What to Trade: Final Cuts (Step 18)

Aug. 5, 2020

We recently decided to embark on a journey to beat the market.

To do that, we decided to start from scratch. 

Our goal is to build a system that will easily outperform the market over time and build this system step-by-step so anyone can follow along. Feel free to ask questions as we go. 

To review, here’s what we’ve done so far:

1. We chose Forex over stocks and futures for the leverage and because we can trade any size account;
2. We picked a system that suits our psyche (buy-low-sell-high) so we wouldn’t get discouraged, and then did a quick run-through of some numbers to see if it’s profitable;
3. We chose one of the most popular currency pairs (EURUSD);
4. We used ATR to build a hypothesis on how our system could work;
5. We calculated a legitimate trade size we could use.
6. We looked at what max drawdown means and how to manage it cautiously.
7. We looked at how to not be so careful and manage max drawdown aggressively.
8. Then we did a quick checkup to see if our system is beating the market. (It did by a nice margin.)
9. We investigated moving to break-even.
10. We examined if certain trading days are better than others.
11. We stressed the importance of quality data.
12. We discussed the logistics of timeframe.
13. We looked at compounding our gains.
14. We examined the inherent problems with any system.
15. We talked about how great and how hard robot trading is.
16. We talked about the danger of diversifying.
17. We looked at a good way to possibly diversify.

Our system from scratch is almost finished. Just a couple items left.

Overall, we’ve come up with a system and looked at all the pitfalls.

We’ve looked at why diversifying is terrible (makes less money with no drawdown improvement) and how diversifying can help (more money with better drawdown).

Now, it’s time to make the final decisions.

First, are we going to focus or trade more than one?

If we trade just one instrument, we have some major benefits.

By trading one thing, our returns won’t be diluted. Some famous Market Wizards say the reason they made so much money is because they DIDN’T diversify. They kept their portfolios concentrated and that produced amazing results.

Also, by focusing, we’ll get to know our instrument intimately. We’ll know quickly if something is wrong and we’ll know how to fix it.

Those are huge benefits.

But focusing also can lead to big drawdowns. There’s nothing to save us during a losing streak. It would be nice to have one instrument winning while the other is losing. That’s the point of good diversification – and who wouldn’t want that?

So, let’s break it down and make a final choice.

If we just trade our original creation, the EURUSD, here are the yearly hypothetical returns since 2008 trading 1.0 lot each time:

The good? Only two losing years and we beat the market by 4x. We can focus and easily make adjustments if necessary.

The bad? We can go a long time between trades and nothing to help the losing streaks.

What if we add the USDJPY and GBPUSD with the same settings but a quicker entry at 1 ATR (as we mentioned in our last email)?

We still have two losing years but our profit has doubled and our losing years are smaller. That’s diversification at its best.

And the return from this portfolio was 6x greater than the market.

It seems like we’ve achieved our goals. We have a simple system that destroys the market.

But what if we went one step further and did something crazy?

It’s our last step in this process and we’ll talk about it in our next newsletter.

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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.