Our Strategy Test

The London Breakout originated as a variant on one of the oldest floor trader strategies: Take the high and low of a period early in the morning of a trading day and catch the first trending move outside of that range. At least that's the idea in a nutshell.

 

In reality, on the other hand, this classic strategy worked incredibly well for a few years then began a painful decline by the end of the 2000s.

So when we decided to backtest some classic simple strategies using high quality data from the last few years, we decided to resurrect this old beast and breathe new life into it with a small modification: Sit tight during the initial breakout and enter on the retracement. The result is both a surprisingly effective daily set-and-forget forex trading strategy as well as a fascinating study into the effect of dealers hunting stop losses.

The London Breakout 2015 Strategy

Around 9:00 am London Time (which is actually GMT+1 during the UK's daylight savings time), open a GBP/USD (British Pound vs US Dollar) chart on an hourly time frame. There are two prices to take note of:

a) The Range Top: The highest high of the last 18 hours.
b) The Range Bottom: The lowest low of the last 18 hours.


So the range we're looking at includes the entire overnight period in the UK's time zone.

Also take note of the size of the range (Range Top minus Range Bottom) which we'll refer to as the Full Range size.

Long trades (buy):

- If the Bid price rises above the Range Top, place a Buy Limit Pending Order at the 23.6% retracement (the Range Top price minus 23.6% of the Full Range size)
- Place a stop loss at entry price minus 1.1 times the Full Range size
- Place a take profit at twice the size of the stop loss (2.2 times Full Range size)

Short trades (sell):

- If the Ask price drops below the Range Bottom, place a Sell Limit Pending Order at the 23.6% retracement (the Range Bottom price plus 23.6% of the Full Range size)
- Place a stop loss at entry price plus 1.1 times the Full Range size
- Place a take profit at twice the size of the stop loss (2.2 times Full Range size)

Every trade was sized so that the applicable stop loss would risk approximately 2% of account equity.

Of course, this is a fairly simplistic implementation of this strategy since there are more agile ways for an experienced daytrader to take advantage of the daily Cable trend. Of course, as is the case with any of our forex strategies that work backtests, the goal is not to create an optimized trading system. The goal is to see what a variant of a simple, well-known trading strategy did over the past few years and this updated 2015 modification of the classic London Breakout was among the surprising backtests that resulted.

Backtest Results

GBP/USD (Jan 2011 to Jan 2015)

Starting Balance: 10,000.00

Net Profit: 12,594.65

Max Drawdown in Balance: 23.23%

Max Drawdown in Equity: 27.07%

Win Rate (% of Trades Won): 45.90%

Average Reward / Average Risk: 2 to 1

The original concept of this strategy originated as the Opening Range Breakout, created by floor traders in the US. The idea was for a trader to catch the first big trending move of the day (originally the opening 15 or 30 minute range of the American equities markets' price action). Of course, the UK-centric forex market eventually caught on to the core premise of it and adapted it to the UK's own currency pair.

Our Review

As usual, when beginners look at a strategy and see a winrate number lower than 50%, they immediately think it's a losing strategy... but that's only true if your losses are proportionately equal or larger than your winning trades. For a trend following intraday strategy such as the London Breakout (in any of its forms), it's important to remember that the size of average wins have to exceed average losses in order to take full advantage of the moves and to avoid being whipsawed by ranging days. (You can play with our strategy expectancy calculator using the 2:1 reward to risk ratio described here and see that a 45% winrate is well in green territory.)

We don't usually advocate the typical guru-speak insistence of this sort of risk-reward because it's actually far more psychologically challenging than necessary for many traders. It just happens that this sort of simple trend-following day trading strategy sometimes requires it for positive expectancy.

Of course, we mainly posted this as a study of how classic, simple strategies of this kind can actually perform in recent years. It's also a reminder that even the old forex strategies you may have already dismissed as being "outdated" or had "lost its edge" over the years can sometimes be revived and adapted to recent market conditions.

Sometimes, an old dog can learn a new trick or two.

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