The Journey

“The journey, Not the destination matters...” ― T.S. Eliot

You might be wondering what the Nobel Prize winning poet, T.S. Eliot has to do with trading. No, he did not leave a secret trading manual in his attic for his grandchildren to stumble upon. And I’m guessing he did not even trade – he was too busy creating immortal prose.

Yet, his quote, “The journey, Not the destination matters...” has profound implications for us as traders. Let me explain…

What if I told you of a Soybean Oil strategy that earned nearly $40,000 in single contract profits in five years? That is $8,000 profit per contract each year. Would you want to trade it?

Right now, margin on Soybean Oil is $660, so you might determine you could trade 1 contract of this strategy with $2,500. So, in five years, your $2,500 would turn into $42,500, which is a compounded annual growth rate of over 76%. Per year!

At first blush, who would not want that?  

The problem is that it's where most traders stop their analysis. They see the start point, and they see the end point five years later, with bags of cash awaiting them. They jump for joy at their performance, and rush to trade the strategy live.

Of course, our friend T.S. Eliot would disagree. He would argue that the journey during those five years, not just the end point, is what really matters.

So what does that journey look like? Here it is:

The end profit is there, sure enough. But look at what we had to endure to get there! A maximum drawdown of $9,000, numerous quick and steep equity collapses, extended flat periods – UGH!

The final profit says this is a nice strategy, but the path to get there is brutal. In other words, the journey is really important. Unfortunately, too many traders ignore that.

Psychologically, this strategy would be practically impossible to trade. Pretend you are trading this strategy, and just imagine yourself at the following point on the equity curve:

What would you be thinking? Most people probably would have quit even before this point, but how much confidence would you have right now? Realistically, you’d have zero confidence that this strategy would ever turn around. Yet, from that point on, that is exactly what the strategy did – its performance took off from that point.

Hopefully, this simple example makes it clear that the path of an equity curve is critical. You can’t enjoy the riches at the end if you cannot stomach the road to get there.

So, how can you take this into account with your own trading? Here are a few simple tips:

  1. When reviewing a Performance Report, make sure you look at more than just the Net Profit. Make sure you look at the max drawdown and any drawdown curves – could you handle the drawdowns? My rule of thumb is that I can mentally handle about half the maximum drawdown that I think I can handle. So, if I think I can handle a $10,000 drawdown, and the system has an $8,000 maximum drawdown, chances are I won’t be able to endure it. In that case, I probably should not trade such a strategy.
  2. You can employ my free Monte Carlo simulator for Excel (see below) to determine the drawdown, profit/drawdown and other statistics for any strategy. This is a simple, but powerful way to see if the risk adjusted return is appropriate for you. I throw away many great profit strategies because the drawdowns are just too severe, and the risk adjusted return is just too low.
  3. Take the equity curve, print it on a piece of paper, then get another piece of paper and cover it up. Slowly reveal the developing equity curve, moving left to right, and imagine yourself at each point along the curve. Try to experience what you would feel at each point. This is hard to do, especially when you know the positive end result, but if you do it correctly, it can be very enlightening.

To wrap up, always remember that the end result of a trading strategy is usually not the most important part. The path matters – a lot.

-- By Kevin Davey of KJ Trading Systems

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About the Author Kevin Davey

Kevin Davey is a professional trader and a top performing systems developer. Kevin is the author of “Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading” (Wiley Trading, 2014.) . He generated triple digit annual returns 148 percent, 107 percent, and 112 percent in three consecutive World Cup of Futures Trading Championships® using algorithmic trading systems.His web site, www.kjtradingsystems.com, provides trading mentoring, trading signals, and free trading videos and articles. He writes extensively in industry publications such as Futures Magazine and Active Trader and was featured as a “Market Master” in the book The Universal Principles of Successful Trading by Brent Penfold (Wiley, 2010). Active in social media, Kevin has over 15,000 Twitter followers. An aerospace engineer and MBA by background, he has been an independent trader for over 20 years. Kevin continues to trade full time and develop algorithmic trading strategies.

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