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2. Number of trades (# Trades) shows the total number of trades taken during the backtested period. For trend-following systems, we want this number to be as low as possible without sacrificing profitability.
3. Number of days (# Days) shows the average duration of a trade. As with number of trades, all else being equal, the lower the number of days in a trade while still generating superior results the better.
The only caveat here is whether the system is trend following or mean reverting. If it is trend following, then the higher number of days in the trade will usually result in larger profits.
4. Maximum drawdown amount (Max Draw) tells us the maximum peak-to-valley equity drawdown during the backtested period. This number defines our absolute minimum capitalization requirements to trade the system. (Although prudent money management suggests allowance for at least 50 percent beyond our worst historical drawdown; see Chapter 8 for more details.)
Most system developers also include the “maximum loss” column in their performance analysis tables. Maximum loss tells us the largest loss experienced on a per-trade basis. Although prudent price risk management suggests that our maximum loss on a per trade basis should not exceed 1 to 2 percent of total account equity, this measure does not consider correlations within a portfolio (see Chapter 8).
Because one of the main precepts of this book is reduction of risk through diversification among negatively and/or uncorrelated asset classes (see Chapter 9), I feel that the maximum loss experienced on a per-trade basis can be a somewhat misleading and therefore an inferior measure when compared with that of maximum peak to valley equity drawdown. If, for whatever reason (e.g., lack of capital, corporate prohibitions, etc.), a diversified portfolio of assets cannot be traded, inclusion of the maximum loss measure and adherence to the 1 to 2 percent rule becomes an absolute necessity.
5. Maximum drawdown duration (MDD) is the longest duration of a drawdown in equity prior to the achievement of a new equity peak. This number is essential in psychologically preparing us for how long we must wait to experience a new peak in account equity.
6. Maximum consecutive losses (MCL) is the maximum number of
MECHANICAL TRADING SYSTEMS
consecutive losses endured throughout the backtested period. Just as MDD is important in dispelling any fantasies regarding a system’s ability to jump continuously from equity peak to ever higher peaks, MCL shows ahead of time exactly how many consecutive losses successful trend traders would have endured to enjoy the system’s total net profit.
7. Profit to maximum drawdown (P:MD) refers to the average profit to maximum drawdown ratio. The higher this ratio is, the better. This is probably the most important field listed because it allows us to examine profit in relation to risk endured to achieve that profitability.
8. Profit loss ratio (P:L ratio) refers to the average profit to average loss ratio. As with P:MD, the higher these numbers are, the better. Trend-following systems should have very good P:L ratios because they generally display a low winning percentage of trades. This means that large profits and small losses are key in generating a good P:MD ratio. These ratios will drop for mean reversion systems, but the winning percentage of trades should compensate for this.
9. Percent winners (% W) is the percentage of winning trades. As stated, trend systems generally will have relatively low %Ws and mean reversion systems typically display high %Ws.
10. Time percentage (Time %) refers to the amount of time that this system has an open position in the market. If all other fields were equal, then a lower time percentage would be preferable because it means our available capital is tied up for less time to yield the same rate of return.
Trading System Parameters: Less Is More
All of the trading systems examined herein are the simplest imaginable while still showing overall profitability. I argue that simple is better because trading systems with the fewest parameters have the best overall chance at generating future results that are similar to their past performance history.
TWO MOVING AVERAGE CROSSOVER
The two moving average crossover is probably the simplest and most robust trend-following trading system. Traders initiate long positions and exit shorts whenever the shorter-term moving average settles above the longer-term moving average; they stop and reverse whenever the shorter-term moving average settles below the longer-term moving average.
Using CQG, the programming code for a typical two moving average crossover system is written in this way:
Long Entry and Short Exit:
MA(@,Sim,9)[-1] XABOVE MA(@,Sim,26)[-1]
Short Entry and Long Exit:
MA(@,Sim,9)[-1] XBELOW MA(@,Sim,26)[-1]
Table 3.2 presents the backtested portfolio results from December 31, 1992, to December 31, 2002, for this system.