Value of Backtesting and Stops

[bluedemon77]

I was very impressed with Van Tharp's book, but he kind of pooh-poohed the value of backtesting. I guess people assume that any system that backtested well will do well in the future and he wanted to destroy that illusion. However, without backtesting and paper trading, what else can you do besides plunk down your cash and hope for the best?

Anyway, I'm working on a system that looks very promising based on backtesting. My problem is I am faced with conflicting philosophies. I mean my backtesting indicates that applying stops at any level will produce worse results in both bottom line and system drawdown than just following the buy/sell signals of the system. However, the "2% rule" says you shouldn't lose more than 2% on a trade and in some cases without stops the trade will lose 4-5%. But if I use stops, it reduces the expected profits by like 10-20% depending on how tight the stops are.

Any thoughts?

Chuck

 

[TSGannGalt]

Van Tharp has the right idea.

Remember that his books are an introductory / newbie books.

Good thing is you are having doubts and questions about "conventional" knowledge. Very healthy for a system developer.

 

[nazzdack]

If you're going to go "stopless", reduce your position size. You'll thank me later.

 

[Sparohok]

I agree with nazzdack. Just reduce your position size.

I do not believe in stops. In my opinion, stops are a crutch. Whenever I get tempted to put in a stop it's a good sign I'm over leveraged.

Stops may be useful for uninformed trading, trend followers, and day traders. I don't know, because that's not what I do. For informed trading and swing trading, I have always found stops of any sort to decrease returns.

Martin

 

[dan05]

I've tested the same results that you posted regarding Stops and a trading system. Tight stops tend to reduce total P&L. Still I would say that mental stop loss should be left for mental money.

The stop loss should like an Airbag. You should have rules that take you out of a trade if the trade is not working. But some stop should be there.

Quote from Sparohok:

I agree with nazzdack. Just reduce your position size.

I do not believe in stops. In my opinion, stops are a crutch. Whenever I get tempted to put in a stop it's a good sign I'm over leveraged.

Stops may be useful for uninformed trading, trend followers, and day traders. I don't know, because that's not what I do. For informed trading and swing trading, I have always found stops of any sort to decrease returns.

Martin

 

[CaptainObvious]

Up until this past weekend I thought backtesting was a fools paradise and stated so. That was before I purchased some software with backtesting capability just this past week. I have found Jesus! Well, that could be overstating it a bit. I don't know that it's the holy grail but I sure as hell know there was no way I was ever going to make any money day trading using the "system" I had been using. Back testing made that painfully clear, as if my account didn't.
Ad far as stops....never use them for swing trading equties and that's never hurt me. I swing trade just fine. It's trying to learn to day trade that's kicking my ass. Stops too tight I lose. Stops too loose I lose more. Yeah! I know, stick to swing trading. Guess I'm just a hard headed S.O.B.

 

[MorganSys]

Position-level stops are a ridiculous concept.

You have to have a portfolio risk/reward reason for making a trade.

----
Notes:

1. Stops are not guaranteed to be executed at the desired price.
2. You should limit the sizes of both long and short positions (profitable and unprofitable, respectively).
3. Your strategy may be improved with stops if position-level profitability is positively autocorrelated.

 

[Prevail]

any action taken to ease psychological pressure in trading will decrease performance. keep the positions small by doubling the max draw down.

 

[bluedemon77]

Quote from MorganSys:

Position-level stops are a ridiculous concept.

You have to have a portfolio risk/reward reason for making a trade.

----
Notes:

1. Stops are not guaranteed to be executed at the desired price.
2. You should limit the sizes of both long and short positions (profitable and unprofitable, respectively).
3. Your strategy may be improved with stops if position-level profitability is positively autocorrelated.

Thanks, everyone, for your responses. MorganSys, I was wondering if you could elaborate on your reason for saying that position level stops are ridiculous. My own testing seems to support your statement, but would like to hear your reasoning.

I would not consider trades that do not have a positive expectation and a risk to reward of at least 3:1. The only reason I am even thinking about stops ("mental stops") is the "holy sh*t" factor, i.e. I don't have enough faith in my system to watch my drawdown approach 10% without bailing out of what appears to be a bad trade.

Chuck

 

[bluedemon77]

Quote from Prevail:

any action taken to ease psychological pressure in trading will decrease performance. keep the positions small by doubling the max draw down.

Prevail, did you really mean to say this? It sounds like you're saying pressure is a good thing.

Chuck