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Seeking Balance In Your Trading System

06/20/11 08:35:48 AM
by Donald W. Pendergast, Jr.

Ideally, the trading system you use should offer a reasonable balance between both long-side and short-side profitability.

Security:   @ES
Position:   N/A

A couple of months ago, one of my silver futures swing trading systems really went on a tear, netting one subscriber as much as $12,000 in gains while trading one full-sized Comex silver futures contract -- in less than three days. The system, although profitable, has made the majority of its back- and forward-tested gains on the long side of the silver market over the past 30 months, and it also wins about 38% of the time. It's definitely a trend-following model, one that is heavily biased toward the ongoing bull run in the silver market. Over time, the system will adapt and likely become more balanced once the silver market's characteristics change after the bull market finally ends some day.

In my extensive testing of trading systems, however, I find it is easier to come up with balanced daytrading systems; one of the better ones is called ES Yukon, which trades the front-month emini S&P 500 futures contract from 0630 to 1315 Central Time before going flat in cash. In Figure 1, you can see the 10-month-long backtest results, which clearly show how evenly this system interacts with bullish and bearish intraday market dynamics.

FIGURE 1: SYSTEM RESULTS. Generally speaking, it's usually best to trade a system with a favorable balance between profits on the long and short side of the market.
Graphic provided by: TradeStation.
Over a 10-month period, the system put in more than 400 hypothetical trades, with a profit factor of 1.58 for long trades and 1.56 for short trades. Hypothetical profits came in at $10,353 on the long side and $9,055 on the short side. Average trade figures were also fairly balanced, too; on the long side the average trade was $49.77, while the short trades managed to return $40.07.

For the last three weeks, the system has been in hypothetical walk-forward mode and has actually done better than in the original back-test -- with a profit factor of 2.063 across 32 trades. Profits in walk-forward mode have been biased to the short side, with a profit factor of 2.811. The long side profit factor so far has been a respectable 1.508.

It's impossible to know if the system will continue to perform this well over the long haul, but it's certainly off to a good start in hypothetical walk-forward mode. Over time, the theory is that the profit factors will become more equalized, much as was seen during the 434-trade back-test run. If this can be achieved, it should be easier for subscribers to stay with the system for a long time than if it did well only on one side of the market.

FIGURE 2: ES, EMINI S&P 500. Daytrading systems may be better able to offer a good balance between short and long side profitability, compared to longer-term systems that can become overly biased during long bull or bear runs.
Graphic provided by: TradeStation.
In Figure 2, you can see how the system did during two consecutive trading sessions, returning more than 32 hypothetical points in the emini S&P 500 futures contract. Will every trading session look like this? Come on, get real now. Of course not! But with a solid back-test behind it, there could be a display of a lovely balance between both long and short side profits. The hope is that potential subscribers will feel more comfortable when deciding to start trading this system with real money.
Always look at the distribution of profits (back-test and forward-test) on either side of the market before deciding to trade a system. A good daytrading system that can help deliver the goods in bullish and bearish environments is preferable to a system that only makes money when a long-term trend is in control of a given market.

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:

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