TRADETHINK ARTICLES

How to Spot a Bad Trading System

November 2, 2007

By Chris Morse

It is very important to know what to look for in finding a good trading system or indicator. It is even more important to know how to spot a bad trading system.

There are several tell tale signs of why a trading system may not be good or robust. To put it blatantly… you need to know how to spot a bad trading system.

In particular we will focus on trend following systems for the commodities markets. There are so many systems available to the trader. Some systems are free, some cost a lot of money and some the trader will try to develop themselves. It is not of great importance where the trading system comes from. What is important is in knowing if the system is going to be worth your time and money to back the particular system.

Here are a few of the tell tale signs to be concerned with when looking at or evaluating the viability of a trading system.

Many Versions

No Defined Rules

Lack of Back Testing

The above three points to look for in spotting a bad trading system is just the tip of the iceberg. There are probably close to fifty things to look for in spotting a falsehood of a system. Here is a good place to start in the evaluation of a trading system or strategy. We will go into a little detail on each point.

Many Versions

Wow… It is so nice of some system developers to update your trading software each year or sometimes even more often. It is so cool to have version 7.0 or 8.0 and have the slickest version of that system out of the box. Hold on. There is a problem here. I can understand fixing bugs in charting software or even making software compatible with a new OS. However these would require just a patch and not a complete new release of another software version. Bottom line is that if what the trading system was doing to evaluate the markets last year in version 6.0 and now you need version 7.0 the software did not continue to work and is most likely a piece of useless plastic or dare I say garbage.

No Defined Rules

When viewing a trading system or supposed indicator it is of immense proportion to have clear and concise rules for entry and exit into a market. Just watch a so-called predictive analysis or indicator which involves a judgment by the user is called trading fast and loose. To see a blue line cross a red line and to think that is a viable entry method is absurd. A quality trading system/indicator will produce precise entry and exit prices or signals. In other words, instead of watching a magical indicator show you it might or might not be the time to possibly enter or exit a position. You need a precise trading signal such as “Buy 1 contract of December Crude Oil at 94.02 stop”. If the market trades in this example to 94.02 then you enter a new long position. If the market does not hit this price you live to trade another day. The trading system I recommend is Trade Think which will give you a precise buy or sell signal and not some magical set of colored lines crossing over one another. The magic lines may make you think you are in control if you decide a particular indicator gave a potential signal. What is more important is being successful even if it is not a natural feeling.

Lack of Back Testing

It may be great to see some pretty colored lines cross on a trading chart. However, if you are unable to ascertain what had happened had you entered and exited each time the magic lines did something then you may have no clue as to what to expect in the future. It is of great importance to be able to measure the viability of a trading system or even a trading indicator. To not be able to see the results in dollars of a strategy in the past through back testing is foolhardy at best. A benchmark is essential to judge performance of a trading system or indicator. Trade Think is a trading system that will give you the ability to view and evaluate a market or portfolio and see how the system performed yesterday, last week, last month or even years ago. It is a must to not only see what a system is doing now, but also be able to measure how the system performed in the past. To try and trade a system or indicator without knowing the precise performance history is shooting from the hip and in the dark. This is not recommended.

Summary

While only touching on a few keys to look for in spotting a poor trading system or indicator such as having multiple software versions or releases, no defined or precise trading rules and a lack of ability to provide back testing. There are many other tell tale signs to look for in what type of system or indicator not to trade. I will be providing several articles on additional things that show what to be aware of when evaluating a trading system. Trade Think is a trading system and indicator that you can evaluate for free and will not have any signs of a poor trading system.

About the Author

Chris Morse is the Developer of the TradeThink trading system. He has been involved in the development of trading strategies for nearly ten years. Mr. Morse developed a very robust system which is now in private use at one of the largest FCM's and has earned sizable returns for the last 3 years. Mr. Morse now focuses his time exclusively on developing and managing his systems.