Monday, July 5, 2010

Five Reasons NOT to Use a Trading System

Yes, it is true. We all want to find a profitable trading system that produces money in the long term and we get easily excited with anything that might look promising. This is especially dangerous for new traders as most of them still don't have the ability to recognize the potential of a trading strategy or the actual defects that will make it very hard to trade or simply impossible to succeed with in the long term. Some people new to forex trading are easily convinced with a few trading setups and a week of results while others venture into using systems that don't even offer clear entry and exit setups that have been proved to succeed in trading. On today's post I will give you some advice regarding this subject, I will talk about the characteristics you should look for in a system and the five main reasons why you should NOT use a given trading strategy.

If you go into any of the currently available forums with a section on forex trading systems you will find people using some trading setups that experienced traders would never use. Often these threads will continue until the system faces a draw down period, time after which the rules are changed and the cycle is repeated. This often continues until the general users loose interest and the thread dies, moving onto the next "new technique". How could you know which systems have the possibility to succeed and which ones don't ? Keep reading if you want to learn the FIVE main reasons why you should run AWAY from a trading system.

1. Lack of Statistically meaningful testing. Any system worth using must be evaluated through a statistically meaningful period. The length of this period - if you want a system that has a fighting chance against future market conditions - is of AT LEAST 5 years. This doesn't mean that the system has to be automated and backtested but that the system needs to be evaluated, even if only visually and a record of these simulations MUST be kept. I have seen HUNDREDS of systems on forums that have just been evaluated for a few months or a year and the result is obvious, they simply fail as the market changes.

2. Lack of risk and profit targets. This is perhaps one of the main reasons why I consider people fail with the thousands of systems proposed in forums. There is simply NO clear idea of what the risk and profit targets of the strategy are. What is the longest expected draw down period ? What is the average yearly profitability ? If you go to any forum and ask these questions about a system you will - most of the time - get no answer. This makes people use a system whose risk characteristics they don't understand, usually leading them to failure. If you want to succeed with ANY system, you need to know its risk and profit targets and these targets must be inferred from periods of at LEAST 5 years.

3. Lack of adequate money management. This aspect is very important as money management includes both the exit criteria plus the lot sizing technique. Money management is not simply "only risk x% per trade" it is the lot sizing plus its complex interaction with exit logic mechanisms that allows you to achieve a profitable outcome over long periods of time. If the system you are trading does not have CLEAR exit rules and CLEAR evaluation that shows over a period of at least 5 years of simulations how the closing logic benefits the system and how the overall money management reduces risk then you are not going to succeed with this strategy. Generally systems on the internet developed my inexperienced traders are filled with very complex entries and a vague and unevaluated money management concept. A weak money management strategy that has not been evaluated adequately is definitely something you should RUN away from.

4. Lack of reproducibility. A trading system cannot succeed for everyone who uses it if it cannot be reproduced accurately. Often you will see that systems proposed or shared online fail to have clear exit and entry rules that allow you to follow or evaluate them accurately. It is fairly common to find very vague descriptions of exits like "exit at the next significant support or resistance or Fibonacci level". What does the author interpret as significant ? How does he plot the Fibonacci levels ? This excessive level of discretion is very bad and it usually leads to systems that are extremely hard to evaluate or use successfully. If the systems lack reproducibility it is a definitive signal to run away.

5. Changes every 5 minutes. Perhaps the thing I don't like the most about many forums where systems are shared is the fact that changes are suggested and made very frequently. You will often find that the first post suggests a 50 pip TP only to find 30 posts later that they changed it to a 20 pip TL and then 50 posts later to a 100 pip TP. This is usually the consequence of LACK of confidence, lack of adequate evaluation, lack of adaptability and a general lack of understanding of draw down periods. Every time some loses come by the users build up a correction of the logic based on a few trades without a statistically meaningful evaluation. If you find that the system's characteristics are changed every now and then, you should move on.

I hope that the above information will be useful if you have been looking for a reliable system to use on some of the forums available online or on the internet in general. It is easy to see why the above criteria isn't met by most of the systems found online. It takes a long time to do 5 year evaluations, figure out profit and draw down targets come up with a robust money management system and a robust overall logic, however by doing this you ensure that you KNOW and understand how the system performs and this will be your ONLY weapons against the draw down periods that will certainly come. Having an understanding that bring confidence into your trading is what separates most successful traders from those who fail.

If you would like to learn about automated trading systems and how you can develop your own with a true understanding of their logic and their risk and profit characteristics 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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