We're talking Sybil here - multiple personalities. The market is going along in a trading range, then one day - BOOM. Up, or down, it doesn't matter. It's trending now. Your system has never seen such behavior. So, it tells you to sell or buy at what it thinks are oversold or overbought levels - and the market just slices past your entry points. And, you lose a lot of money. Back to the drawing boards.
Big problem - your system drawdown is based on previous backtesting. This new situation creates higher drawdown than you're prepared for. Instant depression. This is when the going gets tough.
My rule is: trade the best system I have, exactly as specified, and while I'm losing money use that energy to improve the system. The next time it encounters this "new" market personality, it will "know" what to do. You must make sure you don't lose money in the same way twice.
One big problem with trading without a system is that it's easy to forget where you made your mistakes. At least with a mathematical, computerized system the chips don't forget - ever (unless you drop it or lose it - another topic for later).
And it's because of multiple personalities that there is always the disclaimer - that past performance doesn't predict future gains.
Some pundits have suggested that the market doesn't change. But if that were true all we'd have to do would be to backtest all available data and we would have a perfect system. The fact that the markets DO change makes the game much more difficult.
And why do markets change anyway? Think back 10 years - how many traders were using computers to download data and test their systems with a computer? Not many. Only the very serious. System Writer and TradeStation were not even written yet.
A lot of us were still drawing fancy charts by hand. Some people still do.
Today just about everyone has a Pentium, plenty of software and gets data via a satellite dish, cable TV or over the Internet. 10 years ago if you mentioned this possibility you'd be accused of watching too many reruns of Star Trek - the original.
And, when people lose money they tend to quit the market. New "players" enter the game all the time. And today, a LOT of new players show up every day thanks to corporate downsizing.
So, your competitors aren't the same bunch anymore. You get better, and so do many of "them". And, the market just doesn't trade the way it used to. And that's why your systems "blow up".
When I'm making money I just let the systems "ride". I try to enjoy it. "If it ain't broke, don't fix it." When I go into the dreaded DRAWDOWN, I spend enormous amounts of time working on a system "fix", or trying to come up with another system, or buying a new book on trading, or listening to a new, or old tape. THAT's when I learn.
There's another old saying, "If it doesn't kill you, it'll make you stronger." If you can keep from going broke during your drawdown periods, and you use that time to improve your systems - to grow emotionally, to learn new things about trading, you'll get better, and next year you'll make more money. But, you've got to spare your resources so you'll be around to trade again.
Learn when you lose. Use your losses as tuition in the school of trading techniques. And don't give up.
---Tom Loffman
Copyright, 1997
Tom Loffman, Equity Systems