“Losses are necessary, as long as they are associated with a technique to help you learn from them” – David Sikhosana
By this, David Sikhosana perhaps meant that there is no way we can completely avoid failure while trading. However, if we do not identify the reasons for failures and learn from them, it is a huge problem.
The crux of the matter is to figure out what went wrong with your trading strategy and why it failed.
Here are some reasons why your trading strategy may fail you repeatedly:
1. Having a poor risk/reward ratio
Many traders focus on multiple metrics in their trading strategy, but do not account for a good risk/reward ratio. The ratio suggests how much risk you’re willing to take to earn a unit of profit.
A lot of times, traders end up using strategies that involve taking a tremendous risk for miniscule profit. Risk/Reward ratios should approximately be 1:3, but this should be in tandem with other measures like win rate and should not be considered in isolation.
2. Ignoring the key aspect of drawdown
One of the biggest factors that affects trading success is the lack of knowledge about using drawdown. Understandably, one’s trading strategy aims to achieve greater returns at the lowest potential risk.
However, while trying to avoid drawdowns, one may end up with a curve fitted or over-fitted system (where your strategy is not fit for changing market behaviour).
You cannot completely avoid drawdowns, but you can definitely factor in parameters such as the time to recover from a drawdown for better trading performance.
Time to recover from a drawdown helps you understand how prolonged a drawdown can be, whether it is temporary or permanent.
3. Using too many indicators
Having too many indicators at once in your trading strategies, whether they are intraday trading strategies or option trading strategies, can lead to failure. Having an excessive number of indicators leads to over-analysing and decision paralysis.
Remember, more tools do not mean better trading. In fact, it is quite the opposite. Keep your trading system simple and stick to a few indicators you are comfortable with, to form an optimal strategy, not the perfect one!
4. Not accounting for slippages and transaction costs
Transaction costs like broker fees, exchanges fees, taxes, etc. involved in trading are usually excluded from a trading plan while estimating profitability. However, these costs can be substantial.
It is also important to consider the effect of slippages, like the bid-ask spread when orders get filled. It helps to forecast these slippages as a percentage of the price of the security.
5. Over-fitting/ Using unreliable data while testing your trading strategy
Over-fitting in the trading context refers to adjusting your strategy too closely to a limited set of data. Over-fitting makes the strategy align so closely with the historical data that it ends up failing in other market conditions.
This is because past data does not perfectly determine future market behaviour. Over-fitting can give you false confidence while trading with your strategy. Instead, using extensive sets of reliable data and bulk backtesting can help you test your strategy for robustness.
6. Trying to use your trading strategy universally
Do you have a trading strategy that has worked for you in one particular scenario in different markets or in different scenarios in the same market?
Well, don’t make the mistake of using it universally across markets, securities, and scenarios. No one strategy can win in all situations and markets.
Instead, consider scenario grading and backtesting for different markets to fine-tune your trading strategy each time you use it.
Many a time, you may not be able to ensure that all the above points are taken care of, simply because you do not have the tools and resources for the same.
With an automated trading platform like PHI 1, you can assess your trading strategy for multiple parameters.
Further, PHI 1 offers backtesting using reliable sets of data, so you can evaluate your trading strategy in a jiffy! Not just that, you can also grade your strategy in multiple market scenarios like crash, volatile, choppy, etc. so you are more confident of trading in live markets.
From screening to deployment, PHI 1 is a unified algo trading platform that allows you to focus on the real deal, saving time and money spent on using multiple tools. Further, you do not need to install or download anything. You can access it directly through your browser.
Try our all-in-one algo trading platform for free and browse through our multiple plans for more features!