Learning Your Success

From the first chapter of Hedge Fund Market Wizards comes a quote that quickly gives the example of how you will most likely not stay with the default settings of the Expert Advisors. Testing multiple variations of the settings is encouraged:

Jack Schwager:     Is trading a skill that can be taught?
Colm O'Shea:     It can't be taught, but it can be learned.
Jack Schwager:     What do you mean by that?
Colm O'Shea:     My natural trade time horizon is one to three months, but that doesn't mean it would be right for you. Since I don't know you, I can't tell you what your trading style should be. But if you are willing to put in the effort, you can learn what that style should be. If I try to teach you what I do, you will fail because you are not me. If you hang around me, you will observe what I do, and you may pick up some good habits. But there are a lot of things you will want to do differently. A good friend of mine, who sat next to me for several years, is now managing lots of money at another hedge fund and doing very well. But he is not the same as me. What he learned was not to become me. He became something else. He became him.

What to Expect

If you are not familiar with the basics of Trend Following, most systems have a winning percentage around 30-40% and a losing percentage around 60-70%. The large winning trades during trends overcome the many small losing trades to make the system profitable. The default settings of the Expert Advisors will most likely not be ready for you to trade with a sufficient level of profitability. As the quote above mentions, you will be looking to find a system that matches your trading style and fits your risk tolerance. By testing and customizing your variables, you will be able to work to find a system that fits you.

Finding Your Balance

In testing, you have the choices of making the variables tight enough to find and capture the trend but loose enough to handle the normal market noise.

• Entries - You can get into the trend early with a tighter tolerance on the entry, but this may cause more whipsaws. Getting into the trend too late and you may have less whipsaws, but you will capture less of the trend.
• Stops - Having a tight stop will lead to more whipsaws if the stop is tighter than the normal market noise. Having a loose stop can prevent whipsaws however a wide stop will allow a smaller position size that can lead to less profits when the price trends.
• Exits - A tight exit can capture the profit but also get you out of a trend before it is finished. A loose exit may give back too much profit as the trend ends or reverses.
• Markets - Backtest on more than one currency pair at a time. Realize that a full system will diversify more than one pair alone. While one market is causing whipsaws, another will be trending. Compare the results of testing from pair to pair and also the differences in profit between timeframes.
• Capturing the trend - it is unrealistic to expect to capture the whole trend, from the bottom to the top. Trend Following will capture the middle of the trend. You will enter after the trend starts and you will exit after the trend ends or reverses.
• Track your testing - A testing journal or tracker is recommended. As you change variables, record the variables and the important results to compare the changes to the system. By recording the information for each system change, you can determine what is working and what is not. Determine the expectation of the system at each change to work towards finding the system that best works for you.

Trend Following succeeds when the market is trending and uses risk management to limit losses when the market is not trending. Changing your settings to help the system bring in more profits during trends and less losses in trendless markets will bring better results.

Too Much of a Good Thing

While we recommend testing to improve the results, to help you learn Trend Following, and to work towards a profitable system, we also give caution about keeping your testing productive. Testing and optimizing to the point of curve fitting your results to past data becomes counter-productive. Curve fitting will make a backtest look great but it will not help your future results for live trading.