Tuesday, March 30, 2010

Reversing Strategies... It Almost Never Works !

It is curious how many times during the past few years I have read posts from people in forums or people in other websites asking for a "strongly losing" trading system. It seems that many new traders have thought that given the fact that building a long term profitable system is so difficult it might as well be easier to find a system which is "long term unprofitable" and reverse the logic to get the valuable profitable results. Within this post I will tell you the reasons why this logic is inherently faulted and why reversing a trading system's logic almost never leads to a profitable system. You will see why a logic reversal does NOT imply that all trades are triggered in the opposite direction and why it leads, 99% of the time, to another unprofitable trading system.

To understand what happens when you reverse a system, it is vital to understand trading to a good extent. When you have a logic that buys at A with TP at B and SL at C and the SL is hit, then many people tend to think that reversing the logic to sell at A, with TP at C and SL at B will get them a profitable trade. This assumption is wrong. Why ? The problem is that when you buy at A you are buying at an asking price so selling at A won't happen at the same time because a short trade must be entered on a Bid price which will reach A at a different time (or not at all). The same applies for the SL and the TP. The fact that B was reached as a Bid price does not imply that it will be reached as an Ask price. So effectively reversing the logic can cause the system NOT to reach the same SL and TP values, causing the effect of a reversal to be an overall change in logic which may not correspond to a positive change in profitability.

However the Ask/Bid differences only amount to be a part of the problem. The second part, which is the most overlooked by many traders when they are presented with the "long term unprofitable system" (a system with a 10 year down slopping equity curve) is that the losing character of many of these systems which have "smooth losing curves" is caused by the spread. For example, a system may be losing globally because its TP and SL are too close to the market spread and therefore the system loses money independently of the trading logic (something which many coders which attempt to code scalping systems fail to understand), reversing the logic does not cause any improvements in profitability (because the spread is the same on both entries).

Even if most reversals do not have any positive effect, it is true that the reversal of a long term profitable trading logic will generate a "long term unprofitable" system, however, such systems must be geared so that the above mentioned problems are not important. What people tend not to realize is that coding a "long term unprofitable" system which is NOT so because of the spread and which upon a reversal will not be significantly affected in an unprofitable manner by Bid/Ask differences is JUST as hard as coding a long term profitable system in the first place. Many times people believe they have such a system but they fail to realize that backtesting of a system to see if its equity curve is "smoothly losing" must be done in six month increments (rather than in a straight ten year test) due to the fact that the lowering of equity would cause profitable periods later on in testing to appear insignificant, when the logic reverses, these periods show to be extremely losing. The lot sizing characteristics of a trading system which are made to lower loses and increase profits may indeed make the finding of such a reversable system MUCH more difficult.

I strongly believe that the failure most programmers and traders face when trying to code long term profitable automated systems is mainly because they are NOT approaching the problem in the right way. They almost always fail to understand the indicators they are using, they fail to add adaptability to their systems, adequate money management, etc. The solution is not to attempt desperate things, such as the finding of systems with 10 year smooth losing equity curves but to build an understanding of automated trading and what has to be done to generate long term profitable systems using sound strategies, this of course, comes only as a consequence of gaining an understanding about trading which requires a lot of effort and study.

If you would like to learn more about my experience with automated trading systems and how you too can design and program your own long term profitable trading systems with sound trading tactics please consider buying my ebook on automated trading or joining Asirikuy to receive all ebook purchase benefits, weekly updates, check the live accounts I am running with several expert advisors and get in the road towards long term success in the forex market using automated trading systems. I hope you enjoyed the article !

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