Many traders are beginning to appreciate the benefits of a mechanical, completely objective style of trading. That is a good thing. After enduring years of needless losses caused by shifting from one advisory service to another (sometimes in the middle of a normal drawdown), these traders want to immerse themselves in the highly disciplined, relatively emotionless world of systems trading. That is wonderful, but there can be (and usually is) a large separation between the initial intellectual embrace of a sound concept or belief system and the actual, day-to-day regimen of actually conforming one’s life (or trading activities) in accordance with such a discipline. Here is a look at one reason why – especially as it pertains to system trader hopefuls. System Suitability
In the graphic, you will notice that the statistics for this hypothetical silver futures trading system appear to be very impressive. Even if the system earned half of its backtested results, some traders would still likely consider trading it. That is until it begins a losing streak; one that is clearly shown to be possible (and highly probable) in the backtest results.
Imagine suffering ten losing trades in a row! Would you have the psychological fortitude to serenely ride out such a streak of losses, hopeful that your system would eventually go on to make new equity highs?
Or after five or six losing trades (ouch!), would you start surfing the Internet for the opinions and commentary of the “silver gurus,” looking for some assurance that you should continue to hold or abandon your current silver system position? Or even worse, would you be tempted to abandon the system, probably at the point of maximum pain and drawdown just before the system takes off on a long winning streak?
If you do those kinds of self-destructive things more than a few times, you are definitely not a good fit for a systems trading lifestyle, since such behavior exemplifies a complete lack of faith (unbelief) in the tested logic of the system. If you do not have absolute faith in your system, you will not be able to trade it long enough to enjoy the fruit of long-term profits that such a system can hopefully offer.
How to Build Confidence for the Long Haul
System Diversity
An interesting way to encourage a trader to stick with an otherwise sound trading system for the long haul is to combine the system with two or even three non-correlated systems. The goal of this diversification is to minimize drawdowns and periods of extreme psychological stress. In theory, especially if these additional systems focus on a market from a specific commodity sector, this kind of portfolio management can help make sure that each system’s strengths will help pull the system trader’s equity curve to new highs with smaller drawdowns.
In a perfect world, that is the goal you strive for. But even here, you will still need to tough out some drawdowns, keep on top of the systems for refinement, roll contracts at the right time and so forth. It is not exactly a day at the beach; relying on your systems (or even having others trade them for you) despite all of those advertisements depicting smiling golfers, skiers, boaters and world travelers with the implication being that their brokers and/or systems are raking in piles of cash for them, helping them maintain their exceptionally opulent, highly mobile and care-free lifestyles.
Get real! Even if you are independently wealthy with $10 million in a futures margin account and lots of free time for travel, charitable work and family and friends, you will have to maintain the same level of commitment to systems trading as the small-fry market participant with a $25,000 account who trades a couple of e-mini Russell contracts every day. There is no escaping that fact, even if someone else trades your account for you. The only way to develop that kind of commitment is to study, know, and believe in the backward and forward test statistics for the systems you want to trade.
This is an excerpt from June 2011 issue of Forex Journal.
