Doomed to Fail : Why Absolute Assumptions About the Market Kill Systems

What are your system rules ? – Mary asked – Joe took out a piece of paper and started to write some simple sentences. See Mary – said Joe – my system is very simple, if the market moves 50 pips in one direction I take a position in the other one, adding  more positions every 50 pips until the market reverses and I take my profit. Mary looked quite unconvinced as Joe’s rhetoric reminded her of the first systems she had used and the very bad experience she had obtained. You see  – said Mary – the problem here is that you are making an absolute assumption against the market, your system will fail. Joe looked surprised, shocked and angry. Don’t be so close minded Mary – replied Joe – the fact that you failed doesn’t mean I will too and my system works, it has shown it will make money for the past 6 months.

Does the above story sound familiar ? Joe’s system has a problem which most systems people develop have – to a greater or lesser degree – they make absolute assumptions against the market. On today’s post I will explain what this means and why it dooms systems to total failure, I will explain to you why this makes trading systems completely vulnerable to changes in market conditions as well as how it leads to the creation of extremely dangerous strategies that convince people through what seems like “extensive testing” only to wipe their accounts in the longer term.

The first thing we need to define is what an “absolute assumption” about the market is. In essence an absolute assumption is any rigid criteria which the market is assumed to follow despite changes in overall volatility. Assuming that a currency pair will remain range bound between two absolute price values – like 1.4 and 1.6 – or assuming that a certain inefficiency will have a fixed mathematical expectancy of  “X pips” under different market conditions are examples of absolute assumptions about the market.

The “absolute assumption” problem is important because it assumes that certain “absolute things” that have remained true about the market in an absolute pip or price level basis will remain true for a longer period when in reality this is NOT the case. These assumptions are extremely dangerous since they may take a long time to “break” and in the process what seems like a very attractive and risk-controlled result is nothing but a temporary illusion waiting to be destroyed as the market proves that absolute assumptions can never be made and are ALWAYS wrong.

From the examples of absolute assumptions perhaps the most common is the system with the fixed SL and TP values. No system that uses inflexible fixed-pip take profit and stop loss values will survive in the long term as the system fails to have an adequate capability to adapt against changes in market volatility. When the market moves more the system will risk the same and attempt to take the same SL and TP so the market will easily take the SL (as it is now too tight). When the market moves less the opposite happens and it takes ages to hit either one of the two conditions. In essence the system does not align itself with the way in which the market moves, losing adaptability against market conditions. It makes an absolute assumption against the market that dooms it to fail. New traders usually overlook the importance of mathematical expectancy and the maintenance of an adaptive position against the market, for this reason they always start with systems like this that ultimately lead nowhere.

The next and perhaps most dangerous way in which absolute assumptions can be made is when they are tied to the systems’ logic. This usually happens when someone devices a “mathematical strategy” that attempts to profit from the market by forming a “grid” to trade between certain price levels or assuming that the market will turn after a certain X pip move in one direction. Strategies like this have shown how they can give extremely profitable and stable results for even prolonged periods of time only to wipe the accounts afterward through their lack of adaptation and wrong absolute assumptions.

Robominer was a clear example of such a case. In early 2009 I warned people about this system and its absolute assumptions, many called me close minded and unable to “join the profit” but the fact is that absolute assumptions are never right and sadly people lost tons of money on this system. I personally have met people who have lost from 100 USD to almost half a million dollars using this strategy, a very sad reminder that live results are NOT everything and that adequate analysis of a trading strategy needs to be done to ensure that it has the highest chance of achieving long term success. Grid trading systems keep on coming in many different ways and the end result will always be the same, even if so-called “safe guards” that close trades after a certain percentage loss happens are implemented a string of such “worst case losses” will eventually wipe an account.

In the end systems developed with absolute assumptions are created due to the lack of knowledge of the people developing them or their necessity to show some short term results to get buyers. Systems that assume that anything about the market will remain static on an absolute price or absolute pip level will always lose money in the long term as they neglect to take into account that the market does not follow any absolute movements and that adequate adaptive criteria need to be used for the development of trading strategies. Remember that the market will always make higher highs, lower lows, longer trends and longer ranging periods. Assuming that one of these will not happen is naive and will doom a system to certain failure. Of course, there will always be someone defending these systems but reality remains the same, these systems have never worked and they probably never will. You need to be more like a humming bird, adapting to the resources given to maximize their potential.

If you would like to learn more about system design and how you too can build your own automated trading systems with simple adaptive criteria that change against market volatility please consider joining, a website filled with educational videos, trading systems,development and a sound,honest and transparent approach to automated trading in general. I hope you enjoyed this article! :o)

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