trading price, not candles.
There is nothing stopping you from entering or adding to
winning positions when the current price is higher/lower
than the “first move” as long as all your ducks are still lined
up in the same direction you could still be looking for
opportunities on pullbacks or breaks of the highs/lows.

Here is a question I get asked a lot: If the current price
is above the sma on the 4 hour chart and above the sma on
the 1 hour chart, but the current candle is NOT CLOSED
above the sma on the 1 hour chart, would I wait for a closed
candle on the 1 hour chart before I drop down to the 5 min
chart to look for a buy entry?
My reply to that question would be: The 3 Duck’s
Trading System has a number of rules or “guidelines” as I
would prefer to call them. Rules are good, but sometimes
rules can get in the way of a good trading opportunity! If the
trading scenario in the above question was happening in
front of me I would certainly be prepared to bend one of the
rules if I thought the circumstances where right.
The same can be said for a lot of other trading dilemmas
and questions that may arise from trading this system. I like
to use this system as a guide in addition to my own market
knowledge i.e. what is happening around me today? Is there
economic news out today? What time in the day is it? Is it a
holiday today? Is the market stuck in a choppy range? etc
etc. The principal of this system is to trade in the direction of
the trend and to enter a trade at a price that offers you
some chance of success. Prices on all three timeframes
MUST be above/below their sma’s, this is the one rule I will
NOT bend!

Stop-losses – If it doesn’t work out, get out
What size stop-loss should I use and where should I place
my stop-loss? There are defiantly more questions than
answers in trading! I love stop-losses, I just hate when they
get hit. By knowing what size my stop-loss is and what size
my target is, this will allow me to calculate my potential risk
versus reward ratio. And as I’ve said earlier, risk versus
reward is golden. The size of your stop-loss really depends
on how you are going to trade this system. Positional traders
and swing traders will probably be using wider stop-losses
than a day trader. A positional trader may want to use
support or resistance off a 1 hr, 4 hour or daily chart as a
stop-loss location. The 60 period sma from the 1 hr or 4
hour chart could also be used as a stop-loss location for
positional traders. After all if you where buying and prices
dropped below the sma on the 1 hour chart or the 4 hour
chart, this would mean that your ducks would not lined up
anymore for a buy, so this may be a stop-loss location.
Support or resistance off a 1 hour chart or lower timeframe
may be useful as a stop-loss location for a day trader. Fixed
stop-losses are also good for positional or day traders. A
positional trader may use a fixed stop-loss of 100 pips for
example. A day trader may use a fixed stop-loss of 20, 25 or
30 pips for example. The question of where to place ones
stop-loss can really only be answered by the trader him/her
self.

OK Captain what about the second part of the above title,
the bit about: If it doesn’t work out, get out
A lot of traders will get out of their winning positions too
soon, but do they ever get out of the losing position too
soon? Probably not, they let prices drop down to their stoploss
and get taken out for the full stop-loss amount.
One of the things I like to observe when I am trading this
system is: are prices obeying the 3 Ducks rules (current
prices above/below sma’s on the three timeframes) this is
especially true for when I am in a trade. Let have a look at
the chart below, the current price is above the 4 hour sma
and the 1 hour sma (two ducks are lined up). I am now
looking at buying when prices cross above the sma on the 5
min chart and the last high on the 5 min chart (all three
ducks line up). I am day trading so I will put my stop-loss
below the last decent low on the 5 min chart which would be
20 pips away from my entry. My target for this trade is 40
pips.

Everything is going according to plan in this trade, we have
entered the trade by following the rules and our risk versus
reward is good, now we play the waiting game.
But what happens next may have put our trade in doubt.
The current price has dropped back below the sma on the 5
min chart by more than 10 pips, this mean that all our 3
ducks are no longer lined up in the same direction. Our stoploss
is still in place and has not been hit. We have two
choice, we can either wait and see what happens or we can
get out of this losing position early and save some pips, after
all our ducks are no longer lined up!

This is what I call “If it doesn’t work out, get out” plan. If
this trading scenario was to happen I would gladly get out of
this position early before my stop-loss was hit. Let’s roll this
chart on and see what eventually happened:

This trade would have continued lower and would have
easily taken out our original 20 pip stop-loss. By
understanding this system and been able to identify when
prices are not obeying the system you can save yourself a
lot of pips.
Note: If you where a positional trader using this system the
above scenario may not bother you too much. I would
mainly use this exit plan for day trades.

Targets – Letting it run & knowing when to exit
Knowing when to get out of a winning trade can be one of
the biggest brain drainers for traders. But now that we
understand how this system works and we can clearly see if
prices are obeying or not obeying this system, we can use
this information to our benefit while we are in a trade. As
pointed out in page 3, risk versus reward is GOLDEN so
before you ever enter a trade the potential reward should be
greater than the risk. Support and resistance levels from a
daily chart can be good target areas. Some questions I
would ask myself in relation to potential targets would be:
“has this currency pair been moving in a strong trend? (Have
a look at the 4 hour chart) If the answer is yes you could be
more generous with your potential targets. If the prices have
been moving in a 100-200 pip range, then a more
conservative target may be needed. Letting profits run can
be done by observing how the current price is moving in
relation to the sma’s. Let look at the chart below:
From the above chart you may have bought using the rules
of this system. You can see that prices are staying above the
sma, this is obviously a good sign if you are long! If you are
trading this system you could stay in this position as long as
the current price remains above the 5 min sma. This is an
example of how you can let your profits run!
Positional traders may wish to hold their winning positions as
long as the current price remains above the sma on the 1
hour timeframe.
Knowing when to exit a winning position can also be done
by observing the current price in relation to the sma’s. From
the same chart, we can see when prices drop back below
the sma this may be a good exit plan from you winning
position.

Again, positional traders using this system may decide not to
exit a winning position using this strategy.

Make it your own
You have now seen how this simple system works but you
and only you can make it work for your trading. When I say
“Make it your own” I DON’T mean change the sma periods
or use different time frames. This system works, don’t break
it! What I do mean when I say “make it your own” is: decide
how you are going to trade this system, day trading or
position trading? How much will you risk per trade? What
size stop-loss will you use? How will you decide where to
take your profits? By having a clear plan now, it will help you
later on.
How many pips can I make a week? YOU TELL ME!
This is the one question I get asked on a daily basis and it
drives me MAD! You should be interested in what YOU can
make using this system. If ten traders where to use this
system, I guarantee you would get ten different results.
What I would say is: by having a solid plan, following this
system and having good money management, I would
expect this system to make more money than it loses over
the long term.
By the way, a pip is a pip and a dollar is a dollar, they are
two different things and not to be confused!

A few final words
Becoming successful in trading is really all about making
more money than you lose. Having a system that you
understand and have confidence in and that also makes
sense will make your trading life easier. Having a positive
risk versus reward ratio will certainly help you too. Your
trading results should be really judged over a long period of
time or over a high amount of trades. Not every single
winning trade in your account will end up having a positive
RvR ratio. But by knowing that every trade you enter has the
potential to earn more than it can lose and by embracing the
“cut your losers short and let your winners run” mind frame,
you would be one step closer to successful trading.
The views in this book are my own. I hope that I have
helped you in you trading and that success is close by. The 3
Duck’s Trading System does have losing trades and losing
run, you would be foolish to think it didn’t.