by Eric Chamberlain
Are you tired of trading systems that worked well in the past but are lousy at predicting the future? When I was a novice system designer, I would get excited by every upward trending equity curve that I came across. With an incredible back-test result in hand, I would venture out into the market with real money to trade, only to discover that my system was a big loser. Does this experience sound familiar?
I got so tired of trading bad systems that I began to create my own. Over the next few weeks, I want to share with you some of the steps I take as I go about developing a trading system that can be profitable in the long-term. I want each of you to participate in this discussion and I hope that we may learn from each other.
Step 1: Form a Hypothesis
Write down the concept and the initial rules for the system. Moreover pick a certain strategy, e.g., trend trade, swing trade, mean reversion, breakout, etc. Determine how much time you can devote to your system, and how much you want to risk.
Example:
I wish to trade minor trend changes in the market. (Did you see how easy that was?) A short term system will most likely be fairly active, i.e., it will require a lot of time and effort.
If you want to use a particular technical indicator, you must pick from the list of over 200. Which one shall I choose? Shall I use several indicators?
Don’t make it too difficult! Many technical indicators are doing the exact same thing; however, they report the data differently. I will often just pick one of my favorites indicators because I already understand its strengths and weaknesses.
I’ll use pivot points for this exercise.
Step 2: Create and back-test Rules:
Enter: Buy the close when there appears a bottom pivot point with a closing price reversal confirmation; that is, a low yesterday that is lower than the previous day’s low, a low to day that is higher than yesterday’s low, and a close today that is higher than yesterday’s close.
Before I begin to develop a set of exit rules, I must first test my entries. Many trader overlook this step, I however believe this is the most important step. How will I know that my entries are valid? I will therefore back-test my system’s entry rules and I'll have a random number generator pick the selling points. If my system is profitable; I’ll know that my entries have some validity. I will exclude the affects of margin and risk management in my first simulation.
Here are the results of the EURUSD from 5/7/2002-2/4/2008:
http://www.pfxglobal.com/images/EricC/3.2m.png
http://www.pfxglobal.com/images/EricC/3.2eqc.png
http://www.pfxglobal.com/images/EricC/3.2results.png
http://www.pfxglobal.com/images/EricC/3.2dist.png
Although our system is profitable we need to improve several items, most notably, average gain and drawdown. Our next assignment therefore is to create a set of exit rules to improve our results. Take this system and play with it and offer your insights/replies. More to come.
.
Are you tired of trading systems that worked well in the past but are lousy at predicting the future? When I was a novice system designer, I would get excited by every upward trending equity curve that I came across. With an incredible back-test result in hand, I would venture out into the market with real money to trade, only to discover that my system was a big loser. Does this experience sound familiar?
I got so tired of trading bad systems that I began to create my own. Over the next few weeks, I want to share with you some of the steps I take as I go about developing a trading system that can be profitable in the long-term. I want each of you to participate in this discussion and I hope that we may learn from each other.
Step 1: Form a Hypothesis
Write down the concept and the initial rules for the system. Moreover pick a certain strategy, e.g., trend trade, swing trade, mean reversion, breakout, etc. Determine how much time you can devote to your system, and how much you want to risk.
Example:
I wish to trade minor trend changes in the market. (Did you see how easy that was?) A short term system will most likely be fairly active, i.e., it will require a lot of time and effort.
If you want to use a particular technical indicator, you must pick from the list of over 200. Which one shall I choose? Shall I use several indicators?
Don’t make it too difficult! Many technical indicators are doing the exact same thing; however, they report the data differently. I will often just pick one of my favorites indicators because I already understand its strengths and weaknesses.
I’ll use pivot points for this exercise.
Step 2: Create and back-test Rules:
Enter: Buy the close when there appears a bottom pivot point with a closing price reversal confirmation; that is, a low yesterday that is lower than the previous day’s low, a low to day that is higher than yesterday’s low, and a close today that is higher than yesterday’s close.
Before I begin to develop a set of exit rules, I must first test my entries. Many trader overlook this step, I however believe this is the most important step. How will I know that my entries are valid? I will therefore back-test my system’s entry rules and I'll have a random number generator pick the selling points. If my system is profitable; I’ll know that my entries have some validity. I will exclude the affects of margin and risk management in my first simulation.
Here are the results of the EURUSD from 5/7/2002-2/4/2008:
http://www.pfxglobal.com/images/EricC/3.2m.png
http://www.pfxglobal.com/images/EricC/3.2eqc.png
http://www.pfxglobal.com/images/EricC/3.2results.png
http://www.pfxglobal.com/images/EricC/3.2dist.png
Although our system is profitable we need to improve several items, most notably, average gain and drawdown. Our next assignment therefore is to create a set of exit rules to improve our results. Take this system and play with it and offer your insights/replies. More to come.
.