The question often arises — until when to exploit the trading system, when to stop trading on it? When the current drawdown exceeds the historical maximum drawdown, when the profit factor drops below a predetermined one, when the number of unprofitable transactions in a row exceeds the norm or by some other parameters?
My opinion on this is simple.. When we create a trading system, We must know, what is the advantage over the market or, otherwise I say, what inefficiency, we exploit. And if this inefficiency leaves the market, then trading on this system becomes a meaningless occupation, that is, we stop trading on it. Another thing, if we do not know what inefficiency the system exploits — that is, we just tested some indicators, we look — we got good results and decided to play with this system. Better yet — re-optimize on history so that all coefficients of the system go off scale and, at all, so that there are no drawdowns, and the profit tends to infinity. Then, certainly, in real trading with this system, not knowing what kind of inefficiency we are exploiting, when this inefficiency disappears, we just won't know that she is missing. And you will have to focus only on the coefficients and other metrics of the system. AND, probably, you will have to abandon the system pretty quickly, since in real trading, an over-optimized system will immediately worsen its parameters and, with great probability, will drain.
I will give an example. Let's admit, at the beginning of this century, they played intraday according to the system, which exploited market inefficiencies in the form of a specialist presence in US stocks. As everyone knows, at that time, only the lazy did not make money on this. Then, somewhere in the middle of the first decade of this century, specialists left the markets and the markets became hybrid. Naturally, inefficiency is gone. That's why, when they found out that there were no more specialists, just stop trading the system. Not because some ratio has worsened or the drawdown has exceeded the maximum, but because the specialists “ушли”. But, certainly, if someone did not know that he was exploiting “ineffectiveness of a specialist” or did not know that there were no more specialists, he will focus on the deterioration of the coefficients and other metrics of the system.
Or take, for example, trend tracking systems for a diversified futures portfolio. They catch trends — abnormal price movements to new ranges, or, so called, “long tails”. This inefficiency manifests itself, for example, during inflationary periods, when all goods start to rise in price for a long time, either during economic downturns, when raw materials lose their demand, as production falls — goods plummet in price, are getting cheaper. I.e, one might say, trend tracking systems make money during “economic shocks” and gradually merge during calm periods. Let's admit, начался “quiet period” and dragged on for two or three years, how was it with 2011 to 2014 yy. Naturally, the parameters of trend tracking systems at this time significantly deteriorated.. It was the most unfortunate period for trend tracking systems in several decades.. But this does not mean at all that trading should be stopped due to deteriorated parameters., exceeded the previous norms, and not because of the lack of trends. The speculator sees that there are no trends, which means that trend-following systems cannot earn. And stop trading or not, depends only on — Does the speculator believe that trends will resume or that there will never be trends again?. But not in any way due to the fact that the parameters of the system have deteriorated.. There will be trends, systems will also earn, since it is precisely this inefficiency that they exploit.
Or the ineffectiveness of American stocks, that have been growing for three hundred years or more. You can even just buy a stock at a random point. — with a high probability it will someday exceed the entry point. This inefficiency is actively exploited by investors.. Although they pretend that, Sort of, count on “справедливую цену” stocks or use other fundamental theories, but in fact they are just taking advantage of the inefficiency of the constant growth of the American stock market. To improve the system, you can buy stocks on corrections at a better price.. Can I have any more “хитрые” screw on lotions, but this all goes to the growth of the market. As soon as the market crashes into a bearish phase, so everyone starts to drain. It is clear that the performance of the system is deteriorating.. But the speculator sees because of what they are getting worse — due to the fact that the inefficiency of the constant growth of markets has temporarily disappeared. The further depends only on his beliefs. — whether he sees further growth in the markets after a while or is it all, end of the world, and the markets will only fall and therefore the system must be turned off.
Well, these were examples of the simplest global inefficiencies., who everyone knows. There are also not very noticeable, local character, which we will not consider. But the point is that it is necessary to turn off the systems when the exploited inefficiencies disappear., and for this you need to imagine that we are trading. If we don’t know what we are trading, а просто “the system is good”, then there is nothing else to do but to monitor the coefficients of the system and guess why they are deteriorating.
