Inspired by this brilliant StockTwits podcast with Peter L. Brandt, today I want to present you an article that will shed some light on how far you should actually take your perfectionism in trading.
To make it short and painful: there is no perfect trading strategy. You will have to deal with losses. Yes, there are HFT (High Frequency Trading) outfits that have been posting winning day after winning day for the last 5 years, but let me tell you a secret: you are not a HFT outfit. Plus, these HFT’s also lose – it’s just that they place a million trades a day so their edges play out very quickly.
So stop hoping, and start accepting the fact that you will lose. A perfect trading system is one that makes money in the long run, not a system that makes money with every trade – that is utopia. And you will ONLY start making money ONCE you accept that you will lose money, as well. I know, old story, but if you are not profitable yet, this is one of the reasons. Deep down inside your lizard brain you still think you are better than the market and you are still looking for that trading strategy that gives you a 100% winrate.
Curve Fitting Is Asking For Disaster
If, even after your trading system has proven to be profitable, you still want to improve it, you have to be very careful. A trading system is a very delicate construct and whenever you change a parameter, your winrate and reward:risk ratio will change. So will your variance, average drawdowns, average updraws, and so on.
Changes to a trading system should be subtle and step by step, based on robust data. If you constantly try to perfect your performance, you will eventually end up curve fitting. This means that your strategy will be way too closely aligned with the past which leaves absolutely no room for any changes in market behavior in the future. But as we all know, markets are breathing and constantly evolving.
Fitting a system too tight around past data will cost you a lot of money – the very real dilemma of every backtest. This is also the reason why you should always use an outsample when backtesting – if you have 3 years of data, develop your system on 2 years, and test it on the third year without any adjustments no matter the results in that third year.
At One Point You Have To Decide Where You Stand As A Trader – And Expect To Lose
You may already have a profitable trading system in your hands, you just don’t know it because after every losing trade you want to adjust it so that the loss you just took could have been avoided. However, this means changing your system and opening it up to other potential losses.
At one point you simply have to accept that your trading system will lose trades, it is the nature of trading. In Poker, no one would ever even consider the idea of trying to win every hand they play; it’s a ridiculous thought and absolutely insane.
“Most traders take a good system and destroy it by trying to make it into a perfect system.” – Robert Prechter
Accept that this is you, that this is your trading system, with all its benefits and flaws. Learn to love it and accept that losses are a part of it. Know that you have a positive expectancy and that the system makes money for you – what more do you want? You are already better than approximately 95% of the people that ever set foot in this business.
You Have To Strive For Excellence, Not Perfection
If you cannot fulfill your dream of creating the “Magic Strike Rate Trading System”, what is left? Excellence! It is your job to make sure to follow your system 100%. Not even the slightest deviation is allowed. Make sure you are always trading at the peak of your performance. Strive for excellence and make every trade count!
Every trade that you take outside of your trading system is an insult to yourself, to the time and effort you put into trading, and to your self-respect.
Excellence really comes down to respecting yourself in the end. Once you come to respect yourself and trust your abilities and your system, it will become easier and easier for you to follow your system.
If you encounter a losing streak, research whether you executed all the trades flawlessly and if yes, did the market conditions change, or did anything else happen? During losing streaks, it is essential to stay on course and follow your system, but at the same time understand why you are losing. If there is nothing to be done, good. This describes the process-oriented mindset every professional trader MUST absolutely live by.
Take the losing streak with pride, protect your capital, execute every trade with excellence and you will weather the storm.
Instead Of Optimizing One Setup To Death, Simply Master Another Setup Or Market
It’s fairly simple, really: Once you followed your system for a while (let’s say 50 trades) with the utmost excellence and you are still losing money, you can say with very high certainty that the system is the problem. You can then adjust, but you will never know if your system is a winning or losing one if you don’t follow it in the first place. That’s what demo accounts and backtests are for.
And trust me, the more emphasis you put on thoroughly following your system, the faster you will develop it into a winning system that fits your lifestyle and personality, which is incredibly important.
However, if suddenly you are winning over a sample of 50 trades – wow. This could be it! You may have a winning system. Why change it now? You are making money. Trade the system until you can do it blindly, day in, day out and execute with excellence. If your trading journal tells you that there is a LOT of potential in a certain area – go for it. Test the adjusted system on demo first, of course. However, if you are profitable and can’t find any huge leaks in, leave it be. Again, do not curve fit.
If you get bored, that’s great! The hallmark of excellent trading is monotony. You have mastered your setup, congratulations. You can now, in order to smooth your equity curve and diversify your income streams, develop another setup following the same process.
Over time you may learn 2-3 setups to find trades in every market condition and your equity curve will look almost perfect, although there will still be a lot of losers among your winners, obviously. It all depends on your strike rate, average risk:reward ratio, and risk appetite!
“Multiple systems, traded over a wide variety of markets are necessary to smooth out the equity curve.” Joe DiNapoli
Conclusion: Never Change A Running System
What definitely holds true in the world of bits and bytes also holds true in the world of trading. Once you make it, be happy with it. Do not question your system, ever, unless you consistently start losing money. And ALWAYS evaluate whether you applied your system falsely, or whether the market conditions changed so much that they defeated your system. Curiosity killed the cat.
With Edgewonk, it is very easy for you to test alternative strategies, see where you are leaking money, find out in which areas to improve, and so on. It will also help you tremendously in executing your trades with excellence and building discipline with the immediate response features, such as the Tilt-meter.
And even if you don’t want to invest your money into our baby, a professional trading journal is still a MUST. It will help you manage to follow your plan, will help you to turn a losing system into a winning system and it will help you keep a winning system just the way it is – winning. Don’t be greedy, don’t be a perfectionist. Be an excellent trader that knows that losing is part of the game.