Adrian Reid explains why flipping a long trading system to short won't work as a simple inversion. Long trades have unlimited upside and can tolerate 30% drawdowns to catch rare massive winners, but short trades max out at 100% profit and get whipsawed by rallies. Bear markets produce sharp quick moves while bull markets stretch for years, so short systems need tighter exits and faster profit-taking.
Questions this video answers
March 9, 2022
100% (short to zero)
Effectively unlimited/infinite (example: from 10 to 1,000)
30% trailing stop
About four or five times in 20 years
Chapters
So the question is, if I have a long system, because it's not just about freight trains, any long system, can I flip it and make it a short system and will that be profitable? Yes. Yeah. Okay, so there's a bit of a problem and I want to show you the problem. I'm going to do it over here on my little piece of paper. Can you see my piece of paper?
Okay.
Here'S a stock chart.
And the stock price.
Let'S draw it in blue.
Is going along and we get a short signal.
And there's a trend down and trend up. Now, if we have a.
Short signal here, what is the best possible outcome we can get?
The low. Well, what's the absolute best theoretical profit from a short trade to zero? Yeah. 100% profit right.
Now. How often does that happen?
Never.
And I smell it has happened.
I've had about four or five of them, maybe something like that in 20 years. Yeah, yeah. Not many, not very often, but it does happen. So it's theoretically possible. But in reality, most of the time a stock will go down and then recover at some point in the future. And this dip could be 10% to 95% or something like that most of the time. Whereas if you flip this on its head and I'm going to do in green, imagine a different scenario. You're a long trader and the stock price is going up. What's theoretically the best possible outcome on the long side?
It's infinite.
Infinite. I mean, in reality the stock doesn't go to infinity. Right. But it can go from 10 to 1,000. Certainly possible. Yeah, unlikely, but possible. So if you, if you think about alongside, you've got infinite upside potential. Short side, you've got 100% maximum profit and most stocks don't get to this hundred percent. The best move you can, you sort of get the majority of the time is somewhere sort of in this range.
Yeah.
So, but on the trend following side, on the long side, let's say you bought in at this same point and your trailing stop goes up and up and up and up and up. Very easy to get. 500 to 1000%. Quite possible. Yeah. So because this is possible, you give a lot of room to move in a trend because you want to get those monster wins. Yeah, yeah. Whereas if you give a lot of room to move on the downside, this drawing is getting a bit messy now. But let's say you trail on the downside and my trailing stop is in black here. So let's say you trail on the downside and you Give a lot of room to move. Let's say this is a 30% trailing stop, like would certainly make sense in a trend following system. Right. If you get down to say 80% in the money and then it has to turn around and go up 30% before it hits your.
Stop loss, you don't end up with that much profit.
Right. Whereas on the long side, if it goes up to 500% and then it drops 30% to hit your trailing stop, you send up with a bucket load of profit.
So on the, on the short side. Well, thinking about short systems versus long systems, the asymmetry of what's possible means most of the time you can't just flip a system on its head. Okay. Now the longer term a system is, the harder it is to flip it on its head. The shorter term a system is, the easier it is to flip it and make money. But even if you've got a system that enters and exits in a day.
It still doesn't mean that you're going to be able to invert it and it will be profitable. It may not be because the markets are fundamentally, they fundamentally go up. Right. And there's this edge. I mean, let's look at me, just grab a chart here because this illustrates it beautifully.
Plenty of database on my end.
Okay.
This is the S&P 500.
Over.
30 odd years. Yeah. It's clearly an upward bias. Right? Yeah. So it's much easier to make money on the long side. There's on the short side.
Yeah. And you could probably have two or three long systems and make 10 times more than, you know, 50 short ones, you know.
Yeah, well the difference, the difference is when a short system makes money, it tends to make it very quickly. So a lot of people will say, oh, you can make more money on the short side than you can long side. And yeah, that's true on a per unit of time basis. Yeah. Because market collapses happen very quick book. Bear markets are short and sharp. Bull markets are long and protracted. You know, as we saw in this chart here, bear markets are fairly short and sharp. But the bull markets can be pretty long and protracted with some, you know, intermediate bear markets in here. So because of the asymmetry of the way it moves, it's much harder to.
Develop a short system is to develop a long system.
Yeah. And the odds are in favor in the long systems in comparison to that and use the bear market time to go on a holiday, recalibrate, regroup, and stuff like that.
Yeah. I mean you can trade short. Right. But Just know that not every system inverted will be profitable.
I gathered that. But yeah, it's like.
Yeah.
If you're thinking about return per unit of mental energy expended, it's far easier to just be alongside trader and have a holiday in a bear market. Yeah.
The dead cat bounce and margin calls and all that happen, you get smashed.
Yeah. Right. And if we zoom right in here, let's have a look at this. If you zoom right in here on the bear market, this is 2000. Well the 2000 post tech bubble burst. Right. These rallies are very, very heavy. Yeah. Like they happen with big intensity very quickly. And in fact some of the biggest up days in the market occur during a bear market. Yeah. But it doesn't make them good to trade because as soon as the rally is done, it collapses all the way back down. Yeah.
So the other thing to remember I guess is in a bear market, if you can develop a bear market system, shorting breakouts to the downside, it's not terribly profitable because you always get whacked by the bounce. Always. Very often. So shorting rallies in a bear market often ends up being an easier way to go. But then trouble is at the end of the bear market, if you keep shorting, shorting, shorting all the rallies all the way down, eventually you get whacked by a bull market.
Yeah. You get caught in the end. Yeah.
So it's not my favorite thing in the world, but it's kind of useful to have short systems that do make money.
They're just going to be different. Also you want to, you want to get out more quickly. So like in a short system, let's say slippery dip, it's got a profit target. Right. The reason it's got a profit target, it's only a 30 or percent profit target. Something like that. The reason it's got a profit target is, is when you've got some profit, you want to take it because there's going to be a rally at some point. Yeah.
You're protecting your profit.
Yeah, yeah. And if you don't protect your profit, you'll get whacked by the rally. And even if there's no rally and it keeps going down, if you've already made 30%, there's not that much money left to make.
Don't be greedy.
Yeah. Certainly on the short side, don't be greedy, be quick.
