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When to trade sloppy and when to be precise?
The answer, of course, is that you should always strive to be precise in your trading. But the real question I want to pose here is -- When should you trade with an ECN broker and when should you use the less accurate platform of a spread based broker.
Of course, it depends on the broker and your personal strategy, but the short answer is that if you are using a mean-reversion market making strategy than an ECN with raw spreads is a must. On the other hand, If you are trading trends then spread based broker should be just fine.
Let take a look at the two types of strategies I run in the BK chat room.
My bread and butter setup is a strategy called Boomer in which we are always trying to sell short-term overbought levels and buy short term oversold levels. Just like FX dealers we buy when everyone is selling and sell when everyone is buying. Needless to say, this requires a lot of b-lls and a very quick robot that can juggle inventory during fast markets.
But what it really demands is absolute precision. Just like an insurance company, the business model of any mean reversion strategy is based on making very few and far between mistakes. You won’t survive long in the insurance business if you sell a lot of cheap life policies to diabetics and heavy smokers. Same in FX trading. When you are fading all day long ( trading against the flow like dealers do) pricing is key because sometimes you have just seconds to resolve your trade before another wave of buying or selling overwhelms you. One missed execution could mean days of recovery because you are working on such a negative risk/reward structure.
That’s why despite the overhead of commissions the execution edge is far more important. Suppose you are trading with 5 pip target -35 pip stop (suspend your outrage for a moment and indulge me) If you win 19/20 trades you are doing very well and can basically print money every day. Even if you are winning 18/20 times you are ahead of the game. But suppose you miss just one more trade and the ratio turns to 17/20 and now the net P/L for the series in negative.
When you are trading for 10 pips or less, missing target by the spread can happen as often as 1 out of 10 times. In the example above even if you paid 20 pips in commission (1 pip per round turn) you would still be ahead by 15 pips because you would save at least one -35 pip loss.
So the rule of thumb in daytrading is -- the thinner the edge, the higher the breakeven percentage, the greater the need for an ECN account that will give you the best execution possible.
Another one of my setups in the chat room is called Trendy. This is a much more casual setup that requires only a single entry/single exit structure and has a far more forgiving risk and reward structure. With Trendy, the key to success is not sniper-like execution but a good, general sense of direction.
Trend trades should really be called The John Maynard Keynes, after one of the greatest economists in the world, who was also a very good trader. (He compounded returns at 12% per year for 2 decades at a time when the stock market index lost 15%.). Keynes once said, “I would rather be generally right than precisely wrong.” And that’s what trend trading is all about, because if you get the general direction right, the exact entry is far less important and you will still be able to bank money on the trade.
Trading trend based setups, you really don’t need to bother paying commission. As long as you can call direction right, trend based setups will easily absorb the cost of the spread.
As traders, almost always we focus on nothing else but the pip ahead. Sometimes it pays to step back and examine the subtle differences in our strategies and to determine which platform suits us best for what trade.