A Key Trading Philosophy

A key philosophy I use in the Trading System Mentor Course is to have students understand why their strategy makes money.

What’s the profit driver logic?

It’s an important element to grasp for two reasons;

Firstly, when things get a little tough, which they always will, you’ll be more inclined to stay with a system you fully understand.

If you don’t understand, you’ll tend to drop it and fall into the beginner’s cycle.

Secondly, as humans, we have a unique ability to hone in on randomness. Finding random patterns, in my view at least, is not conducive to robust strategies.

For example, I commonly see strategies that trade one currency pair and use Gold as a filter. Yet on a different currency pair they’ll use Crude Oil.

What’s the logic?

Is there a direct link that drives profits? Or is it just randomness in the data?

Below is a possible random pattern that certainly looks quite profitable, at least on the ASX-200 ETF (STW).

Here’s the rules:

(1) Buy the STW on close.
(2) Exit next morning on open.
(3) Skip next close.
(4) Repeat step (1)

In layman’s terms, we buy the STW on the Monday close. We exit on Tuesday’s open. We skip Tuesday’s close and buy the close on Wednesday, exit Thursday morning, skip Thursday’s close, buy Friday’s close, etc.

The black line represents buy and hold for the STW itself and shows a CAGR of +3.3% (ex-dividends)^.

The blue equity chart starts on Monday 3rd September 2001 which is the first day of a full month’s data for the newly listed STW.

This represents a +10.2% CAGR.

The orange equity growth starts on the next day, so is essentially following the same rules yet on every other day.

This represents a +13.3% CAGR.

Random or not?

I’m not sure. There are however many studies highlighting the importance of the overnight moves for the major US ETFs. 

To better understand if the pattern is random or not, we’d need to test across a broad cross-section of stocks and ETFs both here in Australia and the US.