Disclaimer: This article applies to myself probably more than any trader that ever lived. I write in the hopes that it sinks in for me, and that helps out some readers.
Back in my Move the Markets days, “Mister White Folks” posted a quote from Elite Trader that is very wise, even though short on grammar and punctuation:
Yep don’t fix what aint broke, chop will still kill this system as it will any other so if you are going to spend time on anything, spend it recognizing when to trade and when not to trade
In general, traders (including myself) make trading too hard by focusing first on things that are not important, and neglect the things that are most important. It seems we put way too much emphasis on the particulars of a system–the setups, stop management, profit targets, false positive signals, missed trades that didn’t set up according to the “rules” but went on to win anyway. This is all psychologically satisfying, but it doesn’t help your trading performance in any material way if you don’t have other more important things in place! Further, this effort would do more for your profitability if applied in a slightly different area than is typically done. Unfortunately, it is easier to fiddle with indicator parameters than it is to tackle the bigger problems.
There is a passage in the New Testament (non-Christians, atheists, agnostics, hedonists and satanists bear with me here…) that illustrates this principle very well. Jesus said to the corrupt spiritual leaders of the Jews:
Woe unto you, scribes and Pharisees, hypocrites! for ye pay tithe of mint and anise and cummin, and have omitted the weightier matters of the law, judgment, mercy, and faith: these ought ye to have done, and not to leave the other undone. Ye blind guides, which strain at a gnat, and swallow a camel.
The Pharisees were unjust to the people, ignored the spiritual laws of God and took advantage of their clerical status in society. However, they made many outward appearances of being righteous. While they left the things that were important to God undone, they justified themselves and pointed to their superficial outward acts as evidence of piousness. Jesus didn’t buy it.
As a trader, do you strain at a gnat? Do you spend all your research and energy to find the perfect indicator, the one right system that gives you 100% wins and no losses? The one that catches every possible winning trade no matter what the situation? Do you constantly try to find THE system, the one that makes the most money, the best one?
Do you swallow a camel? Do you ignore position sizing? Do you take no thought for market volatility or the current environment? Do you leave money and risk management for later thought and action–or worse–no thought or action? Do you ignore the “black swan” that could come and take you out of business forever? Do you break your rules and blow your stops? Do you force trades on days where the market is totally stacked against your strategy, or the volume or volatility isn’t there?
Here’s the cold hard facts of life: Almost ANY trend-following system (channel breakouts, MA crossovers and so on) will do well in a trending market. Almost ANY trend-following system will get whipsawed to death in a non-trending market, whether active and choppy or dead and listless. Conversely, almost ANY range-bound system (mean reversion, oscillators, overbought/oversold indicators, etc.) will do well in a non-trending market. Almost ANY range-bound system will get killed in a trending market as you keep fading the strong move and dying a death by 1000 cuts. The systems work well when the environment is right. If they fail, it’s because YOU failed to implement the correct strategy. It’s not because your stochastic was too fast or slow, or because your pivot point used 24 hour data instead of market hours only data. After personal discipline and psychology, the largest part of the battle is as the Elite Trader quote said: Recognizing when to trade and when not to trade.
So, to speak to my carefully crafted, eye-catching, straw-grasping post theme–What Would Jesus Trade? Going by the scripture passage above, he’d ignore the gnats and quit chewing on a camel. He’d fulfill the weightier matters, and leave the less important ones undone. He’d trade a system that explicitly took into consideration what I consider the weightier matters of trading:
1. Personal Discipline
2. Risk Management
3. Position Sizing
4. Market Environment
If you are not disciplined, the market will pistol whip you and take your money. If you put 100% of your equity in an overnight hold of FAZ, you are about to meet Mr. Risk. If your trade size is too big for your account, your days are numbered. And if you don’t have a way to identify what the market environment is, and when to trade and when to sit out, then no amount of clever backtesting, indicators, statistics, or even the Holy Grail is going to make you win. So quit looking for all that other junk, quit wringing your hands over the perfect system, and concentrate on what the market environment is! It’s the way to the REAL Holy Grail 🙂
I am going to define some VERY simple systems to use as baseline strategies for examining this kind of idea–one for trending markets and one for range-bound markets. I will do some research into how to identify the market environments that we may be in, and then I will use these baseline systems to see how they do against how I define the market environment. This should be 90% of the battle. Only after these things are in place will I personally do any more messing around with indicator parameters or new fancy ways of looking at price data. Stay tuned!