I don't understand this, how can a pull back system which as you have already mentioned is trading against the immediate short term trend run at 75-80%, whereas a break out system, which is going with the current trend only run at 50%. The way I see it is that pull back systems win less often than break out systems, but can operate with tighter stops. Break out systems on the other hand win more often than pull backs but have to operate with looser stops.
It depends on how you time your entry. Most people who buy pullbacks try to buy as price resumes moving in the direction of the trend. It's not always as easy as it looks, and sometimes you cannot get a decent pullback when you want one. In contrast, if you simply buy new highs (or sell new lows) you always get the worst possible trade location. It only works when you have a really strong trend.
A pullback system is not in fact intended to trade against the longer term trend, but enter in the same direction. The trader is simply entering after the pullback, or when he feels the pullback has ended, or is about to end. So he is typically following the trend, but at a low price level. However, a breakout trader is jumping into an existing trend during the move. In both cases the trader is with the trend, but entering at different times in the price cycle. A pullback trader enters on weakness, a breakout trader enters on strength. Both have their value, but they do have different win/loss ratios generally. The reason a pullback system will typically have a larger win/loss ratio is because the selling has already been exhausted, and the overhead resistance is now some distance away. So if the entry is timed correctly, a good percentage of trades will often make it a reasonable profit target. However, in entering a breakout the stock is often making a near term high, and is often already in an oversold condition. The trader is taking the risk that the stock will continue to move up. And with many breakout systems, roughly 50% of the time that will not happen. The move will stall. But the breakout trader is willing to lose 50% of the time, with the idea that the winners will keep moving in a strong trend, and overcome a lot of small losses that may have reversed after entry. Both systems can be overall profitable, and often on an equal level. But the winning trades on a breakout can often be larger than those on a pullback, although there are fewer of them. But the big difference in win/loss ratios is why the systems appeal to different kinds of traders. Personally, I prefer a larger percentage of winners which is why I trade pullbacks. Others, who trade breakouts, would rather watch their winners run for a larger gain, and are willing to give up small losers.
2 cents: A trend trading system would possibly have to pick up all the noises (even after filtering) in order to catch each nice trend earlier enough to maintain a good risk/reward ratio. The noises to a pullbacks (anti-trend) or retracements (pro-trend) system would be mainly Real reversals (that sometime could be filtered).
lindq I'll be interested in your intuition on reversals against the trend - especially in choppier markets like the ES.
Sorry, I don't have much confidence in pullbacks trading intraday. However, if you want to take a longer term position in ES, a good pullback from a daily EMA is a pretty reliable signal. Backtest and you'll find strong entry points signaled nearly every month over the past few years.
If you still don't understand, here's also a reminder from a very old post: http://www.elitetrader.com/vb/showthread.php?s=&postid=259983&highlight=trend#post259983 Re: Yang on Moving Averages SQRT((261*(2002-1970))-1)*1*100*3 = +/- 27415 % this is just a very rough order estimation of performance for buying or selling randomly between 1970 and 2002 that is to say a person could make a POSITIVE performance of an order of 27415% and an other a NEGATIVE performance of - 27415% and not be more or less competant than the first one whose people could think he has a financial genious touch whereas it could be just by chance . And since I used an understimated law by taking a random normal law this order should be much greater in reality and reach 50000 or 100000% so that the numbers below are not significant statistically and that's what economists have already said . This is a classical flaw in Stock Market similar to the gambler's flaw in casino gambling. The more frequent the trading and the more expanded the total time period the more big the cumulative percentage. As an other consequence and for exactly the same reason it is also a flaw comparing 1 or 2 days moving average results with 200 days moving average because the law of variation is not the same and is more volatile by definition for short than long MA. This is kind of myth like the martingale for gamblers keep people abreast of finding the holy grail for making eally rich without any effort ... and real edge . Of course counting on chance it's always possible but it is also possible to get ruined as rapidly : -50000% could be as probable as -50000% cumulating all the years. The vendors of trading systems use the same kind of trick for showing superformance. In fact many if not all trading system testers are flawed with that kind of presentation tool when it is the main if not single possibility of visualising performance. This is only "apparent" performance not true that is to say comparable performance.
i would not called it pullback, but it is astonishing to see how different the market trades when it is siginificantly below an EMA compared to when it is above. i think fama - french found something like this for single stocks as well. fear seems to make the market less efficient. did you refer to this effect lindq? peace
Fear creates buying opportunites. Don't know whether you would call that less, or more, efficient. If there is any doubt about the "fear factor", backtest buying a small basket of high cap stocks anytime during the past two years that the daily VIX is at a high level above it's EMA. You'll see the value of fear, and of pullbacks.