Trading Ideas And Systems: Keep It Simple, Smart Guy

One thing that I have discussed in numerous NAS Trading articles is the tendency for traders to believe that complex ideas and systems are inherently better or more desirable than simple, conceptual ideas or systems. Just taken at face value, this notion is completely understandable. After all, if an idea is fairly simple, how could it possibly be “secret” enough to add value to a trading program?

To switch things up, let’s take an example from the macro trading space. The move in the Japanese yen from late 2012 through the spring of 2013 was a windfall for some of the macro trading firms. Yet, to read many pundits, blogs, etc., this trade was “not good” because it was too obvious. The tone was almost that traders didn’t deserve large profits, because the trade was, “obvious to everyone.”  Yet, did these pundits themselves make money? Of course not. Partly as a consequence, they miss the entire point: It is not about how you look or how impressive you sound, it is about what you do and when you do it. In trading, that is all that matters. Saying something was “obvious” but not acting on it is worthless. At first such punditry hardly seems worth commenting on, yet to me it is significant. It provides a textbook example of why some highly intelligent people struggle with the markets. They believe trading is an intelligence test or even an ego contest. The idea that a simple idea could be lucrative if acted upon promptly and with discipline shatters their egocentric notion of how the markets should work.

Here in Chicago there is a tremendously successful doughnut shop called “The Doughnut Vault”. It sells a few varieties of doughnuts and coffee out of a very small space. On most days there is a line that stretches around the corner, and this has been the case since it opened a few years ago. The owner of this business owns several very successful full service restaurants which are far more complicated in concept and implementation. Yet, in an interview he stated that it was the doughnut shop that has created his biggest financial success. best.donut_.place_

Trading is commerce. Our “regular customers” are not people lining up and waiting 45 minutes for expensive (and very good) doughnuts. The other side of our trade is most often other market participants who have immediate, urgent liquidity needs, such as those entering on a greedy impulse, or exiting due to fear of further loss (or even better, a margin call). In other cases, the other side of a trade might be a government looking to achieve a policy objective, or hedgers looking to lock in profits at their operating businesses. I wrote about this concept more extensively in this article (which is one of the first I wrote for this site… I think my style has improved since then). On further reflection, here are three simple questions that I think are useful:

  • Do you have liquidity when your counterparty does not?
  • Do you have an understanding that your counterparty does not have?
  • Does your counterparty have other (non-profit minded) objectives?

To get a real trading edge, I think you need at least one of these things to be true.

One idea that is reinforced over and over again in the classic strategy book, “The Book of Five Rings”, is that in a real martial situation, simple direct movements dominate complex, refined movements. Humorously (and I think particularly relevant to investors and traders) the author also states that complex, “sophisticated” or flashy moves mostly exist to sell new students on a particular school. Replace “students” with “new traders” or “investors” and the above should sound highly familiar. Here is a very simple trading idea (one of the simplest swing trading ideas I can think of) that is useful, yet with substantial room for improvement and development:

  • If today’s close is less than the close 6 days ago, buy (enter long)
  • If today’s close is greater than the close 6 days ago, sell (exit long)
  • Here are the results in the S&P 500 futures, 1998 to present (1 contract per $50k account equity):

lower.than_.6.days_.ago_.system

Here are the results using a look-back parameter of between 1 and 10 days with the above system:

10.parameters.lower_.close_

In fairness “simple” is not really that simple. The right kind of simplicity, in the right amount at the right time, is what creates the genius of a great artwork, a great business or great trading strategy. If you liked this article, you might like some of my other trading strategy articles (click here). You can also join my mailing list here and find me on twitter here: @NASTrading.

– By Nat Stewart at NAS Trading. Original article appeared here.

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  • Marco says:

    The simplest, the most impressive system we can build. I think it’s like the double seven strategy of Connors? I never saw the concept optimized before.
    http://nightlypatterns.wordpress.com

  • Mat says:

    HI,

    Maybe the author feels that reporting the max drawdown of the “simple system” is not important as well as the Sharpe ratio. This system does not worth even mentioning because its performance is due to 5 years of straight up markets. I am sure the author has another example of “simple system’ that poor souls can use to become victims of curve fitting.

    I did not think the quality of this blog will fall so much.

    • For next week’s article I was planning on programming this system in to EasyLanguage and giving my take on it. In benefit of the author, I would point out that the provided rules do not constitute a complete system. The thrust of the article is to demonstrate that a simple trading idea can lead to potentially great systems. Within the article the author comments about the system, “[it’s] useful, yet with substantial room for improvement and development”.

    • You can find drawdown information here…
      http://systemtradersuccess.com/simple-sp-system/

  • Robert says:

    I think it’s curious that the parameter 5 is such an outlier (rather poor performance). That would give me some concern.

    Jeff, perhaps you could explore this issue in your own post — whether this is just a statistical fluke or if this is a particularly bad parameter for some reason. Perhaps you could also run tests against other comparable futures, as well, like @NQ, @EMD and @TFS, and see how well this system holds up.

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