Thursday, June 29, 2017

Trader’s Guide To Identifying A Good Trading System

A good trading system is invaluable to the professional trader and should be an integral part of any trading plan. A good system provides an objective, statistically logical and responsible way to speculate in the forex markets. They are always rule based and they can be automated (like a robot) or they can be used only when the trader is in front of their screen.  However, selecting a good trading system and knowing the potential pit-falls go way beyond whether or not the systems report shows a profit or not.

In this report, I’m going to provide you with a check list for identifying a robust system from an unprofitable or an untradeable one. This check list is not a complete one. The science of system evaluation is vast and covers many variables. But this list will help you tremendously in deciding how viable the system is you may be considering, and it is my hope that it will open your eyes to the many components that must be reviewed before putting real money on the line

It Must Be Mechanical

A good trading system must be 100% mechanical in nature, devoid of any human overrides as it scans the markets. If a system requires inputs or data during the course of a trading day, then the profitability and all other pertinent data are not reliable.

It Must Be Transparent

Every rule, assumption and input that make up your system must be transparent, fully disclosed and understandable. Forget any black box systems or robots that do not provide full disclosure. Look carefully at the conditions that make up the trading rules and be sure that you can understand the indicators used. If a fast stochastic is used in conjunction with donchian channels then it’s important that you know what they are and how they work. Oh, and one more thing…proprietary formula is code for black box.

Works With All Currency Pairs

Well, almost… the system needs to have profitable and acceptable results in any market with similar liquidity. Most one trick ponies have been overly optimized and curve fitted.

Maximum Drawdowns

A maximum drawdown is the total drop in value of an account during a specified time frame. In other words, if a system shows at the end of  2010 that it profited 40% for the year that seems pretty good doesn’t it? But, if the max drawdown was 70% during the same year, could you trade that system? This part of the report reveals that even though the system rallied to earn a profit… the account first had to endure a 70% drop in value. This, in my opinion makes this system untradeable despite its glowing year end profit.

Total Consecutive Losses

This statistic is equally important and is somewhat similar to our max drawdown example. Again, if the system you are trading has had historically 7 consecutive losses before hitting a winning trade, could you stick with it? Maybe you could, maybe you couldn’t… but the point is that you need to know and be prepared.

Statistical Validity

All good systems will have enough data to satisfy normal standards for statistical validity. Here’s what I mean, if you flip a coin 4 times, and 3 of those times it lands heads. According to this report, a coin flip produces 75% heads and 25% tails. Would you consider that to be statistically valid? No, I certainly wouldn’t, look for at least 40 trades, as a minimum, spread out over several macro-economic eras.

Not Always In The Market

A well designed system will not always be in the market. A good system knows and identifies when conditions exist for a set up to occur. Robust systems are never “Jack Of All Trades”…

Never Misses It’s Intended Move

This requirement is really geared towards trending systems only, but I wanted to include it because trending systems can often be the most profitable of all systems out there because they are designed to always catch the big move. They might be wrong a lot… but as long as the drawdowns are acceptable, when a good trending system catches a big move… they make a lot of money.

Consider These Before Trading Any System

An interesting point to consider is that an incredibly profitable trading system might have only 33% winners, while a terrible system could have 75% winners. Take this information and be sure to apply it next time you’re considering how viable a trading system is.

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