Saturday, April 24, 2010

What buildings and bamboo can teach us about creating successful and winning trading models and trading systems

Buildings and bamboo provide some useful analogies that can help a trader build reliable and profitable trading systems and models. Buildings are extremely strong structures, but they have to be flexible enough to move with strong winds, or storms, or else they face a greater possibility of falling over. Bamboo is similar to buildings. Bamboo is a very strong material; however, it too is flexible. Both buildings and bamboo teach us that the qualities of strength and flexibility need to be incorporated into our trading systems and models.

Trading models have to be strong enough to give good and reliable trading signals, but they also must be flexible enough to handle a variety of market conditions. When I first started building trading models I assumed that the more indicators or variables I added to my models, the “stronger” or better the models would be. What a bad idea that was! One of the lessons I eventually learned was that the more and more conditions, indicators, or variables I added to my models, the more and more inflexible the models became. The models were not flexible enough to handle the changes in market conditions. This led to breakdowns in the models, which subsequently resulted in bad signals, missed trades, and the occasional F*** bomb out of my mouth.

Traders use the term robust. A robust trading system or model is: flexible, strong, and able to handle a variety of market conditions. A robust model does not breakdown. It may have periods where it underperforms, but a robust model always comes back from underperforming periods. By the way, do not believe anyone who tells you that their model always performs well. All models have up and down performance. The point is, however, to make sure that your trading model or system is robust.

All trading platforms provide hundreds of indicators and the ability to program and customize indicators. This is all good--but only up to a point. Traders have a tendency to become “indicator happy.” The irony is that the more indicator happy a trader becomes, the more inflexible the model will be. My general rule with trading is to keep things simple when building trading models. Simplicity leads to robust models and profits.

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