A Crucial Question from All Traders

A positive expectancy method makes you risk less than you plan to win; reverse the logic for a negative expectancy method.  Therefore, a negative expectancy trading method is what you must abandon, for there is no reason for you to abandon a positive expectancy method. There is no trading method under heaven, no matter how good it is, that does not go through occasional losing streaks. How should you treat a good method that is currently in a losing streak? This piece gives factual and useful advice for all traders: whether beginners or experts.

Should I Ditch My Trading Method?

When you ditch your trading method for another one, the new method may experience a losing streak right from the start, while it later experiences a winning streak; or vice versa. You can win without even considering the economic effects on a market, for they have already been priced in. When you are using a negative expectancy method, you may want to over-optimize it during back-testing and believe it works fine in future. If the strategy works contrary to the belief, you conclude the system is bad, ditch it and buy another heavily hyped one. Please bear it in mind that if a method worked in the past (as long as it is not a negative expectancy one) it is not bad. It simply means the current market situation is not favorable to it. Is this assumption logical? Think about it. Positive expectancy. 

You would know that your method works and the market favors you when you are in a winning streak. The consistent profits you generate would let you know that the market favors you. The more profits you make through a method, the more faith you have in the method. You use it more frequently and look forward to further trading setups. You cannot wait to trade further setups – sometimes making mistakes of trading suboptimal setups, which make you plunge into a losing period because there is no-one who generates profits (with no losses) for life. The losing period makes you get angry, and you ditch the method. At the time of ditching, the method is about to start making profits again (but you would never know because you are no longer using the method).

When you tell people that the method is now useless, that is when the markets might become favorable to it again. When a good method has sensible positive expectancy incorporated into it, it would not become useless forever. There would always be days and nights in succession; day after night and night after day. There would be periods when a good method would be working contrary to the markets and there would be periods when it would work in agreement with the markets.  Why would you throw away your baby out with the bath water? May be you could stop using the method after you have lost a predetermined amount of small percentage or use another transient method that works in agreement with the current market conditions, so that you resume using the previous method when you sense the market is favorable to it. In a bear market, you use a method that allows you to sell. In a bull market, you use a method that allows you to buy. In an equilibrium market, you use a range trading method or stay out of the market.

 It is important that you sense when a method temporarily stops working in a current market condition so that you temporarily stop using it. For instance, consider the art of following the line of the least resistance, the art is useless when an instrument is in an equilibrium zone, albeit it enables to people garner gains when the instrument again begins to move in a predictable manner. This happens now and then, year after year.

What can you do to escape this kind of pitfall when you know that your method is meritorious? How can we know whether a market condition would be favorable to it or now? Ultimately, what is most important is to realize when a method is profitable, when to stop using it temporarily and when to start using it again. Please do not ditch your method if it is a positive expectancy one! You merely need to stop using it temporarily when it works temporarily against the markets.   The method might soon resume working in favor of the markets. Can you recognize this when it happens? You would need to keep this in mind and sense when the markets are favorable to the method again. The trading results would determine that.

A writer once mentioned that Richard Donchian, who was an astute trend follower for several decades, began trading in 1979 with only twenty thousand dollars. This small portfolio was increased to eighteen million dollars over many decades. While the achievement was commendable, many traders would find it difficult in reality because there were periods of losing and winning streaks. He was able to achieve the goal because he aborted his losers and rode his winners: plus he was not discouraged from opening the next order. He did not ditch his trading methodology that experienced drawdowns, alternated with gains. It was easy to blame our method rather than ourselves.

If you abandon one trading method for another and you do that over and over again, you would never appreciate how a method may survive drawdowns and recover from them.  Whether the trading method is used systematically or discretionally, you need to be faithful to it. The longer you use a method, the more you would appreciate it and the more returns it might generate for you.

Source: www.tallinex.com