Tell me one thing: how do you validate your trading system? How can you be sure that by following these entry and exit signals from the market you will have profitable results? Just because you have executed a backtest and it has given you good results?
In today’s article I propose to rethink your way of working and begin to apply the scientific method as a procedure of development and validation of trading systems.
As we said in our previous article, we can classify trading systems into two groups: those based on models and those based on exploitation or data mining.
In this article we will discuss in detail the systems of the first type, defined as those who propose a model to represent the behavior of the market and from it, try to get benefits.
The algorithms that are part of this group are usually very simple in terms of the rules they use, although its development is usually relatively complex depending on the algorithm. The starting point of the models used for this type of strategy is the detection of a market inefficiency we want to exploit. Inefficiency produces an anomaly or a pattern on the price that can be described using a mathematical model that allows us to predict to some extent where the price will be in the next period based on a function based on historical price information.Let’s look at some of the most common strategies based on models.
Although you probably have already noticed it, the trading systems are evolving and becoming increasingly technical. As you can imagine, some professional traders recommend to make a qualitative leap and try to convince once and for all that the use of trend lines, price chart patterns and obsolete oscillators in the same way that comes in thousands of books it is not exactly the best approach to winning in trading. I know this is a very broad and intense debate and that many people are not quite agree, but I plan to present new ways of seeing trading that might be interesting for some.
That said, we will introduce a new way of looking at trading systems. And for this let us first reformulate their classification. Typically, systems classify roughly in the classical groups of trend followers, countertrend and pattern-based. But today I propose a completely different alternative to any other classification that you may have seen.
Considering how a system is developed, we can establish two groups of trading systems: trading systems based on models and trading systems based on exploitation (mining) of data. We will describe these groups in detail.
The difficult part to begin to trade in any market is to define the strategy or trading system that we are going to apply to make money, as there are many trading systems but:
A robust trading system is a trading strategy that is designed to perform well under different market conditions and over long periods of time. A robust trading system is not overly sensitive to minor changes in the market or to specific market conditions, but rather has a built-in flexibility to adapt to changing market environments.
A robust trading system typically involves a combination of different trading strategies and risk management techniques that are tailored to the individual needs and objectives of the trader. The system should have clear rules for entering and exiting trades, as well as a well-defined risk management plan that includes strategies for managing drawdowns and minimizing losses.
A key characteristic of a robust system is that it has been thoroughly tested using historical market data to ensure that it has a high probability of success in the future. This testing should include multiple market scenarios and time periods to ensure that the trading system can perform consistently over a wide range of market conditions.
Overall, a robust system is designed to help traders achieve their trading goals while minimizing risk and maximizing long-term profitability. By having a well-designed and thoroughly tested trading system, traders can have confidence in their ability to navigate the markets and make informed trading decisions.
We can do a practical exercise to evaluate the robustness of two well-known trading strategies:
Money management is probably the most important aspect of managing a trading account. It is something so simple that can be learned in ten minutes and certainly is one of the most important causes of losses for most traders, usually in a reduced time.
As the name suggests, Monetary Management is nothing more than a set of techniques that help us to determine the size of our position to control potential losses that may arise when the market move against us.
Due to the high leverage offered in the Forex trading, many inexperienced traders assume a higher risk than any investor should take, resulting in hardly recoverable losses.
The scalping can be defined as a very effective (but also risky) trading technique which has become one of the most popular strategies in recent years. It is also known as “Quick Trading” and is one of the most effective trading strategies used in highly liquid financial markets such as Forex. Scalping is a series of short term operations (buy and sell fast trades) over the trading session, which can reach even the hundreds of daily trades with ease. In this case, it involves transactions that may take 1-2 minutes on average and sometimes even a few seconds.
The scalping is classified as an intraday trading technique, ie transactions whose duration is less than a day and can last from several seconds to several hours. Through the scalping, a human trader can make up to 20 or more buy or sell buy and sell trades in an hour to profit from micro-movements of the market. Automated trading systems based on computers are capable of a much larger number of scalping operations per day.
Developing an effective trading system can be a challenging and time-consuming process, and once you have one, it can be exciting and rewarding to see it consistently generate profits. However, occasionally, you may experience your trading system suddenly stop working, and what was once a profitable strategy, now appears to be losing money. In this article, we will examine the … Read more