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2024/07
Does a good trading system necessarily have universality?
Question 1: Does a Good Trading System Necessarily Have Universality?
A superior trading system must and does have universality in terms of market and cycle compatibility, but the prerequisite is that the nature of the assets compared should be consistent.
For instance, a system designed for gold can be tested on silver (with minor rule adjustments) for profitability. However, testing it on GBP might yield a different result because different assets can exhibit vastly different price movement characteristics. In the gold market, trend-following and trailing stops work well because commodity trends often have good continuity. In the forex market, where price movements are more erratic, swing trading and take-profit strategies might be more advantageous.
Testing a system across multiple markets and cycles is a crucial step in system design. This process can reveal whether the system has been curve-fitted, whether it has a significant edge and whether it reflects genuine market patterns.
Question 2: Can a Trading Strategy Fail? How Do You Know When It Has Failed?
A trading strategy can indeed fail. The main reasons for failure include:
- Significant Changes in Market Characteristics:Market conditions evolve, and a strategy that once worked might not adapt well to new conditions.
- Insufficient System Edge:The original system needed a more substantial advantage to begin with.
Determining if a system has failed can be straightforward but rough. You can look at the maximum consecutive losses (or wins). If the live trading maximum consecutive losses are less than those in backtesting, continue executing the strategy faithfully. However, if live trading exceeds the backtested consecutive losses, be cautious about potential system failure (temporary or permanent) and market changes.
Question 3: What Factors Affect the Effectiveness of a Strategy Besides Trend Conditions?
Apart from market trends, other factors affecting a strategy’s effectiveness include:
- Market Characteristics:For instance, commodities like gold have been trend-oriented in the past decade. Trend-following systems perform well in such environments. If the market shifts to a range-bound nature, the profitability of trend-following systems will decline significantly.
- Volatility of the Asset:Different assets have different volatilities, impacting how a strategy performs across various conditions.
Question 4: How to Deal with Strategy Failure?
To cope with strategy failure, consider the following approaches:
- Design Robust Systems:Ensure your system has a significant edge.
- Use Multiple Systems:Employ multiple trading systems across different timeframes and markets to diversify and reduce reliance on any single system’s performance.
Question 5: Will Publicly Disclosing a Trading Strategy Render It Ineffective?
A system that is destined to fail will fail regardless of public disclosure. Finding an excellent system prototype is relatively easy, but finding one that works smoothly and suits your style is challenging. The Turtle Trading system is one of the best-known systems globally. Despite being public for many years, only some can profit from it. This isn’t because the system has failed but because its profit distribution and maximum drawdown don’t align with most traders’ backgrounds. A system misaligned with a trader’s requirements won’t yield expected returns.
Using Multiple Trading Systems
A prudent trader naturally progresses towards using multiple trading systems. This diversification smoothens the equity curve, reduces maximum drawdown, and better manages the complexities of the market. Most trading systems on the market operate on a “waiting” model—profit when the market conforms to their structure. However, we can only recognize past risks and cannot predict future ones. If future markets often don’t fit your system’s structure, what then?
This introspection provides three key insights:
- Design Systems Reflecting Fundamental Market Structures:For example, markets always move in N-shaped patterns.
- Design Systems Independent of Long-Term Trends or Ranges:A system overly reliant on long-term trends will suffer if such trends decrease in frequency or duration.
- Operate Multiple Systems Simultaneously:This reduces dependence on specific patterns and market conditions, mitigating the drawbacks of the “waiting” model.
By using multiple trading systems, you can achieve a smoother equity curve and smaller drawdowns. Diversification can enhance returns without proportionately increasing risk. This diversification can include using multiple systems, trading a variety of uncorrelated or low-correlated instruments, and varying system parameters.
