When to Change Your Trading System?

Trading Systems are a fundamentally important tool for traders of all levels. Whether managed discretionally or with the help of software, they allow trading activities to be approached with the scientific component necessary to tackle an environment as unstable as the currency market. However, perhaps after an initial phase characterized by effectiveness and good performance, the trading system may prove to be a tool no longer able to support the trader's activities. Thus, the need to modify or completely change it may arise. It's certainly a drastic decision, one that should be carefully considered. In this article, we offer some advice on how to do this and, specifically, some tips on understanding when it's time to change your Trading System.

What is a Trading System?

A Trading System, quite simply, is a set of rules that assists the trader in all phases of their activity. It's a kind of instruction manual that essentially has two purposes. To bring a scientific approach to trading. The rules of a "well-made" trading system are obviously not established at random. Rather, they proceed from the analysis, interpretation, and implementation of statistical models. All actions taken within a Trading System have a reason to exist as, on a statistical basis, they have been shown to work. To neutralize the impact of emotions. Following the instructions means limiting the space for hasty decisions dictated by contingencies. In trading, this means reducing the impact of emotions, which are the main cause of rushed decisions. This is perhaps the most important advantage of the Trading System, as emotions can be an obstacle that may arise in the activity of any trader, even the most experienced ones.

Why a Trading System Can Fail

Trading Systems, even after a period of good performance, can fail. The main reason concerns the very definition of a Trading System, that is, a structural component of it: there are no TS suitable for all seasons, all markets, all traders. This is true because Trading Systems, as systems of rules, necessarily proceed from a strategy, which is a variable element by constitution, and whose features depend on numerous factors. In light of this small but important truth, we can list the two types of factors that can determine the failure of a Trading System. Exogenous factors. That is, factors that do not depend on the TS itself. For example, incorrect behavior by the trader. The instruction manual may be perfectly drafted, but if it is not followed faithfully or is misinterpreted, the performance will still be poor. This is what happens when the trader, perhaps unknowingly, deviates from the indications of the Trading System. This is not a minor detail, as it requires a verification of one's behavior before directly blaming the Trading System. Endogenous factors. In this case, we are talking about elements that depend on the Trading System itself. For example, a reduced ability to respond to market stimuli. This becomes visible when the market evolves, when one phase closes and another opens. Now, Trading Systems are systems of rules, and as such they suffer from a certain intrinsic rigidity. However, at the same time, they should be characterized by a margin of tolerance that allows them to adapt, almost without missing a beat, to some market changes. If this margin of tolerance proves insufficient, it is obvious: the Trading System must be modified (or set aside).

When Not to Change a Trading System

Obviously, doubts about one's Trading System emerge when there is a decline in performance, when one trade after another is lost at a rate higher than usual (everyone loses in trading, the important thing is that wins exceed losses). However, it is necessary to understand when it is time to change the Trading System, that is, when the fault for poor performance is to be attributed to the Trading System. It is also necessary to understand when it is not time to make changes. In fact, changing a TS prematurely or unjustifiably only makes the situation worse. The old proverb "he who leaves the old road for the new knows what he loses but not what he finds", although the fruit of popular, almost peasant wisdom, has its validity in trading as well. Here we limit ourselves to giving just one indication, which should be sufficient to avoid this unpleasant eventuality: do not change until you are sure that the origin of your problems lies with the Trading System. This translates into the need to collect a sufficient mass of statistical data to arrive at proof. Therefore, in a nutshell, avoid making changes to the Trading System when you have lost three or four consecutive trades. These, in fact, represent a sample that is too limited to arrive at a definitive judgment.

When to Change a Trading System

It goes without saying: to decree the need to change a Trading System, you need to have data in your hands. The most important and significant data in this regard is represented by the Win-Loss Ratio, that is, the ratio between winning and losing trades. Let's be clear, it is necessary to carefully choose the terms of comparison. To determine the appropriateness of modifying a Trading System, it is not necessary to compare your Ratio with that of the average of other traders. This would result in a distorted picture, compromised by factors such as the actual skill of the trader. The comparison should be made between your usual ratio, i.e. the one recorded when the TS was not a source of doubt, and the recent ratio, recorded when the TS generated doubts. Be especially careful about data sampling. The samples (the "before" and the "after") should be similar in size. Above all, they should be extensive, the result of a few dozen trades. Only in this way does the sample become statistically relevant and capable of producing a faithful picture of reality. Otherwise, the soundness of the judgment would be compromised by excessive randomness and prove useless for the purpose. Therefore, if a comparison reveals a difference between the two periods, yes: the time has come to modify or radically change the Trading System.