As I promised in the last post, I will review my decision of taking a smaller moving average. My purpose wasn’t to overfit the model, I was looking for a drawdown in which I feel comfortable.
How did I start?
I had an idea about a day trading system. My objective was a good performance with adjusted risk. I’m a big fan of the stop loss. If you, as a trader or an investor, can avoid drawdowns bigger than 20-25%, you will be successful over the time.
Our example
The good point about the way I run the backtestings is that it’s easy to change some parameters and adapt to different indicators. Obviously, I ran the strategy with different moving averages in order to know what parameters generated a smooth performance curve avoiding big drawdowns.
Max drawdown and final balance from the different MA, own elaboration
As you can see the best profit to drawdown ratio was the system based on the 5-day Moving Average. This seems logical as it’s a daily trading system. The reason behind the bigger drawdown, in the MA3 system, is that the there is more noise in the entry signals and it´s not accurate enough with the tight stop loss. In the case of the MA9, MA15, and MA50, the signals are more accurate but the retracements and the close stop loss don´t allow the systems to perform as well as the ones with lower moving average. If you see the MA9 system's figures, you will understand that the profit is exactly the same as the MA5 but the drawdown is worse.
Max drawdown from the different MA systems tested, own elaboration
This chart is complementary to the table and the explanation above. Surprisingly, at least for me, the MA50 has a lower drawdown than the MA15. If we think about it, probably the best system would be between the 3 and the 9-day moving average. As I said before, I didn’t optimize the system.
Performance of the different systems tested, own elaboration
This chart is more important than the ones shown above. Here you can see how the MA5 system has barely stayed under the initial balance invested. Even after its worst drawdown the system was up more than 5% while the other ones went under 10K (and the worst one, under 9K) The main reason is that a “small drawdown” is not as painful as a big one, in simple terms, capital preservation will assure you better financial future. Imagine that you could have avoided all mistakes in the stock market (or futures) or at least you could have limited your loses. I’m sure that today, you will be better off. The reason is the asymmetrical leverage.
(second part of this post: First lesson for an investor )
Having said that, I would like to add that I´m not questioning your investments decisions. I´ve made so many mistakes in the past and some of the trades were good considering the expected value of the trade.
Final balance of the systems tested, own elaboration
To finish, I wanted to show you the chart of the final balance after 3.56 years. The best system has returned 56.6% which is a little bit more than 18% per year.
Final thoughts
I hope that you like this post. The main purpose was to show you how to analyze the systems and even extrapolate the basis and test different indicators or the same indicator at a different level. The stop loss can be painful but I wouldn’t place an order without knowing my stop and target. As I said the asymmetrical leverage is very important because recovering small losses is easy while recovering big drawdowns can be really difficult. You have seen this concept with the system reviewed. Thanks.
Have a good trading!!
Disclaimer
I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved
#trading #MovingAverage #Backtesting #Drawdown #Analysis #QuantitativeAnalysis
