How to be a Professional Trader Part 3
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I pulled into Panera Bread at around 2:15. My plan was to arrive before my 2:30 appointment so I could grab some coffee and Tom would not have to wait on me. I use Panera a lot for meetings. It’s quite, and the food is healthy. My goal was to catch the lull between lunch and dinner when there would be the least amount of distractions.
I didn’t know much about Tom. We had met at a networking function and as usual the conversation had quickly turned to trading. Tom worked in sales for a large pharmaceutical company and had been dabbling in the futures market for about a year. When I asked him how it was going, I was surprised how quick he was to admit he had been quite unsuccessful. We talked a little more about his business, how he liked his work and so on.
As the conversation was coming to a close Tom said, “Hey, listen. You think I could buy you a cup of coffee sometime and talk with you a little more about your trading?”
As I approached the front door of the restaurant I could see Tom sitting at a high top table close to the entrance. (So much for showing up early.) He greeted me with a wave as I came through the door. I ordered a coffee and we both sat down at the table. I had asked Tom to bring with him a copy of his most recent trading plan. Going through a trader’s current plan is something I do very early in my evaluation process. It gives me an initial look into the trader and where they’re at in their journey toward consistent profitability.
Tom took from his pocket a folded piece of paper and opened it. On the page he had scribbled a list of rules for his trading system. As I read through it we identified and discussed many of the common problems found in most trading plans. But overall it really wasn’t a bad plan at all.
“Tom, what is the expectancy of your trading system?” I asked.
“What do you mean?” he replied with a rather puzzled look on his face.
“I mean……..let me back up. Have you tested this system?”
“Well, I’ve been trading it for a couple of months.”
“But have you ever back tested the model.” I asked. “Have you collected data on the effectiveness of your system? Things like Win/Loss ratio, average number of loosing trades, maximum drawdown, average drawdown, risk adjusted return. Have you done any of that?”
“Well no,” he replied. “I’m not even sure how to go about doing something like that.”
“Tom, how can you expect to have the confidence to trade a system if you don’t even know if it is effective? Trading can be an emotional rollercoaster even if you have all the data in front of you. You’re attempting to trade from a position of weakness, and that is never a good idea.”
“Well that makes sense. How do I fix it?”
Over the next hour I talked with Tom about the process of back testing. I took out my laptop and showed him how to set up a spread sheet and enter in data like entry, stops, targets, comments, profit/loss and so on.
Traders, back testing is the process of compiling data on your system by taking trades outside of normal market hours. There are several ways you can do this. If you are good at writing code, and you were specific enough in writing your rules for entering and exiting the market, you can program your system and back test it in a few minutes. If you have money, you can have someone else write the code. Or if you are like most people you can do it tick by tick in the market the way I did when I was starting out.
Now, while it is certainly true that past performance are not indicative of future results, here is a simple truth; since we cannot look into the future, the best measure we have for predicting future performance is the past. It’s that simple. (Oh and just so you know, it is a very good measuring stick) The day someone comes up with a better way of doing it I’ll be the first to change. Until then you would be wise to take appropriate action.
So grab your spreadsheet or a piece of paper and start thinking about the information you want to test. Date, time, entry, stop, target, profit and loss, variable money management strategies.
You may also want to test two or three different variations of the same system to see which one produces the best result. This is an especially good idea if you’re not sure if you have a profitable system or not.
By taking the time to back test your model you accomplish several things.
1. It provides you history. Plain and simple
2. When you are done you will have taken hundreds of trades over a large enough time period to see how your rules perform in both trending and consolidating markets. Along with this comes data. A lot of data, and that data is valuable.
3. Testing builds confidence in your system for reasons I’ve just outlined. When you hit the inevitable draw down you can look back on your testing and take comfort in the fact that if you just continue to trade your plan you will eventually achieve new equity highs.
4. You will have a standard with which to compare your actual trading record. You can literally back test every day you trade in the markets. I do this a lot with traders. I will have them trade for an entire week and then go back on Saturday and back test the week. We then look at the difference in the numbers. It’s a real eye opener for traders to see how their emotions have affected their trading over the course of a week, and what it has cost them in terms of profit.
These are just a few of the things back testing provides. Traders, if you have not done this let me be bold and say STOP TRADING IMMIDATELY. You have not earned the right to put your money at risk in the market. And I dare say you are not trading, you are simply gambling.
That’s all for this week. Until next time Good Luck, and Good Trading. |
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Author Resource:-
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By :
Jason Stapleton
Submitted
2012-02-09 09:41:30 |
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