Friday, October 16, 2009

You say profit... I say draw down...

Every time I read a forum thread that attempts to evaluate expert advisors, an expert advisor reviewer website or an EA seller website I realize that most people put the wrong focus in the testing of expert advisors. Today I will focus on a very typical mistake people make when looking at trading strategies and how this wrong focus can translate into loses in the world of foreign exchange automated trading.

Image you enter an EA seller website or a regular expert advisor reviewer website, then you look at an expert advisor, what is the first thing they tell you ? Without a doubt, the first thing most people analyze about a trading system and how most people evaluate these strategies is through the amount of profit they make in a given amount of time. In fact, the majority of expert advisor selling websites just focus on this aspect of trading.

I have always found this to be a totally wrong approach to the evaluation of trading systems. Why is that ? Because I certainly don't care that much about profit because profit is a secondary aspect for me in trading, the most important aspect in trading for me is capital safety. Thats right. Many experienced traders and fund managers will agree with me in that the most important characteristic of a trading strategy is how good care it takes of your capital. I would never trade a strategy that made 50% in one month and then wiped my account 8 months later, I am not interested in taking very high risks in order to achieve high profits. As I have said, the most important thing for me is capital preservation and how the EA can trade in a conservative fashion.

So what is wrong with focusing on the profits ? Everything ! The problem is that when you focus on the profits you ignore the chance the automated trading system you are trading has of wiping your account or leaving you in a very bad, deep draw down. What happens then ? Many people trade expert advisors in the hope that they will get amazing profit returns when in reality these profit levels are tied to insanely high risks through unlimited or very high market exposures.

My advice is very simple. When you are examining a trading system you should know the maximum draw down level it has an the mechanisms it uses to limit its market exposure (more on this on my ebook). That is why you will see that I often put much more focus on the reduction of draw down levels and the control of market exposure through dynamic money management systems than I do in developing a system that can turn 500 USD into one million dollars.

The question expert advisor creators and reviewers have to ask themselves should be reversed. It should not be, can the expert make X money ? It should be, how much money can the expert make with an X maximum draw down ? Of course, the estimation of the maximum draw down level of a strategy must be inferred through extensive reliable historical testing validated by live trading results. If you would like to learn more about how this testing is achieved and what characteristics are vital for long term profitable systems as well as how you too can program and design your own long term profitable trading expert advisor please consider buying my ebook on automated trading or subscribing to my weekly newsletter to receive updates and check the live and demo accounts I am running with several expert advisors. I hope you enjoyed the article !

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