Quality check for trading systems:

The great diversity of trading systems on the market makes it difficult at first sight to determine professionalism and quality of a product. Taking a closer look however you will figure out, that less than 5% of the offered systems are worthwhile.

1. Variable Contract / Share size

A system that only trades 1 contract or 100 shares should not be given further consideration, since either the developer has not understood basic mechanisms of money- and risk management or not taken into account that markets can rise from 10 to 100 or fall from 5000 to 1000.

2. Variable Stop Loss

The same considerations are true for strategies with fixed amount stop loss. Moreover since market volatility changes constantly, how can a fixed amount stop loss be adequate for limiting the risk under these constantly changing conditions?

3. Money management

The amount of money in your trading account changes constantly (because you are trading and generating wins and losses). This is why the maximum potential cost of a loss must be readjusted permanently. If this is not done you are running the risk of ruin. As a rule of thumb even very stable trading systems should not produce an initial risk per trade higher than 2% of your trading capital.

4. Dynamic adjustment to volatility

If a trading system is not adjusting automatically it will not work properly under changing market conditions.

5. Slippage + Commissions

Are slippage and commissions included in the back testing numbers of the system? If not, try readjusting the numbers to get the realistic results.

6. Risk Reward

Divide the maximum loss in every year (going from equity peak to cyclic equity low) by each years win. Average results below 1/3 are not acceptable.

7. Average Trade

Many systems produce a win span per trade that is too low, i.e. an average of 1 point per contract. If in these cases you are looking at optimized values or commissions have not been accounted for, no real win will be reached under real market conditions.

8. Realistic conditions

Some systems trade the market on close or open, although this is not really possible, or trades are generated on close and the market has already closed at this time point. Also a lot of strategies do not account for the fact, that not every stock is shortable or that is not allowed to place short orders on a downtick.

9. Number of trades

The number of trades in a single market should be greater than 500 or using the same strategy on multiple markets with unchanged strategy settings should have stable returns. Systems that are applied to daily or weekly data may work with a lower number but should supply at least 10 years of back test data.

10. The worst is coming

In general you can calculate that future draw downs will be higher then the (optimized) ones displayed in back testing. So if your system up to now generated a max. drawdown of 40%, you can assume a future dd. of 50 %. Can your system take such a drawdown? Is the possible annual win a multiple of this maximum drawdown? Does your capital support further trading, even if this maximum drawdown is reached?

11. Technical data

% profitable should equal or higher than 40.
Average win/loss, the higher the better - but dependent on % profitable.
Use our random curve generator to get a picture of system stability.
Max. dd. and highest win should produce a reasonable value in relation to total win.

12. Optimization

Systems using lots of parameters have usually been over optimized and are adjusted to the past. Only rarely do they will full fill future expectations.

13. Price

Price and method of payment often tells you more about the professionalism of an offered system, than reports of past performance.