SCOTT WELSH TRADING BLOG

How To Be Smarter Than The System

How To Be Smarter Than The System

Apr. 29, 2020

Trend following is the most researched, most successful trading strategy in the world.

It’s also the hardest system in the world to trade.

When it comes down to it, nobody really wants to buy new highs.

By the time the signal fires off, price has already moved a ton. Any sane person would say, “The move has already happened. I should be selling here, not buying.”

What kind of person waits for a new car to come out, waits for it to become really popular, waits for it to get really expensive, and then pulls the trigger?

Only an idiot would do that.

For example, what would you do with this chart if you had to make a decision right now (where the arrow is)?

Price has risen from $180 to $327. That’s an 81% gain. Plus the indicator below is Overbought. Plus we just had a big bar up. Nothing goes up forever.

A reasonable person would not chase this expensive price.

On top of all that, most breakouts fail anyway.

Any successful trend follower will tell you that the typical win percentage of a great trend following system is 40%. That means 60% of the trades lose.

Add all this up, and it’s easy to think trend followers are loony birds.

How about this?

How about we make that 60% win rate work for us, not against us? What if we FADE breakouts instead of going with them?

If we do that, we get to take advantage of the win rate, overbought/oversold indicators, value investing principles, and common sense.

That was my idea.

So, let’s examine a volatile instrument to see how smart I am.

We’ll use the Gold futures contract for its volatility. We’ll use a simple 40-day breakout methodology. But this time, we’ll go in the opposite direction of the breakout. Instead of buying a breakout above the 40-day high, we’ll sell it.

And watch the high win percentage do its magic.

Here’s an example of my great idea:

In the rectangle you see that as price broke out above the high, we went Short. And it paid off nicely.

Feeling proud of myself, I rolled the chart back to 2008, and here’s what I found:

Yikes. It was negative. Fading the breakout didn’t work at all.

So then I switched the system back over to regular trend following. This time I bought the breakout and kept the profit target and stoploss exactly the same as I did for the FADE. Here’s what that looks like:

My beautiful FADE trade turned into a loser. Just what I thought.

Here’s the Performance Report:

It created a nice chunk of profit.

What I want to do has horrible results. What I think is smart isn’t.

And here’s how that TSLA trade would have turned out:

Against my better judgement, buying the ridiculous breakout watched $327 turn into $887 (almost a triple).

My only hope is that Gold is an outlier. Maybe another instrument will show how smart I am.

We’ll find out in our next email.

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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.