Designing a system always faces some trade-offs
The above represents some of the typical trade-offs you need to do when you
design a system. I have developed and tested many, and always find it necessary
to select between the above.
- It is quite easy to find statistically profitable systems with a winning
percentage of around 30%. If you have a winning percentage in that neighborhood
you are likely to face a lot of consecutive losses now and then (situation 1
- It is not too hard to improve systems to the neighborhood of 55-65%
winning percentage, but those systems are likely to miss the big wins (situation
2 and 3 above).
- If you define systems that try to pick up movements in stocks
that are cheap and not traded in a high degree, then you can make some really big
wins, but you will also sometimes find yourself holding stocks that are either worthless
or virtually untellable (situation 3 above).
If your personality does not fit the system you are trading, you will second
guess it and lose money
Say for example you have had a great number of losses and you are finally
sitting there with the winner, the stock climbing, you are finally going from an accumulated
loss to an accumulated profit.
Will you be able to hold on to the profitable run according to your system? Or will
you be scared when the first larger counter reaction comes, sending your
selected stock down the price scale?
If you do not hold on to your system at that moment, you
will be able to sell with a profit, but you are likely to take more risks than
your average reward using that trading system. Why? Because if you are running a
profitable system and find yourself in this situation, then it is likely that the systewm is trading with high profits on less
winning probability, and you are stepping out too early from the wins it needs
to stay profitable in the long run.
You are simply not trading the right system
for your personality, it is built for those wanting to take more chances and
getting high rewards.
As another example, take the opposite. You have been doing a great number of
trades. You are profitable. But your friends have made more profitable trades than
you: "I had that stock that climbed 120% in two weeks you hear". You
have almost not had any big winner at all, but many profitable ones. You have
seen many of your stocks climb to new highs after selling them. What do you do
Do you still sell with you system, or are you likely to hold on to some of
the trades a little longer (feeling that this is the one that will climb more in
just a day or two)? Once again, if you do you are likely to get less profit in
the long run. Why? Because if you are running a profitable system and find yourself in this situation, it is likely
that it is trading with low profits and high winning percentage, and you are
taking steps that lowers the winning percentage. With those small margins, the
system is not likely to win back those money easily.
Once again, the system does
not fit your personality, it is not built for the chance takers but requires the
structured repeatable careful trader.
If the above is happening to you, you might be trading systems that does not
fit your personality, or you might not have understood the personality of your
trading system. It is of course also possible that your system is not
statistically profitable at all. Change the system, fight your tendencies to
second guess the system, or test
your trading idea to be more certain what to expect.