One of the biggest problems we see from traders wanting to improve their performance is they are not using fact based triggers, and they don't' know it. A fact based trigger is when price closes above a specific level, and not just moves above it. Another example would be if you use a moving average for your trigger/signal. It's very different to say buy when the green line moves above the red line then it would be to say if the green line is above the red line on the close of the candle, then buy. It would be the same effect with a momentum indicator. Taking a trade trigger when an indicator such as a MACD crosses is different than taking a signal once the MACD has crossed on a closing candle basis. This closing basis is critical because when you look back in time at a chart you are looking at closed candles only; i.e.: fact based signals only. Every candle on the chart other than the current one is closed. There is no way to see how often moving averages and other indicators crossed back and forth, or in programmer jargon re-painted before the close of an individual candle. For example using a 4-hour candle the moving average can cross and uncross -- give a signal, take away a signal -- several times, while a MACD screen shot of the same market 2-hours into the candle can look completely different. If you do not account for that closing element you take away a key variable and your future performance is less likely to match you're back-tested results. Your forward tests will have false signals, a.k.a. repaints.
The fact based signal to avoid repaints is an important concept in considering a trading methodology. If you aren't using a closing candle signal you cannot measure if your tactic gave signals before the close of the candle, so you're trading results when taking a non-closing candle signal will be different than your closed candle back-test. Without closed candle signals, i.e. fact based triggers, you won't be able to quantify your method, and will have trouble developing the confidence to stick to your trading plan.
To see Jay live online tomorrow on FXStreet.com and demonstrate a fact -based trigger go to: Live Market Webinar
Jay Norris is the Director of Forex Learning at IBUniversity.com and author of Mastering the Currency Market, McGraw-Hill, 2009 and Mastering Trade Selection and Management, McGraw-Hill, 2011.
DISCLAIMER: Trading involves substantial risk of loss and is not suitable for every investor!