The strategy is now applied to 30 minute FOREX data from 21/10/2002 to 4/7/2008. All the following calculations in this chapter are based on a one contract basis. Keeping the beginning simple we calculate the trading system’s results without any slippage and commissions. These will be added in the next section where we will examine their impact on system performance. Furthermore please note that at first we check the system just with entries and trade reversals, leaving out exits.
As first input parameters for the trading system’s entries we choose 10 bars for the fast and 30 bars for the slow moving average. With 30 minute bars this means the fast moving average is calculated from the last 5 trading hours whereas the slow moving average relies on the last 15 hours. Figure 3.2 shows the resulting equity curve in a detailed form.
With “detailed form” we mean that this curve shows all run-ups and drawdowns of the trades which happen during their lifetime. Like this the equity line is more informative compared to a form where just end-of-day or even end-of-month results are shown.
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Figure 3.2: Detailed Equity Curve of the trading system LUXOR on British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Input parameters: SLOW=30, FAST=10. System without exits, always in the market. Back-test without any slippage and commissions. Chart from TradeStation 8.
The equity line looks like a good starting point for a viable trading system. Although some drawdowns occur the system always recovers quickly and achieves new highs, so that you get a relatively steady growth of the initial capital. The profitability of the trading system is also revealed by the trading figures (Table 3.1). Here you see that LUXOR gains a total net profit of $66,000 with only one traded contract within the testing period from October 2002 until July 2008. The biggest drawdown within this period was
$16,000. If you assume a starting capital of $30,000 then this would mean that your total profit is more than 200% in the last six years, with a maximum drawdown of about 50%.
Equity curve detailed – GBPUSD 30 min(21/10/02 02:30 – 04/07/08 12:30)
Equity ($)
How to develop a trading system step-by-step – using the example of the British pound/US dollar pair
Table 3.1: Main system figures of the LUXOR system. British pound/US dollar (FOREX), 30 minute bars, 21/10/2002-4/7/2008. Input parameters: SLOW=30, FAST=10. System without exits, always in the market. Back-test calculation without any slippage and commission.
The considered system shows the main properties of trend following trading strategies:
• The percentage of profitable trades is low (36.5%). From the 1913 performed trades, only 698 are profitable whereas the majority (1215) end with a loss.
All Trades Long Trades Short Trades
Total Net Profit $66,318 $56,918 $9,400
Gross Profit $590,530 $310,301 $280,230
Gross Loss ($524,213) ($253,383) ($270,830)
Profit Factor 1.13 1.22 1.03
Total Number of Trades 1913 957 956
Percent Profitable 36.49% 39.81% 33.16%
Winning Trades 698 381 317
Losing Trades 1215 576 639
Avg. Trade Net Profit $35 $59 $10
Avg. Winning Trade $846 $814 $884
Avg. Losing Trade ($431) ($440) ($424)
Ratio Avg. Win:Avg. Loss 1.96 1.85 2.09
Largest Winning Trade $5,628 $5,628 $4,338
Largest Losing Trade ($2,522) ($1,652) ($2,522)
Max. Consecutive Winning
Trades 6 6 6
Max. Consecutive Losing
Trades 16 10 11
Avg. Bars in Total Trades 37.77 39.18 36.36
Avg. Bars in Winning Trades 61.84 62.96 60.5
Avg. Bars in Losing Trades 23.94 23.45 24.38
Max. Drawdown (Intra-day
Peak to Valley) ($15,644) ($11,133) ($19,746)
Date of Max. Drawdown 27-Nov-03
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• The overall gains of the system result from the high ratio of average win/average losing trade. The average winning trade is with US$846, which is bigger than the average losing trade (US$435) by a factor of two.
• The average time in winning trades is about three times longer than the average time which the system stays in losing trades (62 bars versus 24 bars).
This shows that the system logic follows perhaps the most important rule in trading which everybody knows but which is yet difficult to follow: cut the losses short and let the profits run. This trading rule is psychologically hard to adhere to since you often suffer directly from your losses and on the other hand you have to wait a long time until you can earn your rare but hefty gains.
It is worth mentioning that the long side of the trading system is much more profitable than its short side ($56,900 vs. $9,400 net profit). This observation will be examined in Chapter 5.3 again when we discuss the so called “market bias”. The “market bias” means the tendency of a market to favour special features or parts of a trading system, like in this case the better profitability of the trend-following system’s long side in an overall upward trend of the tested market. The good point for our trading system here is that although there is such a market bias with an up-trend, the short side of our trading system is still in the profitable range. This underlines the stability of this symmetrically built system.
Furthermore, you of course get nearly the same number of short trades (956) as long trades (957) because the trading system only reverses positions. Since we have not added any exits the system stays in the market 100% of the time, holding either a long or a short position.
Finally we want to underline a fact which should never be underestimated when developing trading systems: the statistical significance of your performed tests. If you develop a new system and in testing you have only 100 signals, or even less, the probability of achieving profitable results just by accident is very high. With nearly 2000 trades in our back-test the statistical probability is high that this strategy will perform in a similar way in the (near) future.
So what have you gained so far? Statistics show that the entry logic is sound and has a certain probability of maintaining its behaviour in the future. If you however take a closer look at the trading figures you will see that the system produces only an average profit of US$35; this level of average profit per trade without any trading costs is very low! So what you have so far is just a trading rule which detects a tiny profitable bias in prices.
How to develop a trading system step-by-step – using the example of the British pound/US dollar pair
Therefore we are now at a point when the trading system development work has just started. There are lots of steps to perform until you can work out a complete trading system. The profitability of this system must be increased and exits must be added. Before we do this we take trading costs into consideration to make the whole approach more realistic.