SCOTT WELSH TRADING BLOG

The Power of Stop-And-Reverse

The Power of Stop-And-Reverse

July 14, 2021

Maybe I’m just noticing it more, but the trading world seems to have lost its mind when it comes to over-optimization.

In nearly every book I read or podcast I listen to, it doesn’t matter how different the trading strategies are, they all agree on one thing.

NEVER OVER-OPTIMIZE.

If you over-optimize, you die.

Well, your system dies anyway.

What does “over-optimizing” mean?

It means doing anything.

One little click to change the profit target will doom you to the poor house forever.

One little click to change the stoploss will cause earthquake disasters all over the globe.

No, the ONLY way to trade is to never attempt to do better with your trading system.

End of story.

So what am I supposed to do then?

The only thing you can do is:

  1. Follow the exact rules of an old system that’s been forward-trading for many years.
  2. Use a stop-and-reverse exit.

Okay, what’s stop-and-reverse?

It means the exit is your entry in reverse.

Here’s an example.

Let’s say you’re trading 100-day breakouts on AMZN starting in 1998. To use stop-and-reverse, you would enter on a break above the high of the past 100 bars. Simple.

What’s the target? There isn’t one.

What’s the stop? There isn’t one.

Then how do we get out? Only when price breaks below the low of the past 100 bars.

See what the experts mean? There can’t be any optimizing when there’s no optimizing.

Here’s a sample trade.

The entry is above the high of the past 100 bars and we don’t get out until price goes below the lows of the past 100 bars.

How did this stop-and-reverse “strategy” do?

Pretty amazingly.

It would have turned a hypothetical $10k account into $126k. Yes, the max drawdown looks large, but that would have happened after we were rich. This system never came close to the original hypothetical number (the first trade was a monster).

Could we do better with optimizing? Of course.

Could we ruin the strategy if we do? Maybe.

And that’s their whole point. A stop-and-reverse exit takes away the danger of curve-fitting.

A trader can sleep well at night if she uses a stop-and-reverse exit.

Or so the theory goes.

But does it work on Forex?

We’ll investigate further in our next Newsletter.

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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.