SCOTT WELSH TRADING BLOG

Good Ideas Gone Bad

Good Ideas Gone Bad

Mar. 12, 2014

I have so many great ideas.

I can’t even tell you how many times I’ve tested out the best trading Strategy you’ve ever seen. First I get the perfect idea, and then I test a number of trades, and then pretty soon I’m convinced that I should sell my car and put the money in a new trading account.

And I can’t tell you how many times that it hasn’t worked out.

We as humans are riddled with problems. Our brains are wired to seek out patterns that don’t exist. “You know, it rains every time I wear blue…I can control the weather!!”Furthermore, we create these nonexistent patterns and then subconsciously seek out data that will confirm this made-up, faulty opinion. Brilliant!

Here’s how that scenario plays out for me. First I get a genius idea. For example, on my GBPCHF 14-minute chart, I absolutely hate it when the trades take too long. Not only is it incredibly annoying, but it breaks the #1 rule of trading: NEVER HOLD ON TO LOSING TRADES! So I decide to exit trades after a certain amount of time.

Then I go to the numbers. In analyzing the data, I notice that, over the past ten years, the average losing trade on my GBPCHF chart lasts 52 bars. See, it’s true! Long trades = losing trades.

Then I look back on my charts and see that many losing trades could have been cut off and a lot of money could have been saved. By cutting off my losers sooner, I am letting my winners work their way out and lessening the bad trades…just what I’m supposed to do.

After all this,  I then call my programmer and get  a time-based exit built into my Robot. In other words, I get an input installed that allows me to cut off a trade at a certain number of bars, no matter what. And then I test it.

Here is what happens on the GBPCHF 14M chart when I let the losers run.

The winning percentage is 85%, and it had a maximum drawdown of -$1,610 (a 22:1 profit to drawdown ratio).

Now here is where I work my magic. I decide to start cutting off my trades after 15 bars. That’s almost four hours of real time. Furthermore, almost all of my winning trades work out before four hours is up, and the losers usually last three hours longer. Taking trades out after 15 bars seems like an all-around amazing idea.

However, the winning percentage drops to 62% and the profit is cut in half. And the max drawdown is -$2,464 so the profit to drawdown has dropped down to 7:1.

I took a great trading maxim to heart, analyzed the data, did a little hand-testing, and what was the result? I butchered my System. Even though my idea seemed sound, it wasn’t. Even though my brain looked at the chart and thought it was an improvement, it wasn’t.

That doesn’t mean you shouldn’t continue to work on your System. You should. But you need to be very careful when tweaking your System, or creating one. Never go live until the numbers absolutely, positively confirm that your improvement is a valid one.

It’s okay to be a genius. Just make sure the numbers say so, too.

 

Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.