Tuesday, June 21, 2016

How most traders trade without an edge and don't even know it

There are two mistakes most traders make when building a basket of trading setups.

1. They trade setups without and edge.
2. They trade the setup in the wrong market.

Your trading "edge" gives you a reliable idea of how much you can expect to win with your setup over time. A well tested setup gives you a a predictable probability rate.

This seems counter to my article titled "the fallacy of backtesting".

It is not.

While I find backtesting in the way most do it a waste of time, it is not because the past is not reliable. It is because most do not backtest correctly.

Most backtests plug in the parameters of the setup and test over a given period of time. This type of unrigorious testing is worthless.

To properly test a setup you must account for how a setup reacts to different markets.

A common trading cliche is that 70 percent of a stock's move is related to the market and it's sector.

If  gold is getting crushed odds are so will the gold related stock you are trading, regardless of the setup.

I wouldn't touch a breakdown short setup in a ramping market.

So you decide to test breakdown setups going back 7 years. I'm willing to bet your stats for this setup will be horrible, considering the market has gone up over that time frame. You'll think the setup is worthless and discard it.

However, now test for that setup when the market is below it's 50 day moving average and you might have something.

Never forget how important the market and sector is to the stock you are trading. As a swing trader, you are not just trading stocks and setups. You must be in tune to the market and sector you are trading.

If you would like to learn more about how I trade, receive my nightly focus list with market analysis, setups and trade alerts, sign up at BullsonWallStreet.com


Johnny B said...

Hi Paul, When you refer to the market being under it's 50 DMA for a particular test, are you referring to the S&P 500 or some combination Indexes .... ??

Zach Smith said...

Hey Paul, great advice. BTW I love your interview on Chat with Traders with Aaron F! Some great tips in there. Anyways in regards to backtesting, How do you perform backtests for a strategy? Do you gather data and dl to excel and run a macros? Or is there software available that is better? I find this area challenging and I get stuck often..

Aeldra Robinson said...

Another helpful post. This is a very nice blog that I will definitively come back to several more times this year!

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Jenna Catlin said...

The set up reaction to every market is is different. Analyzing that will be a challenge.
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