Why You Need an Objective Trading Strategy?

An objective trading strategy is required because it can be backtested. While backtesting results do not guarantee future success it really helps to choose the appropriate parameters in the indicator. Traders may be using an indicator or parameter that does not work at all. The quantitative trading strategy is crucial to stay away from subjective trading.

Mainly retail traders are unknown on the subject of backtesting and quantitative analysis. Usually, amateur traders learn to draw some lines on their charts based on traditional technical analysis philosophies and they do subjective analysis which cannot be tested by the computer. Anything that cannot be tested is a subjective analysis.

Yes! Chart patterns, Elliott waves, trend lines, and support and resistance can be called subjective because it is almost impossible to test these techniques precisely. While saying all these things I don’t mean to say that price action analysis does not work, what I just meant is that they are hard to test quantitatively.

A few years ago I was a pure price action trader. I used to manually analyze the charts and execute trades but as I got involved in institutional side I realized that it is not possible to scan thousands of stocks manually every day.

Apologies for talking about stock on currency trading blog (I know people don’t like that) but I got to learn a lot of stuff from the institutional investment banking which completely changed my thinking. And believe me stock market is interesting too, you can diverse your long-term portfolio to this asset class for value investing.

You do not have to be a pure day trader or a pure value investor, you can become a little bit of both. So, for a currency trader, it is an advantage that he/she does not have to look over thousands of instruments to trade. For short-term trading currency market is my favorite one.

The objective trading strategy has a fix parameters to trade. It can help you to become more disciplined. If you have been drawing fancy lines on your chart yet you fail miserably, it’s whether because you are trading with something that does not work or you are not following your strategy.

I have seen many successful price action traders and they are successful only because they have a high level of discipline. It takes a lot of time to be a price action expert. Whatever trading strategies you see on trendfollowingsystem.com are quantitative objective trading strategies. They are all indicator based which means they are quantitative and testable.

In MT4 indicators cannot back tested, you can test only Expert advisors (robots). For a non-programmer person backtesting an indicator can be a tough thing to do. It is okay if you don’t know anything about backtesting, I will share a small piece of backtesting process in this article.

Let’s backtest a simple moving average. The moving average is one of the most popular and powerful indicators of all time. Although the moving average is widely used traders are less likely to test it on past data to see how it performed in the past. To know the best parameter for your indicator you should optimize your indicator.

Optimization is another important aspect of an indicator. In the future, I will write on how to optimize your forex indicators. Excel is a simple yet powerful tool. You can actually use it to backtest your indicators. Many of you may be surprised to hear this but yes you can backtest indicators in excel as long as you can create that indicator in excel. For a non-programmer trader excel can be a good start. As mentioned earlier optimization will not be covered in this article, let’s focus on backtesting!

Suppose you think 21-period exponential moving average is a very good indicator. If it is really good it must do well in the past as well as in the future. To know that should backtest it. Let’s backtest 21 EMA on EURUSD daily chart.

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The look back period for backtesting is 01/01/2000 to 8/20/2018. When price cross above 21-EMA long position is initiated and long position is closed when price cross below 21-EMA and short position is taken immediately. A short position is closed when price cross above 21-EMA.

ema 21 backtesting
ema 21 backtesting

ParticularsAmount
Initial Balance$5,000
Ending Balance6224
Profit (%)24%
Net profit amount1224
No. of trades607
Winning trades140
Losing Trade467
Largest Win1504
Largest loss292

In the backtested period 607 trades were made by 21-EMA and price crossover strategy. It surely looks like using only 21-EMA to trade EURUSD would be a disaster. In this backtesting fix lot size of 0.1 was used to trade.

I hope now you realize why it makes sense to use quantitative trading strategy and why backtesting is important. Backtesting is running your strategy in the past data and looking at how well it performed but unfortunately, future market behavior may be completely different from the past. In this case, even if your strategy does good in backtesting it may fail to perform well in the future.

Hence, building a robust trading strategy is every trader’s goal. A system is said to be robust if it can trade any market environments. In today’s time, institutional fund management companies hire programmers and mathematicians to build robust quantitative trading strategies in an attempt to beat the benchmark return. If you are not so much familiar with quants and algorithmic trading I hope this article helped to arouse curiosity. Never panic and never give up, you will learn slowly.

On trendfollowingsystem.com I’ve tried to share trend following strategies which are all technical indicator based and they will help you to become more objective in your trading. You can do algorithmic trading in MT4 but I have not focused on it yet.

Before jumping into algo first you need to have an objective trading strategy. This is the first article on objective trading strategy, I will keep writing on it in future too. Thank you for having your time to read it. If you have any queries/suggestions feel free to drop a comment below. Take care!

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I have been actively trading stocks and currencies since April 2012. Besides trading with my personal money I am a technical analyst in a mutual fund which has Rs. 1 billion in assets under management. At my leisure, I love attending live music, traveling, and partying with friends.

3 thoughts on “Why You Need an Objective Trading Strategy?”

  1. Arun,

    I found your site accidentally. Just wanted to say, “Wow!”
    Your articles contains wealth of helpful information, and I know that I will check up on your site regularly to improve my trading skill.

    This specific article answered my years of confusion. A lot of traders put (or hype?) price action as it is the highest level of trading kung fu.
    However, I had been confused on how to backtest those price actions before I read yours. Now, I am confused no more. Don’t care if I use price action or not, as long as the trading strategy is objective, can be tested (backtest and forward test), proven profitable, that all that matters.

    Thank you Arun. Keep up the great work!

    Reply
    • I’m glad that you found this article helpful. Yes, during my earlier trading years I relied too much on indicators, after that I believed that price action is the best and shifted to price action. Now again, I’m back to indicators because they are easily testable, objective, and can be turned into algorithmic trading. Few years back, I used to spent my whole time looking at the charts but today most of my time is spent on Excel. I will definitely publish more articles on it. Thank you.

      Reply

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