Adrian Reid explains when to stop trading a strategy. Suspend a system if live drawdown hits 1.25 to 1.5 times the historical maximum, though extreme events like COVID can blow past that without breaking the strategy. Systems get retired when they erode or when you find a better one.
About 1.25 to 1.5 times the maximum historical drawdown.
As a systematic trader, should you turn off your trading system under any circumstances or should you just let it run? Well, in this video I'm going to talk about exactly that. When you should turn the system off and when you should just let it run. So check it out. But before we go any further, make sure you hit the subscribe button and give this video a thumbs up so that you get notified of all of my future videos, because I've got new trading content coming out all the time and I don't want you to miss a thing. So there's a small distinction between switching off and going to cash. So all of the systems should eventually go to cash if the market conditions are not suitable, just part of, they don't have any more buy signals and all of the open trades close out, therefore you're in cash.
The switching off is more like, oh, the system is broken, I need to stop trading that system. Right. So in that case it's a, it's a, it's a bit more complicated because there's several reasons why you might turn a system off, but probably the biggest one is the drawdown you, you see in live trading in the future is bigger than the historically expected drawdown that you got in your backtesting. So let's say you're running the system and your backtest generates a drawdown of 20%, maybe at 1.25 or 1.5 times the maximum historical drawdown. You say, you know what, something's really wrong. I'm going to suspend the system and investigate.
And then you go. Then therefore you turn off the system, you close all the positions, you then do the investigation. And depending on the environment, I normally do that between about 1.25 or 1.5 times the max historical drawdown. Because any long side system is going to have a big drawdown. When the market is at all time highs and turns around and goes straight down, it's like there's going to be a drawdown and that's not, the system's not broken. And in fact, Covid was the first time in history ever that the market went from all time highs straight into a bear market with no rally.
Basically just went straight down from a, from a high.
And so therefore the system had never had that in back testing. So my reasoning in that situation was, well, in that situation it's going to have a bigger drawdown than what it would have in the past because there was no chance to get out until everything hit their stops.
So my approach was to keep trading it, but then learn from that and think about how would I adapt going forward knowing that actually we can go from an all time high straight into a bear market because we've never seen that before.
And then you can just adapt and learn from it. The other thing I would say is that as you progress, you're going to be testing different systems and different ideas because if you love this, you love it and you will keep playing with system ideas. And so you might say, okay, I'm trading, I've got my portfolio and you find a new system which is better than something you've already got and so maybe you replace it and then you find another system that's better than this one and you replace it and gradually your portfolio might get better and better. So it's actually two things you consider. You might retire a system because you've got something better and you don't need both, or you might retire a system because it's eroded.
But the more systems you've got, and the more you're working on it, the more you retire them because you've got something better rather than it's eroded. I haven't retired that many systems because they're eroded. A few, but not that many.
Sam.
