In This Episode
- Why tight stop losses are good
- Which type of trader are you (2 choices)
- The Compleat Trader by Jake Bernstein
What's the Best Way to Improve a Trading System?
We answer a viewer question in this episode and explore the best way to improve the return of a trading strategy. When most traders are starting out they focus on the entry.
But we both agree that the exit is an easier place to start when optimizing a system. Listen to the episode to learn why.
Read the Transcript:
Walter: Hi, Hugh. I got a question from a trader yesterday. This morning actually and he was talking about back testing. He said, “What can I do? I know that back testing is really important. I spent a lot of time on Forex Testers but where should I be focusing?” That was his main question.
We were just chatting a minute ago right before this call. What I recommend he do is to spend a lot of time and I am pleased to see how you do this. So I ask him to really dig deep into exits. The reason why this is important is because that is where I found a lot of the easiest way to improve trading systems.
For example, let us just assume that you have a signal that is pretty good. Your entry rules are pretty good and identify whatever type of move that you are trying to catch. Whether it is an end of the trend or a reversal or a trend continuation or breakout. Whatever sort of thing you are trying to catch but you are not happy with it for whatever reason. The bottom line is it is not making enough or whatever.
Typically, what I found is that by tweaking the exit, it makes a drastic difference. For example, there are some exits that kind of follow price along and are really tight, those exits are really good. First of all, this is a Psychology podcast. So you know, you’ve got to think about what kind of a trader you are.
Are you okay having a trade go two hundred pips in your favor and then you have to give back seventy-five pips so that you only end up with a hundred and twenty-five? Are you okay with that? Is that okay?
Or, are you the kind of a trader that is happy if you have a trade where you make a hundred and twenty-five pips and you get out. You are done and then you watch and it goes another seventy-five pips. It goes a total of two hundred pips in your favor if you had just held on.
Hugh: Hey there! I hope you find this episode useful. I just want to let you know that Walter and I give away something valuable every month that helps traders improve their skills. You can enter to win by simply leaving an iTunes review and leaving a comment on our YouTube videos.
At the end of each month, we'll look at the comments and reviews from the month and we'll pick a winner at random. Each comment and each review counts for one entry during the month that it's pitted.
So, if you're interested in that, be sure to enter after this podcast is over. Alright, back to the episode.
Walter: Those are two different kinds of scenarios. It is the same result but of course it is two different kinds of scenarios for different types of people. One of those is going to be more stressful. More difficult to deal with. So you kind of have to know that.
When I was talking about exits, you have different types. Where you have some that are really tight. Those are really good at increasing your win rate. Those are really good at getting you out of really bad trades. Those are really good at making you feel like a winner because it is so easy for you to capture a little bit of profit if it would have been otherwise a loss for example.
Those really tight exits that hog price as it moves are good in that. However, they are typically terrible at capturing the large move. The reason why is that every little sort of retracement moves against your expected direction whether the up or down. Those little jigs are more likely to pop you out of a trade with those really tight trailing exits.
Now the losers, the wider exits, those are bad in terms of keeping your win rate up because they reduce your win rate. Historically we’ve seen this and then there’s also trades that go a little bit in your favor, they often do not make any money at all. They end up as a full loss or a partial loss. They are really good at capturing the lion moves, the big moves. The moves that make your years sort of thing.
So, those are two different types of traders that would be better with those types of exit. The trader that is okay with the move that goes two hundred pips and then retraces and goes seventy-five pips against you and you get out at hundred and twenty-five pips. The trader that is okay with that is going to be the trader that is okay with the loser exit. The one that is the kind of trader that made that bag that six hundred, seven hundred, eight hundred pip move.
The trader who is better, who is more comfortable taking the hundred and twenty-five pip profit and then later on seeing the market go another seventy-five pips in your favor that trader is probably more suited to the tighter exit. So that is the kind of thing I was explaining to this guy and he is really a good trader.
He is just kind of, he is at the stage now where he is getting comfortable with his strategies. He just wants to improve his bottom line. Exits for me, exits are a really good spot for that but then again, you’ve kind of map what you believe, what you are comfortable with, what you like to deal with in trading versus those things that are really going to be stressful for you.
Hugh: Totally. I agree and I think you really have to go with the golden mine like number one, knowing your personality. Number two was the goal for your trading. Is it to build this huge account or is it to have steady gains. I think also, there is a tendency to try to optimize the entry also at the same time which usually leads to disaster. So a lot of people try to take a nap at the entry.
Try to take a nap at a stop loss but I think in general, it is just a better idea like you said to try to tweak the exit and then maybe you can get some gains on the entry but generally, the exit is going to be the thing to them that makes or breaks the trade.
Walter: Absolutely. So exits, stop placement and the risk rules, those are the big ones I would say. Entry, as long as you know it works as long as you identify what type of a market you are trying to get in.
It is funny because that is where I spend all of my time. Most traders actually, we spend all of our time on our entries. Especially when you first get into trading. I do not know what it was like for you but I would find the system or create a system you know kind of like reading a book. There was a book by, I do not know if his name was Carter or something. Anyways, all of his entry and stuff, there is another book, The Compleat Trader by Jake Bernstein.
There is always a book that I was reading and I sort of got these ideas and so I would try a system and then I did point and figure charts, and rolled them out in a graph paper. I just go, “Ow! This sucks. This does not work” and I threw it away.
In hindsight, what I should really be doing is keeping that front end part of it and just tweaking the back end and that probably would have given me more systems that I would have enjoyed trading. Probably could have stuck with me but it is like anything you know, wisdom is great. You know right before you figure out life, then you die. Do you know what I mean? That sort of thing isn’t it? Same like trading, as soon as you forget trading, it is like, “Oh man, I do not have many more years to trade”.
Hugh: I could not even imagine how many great systems have been thrown away just because you did not tweak the exit to fit your personality.
Walter: It is so true. So we agree on that. Exit is definitely a spot to check out.
Hugh: Alright. Thanks, Walter.
Walter: See you!
Hugh: All the information in this podcast is for educational and informational purposes only and is not trading or investment advice.
Listen to the Audio Version
Click the play button below to hear the audio-only version. You can also download the mp3 file below.
Podcast: Play in new window | Download
How to Get New Episodes of The Think Profit Podcast
You can get notified of new episodes of the podcast by subscribing to our email list, or subscribing via any of the major podcast platforms that can be found here.
If you enjoyed this episode, a 5-star review on your favorite podcast platform is always greatly appreciated!
Thanks for listening and we hope that your trading is going well!
