April 10, 2017 Barbara Rockefeller
The Rockefeller Lazy Man’s Trading System The Rockefeller Trading System is a trend-following system that has three built-in Contingency Rules running off the stop and target that you can customize to suit your own skills and your own risk preferences. Or the System can be followed blindly—set it and forget it. The key feature of the system is to take a bite or two out of every move, not to be in the market all the time or to call tops and bottoms. Introduction In technical analysis, EVERYTHING WORKS. Trend-following works. Momentum works. Set-ups work. Bar-reading, especially candlestick reading, works. Every technique dictates a trading style encompassing what timeframe chart you are looking at, how often you trade, where you set stops and targets, and so on. The problem is you can’t do it all. You have to pick a trading style and stick to it. You must ignore the siren call of some smart guy halfway around the world who is trying to seduce you into using his technique and his trading style. For all you know, the guy is not a fruitcake and his trading system works perfectly well, but at some point you have to ignore the noise from the trading universe and go your own way. You can keep track of smart guys with good ideas, but you need to follow your own signals and not let others contaminate your system with new ideas, however valid they may be. If you read about some system that makes sense to you, before you try it, you have to drop the one you are using now. To steal an idea here and there is to add vinegar to a cupcake. For example, some traders do only short-term momentum trades and they get confirmation of the momentum from multiple technical tools (RSI, stochastic, ADX, etc.). Momentum leads price so this is an excellent approach. The problem is that it’s time-consuming and hard on the nerves. You have to sit at the screen and watch your momentum trades, and change your stop and target on the fly. Well-executed momentum trades can generate a win-loss ratio of 5:1, but consider that before you get to a momentum move, first you need the breakout, and about half of all breakouts are false. Worse, FX does not always move with momentum and then you are twiddling your thumbs. The 10,000 Hour Problem Malcolm Gladwell, in the book Outliers, formulated the “10,000-Hour Rule.” The rule states that to become proficient and expert in a task, you need to practice 10,000 hours. This is a cousin to the old joke, “How do you get to Carnegie Hall? Practice, practice, practice.” And not just any old practice, either. It has to be “deliberate,” meaning you correct mistakes and don’t forget the corrections. Bill Gates was writing software code as a teenager. The Beatles put in their 10,000 hours in second-string venues and beerhalls in Germany before hitting the big-time. And practice may be necessary but it’s not sufficient. You really do have to have some natural ability to which to apply the 10,000 hours. As Gladwell said, “I could play chess for 100 years and I’ll never be a grandmaster. The point is simply that natural ability requires a huge investment of time in order to be made manifest.” Every trading coach knows that some people are never going to make good traders. They lack either the natural ability to grind through the techniques and select the ones that suit their own risk appetites, or they lack the discipline to grind through the work. And make no mistake—learning how to read charts is grinding. It’s also lonely. Financial writer Desmond MacRae says trading is a monastic experience—it’s just you alone with the market. Here’s the real 10,000-hour problem: you have been trading for a while and you are dissatisfied with your results. You go out looking for a coach or a system to buy. But say you already have 2000 hours in your existing, unsatisfactory trading regime. You do not know for sure that another 8,000 hours won’t lead you to refinements that will make it work better. If you were honest with yourself, you would admit that you are reluctant to give up the 2000 hours you already have invested. To drop what you already have—let’s call it an asset, since knowledge is an asset—to take on another system is literally to ask too much of you. Therefore, you may try Mr. X’s System and Miss Y’s System and the Rockefeller System, but your heart is never fully in it. And once you decide to tinker with your trading habits, you become a loose cannon. One day you find yourself beguiled with an approach that offers a huge gain/loss ratio, but after a loss or two, you get more interested in less gains but lower losses, too. Then you stop hopscotching around various techniques and before you know it, losses are big and you feel lost at sea. Sound familiar? We are not asking you to give up whatever knowledge you have earned, or your own personal risk-reward ratio. The Rockefeller System was designed to offer a framework with plenty of room for tinkering, or customizing to your own special abilities and risk preferences. Or you can follow every trading signal exactly as ordered and not bother to add your own bells and whistles. We designed the Rockefeller Trading system as a lazy man’s trading system that is easy on the nerves. The gain-loss ratio is unimpressive—about 1.8:1, or $1.80 gain for every $1.00 loss. But it’s tremendously reliable—we have never had a losing year in 21 years. You already know upfront that you will be taking losses, and believe it or not, you come to shrug and accept losses as a cost of doing business. This is actually one of the secret weapons of the Rockefeller System and not a drawback at all—the ability to take losses without undue emotion is the single most valuable thing you can learn in developing trading expertise. For evidence on this point, read Market Wizards by Jack Schwager. The Lazy Man’s Trading System 1. We want to be out of the market as much time as possible to avoid catastrophic losses that can accompany the use of high leverage. We may trade several times per day but according to plan, not impulse. 2. The Contingency Rules are the core components of the Trading Plan. You may modify the number of points in the Rules to suit your risk appetite. 3. We choose our initial starting-point trade (from which Contingency Rule trades flow) according to whether the market is trending or range-trading. 1. Stay Out of the Market as Much as Possible Most beginners chose FX because of the wonderful leverage that is not available in equities. The problem with leverage is that while it magnifies gains, it also magnifies losses. The market can be flaky and turn on a dime. And even though you will take losses in trading, you want to avoid catastrophic losses. Leverage makes us want to be in the market but leverage also forces us to reduce exposure to the least amount of time possible that still allows a profit opportunity. You are taking no risk of loss when you are not in the market. A stop is not a substitute for rationing the amount of time we are in the market. Stops are necessary and a big help, but a stop will not always save you from a catastrophic loss. If the price gaps over your stop in a fast-moving market, you will get the next available price. It can be 100 or more points away from your stop. We therefore keep positions as short-lived as possible. The best of all possible worlds is to do only a few trades per day with a high probability of winning and a low probability of a loss going in. The rest of the time, you are out and therefore “safe” from getting hit over the head by a surprise development in the market. 2. Trading Plan behind the Contingency Rules We issue one set of buy/sell signals per day with that goal in mind—to minimize the amount of time our money is at risk. This is not to say we trade only once per day. That would be to forego profit opportunities. In fact, our time horizon is anywhere from one hour to 24 hours, depending on what the market is showing us on the charts. When the market is trending, we aim for 2-4 trades per day, each trade starting with our original entry order and multiplying according to Contingency Rules 2 and 3. When the market is not trending, i.e., range-trading, we aim for one trade per day. We call these quickies and are often not with the trend, but against it. You should think of the Contingency Rules as a core component of the Trading Plan. Gurus write about “trading plans” all the time but we have never seen anyone explain in full detail what a trading plan contains. In a nutshell, a trading plan defines How much capital stake you have overall. How much capital you will allocate to each trade. How big a loss can you tolerate overall and per trade. How much profit do you need to make to tolerate those losses? This sounds simple at first but consider that if you have $5000 in a capital stake and allocate half of it to a single trade, and that trade is a 100% loss, you can do only two trades before you are out of the market until you step back and save up some more capital. We developed the Contingency Rules by observing professional interbank traders at Citibank over many years. No one ever actually stated that these rules were consciously being followed, but we saw the same behaviors repeated time and again. We actually have a few more rules that we discovered among professional traders, but the three we use today are the essential ones and more importantly, not hard to implement. The Rockefeller FX Contingency Rules embody a specific Trading Plan. Your risk tolerances will no doubt be different and therefore you should consider changing the stop or target and contingency rule number of points we recommend. But do not ignore or disregard the Rules. They are essential to long-term trading success. The virtue of the Rules is that you can customize them to suit your own special skill set and your own specific risk tolerances. The first item in the trading plan is how much capital you have and therefore how much you will allocate to each trade—your leverage. The brokers will allow you to use an obscene amount of leverage, at least outside the US. (Within the US, the government has mandated no more than 50:1). We tend to use the maximum US leverage in the Rockefeller System but that doesn’t mean you have to. The right amount of leverage is the amount that lets you take a normal number of losses and not have them drive you insane with worry. You should look at the track records, shown trade-by-trade on the second page of every report and in the Track Record Archive on the RTS website, to see how using our level of leverage will make you feel. For example, in March 2015, we had a net loss in the first nine days of the month that maxed out at $361 on a starting capital stake of $10,000. That was 30 losing trades out of a total of 58, or over half. But in the next five days to March 14, we reversed that and were up $509. If you can’t tolerate half your trades being losers, this system is not for you. Or you would have to customize it in some way to make it more palatable. And the earnings volatility is admittedly quite high. But remember, we have never had a losing year. On the other hand, if you have surplus capital beyond what we need for our bare-minimum trades, you can put it to good use customizing the system. You can scale in an out, cherry-pick trades, and allocate more to winning currencies and less to the losers. You shouldn’t reallocate more than once a month, but experienced traders will tell you that you can make as much or more from differential allocations as from the buy/sell signals themselves. And if your customization starts going off the rails, you can come back to the System, knowing it’s fairly safe. How the Contingency Rules Work There is nothing more frustrating than to exit at our established target only to see the price keep going in the same direction, delivering an opportunity loss. For this we use Contingency Rule 2, the “continuation” rule, which has us re-enter in the same direction if conditions are met. Rule 2 can come into play four or five times in a single 24-hour period. The last Contingency Rule 2 trade is almost always a loss, since it comes near the end of a trading session and other traders are paring positions. But by then, we have made so much on the winning trades that a loss on the last trade is tolerable. For example, let’s say we made 40 points on the original entry recommendation, and then 60 points on each of two Contingency Rule 2 trades for a total of 160 points. The final Rule 2 trade is a loss of 40 points, so net-net, for the period we have a net gain of 120 points. This is triple our original goal for the day of 40 points. Contingency Rule 2 has us re-enter in the same direction in a trending market after the price has “proven” the rally is real by moving an additional 40 points. The stop on a Rule 2 trade is 40 points and the target is 60 points. Where do those numbers come from? The re-entry at target + 40 points means that the price has already moved about 70% of its ATR. This occurs only early in a new move. When a price is really in a hot new rally (or rout), we expect to see it move by 200-300 points in a 24-hour period. We often get our targeted gain of 30-40 points plus at least one Rule 2 trade for a total move of ATR + 50-100%. Why not just set a bigger target in the first place? Because we may suspect a rally is going to occur but only the price move is proof. To make up on the fly what the new target and stop should be is not careful planning—it’s impulsiveness. The 40-point stop is about one-third of the Average True Range of about 120 points. It’s an average over all the currencies and many years, so the actual ATR of a specific currency could be 20 points in a thin market or 50 points in a newly trending one. You are free to alter the number of points. Similarly, the target of 60 points is about half the average ATR. By the time you get to that many new points accumulated—your original profit of 30-40 points + 40 points to trigger Rule 2, you may think getting another 60 points is to except too much. And yet Rule 2 works to deliver a gain about 75% of the time. Contingency Rule 3 is also useful when the market is trending but choppy. Rule 3 says that you re-enter in the original direction after the stop is hit if the price returns to the original entry. You were willing to bet on that level in the first place—you should be willing to bet on it again. You apply the same stop and target as in the original entry. Rule 3 also works—delivers a profit–about 75% of the time. Rule 4 is more complicated. This rule comes into play when the price has moved so much in the opposite direction that we suspect an outright reversal, or at least a big enough correction that we can take advantage of it. Rule 4 is applied when you take a loss and the price goes another 80 points in the same direction. Let’s say you entered long and took a loss of 32 points. Now the price falls another 80 points for a total of 112 points. This is kissing distance from a full ATR of about 120 points and hardly ever occurs within a single session unless there is a major correction going on. Under Rule 4, you place the stop at 44 points from entry and target at 48. These numbers of points are derived from observation of the limits of corrective moves. Rule 4 works about 60% of the time to deliver a profit. The Contingency Rules throw up losses, of course. In a choppy wide-range ranging market, you can get a Rule 3 that fails three times (our limit) and a Rule 4 that loses for a total of 40 + 40 + 40 +44 = 164 points of loss. If 164 points is too much for your capital stake overall or per trade, you shouldn’t use Rule 4. If the correction is a lasting one or it’s a true reversal, you have to wait until the next Entry is published at the end of the US trading day. What about lowering the bar from 80 points to 50 points? You are free to give it a whirl. But be aware that 50 point moves are common and a meaningful 80-point correction/reversal is relatively rare. Why evaluate the market only once a day? The answer is simple–the primacy of the close. The close summarizes market sentiment for the day just ended. The day starts at the first trade after 5 pm in New York, meaning New Zealand and Australia, then Singapore, Tokyo and Hong Kong. The market moves on to the Middle East, then Europe and finally, the real pace-setter, London. New York then feeds upon London and sometimes adds a factor or two. We sometimes get an outright reversal in the New York timezone when the Fed meets or some other Event occurs. The close therefore encompasses everything that happened in the FX market in Asia, Europe and the US the day before. When the close is substantially higher than the day before, and especially if the close is near the high, we have a bull market. When the bar is a small doji, we have indecisiveness. Reading the daily bar is a necessary exercise. You cannot trade well without it. When writing the chapter on bars and candlesticks for Technical Analysis for Dummies in 2004, we made the most money of our entire career. Most FX traders today prefer to trade in the one hour to 4-hour timeframe, which is understandable given limited time to sit at a screen and the dangers of leverage, but lacking a full grasp of the daily New York close is a major, horrible mistake. What looks like a big move on the 15-minute chart may be just a re-positioning by some big trader or group of traders. Without the context of the NY close, you cannot properly judge. Anyone who fails to take a hard look at the daily bar is doomed in the long run. 3. Is the Market Trending or Range-Trading? Leverage is a blessing and curse, of course. It’s a blessing when the market delivers a long-lasting trend and you can pick the fruit over and over again, multiplying gains into a tidy sum. It’s a curse when the market is trading sideways—range-trading—and you get the first entry direction wrong. The entry direction will be right in a few minutes or hours, which is the nature of range-trading, but by then you have taken a loss. Worse, if you switch direction upon taking a loss when the market is in range-trading mode, you can easily rack up another loss. The first job of the Rockefeller system is to determine whether the price is in trending or range-trading mode. Statistically, this is a nearly impossible job, which is why judgment always enters the picture. Trending or range-trading determines the timeframe of the holding period. When a currency is trending strongly, we have a strong bias for positioning only with the trend. Targets can be bigger than usual and stops smaller because the probability is good that the trend will persist. We expect to buy and hold for a juicy gain, usually 40% of the recent average true range, and if the trend picks up momentum over the course of the next 12-24 hours, Rule 2 has us re-enter repeatedly. Rule 2 trades are the single biggest source of profit in the entire system. It’s when the market is range-trading that we face the real problem. When a price has been trending and then pauses, any price burst in the direction of the original trend looks like a resumption of the existing trend. But these fail about half the time. When a price corrects in the opposite direction of the original trend, we rush to the deduction that a Correction is forming and start searching for historical levels for the correction to aim at or some other seemingly sensible ending place, like a Fibonacci number. To jump on a seeming correction and to fade the trend also fails about half the time. We use a set of eight indicators to identify trendedness and momentum. We may sometimes have a strong trend (high slope) but with momentum failing. We hardly ever get all eight indicators lining up in a tidy fashion, so choosing the preponderance of the signals upon which to base the next trade is always a judgment call. If you examine each of our eight indicators in the Chart Package and then look to see which direction we are trading and where the stop and target are set, you can easily deduce which indicators won out in the preponderance sweepstakes. As a rule, we will fade the trend when momentum indicators tell us that the probability of a correction is high. This means momentum itself, the RSI, and the stochastic are all pointing in the opposite direction of the primary trend. Guerilla Trades We want to be square at the end of the New York trading day. We examine the close for where we want to place our next trade. Normally this is the close, although of course by the time the report is published, the close is long gone. When we enter the close as the recommended entry, what we really mean is “as soon as possible” upon receiving the report. In futures, the delay before Globex opens can make the spread between the Chicago close and the open quite wide, but in spot terms, it’s hardly ever much (except at the Sunday open). We chose to open a new position at the open not because we are lazy, but because it’s a market order, and market orders are the only ones that are sure to get filled. Besides, guessing how the open will vary from the close is usually a fruitless task. We know position-paring will be taking place, especially after a big move, but we never know how much. But sometimes we can see that the upcoming price range doesn’t offer a profit opportunity. The stop is all too likely to get hit even if the profit target will also get hit at some later point. We don’t like the open for an entry so we select a different entry that is more likely to get us to the target before the stop. We call these guerilla entries and the concept is important because it reinforces the idea that while you are always a price-taker, you don’t have to take any price you don’t like. Some traders feel they have to be in the market all the time, regardless of whether a cold-eyed examination of the chart shows little opportunity for gain. As you customize the Rockefeller System for your own preferences, do not fail to examine the guerilla trade levels. They always mean we see something to be wary of, usually that the market is going to test a low (or high) before it settles down into the direction we want to go. How to Tinker When the market is trended, you are safe just to follow the Rockefeller signals but to make your own adjustments to the stop and target and to the Contingency Rules. In a hot trend, for example , why wait another 40 points after hitting a profit target before re-entering in the same direction? You are free to raise the target or change the rule to (say) 20 points. Similarly, the profit target on a Rule 2 trade is a fat 60 points. We often get it, but it might be a bit much in some moves or it might be a bit much for your stomach—and you are free to cut it down to a size, like 30 points, that pleases you. Or you can scale the rule itself, from 60 points the first time the rule is used to 40 points the second time and 25 points the third time. On Rule 4, the reversal rule, when your own bar or candle reading shows the Rockefeller system will be late—80 points late—to a reversal, you are welcome to jump in well ahead of the system. When the market is choppy and range-trading, you have the opportunity to cut the stop and profit targets to what you consider practical. The point is to use the three Contingency Rules, but to apply them in a manner that suits your risk preference and the amount of time you have available to trade. You can set it and forget it—i.e., follow the Rockefeller System blindly—or you can tinker. Or sometimes you may have the time, energy and growing expertise to add trades of your own within the context of the system. It doesn’t hurt our feelings when our system-followers branch out and tap-dance around the floor while we waltz on. Conclusion To conclude, our best trading market is a trended one. We can do the same trade in the same direction repeatedly and we are content to hold with-trend positions, even over many days, without much anxiety. In a range-trading situation, we lose about half the time whether we go with the trend or against it, and therefore we want to know as soon as possible if we have a loser. These losing trades last only 4-12 hours, and generally 2-3 hours, not days on end. There are any number of equally valid ways to trade FX. You can trade for just a few minutes per trade on set-ups, the most popular mode in recent years, or on trends. We chose trends because trend-following has tied-and-true technicals, FX is often highly trended, decisions don’t have to be made in fractions of a second, and we don’t have to hang around waiting for set-ups to appear. We also chose to systematize trend-trading with the addition of the Contingency Rules, acknowledging the prime importance of the daily bar. Finally, we pretty much know the economics and other fundamentals of the FX market. We are as qualified as anyone to judge whether a correction is real or a head-fake. Even so, and even after decades of observation, we still get range-trading trades wrong about half the time. The point is that you can know what’s going on and still take losses. That’s why profit targets are always bigger than stops. Over time, range-trading errors do not result in catastrophic losses. And while we take losses along with everyone else, we have never had a losing year since we started publishing the Futures report in 1994. Note: if your broker or platform will not allow you to establish the Contingency Rules, shop around for a broker that will. You should be able to “set it and forget it.” We do not offer advice on choosing brokers for legal and other reputation reasons. Brokers make their money a fraction of a penny at a time. How honorable can any of them be?
President + Author