Less Is More–Usually

Less is more—most of the time.  In my early days, I started out with almost twenty different indicators in a single system—and why not; the computer was going to do all the work.  I figured that if I combined enough techniques, I could find the perfect entry signals—I hadn’t even thought about the importance of exits back then.   Well, needless to say I immediately ran into two problems:

1)       The first was that in looking for the perfect entry, I found almost none.  I had set so many hurdles to get over so that rather than finding the perfect entry, I stumbled and fell most of the time.

2)      But more importantly, I was using a multitude of techniques that told me the same thing.  My first systems tended to be trend following, and I might have as many as a dozen trend following techniques all in the same system, and guess what—they all told me the same thing with a few nuances so there was no way for me to determine what was really contributing to my returns and what was just noise.

The best way to build a trading system using multiple techniques is to select a few techniques from different categories of indicators.  For example, let’s look at our best trading system:

1)      It started out over ten years ago with just a proprietary momentum technique as the setup with a couple of candlestick patterns as confirming triggers to take the trade.  It worked great in selling option premium.

2)      A few years later as we moved into trading equities long/short, we added a trend following technique which reduced the number of trades, while adding to the P&L.  We added an additional price confirmation trigger about the same time.

3)      After a couple more years, we added a cyclical component which again reduced the number of trades while improving the P&L—a lot in this case.

4)      And a few months ago we added an additional trend following technique that dramatically reduced the number of trades with a large improvement in performance.

5)      We then took a really good trading system for equities and adapted it to the FX market where we found that adding aggressive stops and price targets made a huge improvement, whereas they were of limited importance in the equity market.

6)      And we are constantly testing other possibilities, always looking for a new positive surprise.

The point isn’t to emulate what worked for us, but rather to understand that it will usually be a small number of techniques from different categories that deliver the majority of the return, and that combining too many techniques will likely limit your signals and if there are too many from the same category, they will not really add to the robustness of your system–you won’t really know where your returns are coming from so it is hard to make improvements.

Take a look at the following table—this is just a small sample of the indicators that are available, and of course you can write your own as we did because we wanted a momentum indicator that didn’t jump all over the place and there was nothing available that fit our needs.

Trend Volatility Momentum Cycle Market Strength Support Resistance
Moving Average

X

Linear Regression

X

MACD

X

X

Trend lines

X

X

Average True Range

X

Bollinger Bands

X

Linear Regression Slope

X
Momentum

X

Rate of Change

X

Stochastics

X

RSI

X

Detrended Price Oscillator

X

Fibonacci Time Zones

X

Fourier Transform

X

Accumulation/Distribution

X

Money Flow

X

Moving Average (Volume Adjusted)

X

On Balance Volume

X

Volume Oscillator

X

Fibonacci Retracements

X

Gann Lines

X

If you have been having trouble getting started or have been working on a system that just doesn’t perform, maybe it is time to select no more than three techniques from this table—each in a different category—to get started.  Sometimes a clean sheet of paper is the only way to clear your head and get going down a new path.  Give it a try.

Author:  Rick Martin

For more information or answers to your questions, email Rick at [email protected]

Hypothetical computer simulated performance results are believed to be accurately presented. However, they are not guaranteed as to accuracy or completeness and are subject to change without any notice. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Since, also, the trades have not actually been executed; the results may have been under or over compensated for the impact, if any, of certain market factors such as liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any portfolio will, or is likely to achieve profits or losses similar to those shown. All investments and trades carry risks.

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