You Don’t Back Test Your Life

Boris Schlossberg

In his book, PitBull Marty Schwartz writes about one of the greatest individual trading runs in the history of the markets. As a pioneer trader in the S&P futures pit in the early 1980’s Marty noticed that there was a strong relationship between the price of bonds and the S&P futures. If interest rates rose stock index futures dropped the next day. If interest rates declined, equities were bid up. Since bonds stopped trading at 3 PM NY time and S&P futures traded until 4:15 PM there was a little more than an hour where you could watch the bonds trade in the cash market in after-hours trading. If bonds staged a significant rise of 3/4 of a point or more the probability of S&P 500 opening higher the next day was very high. As Schwartz noted, “Being ahead at the opening was like waking up with a woody.”

Here is how he describes the trading run.”All through October, I smacked the S&Ps when they went up and I smacked them when they went down. On October twenty-second, on rumors that the Fed was not going to lower the discount rate before the election, the physicals plummeted in after-hours trading, the S&Ps opened down 1.85, I was short 150 contracts, covered at the opening, and in one minute made $138,750. By the end of the month, I was up $1.4 million. My legs were sore from jumping up and down, my voice was shot from screaming at Debbie on the phone, and Audrey’s ribs were tender from being hugged. In February, when we’d crawled out on a limb and dumped $400,000 into the beach house, our net worth was $1.2 million. Now, in one month, I’d more than doubled that, I’d made more in a month than I’d made in my entire lifetime. I can’t begin to describe that feeling. Every day, for twenty straight days, we’d get in the Eldorado to drive home from work and we’d be, on average, another $70,000 richer. It would have taken me a whole year to make $70,000 if I were still a securities analyst.”

Here are a couple of things to keep in mind about Marty’s “system”. He didn’t backest it on a thousand samples across an array of markets to prove its robustness. He didn’t optimize parameters or run Monte Carlo simulations, or try to see if this “signal” worked on wheat or pork bellies or some other unrelated nonsense. He also stopped trading it the moment it stopped working.

His system – like all successful trading systems – was simply a behavioral edge that he exploited until it stopped working. It’s not that he didn’t do research. Before committing capital to the idea, he did check past occurrences and started making relatively small bets until his thesis was proven correct – but by standards of “data scientists,” it was a woefully inadequate test and yet it was one the most successful individual exploitations of the market ever recorded.

I bring this up because I think most retail traders are far too obsessed with backtests. Backtests are good at only one thing – showing you how to make money yesterday. If you really want to learn how to make money today and tomorrow and the day after tomorrow you need to stop testing and start doing. Losing, as I noted in last week’s column is the single best test that you can run. Losing in real market conditions will finally tease out the profitable idea in your thesis – if there are any. Lose and backtest. Lose and backtest. Lose and backtest until you start to win.

Otherwise, you will simply waste all your time trading yesterday’s data while learning nothing about how today’s price action differs. How many times have you seen a system with a perfect equity curve, passing every statistical test under the sun, fail in real market conditions?

100%.

I have never seen a backtested system that could maintain its profitability for more than a few months without serious editing and adjustment to its initial assumptions. That’s because successful trading is a function of understanding past price behaviors and while being finely attuned to any present-day variations in the market. Yes of course price action is cyclical and basic buying and selling patterns persist over and over. After a self-off comes a rebound. After a rally comes a selloff. But the amplitude of each move is highly variable that’s why the future is just different enough from the past that you won’t be able to exploit it mechanically.

Backtests should be viewed not as justifications for systems, but rather as insights into certain behavioral edges that will not last. That’s the other key to understanding backtests. They will all fail under future market regimes – and if you understand that going in it will be a lot easier to abandon them or modify them when they stop working.

There are literally hundreds of exploitable edges in the FX market every year, but they are fleeting and usually very instrument dependent. There is no “universal” system of trading that will work across all markets. That’s why the most successful individual traders tend to specialize in one market or even one product.

So stop wasting hours on a perfect tweak of yesterday. You don’t backest your life. You live it. Do the same with trading.

GBPUSD – Test of 1.3600 Coming?

GBPUSD – Test of 1.3600 Coming?

Chart Of The Day

Cable popped in late London trade on reports from the Independent that EU and UK have agreed to a Brexit divorce bill. While no details were given, the news if confirmed is the first bright spot in Brexit negotiations for PM Theresa May and suggests that two parties may be finally reaching some key compromises on the issues.

Still, Brexit talks face an uphill test, especially given the key negotiating deadline of December 4th next week, and unless UK can offer palatable solutions on both the Northern Ireland border issue and on freedom of movement concerns, today enthusiasm may evaporate and GBPUSD could tumble towards 1.3000 once again.

On the other hand, if this is the first step to a serious Brexit agreement, the upsurge in cable could continue unabated for much longer than anyone imagines and the pair could challenge 1.3600 before year end.

USDCHF to Test 1.0100

USDCHF to Test 1.0100

Chart Of The Day

The U.S. dollar traded sharply higher against all of the major currencies today as the fundamentals we have been highlighting returned as drivers for the currency. On Tuesday when the greenback tanked for the seventh day in a row versus the Japanese Yen we said hawkish Fed speak and stronger data meant that further losses were limited. Today, a series of healthy U.S. economic reports followed by a positive Beige book carved out a bottom for the U.S. dollar. The currency’s rebound was then magnified by optimistic comments from Janet Yellen. U.S. rates also shot higher with 10 year yields rising nearly 10bp, validating the reversal in market sentiment. So unless Donald Trump attacks the dollar again on Friday, we’ve seen the end to a month of losses in the greenback. With oil prices rising, inflation ticked up in the month of December. Industrial production is also up and according to the Beige book, a number of Fed districts reported tightening job market, higher wages and increased inflation. Even Janet Yellen admitted that they are close to reaching their goals

Technically, USDCHF is still in a downtrend but with the dollar rising strongly against all other currencies, we think its only a matter of time before this pair catches up. Resistance is right above 1.01 (near 1.0110) according to the 4 hour chart included so we’ve set the profit target on our long trade just under 1.01 at 1.0097.

GBP/USD to Test 2010 Low

GBP/USD to Test 2010 Low

Chart Of The Day

GBP/USD to Test 2010 Low

With U.K. CPI, retail sales and employment numbers scheduled for release, sterling is in play this week. Tomorrow, Bank of England Governor Mark Carney will be delivering his first speech on the economy this year. Given the recent slowdown in manufacturing and service sector activity along with the drop in commodity prices, we are looking for inflationary pressures to ease, which should lead to more caution from Carney. At the last central bank meeting, we learned that U.K. policymakers were concerned about market volatility and low oil prices. According to the central bank “Recent volatility in financial markets has underlined the downside risks to global growth” and recent declines in oil “will depress global inflation in the near term.” While they also mentioned that lower commodity prices could boost spending, wage growth will curtail it. Dovish comments from Carney and/or lower CPI could drive sterling to fresh lows versus the U.S. dollar.

Technically GBP/USD slipped to fresh 5 year lows today and appears headed for its 2010 low of 1.4230. This is the closest support level for the currency pair before 1.40. Should GBP/USD retrace, resistance can be found at 1.4400.

USD/CAD Will Test 1.40 Again

Chart Of The Day

USD/CAD Will Test 1.40 Again

One of the best performing currencies this year is USD/CAD, which climbed more than 15% to a 12 year high. We have not seen the Canadian dollar this cheap since 2004 and there’s no doubt that its weakness reflects the underperformance of Canada’s economy. The biggest problem for Canada has and will continue to be oil. The price of oil is down 30% in the last 12 months and 60% in the last 18 months. Since economic data is released with a lag, we will continue to see the aftermath of lower oil prices in early 2016. The market is only pricing in a 25% probability of easing by March but we believe that the odds will grow as the year progresses. With many analysts calling for WTI crude to drop to as low as $20 a barrel in 2016, USD/CAD will not only test but also break 1.40 in the coming year. Oil supply and demand remain major problems for Canada’s largest industry and with no respite in sight, we expect the Bank of Canada to lower interest rates again on the back of weaker data.

Taking a look at the daily chart, USD/CAD is already attempting to rise above the first standard deviation Bollinger Band. Any dip towards 1.38 should be seen as a buying opportunity. We need to turn to the monthly chart to find resistance for USD/CAD. Right now the 12 year high of 1.40 is the most important resistance level. When this level is broken, the next important level will be 1.43, a level the currency pair broke down from in 2003, found support in 2000 and resistance at in 1995.

GBP/CAD – Test of Old Highs Ahead?

GBP/CAD – Test of Old Highs Ahead?

Chart Of The Day

One of the cleanest uptrends over the past year has been in GBP/CAD pair which continues show no signs of exhaustion. After taking a breather from fresh highs above the 2.0700 level the pair looks ready to roar higher especially if UK data continues to impress.

Earlier this week the UK PMI Manufacturing report came in much better than expected, but the true test of the state of the UK economy will come tomorrow when the market gets a look at the PMI Services data. If that release beats expectations than the BoE will have little choice but to consider tightening by year end.

Although no one expects any change out of the BoE on Thursday, the central bank may hint at a more hawkish posture in its communique and that in turn would send GBP/CAD towards its recent highs at 2.0500 level

BK EUR/GBP Out for +40

Swing

Out of EUR/GBP +40 on trade

BK – Close 1/2 EUR/GBP at 0.7226 for +40, move stop on rest to our average entry price of 0.7266

EURGBP Second Entry Triggered. Now short 2 lots with average price of 0.7266

BK EUR/GBP Big Trade – Aiming for Another Test of 70 Cents

The Trade:

SELL EURGBP

Place Order to Sell 1 Lot EUR/GBP at market (now 0.7203)

Pace Order to Sell 1 More Lot at 0.7328

Stop at 0.7460

Risk on our BIG TRADES is large, so make sure your position is small.

We will manage the take profit dynamically and send out alerts on when to take profit and/or move your stop.

—–

Revisiting Our Monetary Policy Divergence Trade

Since the beginning of the month we have largely seen the euro and British pound move in the same direction but the decline in the euro was far more aggressive, leading to sharp slide in EUR/GBP. However after the launch of Quantitative Easing, the selling in the euro began to ease and today, the euro is rallying while sterling is falling. The decline in the British pound reflects the market’s concerns about tomorrow’s Bank of England minutes and the possibility that it will reflect a less dovish central bank. While this may be the case, it won’t detract from the fact that the central bank will still be talking about raising interest rates and that <em>monetary policy in the U.K. will be drifting further away from the Eurozone in the coming months. The recent sell-off in the British pound was driven by BoE Governor Carney’s concerns about a strong currency but in the same speech he called for gentle rate rises, a view that has been echoed many times by fellow members of the central bank. Just as the prospect of Fed tightening has been extremely positive for U.S. dollars, when the BoE grows closer to raising rates, sterling will take off as well.

Right now we see a good opportunity to sell euros and buy pounds because the European Central Bank just started its Quantitative Easing program and they pledged to continue buying bonds for the next 18 months. The BoE will raise rates well before September 2016. The latest rebound in EUR/GBP provides an attractive level to start scaling into a short position particularly since there is a chance that the BoE minutes could be less dovish. Also, we are looking for an upside surprise in the labor market report after the PMI numbers showed strong job growth in the manufacturing and service sectors.

Technically we are looking for another move down to 70 cents. The 61.8% Fibonacci retracement of the 2000 to 2008 rally near 0.7260 is a key resistance level

EURGBP031715

The Trade:

SELL EURGBP


Place Order to Sell 1 Lot EUR/GBP at market (now 0.7203)

Pace Order to Sell 1 More Lot at 0.7328

Stop at 0.7460

Risk on our BIG TRADES is large, so make sure your position is small.

We will manage the take profit dynamically and send out alerts on when to take profit and/or move your stop.

USD/JPY Fails at 1st Test of 100.00 Forex Daily Technicals 4.09.13

Video

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