The Problems With a Good System

Sept. 18, 2024

This week we’re talking about a system I really want to trade.

Why do I want to trade it?

Because it does this on a hypothetical $15k account since 2002:

On that size account, those results destroy the market’s returns.

So, what’s the problem? Let’s go one by one. Here are the details again:

• It’s for the Daily chart. That’s good and bad, as we’ll discuss.
• It’s on the E-Mini Dow during Regular Trading Hours (YM.D in Tradestation). Why the Dow?
• It uses the RSI 2 (RSI indicator with 2 Length). A standard way to try to avoid overfitting.
• It gets in at the open of the next bar when RSI closes into Oversold (15). Typical for RSI 2.
• It has an ATR target of 0.8x the ATR stop of 16x.
• It has a timed exit of 52 days. To get out when nothing’s happening.
• It’s Long-Only. To capitalize on stock markets’ upward bias.

Problem #1: it’s on a Daily chart. Did you know that Tradestation sometimes won’t close out a trade if it happens exactly at the close of a Daily bar? It happens. There are workarounds but that’s annoying. Further, Daily charts are many times the worst bars to test on. You could spend hours testing a system and be ecstatic. And then you run Intraday data and it’s not even close. That also can be fixed, but Daily bars tend to be the most dangerous (when it comes to over-fitting).

Problem #2: the RSI. While I love this indicator and have used it for years, it has a lot of variables. What’s the length? What’s Overbought? What’s Oversold? You can test an RSI system for weeks and only end up with something that doesn’t work in real time due to over-optimizing.

Problem #3: it’s the Dow. Why the Dow and not the S&P 500? They both work but the Dow is better. Why? It’s not as volatile. Less volatile works better with RSI pullbacks. Still, the Dow is becoming antiquated. What if the Dow goes away sometime soon?

Problem #4: it enters when it enters Oversold. What happens if the entry is only the beginning of a long, horrible drawdown? If it is, that’s going to be a really bad trade.

Problem #5: the timed exit. Do you see what our exit is if we don’t reach the target? 52 bars. That’s 52 trading days. That’s almost three months. Who wants to be in a bad trade for 3 months? And who wants to wake up and see a drawdown for three straight months with no real hope of a comeback. The only hope in extreme cases like that is to have the loss end up a little less traumatizing. Yikes.

Problem #6: the ATR target. This is negative reward-to-risk and it’s pretty extreme. If the max loss gets hit too many times, we’re in trouble.

Problem #7: long-only. Some people think we have to trade both ways no matter what. This system doesn’t listen to that scolding advice.

Are there rebuttals? Of course.

The first is:

Look at that freaking Equity Curve! Are telling me you’re so weak-minded that you can’t wait out a few bad trades for a 1,000% return over time??

Whoa, that’s a little harsh. But I hear you.

As far as the Daily chart, Daily signals are also the best signals most of the time.

As far as RSI, we didn’t optimize. We just used RSI 2, which has been around for decades.

As far as the Dow, it’s almost certainly going to stay less volatile and be available to trade.

As far as Oversold, it also gets us nice, quick winners when we enter on the first foray into Oversold.

As far as the timed exit, that’s tough. It would take a mindset change but is WAY better than what index funders have to go through. Index fund traders would’ve looked at a losing account for over a decade starting in 2000 and from 2007 through 2012.

If they can do it, we can surely do a few months (in the worst-case scenario).

As far as negative reward-to-risk, it’s no different than extreme r:r the other way. A system with a 10x target and 1x stop is no less dangerous than this one.

As far as long-only, to argue against the validity of long-only in stock trading is silly.

So, where do we stand?

Is this a go or a pass?

Before I make my final decision, I have a crazy idea.

And we’ll talk about that in the 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.