The markets are a hard nut to crack. The only chance the majority of investors have of ever making consistent returns in the market is just by investing in the market as a whole and compounding their profits. Day trading and intraday trading are extremely hard to master but even if you manage to find a successful strategy with an edge in the markets, you may not be safe forever…
Trading strategies do and will stop working over time. This can be caused by a number of factors, from market conditions, volatility, volume and even the market conditions the strategy was tested in. Trading strategies modelled properly should last years without a significant change in performance. Let’s find out more…
Do Trading Strategies Randomly Stop Working?
Trading strategies do not last forever, sadly. This can be very disheartening to hear, especially for newer traders that have just spent 2 years coming to grips with the market and their strategies, to hear that at some point in the next few years it might just stop working.
To understand this, we need to understand what a trading strategy actually is… In essence, a trading strategy is just a very small edge in the market. That very small edge is usually going to be built from looking at patterns within the markets. Patterns that keep recurring over and over again so we can find a very small edge in exploiting them.
It’s important to note that most trading strategies do only have a very small edge. You’ll be hard pushed to find traders, especially forex traders, that have been consistently making money in the market for many years with a huge edge as a huge edge would usually indicate a market inefficiency. In this day and edge, for retail traders, there are no market inefficiencies and everything (market condition wise) is in perfect balance.
Has Your Trading Strategy Stopped Working? What To Look For…
The majority of people that will think their trading strategy has stopped working, would never have fully tested the system in a range of market conditions in the first place. It’s often a huge shock to newer traders when they have backtested a trading strategy that appears to be hugely profitable, only to lose money in the live markets from taking the exact same trades… But has your trading strategy actually stopped working?
1. Losing streak
The first symptom that your trading strategy is no longer working is simply a losing streak. I don’t mean a few trades, I mean a huge amount of losing trades in a row. For any strategy you are trading, you should be completely aware of the maximum losses in a row, over the last year or last 500 trades etc. This would be been shown clearly when backtesting the strategy before ever touching the live markets.
Let’s say, over the last 500 trades that suited your trading strategy, there was a maximum losing streak of 19. This is fairly aggressive but it’s just a simple metric to work by. If you’re now sat at a losing streak above that 19, it’s possible that the trading strategy is no longer working.
On the flip side, it’s not worth abandoning the strategy just yet because this could just be a slightly larger losing streak caused by market sentiment, conditions or fundamentals.
2. Abnormal drawdown
Similarly to the losing streak, if you trading strategy was backtested and had a maximum drawdown of 17%, if you’re sitting at 30% drawdown by following the rules to the point, this could indicate the trading strategy is no longer performing profitably.
Again this doesn’t mean you should abandon ship yet. Annoyingly it’s very hard to know if the strategy has stopped working or the market conditions are just rough for you and putting you in some drawdown. This does mean you need to dial in and track the results over the following weeks to see where you are and if the system rebounds.
What Makes Trading Strategies Suddenly Stop Working?
There are a few simple reasons of why a trading strategy will suddenly stop working. Although these reasons are simple, they are not easy to deal with and many traders get caught as a result…
1. The strategy was never going to work in the first place
It’s possible that the trading strategy you’re using was never going to be profitable over the long term. If you have tested a trading strategy 50 times, think you’ve found a bit of an edge then committed to the strategy, I’m not surprised if it ‘stops working’ because it likely never did in the first place. You should want to see hundreds, if not thousands of trades over years of data to validate a trading system before ever trading on the live markets.
It is perfectly normal for a trading strategy, even a losing one, to win 20-30 trades in a row or even have profitable months, profitable quarters. This is why backtesting is incredibly important. The more data you have, the safer you are.
2. Market conditions have changed
Markets change. Are the forex markets operating exactly as they did back in 2001? Absolutely not. Market inefficiencies are always changing, institutions are always changing practices, algorithms are becoming more dominant and the fundamental factors around the world are changing faster than ever.
With all of this in mind, of course a trading strategy isn’t going to work forever. You just need to adapt and have multiple options at your disposal. When you also consider that even profitable strategies only have a few small edge in the market, this hammers the point home even further.
Keep Yourself Safe From Exposure To A Failing Trading Strategy
Traders are always going to end up trading a failing strategy at some point in their trading careers. Even if you have had a huge amount of success trading for 10 years, the strategy could take a turn and you’re now just burning through the previous years profits. So how can we keep the risk of this as low as possible?
1. Journalling all trades
Journalling your trades is a very good way to keep aware of what’s actually going on with your trading. If you aren’t aware of the stats, metrics and how your trading is going, it becomes very easy to start going down a slippery slope. The fear comes in, the anger comes in and then risk management flies out the window.
2. Trade multiple trading strategies
Putting all of your eggs in one basket when it comes to a trading strategy isn’t the smartest move. In fact, if you have an arsenal of 3 or 4 trading strategies, your risk of ruin from one strategy is going to be greatly decreased. I would advise trying to use a completely different strategy alongside your main trading strategy. Potentially a swing trading piece, alongside a scalping piece. Make sure you’re using different indicators and different ideas to keep the trading strategies as separate as possible to ensure that there isn’t a correlation between results.
3. Keep position size realistic
If your trading strategy stops working suddenly, you don’t want to lose your whole account. I would expect this to put you in a fairly substantial drawdown if you’re only trading one strategy but still not be losing an account. I would recommend using a conservative position size. The industry standard for retail traders is 1% but if you’re trading with a substantial amount of capital I would argue that even that may be too high of a risk for the majority of investors.
4. Different strategies for different market conditions
The reason most traders are losing money is because they are trading strategies that work within a trending market. As harsh as this sounds, anyone can make money in a trending market because it’s extremely easy. You buy, you hold, you buy again, you sell.
However, most traders are giving back their trending market profits when the market starts moving sideways. This is incredibly prevalent in forex as you’ll usually find the market is consolidating 60%-70% of the time in most currency pairs.
Being able to use a different trading strategy in a trending market compared to a ranging market is incredibly useful. This will take a long time to master, being able to actually identify the market sentiment and of course you aren’t going to get it right every time.
In Conclusion – Will My Trading Strategy Stop Working?
In short, yes, your trading strategy will stop working at some point. Trading strategies only have a few small edge over the market and when market conditions, fundamental factors and inefficiencies change, your small edge can be wiped out and sadly it is unavoidable. The only way to mitigate this is to trade multiple trading strategies, keep risk to a minimum and keep a trading journal to track how the systems are going and whether it’s time to pull the plug or hedge risk.
If you have any questions or anything to add please do drop a comment down below, I’d love to hear your opinions on the question.