The Foundation of a Trustworthy System

Aug. 5, 2022

Why do millions of people put billions of dollars into index funds?

Why do people swear by an investment that makes zero dollars for 12-year periods while suffering drawdowns over 50%?

They do it because people trust index funds. The question is why.

What’s so great about passively investing in the stock market? Is it because it sometimes makes money over time? Maybe. Although “over time” is subjective. What would the answer be if we asked someone about index fund investing who started in 2000 and stopped in 2008? Would they agree that passive investing makes money over time?

Of course not.

No, we trust the market because we’ve seen the famous chart that’s been cherry-picked from 1926-2006:

I want to invest in THAT!

As we know, however, the previous 80 years produced no such chart. The previous 80 years were flat. 

In short, millions trust the stock market because of a misleading chart and the fact we’re familiar with U.S. companies. We can go to a Bed, Bath, and Beyond store, so that must be safer. (Yikes!)

Is there anything else more trustworthy? If we look at facts, yes. Trend following systems are more trustworthy. What’s a trend following system? It’s rule-based trading with stops and sometimes targets that attempts to ride momentum. Does momentum really exist? Yes. Do stops make all the difference? Of course.

And trend following research goes back hundreds of years, not just to 1926.

From a fact standpoint, trend following wins the trust war. Trend following is better than the stock market. But in this Newsletter, we’re talking about specific trading systems. And we know that marketing hustlers lie about systems to take people’s money.

So what makes a system trustworthy?

First, it would have to be a trend following system. That means it must enter on breakouts, either a price breakout or an indicator breakout. When price has momentum, that system must enter.

Second, it can’t have a lot of inputs. A guideline is 4 inputs or less.

Third, it has to trade on something that trends. You can enter horseraces with a mule if you want to, but a real trend following system only uses things that are hard-trending.

If it has those, it should be trustworthy.

In the last Newsletter, we talked about a system that embarrassed the stock market from 2003-2022. Using that criteria, is it trustworthy?

You can see all the details about this system in this video.  It uses a Bollinger Band™ breakout on a 1-hour chart and is covered monthly on the Performance Page.

1. Is it a trend following method? Yes.
2. Does it have 4 inputs or less? No. It has a target, stop, break-even, Band Length, Band deviation, and time exit. Uh oh. Too complicated? Over-optimized? Maybe. But timed exits have been used in systems for decades, the Band inputs were not optimized, and the target and stops were lightly optimized. Further, it doesn’t trade a lot, so it’s not likely to get hammered by typical market noise.
3. Is it used on a hard-trending instrument? Yes. What are some hard-trending instruments? Meme stocks, Bitcoin, Gold, Silver, Oil, growth stocks, and the GBPJPY. This system uses one of those.

Does it pass? For me it does. It passes two of the three and the lack of optimization on the Inputs makes it seem trustworthy. Also, the “walk-forward” un-optimized period for the robot includes all of 2022 and it’s done very well this year.

And here’s the Equity Curve of this system risking 7% each trade and starting with $25k.

It turns a hypothetical $25,000 into $600,000.

The big problem is that Forex–specifically GBPJPY–is not Bed, Bath, and Beyond or Best Buy (both struggling, by the way). You can’t walk into the GJPY Store and take a look around.

Forex is a vague, scary, non-touchable thing, and that’s a very important reason why someone wouldn’t put big money on it.

But is that the best decision?

In our next Newsletter, we’ll talk about another potentially trustworthy system.

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.