Steve Palmquist.Author of ‘The Timely Trades Letter’. ‘How to Take Money from the Markets’, and Money-Making Candlestick Patterns.
Many traders are interested in knowing how a trading system did last year, or the year before. If they see these numbers it makes them happy, and they feel that is what they should expect going foreword. When some people evaluate mutual fund, or money manager, performance they want to know how the performance was in each of the last few years. While this seems to make people happy, it does not mean much, or give a realistic expectation of what to expect going foreword. The reason is that the market is not the same from one year to the next. How the market, or a trading system, performed last year may have little to do with how it will perform next year. Looking at annual returns may be interesting, but it does not tell you how and when to use a trading tool. I know traders who took significant losses during 2008, using techniques that showed strong results over previous years. They had developed these systems by looking at annual results over several years. When 2008 came along, and the market did not look much like it had the previous few years they experienced losses that wiped out the profits of several years of trading. I have seen traders that are looking for the hot hand, and when they find someone with good results in the previous year, they want that person to manage all their money because they think the hot hand will perform again next year. Strong results in the past year or two may have no bearing on next year if the market conditions change. Rather than look just at annual results, I want to know how a trading system performs in bull and bear markets. No one knows what the market will do next year. Even the ‘expert’ economists have predicted ten of the last three recessions; they usually all over the financial channels telling you we are in a recession, or a boom period, after they have started. Few, if any, consistently predict them in advance. Driving while looking in the rear view mirror can be problematic.
The market has just three basic modes. It can be trending up, a bullish period, it can be trending down, a bearish period, or it can be just moving sideways, a trading range period. During the testing and evaluation of numerous trading systems I have seen that the market conditions, bullish, bearish, or trading range, have a strong effect on most systems. Because of this I have developed different trading systems for each of the three market conditions and refer to the collection of trading techniques as my trading tool box. The markets overall movement is made up of a combination of bullish, bearish, and trading range periods. Years are convent for us to mark time, but the market does not care about them. It simply moves in combinations of bullish, bearish, and trading range periods. It is hard for it to do anything else.
The successful trader has a tool box with a variety of trading tools for use in different market conditions. The trader, like the carpenter, must go beyond just acquiring the tools. Traders must understand which tool to use for a specific task, and have a clear understanding of how the tool works, and what can and cannot be done with it. I have extensively tested several trading systems, the results of this testing on specific trading trading tools are outlined in ‘How to Take Money from the Markets’, and Money-Making Candlestick Patterns. The testing process helps us understand how stocks usually behave after forming a specific pattern such as being outside the Bollinger Bands, showing strong distribution or accumulation, or pulling back or retracing during a trend. Understanding what a stock is most likely to do forms the beginning of a trading strategy. Trading without this information is taking unknown risks.