Beware! How To Spot Sneaky Trading Tricks

I saw an advertisement for a futures trading system (I can't remember if it was an algorithmic trading system or not) the other day, and I'd thought I would discuss it here.  It is a good example of what I call "sneaky trading tips."

Sneaky Tricks in Trading

 
Now normally, I trade only futures, forex and commodity trading systems I create, since I know exactly what goes in them, how they were developed and tested, etc. That's not to say there aren't other vendors and trading systems out there that are good. Some are very good, and worth checking into.

I usually scan ads to see what other system vendors in the industry are up to, and alert my readers and subscribers of some of the tricks to be on the lookout for. I'm going to share one of those sneaky tricks in a minute.

This ad caught my eye because it showed tremendous past performance, such as the ability to make hundreds to thousands of dollars per day on 1 or 2 mini S&P contracts. Performance so good that it makes you wonder why the vendor is selling it, but that's another story...

Enticed by the ad, I clicked on through to show hypothetical performance data. In the vendor's mind, once I saw how good the trading system was at picking trades - how well it picked tops and bottoms - I would undoubtedly be hooked. Unfortunately for them, it had the opposite effect.

Why would hypothetical price charts that showed how well an algorithmic trading system picked tops and bottoms work against the vendor? Simple: incorrect backtesting. Please let me explain.

The trading system in question showed many trades where the system bought at the absolute low of a bar, and sold at the absolute high of another bar. Since there is a bid/ask spread in every futures market, it is normally impossible, or darn near impossible, to get filled on a buy order at the exact lowest price (and the same for selling at the high). You might get filled once in a while at that price, but not consistently.

But when a vendor backtests incorrectly, the system can hypothetically get filled EVERY time at the low (for buys) or at the highs (sells). Those are the results you'll see in the trading system performance report. In real life, you'd only get filled on the losing trades, but only rarely on the winning trades. So, your results won't be nearly as good as the hypothetical, vendor reported results. In fact, many times correcting for this trick turns a winning algorithmic trading system into a real life losing system - it is potentially that bad.

Here is a recent example.  This was presented at a trading webinar.  I am sure if I told you this "trader's" name, you would recognize him.

This is beyond sneaky.

It is.

100%.

FAKE!

No way can this be real life.  Experienced traders will tell you bottom tick buy fills occur once in a blue moon.  This joker did it 5 times in about an hour! 

How To Avoid Sneaky Dirty Trading Tricks

Confused? Well, it is a complicated topic, one most people would not even recognize. But here is what to look for: If hypothetical results show the trading system can consistently buy the absolute low and sell the absolute high (the extreme points) of a price bar, chances are the system will not work in real time.

The lesson here: make sure you look at any performance history with a skeptical eye. Doing so might save you a ton of money.

Best Trading Tips

So how can you avoid some of the sneaky trading tricks that are out there?  Here are my top 3:

1.  Be skeptical of everything you see.  Remember, trading vendors lie all the time on the Internet (shocking I know, but it is true).

2.  Verify everything with your own research and work.  If someone told you "buying XYZ stock every Monday, and selling every Wednesday, produced phenomenal profits" that is easy to test and verify.  Prove to your self it works!  (A great example of the "test it yourself" mentality is a study I did recently: which is best - dollar stops or ATR stops?

And tip number 3 deserves its own category:

Hypothetical Trading Performance

3.  Treat ALL results you see as hypothetical.  Unless it happened in your own live account, it is HYPOTHETICAL. 
​
  Great sim results? >> Hypothetical
  Terrific Guru performance spreadsheet? >> Hypothetical
  Backtest you ran? >> Hypothetical
  Next Door neighbor tells you of his trading success? >> Hypothetical
  Some anonymous internet stranger posts his Tradestation account statement online? >>Hypothetical

The point is all these results may or may not be real.  And even if they are, you may not need have been able to achieve them in your own real money account.  In other words, they are hypothetical!

When you treat everything as hypothetical, you'll end up using tips 1 and 2 a lot more, and being a much more informed trader because of it!


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About The Author:  Kevin Davey is an award winning private futures, forex and commodities trader. He has been trading for over 25 years.Three consecutive years, Kevin achieved over 100% annual returns in a real time, real money, year long trading contest, finishing in first or second place each of those years.

Kevin is the author of the highly acclaimed best trading book "Building Algorithmic Trading Systems: A Trader's Journey From Data Mining to Monte Carlo Simulation to Live Trading" (Wiley 2014).  Kevin provides a wealth of trading information at his website: http://www.kjtradingsystems.com


Copyright, Kevin Davey and ​KJ Trading Systems. All Rights Reserved.  Reprint of above article is permitted, as long as the About The Author information is included.


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