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.

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The Fallacy of Backtesting and Adapting to Current Market Conditions

I recently engaged in an interesting chat with a novice trader this weekend. It got me thinking about the fallacy of backtesting and why I don't rely on past statistics. 

You heard me correctly. My take on backtesting is controversial and puts me in the minority. Some have called me an idiot for this view and I don't mind at all. The majority is often wrong, and I've made a career out of going against the grain. 

Here's the conversation that illustrates my point.

Paul, how are you doing trading breakout-pullbacks?

I haven't traded any this year.

Why not? A few years ago you made a killing off that setup.

That was a few years ago.

Yeah, but I backtested the past 10 years and they have a 58 percent win rate and average gain over 7 percent on winners.

Nice stats but they don't apply to this market.

Stats don't lie Paul.

Have you made any money this year trading breakout-pullbacks?

No.

The take away from this chat is that you need to understand the current market you are trading. Backtesting can give you a general idea of how reliable a setup is, but there is much more to trading a setup. 

You can not test for every variable and different market reacts differently to specific setups. A successful swing trader must understand the current market and adapt accordingly.

Forget about backtesting, understand the current market conditions, and trade right setup for the right market.

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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.