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TRADING SYSTEMS


A .370 Batting Average?

02/22/11 10:55:42 AM
by Donald W. Pendergast, Jr.

Some traders are more comfortable with a system that wins 70% of the time rather than one that only wins 35% to 40% of the time. But what if winning less frequently actually resulted in substantially higher profits?

Security:   @YG, YGH11, SIH11, SLV
Position:   N/A

Most traders shouldn't even be trading at all, given that many have insufficient account equities, no proven system, and very little self-discipline. However, for those who are actually well prepared to take on the financial markets with a proven system, they still need to find one that is within their psychological comfort zone -- one that will help keep them motivated to keep on trading it through thick and thin. Here's a look at a system with a lot of promise -- and a relatively small winning percentage rate. Could you actually trade it? Let's take a look.

FIGURE 1: PERFORMANCE RESULTS. This system seems to be the epitome of the old trader's saying of "Let your winners run and cut your losses short." But could you truly be comfortable with a system that only wins 37% of the time? These are hypothetical, backtested results, trading a single contract with no slippage and a $20 round-trip commission rate per contract.
Graphic provided by: TradeStation.
 
Figure 1 is the latest backtest stats for my Silverado trading system. The system, an intraday mechanical strategy for Comex silver (SI), currently has one of the highest out-of-sample, walkforward performance rankings at Striker Securities, Inc., and had a very nice winning trade last week, latching on to the powerful upside trend momentum of this highly emotional market. As you may already know, sometimes backtested results differ substantially from those obtained in out-of-sample, walkforward mode, but in the case of the Silverado system, it still continues to display strong performances in both testing modes.

Incredibly, as of this writing, the system has no current subscribers. Why is that? If it actually has been making good money in hypothetical, walkforward mode, why aren't traders jumping on board in hopes of making a profit, especially as the silver market surges to fresh 30-year highs?

Well, take a look at that Percent Profitable statistic; this system wins less than 40% of the time (in both backtested and forward test modes), and that is probably one of the main reasons why no one has been willing to trade it in the real world, with real money. It also has longer losing streaks (seven losers in a row) than winning streaks (four winners in a row). Silverado is also currently displaying a long-side bias (more trades and profits on the long side rather than on the short side), but that is easily explained due to the incredible bullish bias of this market since August 2010. It has been making hypothetical money on the short side from time to time, but it just hasn't had many opportunities to do so as silver pushed higher and higher.

So, who might be a realistic candidate to trade Silverado in the real world, anyway? Perhaps a trader who is already trading several systems across several markets and who is interested in adding even more diversification to their futures market systems portfolio. For example, if a trader were using an emini Standard & Poor's 500 intraday scalp system, a grain swing trading system, a daily bar gold system, and a countertrend intraday crude oil system, perhaps adding Silverado to the mix could help smooth out the overall portfolio equity curve and/or help boost its ultimate profitability too.

Then again, Silverado might be all wrong for a trader who only has enough capital to sustain small drawdowns and who needs to make every bullet count in hopes of rapidly increasing account equity as safely and smoothly as possible. Portfolio construction can be just as important a task as selecting a trading system, and you really need to put a lot of time and thoughtful effort into both activities.

As always, remember that past/present system performance in no way guarantees that such a system will remain profitable in the days, weeks, and years ahead. Always talk to a licensed stock or commodity broker before trading any system, no matter how good its performance record appears to be, and only trade with funds that you can safely afford to lose.



Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title: Writer, market consultant
Company: Linear Trading Systems LLC
Jacksonville, FL 32217
Phone # for sales: 904-239-9564
E-mail address: lineartradingsys@gmail.com

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