SCOTT WELSH TRADING BLOG

Do You Trust Your System?

Do You Trust Your System?

Feb. 3, 2021

Traders tend to be irrationally confident or scared to death.

The irrational ones are the ones who go on social media bragging about things that may or may not be true while making profits that may or may not be lost in the next downturn.

Good luck to them.

The scared ones are the ones who could be making money consistently but are too worried to get started.

Is this online robot a scam?

Is it too good to be true? 

Or maybe some traders already have a system but don’t know when to take it live.

Is my system over-optimized?

Will it break?

I’ve said many times that trust is the number one requirement for success.

You have to trust your coach. You have to trust your partner. You have to trust the process.

And you have to trust your system.

So how do we do that? How do we know when it’s okay to go live?

Let’s take a look.

Here’s a sample system.

After backtesting it conservatively (not looking for a perfect backtest), through 2019, here’s what you have.

First, the Equity Curve through December 2019:

A lot can be learned from an Equity Curve. What can be learned here?

For one, it seems to go consistently up over time. For another, there are definitely drawdowns.

It seems crazy, but the best systems are the ones with definite drawdowns. If I don’t see drawdowns, my trust diminishes quickly.

On top of that, I know the backstory of this system. It’s trend following in nature, so that means it’s using principles that have worked for hundreds of years.

And principles are more powerful than methods.

In addition, this sample system has no losing years. Some years are very profitable and some years are barely profitable, but that’s okay with me. Feast and famine is another thing I look for. I’m fine if it doesn’t work sometimes. That just means it’s really going to work other times.

Last, with no compounding, I calculated that this sample system averages 60% per year. Now, that’s with a very aggressive trade size and it’s misleading. There are years that were over 100% and other years that were only 10%. Still, the hypothetical average was 60%.

Knowing all that, what would you do?

Would you still be too afraid? Would you watch it trade another year? Would you go buy GME at $400 instead because everyone says it’s going to $1,000?

For me, the above metrics would be good enough.

I wouldn’t obviously know how it will do in the future, but I would be confident it would produce profit in the long run because of the principles and the feast-and-famine nature of the testing.

How do you think this sample system did in 2020?

If I run the testing forward, it made a hypothetical 37.9%. Not the average but perfectly acceptable, especially since 2019 was a monster year.

My trust level would still be high.

What about you?

What would it take for you to trust a system?

In our next Newsletter, we’ll go even further. We’ll compare a live robot to a hypothetical one and see if we trust the new one.

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.