Filters: preventing possible losses and optimizing the trading system
Very often in the environment of novice traders, there are situations where they enter a position in advance (out of impatience or giving in to emotions), or vice versa, when they enter a trade, they do not know when to exit it (or close it before the time). This is where the so-called filters come to the rescue.
Types and examples of filters
filter - is a rule of the trading system, after the completion of which, the trader must perform a certain action (for example, open a deal, move the stop loss, close the position, etc.). They are used to prevent possible losses on (so to speak, ways to check false signals) and serve to optimize the trading system.
Today, there are many filters that are present in various trading strategies. We will consider only 4 of them, which are used more often and are the most common among traders.
So, The first is an entry into a position after the close of a bar (or Japanese candle). The most popular filter for trading strategies. That is, the signal to open a trade comes only when the candle on 100% closed above (or below) some level. For example, as shown in the figure below, entry into the buy position after the bar closes above moving average. By the way, this filter is used in the trading strategy - "Moving Average Breakdown".
The next filter - entry into the market after the closure of two consecutive bars in the right directionу. What does this mean? If the rules of the trading system require the trader to wait for a sell signal (while ignoring the buy signal), and this signal comes, he must wait for the two candles to close in a bearish position, and only then enter short Sell position. It is illustrated in the figure below.
filter - opening a trade if a candle is less (or more) than N points. This filter is often used in conjunction with a moving average indicator (or the intersection of two moving averages). If the trader receives a signal to open a long position, and the Japanese candle closed less than a certain number of points in the right direction, it is possible to enter the position. If, on the contrary, it closed more than a certain number of points, then we ignore this signal and wait for the next one.
Time filter - exit from a losing position after N hours. If a trader opened a position, and then the price level went in the unfavorable direction for him, it is not necessary to wait until the price reaches the stop loss level, and close the transaction after a few hours.
These are the basic filters that can be used in your trading system. Finally, I would like to add that you should clearly analyze whether you need a particular filter or not. And be sure to test and check the effectiveness of the trading system after it has been installed.