Two Danger Signs of a Trading System
Many investors attempt to find their own successful trading system or a trading system offered by someone else that can consistently beat the market. Many will believe that they have discovered this “Holy Grail”. But investors and investment managers who believe that they have found such a system are almost always wrong.
Here are the two warning signs of trading systems that will fail:
- The system has trading rules that contain arcane parameters. When a trading system has one or more unusual parameters that can be adjusted, it is almost always the case that the person designing the system will experiment with parameters values until the hypothetical past results look good. It is almost inevitable that the chosen parameter value will fail to thrive on a forward-looking basis.
- The system changes. I have listened to countless investment managers describe the success of their current trading system. It almost always turns out that the actual trading history is not successful. The investor has frequently tweaked the system each time it performed poorly to avoid repeating past mistakes. The result is a system that would have worked well if it had been used in the past, but has little or no chance of working in the future. These managers are “frequently wrong, but seldom in doubt” right up to the point that the money is gone. Any trading system that is modified in reaction to losses is not a viable trading system.
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