Robustness : Ideal Trading System Characteristics to Withstand Change

Perhaps the most important question a person can ask about a given mechanical trading strategy is : Will the strategy survive under future market conditions ? This question is not only vital for any given individual mechanical trading system but it is vital for the field since the whole idea of developing systems with sets of fixed rules is to use them successfully in the future.  Sadly there is simply no straightforward answer to this question since the future is unknown – and therefore profitability in the future remains unpredictable – but we can certainly take a look at the systems that have achieved this status in the past and evaluate what their main characteristics are and how we could potentially reproduce their success. On today’s post I am going to talk about “robustness” which – when talking about trading systems – is the ability to remain profitable despite changes in long term market conditions, what the characteristics of robust systems are and what we can do to ensure that our systems remain as profitable as possible for as long as possible.

Whenever someone develops a mechanical trading strategy it is not only vital to be able to obtain profit and draw down targets from long term historical data but it also important to ensure that such results will be likely to repeat themselves in the future. People who say that profitable mechanical systems are not possible – which by the way are wrong (track records of trend following systems on futures go back to the early seventies) – usually say that we cannot develop a successful mechanical strategy because a system simply cannot “adapt” to changes in market conditions and the market will eventually turn the rules unprofitable in virtue of their “stiffness”.

It therefore becomes vital to understand first what is needed to achieve profitability in the future and what will make a system inherently bound to fail under unknown market conditions. In order to do this the first thing that we need to do is explore the systems which have succeeded in the long term, see what they have in common and use these characteristics on our trading strategies.

The more of these characteristics we use the more robust and able to succeed our systems will be under future market conditions. There are sadly no track records of foreign exchange systems in the long term – as the market as we know it is rather new – but systems in the futures market – especially long term trend following systems – have extremely extensive track records (sometimes even 30 years long). After you go through these systems you will notice that they have the following in common :

  • Use of the daily time frames : I could not find any single system that has traded for more than 20 years that did not use the daily time frame or a time frame above it (very rarely weekly charts). The reason for this might have been technical (positions could not be placed as fast now as they were placed 20 years ago) but it is likely that the inherent obviousness of trends on daily charts triggered the use of these strategies from the beginning.
  • Use of simple concepts : A very common characteristic shared by all systems that have worked for a long time is their inherent simple character. These strategies were not developed using a ton of indicators, neural networks or genetic programming but they are simple strategies using simple concepts derived from a fundamental view of how the markets develop.
  • Use of many instruments : Perhaps one of the most relevant aspects of these strategies is that they are all traded amongst at least a basket of 10-20 different instruments (even sometimes on different markets). This makes the strategies robust since they tackle very fundamental aspects of crowd behavior, something that develops within almost every possible traded asset simply because it is being traded by large groups of human traders.
  • Adaptations built around volatility : Another key aspect of these strategies is that they trade with adaptations based around market volatility. Early in the 1980s traders realized that when the market changes only their volatility appeared to vary while more fundamental market characteristics – such as those exploited by these systems – remained true.

As you see, we know exactly what we need to do to develop a trading strategy that is as robust as possible. Develop a system on the daily time frames that uses volatility adaptive criteria, trades many instruments on the same settings and uses simple trend following concepts.

Of course, these systems were all developed 20-40 years ago and they could not benefit from many of the things that are now possible in trading. A very notorious difference between trading then and now is the drastic reduction we have seen in trading costs making the exploitation of inefficiencies of trading strategies below the daily time frame possible, this difference is particularly noticeable in the foreign exchange where costs have been reduced substantially during recent history.

One of the things I have tried to do during the past few years with my work is to borrow some of these concepts from the “old time traders” and apply them to some strategies that exploit inefficiencies which are now able to be tradable on the lower time frames thanks to lower trading commissions. My approach to system development uses the concepts of simpleness and adaptability although my systems sometimes exploit inefficiencies which are particular of each different currency pair’s behavior, an approach which I think will be successful in the future. Up until now several systems have shown encouraging results but we will not have a definite answer for the next 3-5 years.

Meanwhile I am also developing systems following the example of the past century’s most successful trend followers, systems with all the above mentioned characteristics. Currently the only system in Asirikuy fulfilling all of them is Ayotl (my implementation of the turtle trading system), but in a few days Quimichi, a new trading system using the daily time frame, a simple concept and the exact same settings on at least 6 different instruments, will also be added to our arsenal of robust trading systems.

If you would like to learn more about automated trading system development and how you too can learn how you develop robust trading strategies 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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