SCOTT WELSH TRADING BLOG

Building An Eternal System

Building An Eternal System

May 13, 2020

I’m still angry about it.

Mostly, I’m angry at myself.

For some reason I thought the way to build a system that will always produce profit –an eternal system– came from hard work.

If I worked hard enough, I would find a system that would work for years, maybe even the rest of my life.

The problem? Doing it that way is backwards.

Looking only at the results can lead to account-ending conclusions.

For example, have you ever sat on the couch and watched your favorite sports team make a miracle comeback at exactly the same time you switched to the other side of the couch?

On the right side, your team loses. On the left side, your team wins.

Conclusion? Sitting on the left side of your couch means your team will win.

How much money would you bet on that? How much would you bet if the couch-sitting happened successfully seven times in a row? More? Less?

A study was done a few years ago along these lines. After crunching incredible amounts of data, two researchers found that Bangladesh butter production numbers accurately predicted the movement of the S&P 500 with 99% accuracy.

The S&P followed Bangladesh butter production every time.

How much of your life savings would you put into that system?

If your answer was zero dollars, you’re smart. Even the authors of the study knew it was just a fluke coincidence.

Couch sitting and butter production do not cause unrelated things to happen.

The data says, “Hey, this causes that. It happens every time!” Common sense says, “No way.”

Nonetheless, that’s how I went about finding a system. I crunched numbers until it seemed to work. And it did work, at first, because my numbers actually led me into a common-sense methodology.

But then it stopped working because I didn’t use common sense. Logic would say that going for small profit targets (which I was) is open to execution failure. Scalping looks great on paper and can trade fantastically for a while. But one small change in environment can ruin everything.

Small anomalies are not eternal. They can be exploited for a short time but will probably fail pretty soon. I should have known that.

So, how do we fix this?

To make an eternal system, we need eternal truths.

What is true now and was also true centuries ago? If a principle fits both those categories, we can assume it will work for decades to come.

What’s an example? Breakouts.

Breakouts will always produce profit. Unfortunately, breakouts on long-term charts are very hard to trade. Most people can’t handle only 4 trades a year.

Can we be more specific?

How about monthly breakouts?

If price makes a new high during the month, what does that mean? It means something is stimulating growth. Something is definitely happening.

Taking it a bit further, every massive move in any market can be traced back to a new monthly high. Right?

Apple’s move from $10 to $300 had to start somewhere. When AAPL broke out, what are the chances that that breakout was a new monthly high?

One hundred percent.

AAPL didn’t move up 3,000% by making new monthly lows.

That will always be true for any instrument.

So, what if we built a system based on new monthly highs and new monthly lows?

What are the chances that monthly breakouts will turn out to be a stupid, ineffective methodology someday?

In our next email, we’ll look at the numbers to see if this is possibly an eternal idea.

Talk to you soon.

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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.