New traders are trained by the financial media to believe that accurately predicting the market is the only way to gain an edge. Meanwhile professional traders and prop firms around the world successfully navigate the market without forward-looking analysis.
Here are three over-simplified components to a portfolio strategy that do not require predictive trading:
1) Buy (long) instruments that are rising and tend to have big moves
2) Sell (short) instruments that are declining and tend to have big moves
3) Hedge (contrarian) with broad-based instruments that tend to not have big moves
The rise, decline, and tendencies of instruments can be quantified and objectively measured using some backtesting software and very simple algorithms.
As my friend and mentor Rick Martin has said in the past,“Either it works or it doesn’t work.” Monitoring what is working and sticking with it until it doesn’t work is the best way that I’ve found to navigate the market without a functioning crystal ball.
Big movers can be found using a beta filter. Back testing a trend/momentum strategy on these high beta instruments helps to narrow down effective strategies. If the instrument doesn’t work on a trend strategy, then don’t try to predict that it will start having big moves. If the instrument does have a good track record of performing on a trend strategy and the current signal is long, then stop trying to predict that it will decline.
This may seem oversimplified, and it is. In reality there is hard work, discipline, and risk involved. The hard work is digging through the hundreds of tradable names and backtesting strategies until you find some that work. The discipline is sticking with the strategy when it works and cutting it when it stops working. The risk is the historic drawdown in strategies and event risk not demonstrated in backtesting.
Rick and I will be filming a live course in February to introduce the tools that we use to find strategies that are working. If you would like to receive information on this course or other resources that are made available for systems trading, please send an email to [email protected] and I’ll add you to the SMB Systems list.
Andrew Falde
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