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Why inverting trades doesn't work?

  • #1
  • First Post: Aug 8, 2010 3:48pm Aug 8, 2010 3:48pm
I recently saw a BBC Planet Earth documentary where they compared the humans failure of understanding the laws of the universe with a dog's failure of understanding simple physics. In this problem I am about to present to you I feel like the dog in the example.

I have been creating EAīs for Metatrader for more than a year now with limited success as far as any results goes. Because of the failures to produce a continious positive equity-curve over any longer period of time whatsoever and the relative ease to produce a negative equity-curve I set myself a new goal.
That goal was to create a higher timeframe-based system continious negative equity-curve and then inverting the trades in all aspects.

I have now reached that goal and I canīt say that I really thought it would work but I also wouldnīt have expected theese confusing results.

What are the reasons for both curves being negative?
We canīt blame it all on the spreads because it is based on hourly timeframes, and although it surely may have some effect it just canīt be the whole explanation.

First attachment below is the original trades curve over a 2,5 year period (starting Jan 2008 - today).

Second attachment is the inverted curve over the same period of time.

My question to anyone is, what are the reasons that inverting trades also seem absolutely impossible, even on higher timeframes, wide tpīs & slīs and over extended periods of time? Stops and TPīs average around 50-500 pips so once again, spreads just canīt be the whole reason for this. Or could it? What is it that I fail to see and understand?

Thanks so much in advance to anyone who might shed some light to a dog trying to understand the laws of financial instruments.

/ McKeen
Attached Image(s) (click to enlarge)
Click to Enlarge Name: TesterGraph Original.jpg Size: 39 KB
Click to Enlarge Name: TesterGraph Inverted.jpg Size: 38 KB
  • #2
  • Aug 8, 2010 3:54pm Aug 8, 2010 3:54pm
If it had been manual trading I would have said psychology and trade management but that obviously doesn't apply here.

Sorry, can't help because I have no idea, but it's an interesting question!
  • #3
  • Aug 8, 2010 4:00pm Aug 8, 2010 4:00pm
Trading consists of a multitude of variables. The 'heads/tails' analogy often comes up by people who don't understand how the markets work. If two novice traders enter the market on the same day, both without any edge, and execute trades against each other ... they both can lose. And this happens quite frequently. My advice to you would be to focus-in on one aspect of trading and learn how to trade it. Designing EA's is a waste of time unless you know some sort of trading edge.
  • #4
  • Aug 8, 2010 4:26pm Aug 8, 2010 4:26pm
The oposite of a positive edge is a negative edge. A random system fails due to transaction costs, but taking the opposite position triggered by a random event is of course still a position triggered by a random event. You are replacing one random system with another random system.

I am quite puzzled as to why most people completely fail to undertand this
  • #5
  • Aug 8, 2010 4:50pm Aug 8, 2010 4:50pm
Quoting Razzle
The oposite of a positive edge is a negative edge. A random system fails due to transaction costs, but taking the opposite position triggered by a random event is of course still a position triggered by a random event. You are replacing one random system with another random system.

I am quite puzzled as to why most people completely fail to undertand this
I understand your point in the real market but here we have static historical data. Maybe we could call it random in the original backtest but since the history data is identical in the case of the reversed results I am not sure I can agree on it being random. Let me expand my point by revealing the following statics about the setup. (I am definately not trying to state the system isnīt random in a real market or that I would have found an edge)

In original curve the following statics are there:

All trades are triggered by 4 types of stem-candles. (hammers & hanging man + their respectives)
StopLoss is the High / Low of that stem-candle.
Takeprofit is when an opposite candle appears.

In the reverse curve the statics are:

Identical trigger candles but reverse trade direction. (Identical to the above's trigger)
StopLoss is when an opposite candle appears. (Identical to aboveīs tp)
Takeprofit is the High / Low of the stem-candle. (Identical to aboveīs SL)

How can that be random when the data we are running it against also is static? What is it I fail to understand?

Please elaborate without flaming...

/ McKeen
  • #6
  • Aug 8, 2010 4:53pm Aug 8, 2010 4:53pm
Looks like your EA does not trade the exact opposite:

The first pic shows about 2500 trades, the second only about 1900

Dont ignore the spread!
You are in GBPUSD so your spread is about 3 or 4 pips
overall this is a difference of 7500-10000 pips for 2500 trades, this can absolutely make a difference.

If your EA doesn't have a fixed TP and SL then this is the reason why there are differences. You can't operate with trailing stops/entrys when trying to get the exact oposite.

Hope it helps
woozy5
  • #7
  • Aug 8, 2010 4:56pm Aug 8, 2010 4:56pm
  •  Czech
  • | Joined Feb 2010 | Status: You Don't Know What You Don't Know | 111 Posts
Lets imagine for a minute that inverting trades DID work. Anybody can create a losing system in the long run. All those systems could be inverted for an excellent 100% of traders being profitable!

what they said tho^. a losing system is losing because there is no discernible edge. When you reverse it your entires are still random and while you may have some short term gains, they will ultimately be leaving your account when met with the law of large numbers.

Random entry + spread = negative expectancy
negative expectancy x 1000 trades = empty trading account


edit: to clarify.. the entires are random because they aren't based on an edge. You're basing your entry on "something" (so its not random to you per se) but that "something" doesn't actually give you any information on where the market is heading
  • #8
  • Aug 8, 2010 5:13pm Aug 8, 2010 5:13pm
There are only two possibilities. Either the original losing system doesn't have a large enough average loss per trade to cover the actual trade costs (spreads) - [less likely given that I don't think the MT4 backtester takes spread into account], or the second system isn't a completely opposite reproduction of the original strategy. Those are your only two possibilities. Answer the question of what is the original strategy's average loss per trade, and you can know what is causing your problem. Actually a third possibility exists: namely inconsistency in the Metatrader backtester. Not that THAT would ever happen!

After answering the average trade question, run through the two tests trade by trade to ensure they are in fact duplicate opposites of each other.
  • #9
  • Aug 8, 2010 5:17pm Aug 8, 2010 5:17pm
Quoting McKeen
Please elaborate without flaming...

Most popular TA and price action based approaches are essentially random. Those trading them may not think of them in that way, but in reality they are. That statement is going to upset a lot of people, but its a verifiable fact, and the work you've done goes some way to proving that.

If you where compare the distribution of gains and losses from those kinds of TA/PA based systems against a purely random entry, over a large enough sample there's generally no statistically significant difference.

I think this is where some of the confusion lies, you possibly initially believed that your original entries are NON RANDOM. Someone may have believed that they had an edge, and you tested it, and discovered that it did not. You may have incorrectly thought that it had a negative edge (because it lost money), but in reality, it highly likely that the methodology was in fact random, and its the transaction costs that result in long term losses. Your results certainly back up that hypotesis.

IF the system had truly had a negative edge then doing the opposite would have made money. The truth is that negative edges are almost as diffficult to design as positive edges (theyre a bit easier to build because of transaction costs, but if you assume zero cost, they are equally as difficult to design).

The reality of your test, is that you are reversing a completely random system , and therefore, you get the same result you'd get from any other random system, which is basically break even minus transaction costs.

I have a positve expectancy system, and when I trade the inverse of that system it loses money much faster than I'd expect by random chance, and I do actually trade the inverse in demo on an ongoing basis.

Someone said earlier that its pointless building EA's unless you have an edge to exploit. I'm not sure I fully agree, but in the short term your much more likely to find a tradable edge from discretonary trading than you are from EA development, actually I think most people benefit from a little of both.

I wouldnt be discouraged, understanding why this is happening is a bit of a key stage in a traders development.
  • #10
  • Aug 8, 2010 5:18pm Aug 8, 2010 5:18pm
Quoting McKeen
spreads just canīt be the whole reason for this. Or could it?
No, it couldn't, IT IS.

With more than 2000 trades, I assure you that the spread is the reason of the failure.

I did the same experiment many months ago, after testing a lot of estrategies and always blow up the virtual account, I have the "brilliant" idea of modify EAs simply changing buy orders for sell orders and viceversa, and results were the same: the total ruin of virtual accounts, looking closer, trades didn't open at the same time, because of spread, a lot of trades didn't open at all, that's because it's impossible to test exactly the opposite of your trading history, and in the long term this lead to lose all the virtual money.

Take a closer look to spreads and comissions of your broker, it doesn't matter what some people here say to you, the spread is always against you.
  • #11
  • Aug 8, 2010 5:28pm Aug 8, 2010 5:28pm
  •  Czech
  • | Joined Feb 2010 | Status: You Don't Know What You Don't Know | 111 Posts
Quoting FXEZ
There are only two possibilities. Either the original losing system doesn't have a large enough average loss per trade to cover the actual trade costs (spreads) - [less likely given that I don't think the MT4 backtester takes spread into account], or the second system isn't a completely opposite reproduction of the original strategy. Those are your only two possibilities. Answer the question of what is the original strategy's average loss per trade, and you can know what is causing your problem. Actually a third possibility exists: namely inconsistency...

OR (thinkin out loud here) what if hes using variable position sizing. ie: 2% of your account balance per trade.

If the first trade was a loss for 2% then he'd need a 2.4% gain in order to get back to break even (the numbers are made up but the principal stands). When his odds of guessing correctly are 50-50 then his results are what we'd expect in the long run, right?
  • #12
  • Aug 8, 2010 5:39pm Aug 8, 2010 5:39pm
Quoting McKeen

What are the reasons for both curves being negative?
We canīt blame it all on the spreads because it is based on hourly timeframes, and although it surely may have some effect it just canīt be the whole explanation.
Say your original system got +2pips edge before spread, so inverting the original system will have -2pips edge before spread. However Your spread is 3pips therefore both of them losing money consistently after consider spread.

Based on your equity charts, I'm pretty sure that your original system has positive edge before spread, but just too little to overcome spread.
  • #13
  • Aug 8, 2010 5:43pm Aug 8, 2010 5:43pm
Quoting Czech
OR (thinkin out loud here) what if hes using variable position sizing. ie: 2% of your account balance per trade.

If the first trade was a loss for 2% then he'1 lot flatd need a 2.4% gain in order to get back to break even (the numbers are made up but the principal stands). When his odds of guessing correctly are 50-50 then his results are what we'd expect in the long run, right?
I must get back to comment on all you guys comments tomorrow after further investigating the points made by FXEZ and also do some calculations on the spreads. (There are also no commissions) but I just wanted to mention that 1 lot is another static variable in this equation that I previously forgot to mention.

IE I do not use variable position sizing.

Thanks all for your replies so far..

/ McKeen
  • #14
  • Aug 8, 2010 6:03pm Aug 8, 2010 6:03pm
Quoting FXEZ
There are only two possibilities. Either the original losing system doesn't have a large enough average loss per trade to cover the actual trade costs (spreads) - [less likely given that I don't think the MT4 backtester takes spread into account], or the second system isn't a completely opposite reproduction of the original strategy. Those are your only two possibilities...
Another possibility is the duration of the trade. Just as randomperson said, two people taking opposite position can both lose, simply because they exit at different times.

It's probably your exit rules which are killing you.

Rob
  • #15
  • Aug 8, 2010 6:25pm Aug 8, 2010 6:25pm
heres my penny's worth, if by inverting you mean your now selling on your orignal buy signal and vice versa.

if your trading with a stop of 50 pips and a profit of 100 pips, its easier to reach your stop then it is to reach your profit.

in your orignal system, when you buy the price may head to your profit by atlest 50 pips before reversing and hitting your stop.

so when you invert the trade, and you have a 50 pip stop, that stop will still be hit.

if you are going to invert the signal you might wanna try and invert the stop and profit targets aswell. not great for r&r, but it should make an interesting study.
bull in a china shop
  • #16
  • Aug 8, 2010 7:49pm Aug 8, 2010 7:49pm
Quoting Trad3r
No, it couldn't, IT IS.

With more than 2000 trades, I assure you that the spread is the reason of the failure.
Don't be so sure. He'd have to pay a 5 pip spread to lose $100k over 2000 trades, trading 1 lot per trade. If he did, fine, but if he didn't, there's something else at work. It would be nice to know the average spread paid.

I also question the experiment. You can't just trade the opposite signal, you have to take the same entry, and flip the target profit and stop. Go long precisely where you went short, take profit where you would have been stopped out, and put the stop where you would have taken profit. Otherwise we're just trading one bad system for another, rather than taking a look at the other side of the trade.

My guess is that he lost more than the spread on both occasions. Unlike some posters in this thread, I strongly disagree that the markets or these two systems are random, and suspect both of these systems were -ev before the spread. It would be more revealing to show a truly inverse test.
  • #17
  • Aug 8, 2010 7:56pm Aug 8, 2010 7:56pm
Ever heard about Murphy's law?

Well..... Forex is a perfect environment for this particular law to blossom.

Why?

Because we are hard wired to "err", especially when dealing with binomial or multiple choice (random) matters.

I'm not gonna get into the metaphysical/philosophical implications of Murphys's, but speaking about trading, for as long as you are doing it "consciously" you will face the same problems and commit the same mistakes, not because of what you do but because of what you are.

Lets take a example.....

We all know that we should not use a hammer on screws but lets take something even harder. Lets try to put a nail in a hard wood with a screw driver.........kind of tough huh!

Well Forex is the nail and you are the screwdriver.........got it?

So for as long as we are creatures prone to "err" and on Forex there is no barriers against error ( like a boss, mother, espouse, cops, etc...etc) Murphy's law will blossom.

One way of playing the "inversion" game would be to "trick" the hard wire on your blue print by trading out of consciousness. Thats what researches do with placebo...right? If you take somebody and program a platform so losses will show as win, and and win as losses ( off course without the guy having any idea of it), the results will amaze you.

Another way is constraining the natural inclinations ( hard wire) by putting the trader under strict supervision and only executing trades under the supervision of somebody or a team of people that already have the hard wire stuff under control. Risk management team in banks exist for this reason.

Third and best way IMHO is to through time and practice "rewire" yourself away from the natural error blueprint. People usually call it discipline, experience, etc.
  • #18
  • Aug 8, 2010 8:52pm Aug 8, 2010 8:52pm
I can't believe the amount of crap people write on this forum (the above being a prime example), Razzle nailed the answer first time, yet everybody clatters on about all sorts of irrelevant shit as if he had never posted.
The breaking of a wave cannot explain the whole sea.
  • #19
  • Aug 8, 2010 9:01pm Aug 8, 2010 9:01pm
Quoting Craig
I can't believe the amount of crap people write on this forum (the above being a prime example), Razzle nailed the answer first time, yet everybody clatters on about all sorts of irrelevant shit as if he had never posted.
So true -
Time hides Nothing
  • #20
  • Edited 9:30pm Aug 8, 2010 9:09pm | Edited 9:30pm
Quoting Craig
I can't believe the amount of crap people write on this forum (the above being a prime example), Razzle nailed the answer first time, yet everybody clatters on about all sorts of irrelevant shit as if he had never posted.
Ohhh crap.....I mean....Ohhhhh...Craig....you hurt my feelings......!!
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