A few days ago, a friend approached me, asking me to analyze his trading system for him. He has been slapped around by the market recently, incurring significant losses, to the point where he's hesitant to make trades.
He wanted to know whether the issue was with the market conditions or with his system.
I took a look at the recent European and American market trends. I've included the chart below, which is a 4-hour candlestick chart.
The Euro to US Dollar exchange rate has been in a bottoming phase since the end of September on a 4-hour scale, with no significant trend space, fluctuating wildly with rapid rises and falls. It's challenging to catch trends in such conditions, especially with many V-shaped reversals, making entry points difficult to grasp, and indeed, trading can easily result in losses on both sides.
Upon reviewing his trading system, I found that while the difficult market conditions were one aspect, his system also had issues.
His system's criteria were too crude, leading to a high number of stop losses when faced with uncooperative market conditions, resulting in substantial drawdowns, making it nearly impossible to execute consistently.
I've noticed that when people establish trading systems, they often only consider whether the system can make money and how much it can earn, but they overlook the question of whether we, as human beings with emotions, can implement the system effectively.
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So today, drawing from my own experience in building trading systems, I'd like to share some details that need to be optimized for a trading system to be both profitable and executable. This can help you identify issues in your trading and elevate your trading system to the next level.
1. How to optimize the issue of low win rate?
A low win rate, with a series of consecutive losses in trading outcomes, is a nightmare for many traders.Every mistake strikes our hearts like a heavy hammer, and as the number of strikes increases, the damage grows exponentially.
At first, making two or three mistakes can still be taken calmly, but after five or six mistakes, one starts to get irritable. After seven or eight mistakes, fear sets in. If one makes more than a dozen mistakes in a row, there is basically a sense of despair towards trading. At this point, one may become extremely negative or extremely angry, and the outcome of such trading will definitely not be good.
Therefore, a low win rate in trading is a very fatal flaw in the trading system. We can use some technical means to filter trading signals to improve the win rate.
There are two most commonly used methods: technical indicator filtering and period filtering.
Let me give an example to illustrate.
Firstly, we use the break of a trend line to enter the market for long and short trading. Let's look at the results of the trading.
The chart is a 1-hour candlestick chart of the Euro to US Dollar. Trading was done for nearly a month using the break of the trend line, with 13 trades made, 4 correct and 9 incorrect, resulting in a very low success rate.
Next, let's filter the trading signals, requiring the market to break through the trend line and also to break through the previous inflection point before confirming the reversal, and then we can enter the trade. Let's look at the data for the second method.
The chart is also a 1-hour candlestick chart of the Euro to US Dollar, with the trading time being exactly the same as in the previous chart, also trading for nearly a month, but the entry criteria were added with the previous inflection point for filtering.
You can see a very obvious change in the trading data. First, the trading frequency has decreased, with 6 trades made, 4 correct and 2 incorrect, resulting in a significantly higher success rate.If your trading system has a low win rate in real combat, it is recommended that you incorporate technical indicators to filter and optimize trading signals. As for the effectiveness of the optimization, you can compare the data retrospectively, as I did in the operation mentioned above.
Here is a reference value for you:
Try not to let the signals of the trading system fall below 30%, with a success rate of 40% to 50% being more appropriate. At this ratio, the number of consecutive losses in trading will not be too high, which is conducive to maintaining a relatively stable trading mentality.
Additionally, if the win rate is very low, you can appropriately reduce the position size in trading. This way, even if consecutive losses occur, the absolute value of the losses will be small due to the smaller position size, which will also be of great help to the trading mentality.
2. How to optimize if profits are low?
Many traders have experienced this: after going through great difficulties to build a trading system, with all the details refined and the execution not too difficult, they find that the profit rate is too low, which is very frustrating.
Some people at this point will start looking for a new trading system, but it is not necessary. You just need to optimize to increase the profit rate.
There are mainly two ways to increase profits.
(1) Increase the variety of trades.
The three elements of a trading system's profitability are success rate, risk-reward ratio, and trading frequency. The success rate and risk-reward ratio of the trading system are basically fixed due to technical standards. The only simple way to increase trading frequency is to increase the variety of trades.For instance, if a trading system trades a single variety 10 times a month, the frequency of trading for two varieties would increase to 20 times. As long as the trading system is profitable, increasing the frequency of trades can bring more profit.
There are two factors that must be considered in practice when deciding how many trading varieties to add.
One factor is that while adding more varieties, the potential drawdowns that may occur during market downturns will also increase (the issue of large drawdowns will be further discussed later in the article with optimization solutions).
The other factor is that after increasing the trading frequency, executing the trading system requires more effort.
(2) Engage in compound interest trading appropriately.
A trading system with an annualized return of 50% can only earn 50,000 from a principal of 100,000 in a year. However, with a principal of 1,000,000, it can earn 500,000. The profit ratio is the same, but the absolute value is completely different.
Therefore, finding ways to increase the principal can lead to more profit. Of course, our funds are relatively limited, so the best choice is to operate with compound interest in practice, gradually increasing the principal and improving profits.
The method of compound interest is also simple: after profits increase, correspondingly increase the position size according to the profit ratio.
For example, if we originally had 100,000 yuan and opened 1 position each time, when the profit reaches 110,000, the position size would increase to 1.1 positions. As compound interest rolls over, the position size will become heavier and heavier, and the profits will also increase more and more.
Imagine, originally opening a position with 1 hand, and when gradually increasing the position size to 1.5 hands, the profit will increase by 1.5 times, which is quite substantial.Both of these methods do not require changes to the original technical standards of the trading system, which are hassle-free and labor-saving solutions to increase profits.
3. How to optimize a trading system with large drawdowns?
When a trading system experiences a large drawdown, it can severely undermine our confidence in the system. Continuing to trade may lead to further losses, while not trading could mean missing out on significant profits, creating a dilemma. Therefore, controlling drawdowns is a crucial aspect of trading profitability.
When we were discussing the issue of low profits in the trading system, it was also mentioned that if the number of traded varieties increases, there could be a resonance of product losses, potentially leading to larger drawdowns.
What should we do?
One approach is to maintain a light position for "scouting" to control drawdowns and add positions at key opportunities to make profits.
Let's take an example from this year's futures competition. The heavyweight champion of this year's futures competition, "WDD," turned a little over 2 million into a profit of 80 million. Most of this profit came from two market trends in two varieties.
The first wave was a long position in glass futures, building a position from 1635 yuan to a close at 1875, with a full position operation. The second wave was a long position in soda ash futures in June, also with a full position operation. Outside of these two key market trends, he maintained a light position in "scouting" in varieties such as iron ore, cotton, methanol, and rebar, to keep his trading touch.
See the bar chart of his trading profits below (image from the internet).
Soda ash and glass are the main varieties that generated profits, while other traded varieties produced very little profit in the overall account balance, which can be disregarded. These trades were merely for the purpose of maintaining a trading touch through scouting operations.Such operations control the drawdown and seize important opportunities, thus making high profits possible.
How should we operate in a real trading scenario?
Trade with a light position under normal circumstances, and increase the position when the trading system is gradually declining and the probability of profit is high.
The profit curve of the trading system is similar to the market trend, both rising in a wave-like pattern and gradually increasing. For example, when encountering uncooperative market conditions, there will be a phase of losses, and the capital curve will decline. After the losses, when the market starts to cooperate, the profit period will come, and the capital curve will rise.
So we can start by trading with a light position, waiting for the trading system to experience a loss and account drawdown (since it's a light position, the drawdown will be small), then increase the position during the profit period (enter the market when the capital curve is about to rise), to make significant profits.
This operation can ensure a normal trading rhythm and feel, maintain contact with the market, have a complete understanding of market changes, and the system's drawdown is minimal, while increasing position trading during key profit opportunities.
As we mentioned above, to optimize the profit of the trading system by increasing the number of trading varieties, we can learn from this method. We can select the main varieties to trade with a normal position.
Other additional varieties are traded with a small position under normal circumstances, until the variety shows signs of decline, and the probability of subsequent profits increases, then trade with a normal position.
For example, normally trade with a normal position in two varieties, such as the euro against the US dollar and gold spot, and also select 3 additional varieties to accompany with a small position. When these accompanying varieties show consecutive declines, start to gradually enter and increase the position until it reaches a normal position, stop after making a profit, and wait for the next decline to appear.
With this operation, increasing the number of varieties will not increase the drawdown, but can also increase profits.4. How to optimize if trading becomes exhausting?
If trading feels exhausting, it indicates that there are likely some unreasonable settings in your trading system that do not align with your lifestyle or personality. There are generally a few scenarios:
(1) The trading frequency is inappropriate.
Sometimes you may find that you have to spend a lot of time watching the market every day, to the point where you might experience back pain from sitting for so long, and your eyes become strained from constant monitoring. Trading every day can feel like a blur, as if it consumes your entire life, leaving no time for anything else.
This suggests that your trading frequency is too high. Most traders are part-time, and trading 2-3 times a day can already be tiring. Some people even manage to trade more than ten times a day, which is essentially overdrawing their physical and mental energy.
At this point, you can consider expanding the time frame for your trades and reducing the number of varieties you deal with, which will help lower the daily trading frequency.
One should not be overly greedy; more trades do not necessarily translate to higher profits.
(2) The trading times are not suitable.
Many friends have to work during the day and take care of their children, only finding time to trade in the evening. However, they may discover that their trading system identifies trading opportunities during the day, leading to a chaotic schedule and mental exhaustion.
In such cases, you can adjust the types of assets and times you trade, shifting to the afternoon and evening sessions. This way, you won't disrupt your normal life or miss out on trading opportunities.(3) Inconsistent trading standards.
Many friends have asked me to review their trading systems, and I've noticed that it's easy for people to use vague criteria as entry and exit conditions.
For example, a friend told me that he found the triangle consolidation pattern formed after a rapid and significant price increase to have a very high success rate, so he took this observation as his entry condition.
At this point, I asked him, how should a significant increase be defined? Does a 1% increase count? Or a 5% increase? And what about at 4.9%? Everyone has a different definition of a significant increase in their minds, or the same person may have different definitions at different times, making this definition too ambiguous.
Moreover, different trading instruments have different volatility levels, and using a fixed percentage to define a significant increase for different instruments is not scientific.
This kind of experience is usually a trading opportunity that is particularly memorable due to its high quality, which could be the result of a lucky trade that made a lot of money, leaving a strong impression; or it could be an opportunity that has been observed many times and found to have a high success rate, forming a subjective impression.
However, this opportunity could also be a result of observational bias. When placed in the context of decades of market data, the success rate may not be as high as one might think.
Such ambiguous experiences will make your entry and exit criteria inconsistent each time, and once subjective judgment comes into play, emotions can easily be swayed by market movements, making it seem as if there is no trading system at all.
Therefore, in trading, every standard must be absolutely clear and unambiguous, with no gray areas, otherwise, it will be very tiring to execute because it's difficult to determine whether it meets the trading system's criteria, whether to enter the market, and after entering, one may feel uneasy and anxious. Each trade made in this way may not even have statistical significance.
How to determine if your trading has consistency?It's quite simple: you hand over your trading system to other friends for trading and see if they can perform exactly the same operations. If the trading system can be operated identically by anyone, it indicates that it has consistency.
Additionally, you can use your trading system to trade the same market segment multiple times and see if you make the same judgments. If that's the case, it also suggests that the system has consistency.
These are essentially the issues often encountered with trading systems during the trading process. Let me remind everyone that no matter what adjustments are made to the trading system, it is still necessary to go through a certain amount of simulated trading or backtesting before entering real trading.