Futures For You
| INSIDE THE FUTURES
WORLD
Want to learn how the futures markets really work? Dan O'Neil, a principal at online futures and forex broker Xpresstrade (www.xpresstrade.com), responds to your questions about today's futures markets. To submit a question, post your question to our website at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. |
Dan O'Neil |
WORKING THE SYSTEM
Do you believe the claim that some system marketers use that their system works across all time frames and all types of futures (emini indexes, grains, softs, energies, and so forth)? Have you ever seen or heard anything that indicates that this could be true?--Randy Glick
Before we jump into the verity of published trading results, let's start by taking a look at just what a trading system is. Trading systems -- also known as "black boxes" -- use a set of rules or computer algorithms to decide when and what to buy or sell, with exit and entry criteria based on parameters that have been validated by historical testing on quantifiable data. The trading criteria for a particular system can include all kinds of technical indicators, chart patterns, volume, open interest, and even fundamental factors.
System trading has been steadily growing in popularity, with the number of systems offered proliferating, and the number of traders expressing an interest in black-box trading rising in turn. More and more traders are researching professionally developed systems that automatically generate buy and sell signals, hoping to capitalize on the same algorithmic tools that have become such a well-publicized phenomenon on Wall Street.
A major advantage of system trading is that it takes the human emotion factor out of a trade -- an important topic that we've discussed here before. Many veteran trading professionals argue that the downfall of futures traders is their own emotions and lack of trading discipline. By strictly adhering to the criteria built into a trading system, a trader cannot be swayed by emotions like fear or greed in the heat of battle during the trade.
As you point out in your question, trading systems can be backtested by running the program through many years of previous price data for one or many markets. A trader may discover that his particular trading system works best in Treasury bonds or metals. Through backtesting, a trader can refine the trading system's parameters to get what he or she feels is the best system based on price history and for various markets. This is what trading system advertisers and marketers call "hypothetical trading results." However, as is the case with any trading method based on historical data, there can be significant differences between hypothetical and actual performance, and neither is any guarantee of future trading results.
The disparity becomes clearer when we begin to consider some of the disadvantages of the system trading methodology. For example, one consideration is the potential for severe drawdowns in a trading account. Since many trading systems have a trader in the market practically all the time, either long or short; big unexpected price moves can be devastating to a system trader who does not have a larger trading account.
Further, there is sometimes a propensity for marketers to "hype" a trading system as generating immense profits based on hypothetical results. For instance, a trading system may be advertised as generating 300% profits over the past five years based on hypothetical backtesting. But what the marketers and advertisers don't tell you is that the drawdowns on an account may have been so severe that the majority of traders would have been wiped out before the market ever turned around.
Not only that, while trading systems attempt to eliminate the potentially negative human emotion factor, they also eliminate the very important "trader's intuition" and experience tools that can be extremely valuable. While computer trading programs are very powerful and take into account many, many variables -- as many as the developer wants to add -- there is no substitute for the power of the human brain and its capacity to learn from mistakes.
So while trading systems offer potential for some traders in certain circumstances, it's important to remember that there's no single magical futures trading solution that can guarantee tremendous profits. This is a rule of thumb to keep in mind when the hypothetical results in the brochure or on the website seem too good to be true.
Originally published in the February 2008 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2008, Technical Analysis, Inc.
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