10/19/2022 |
TrendSpider Software Update: Major Strategy Tester User Experience Upgrade
Hello, traders, and welcome to yet another software update from your friends here at TrendSpider! In this update, we’ve added some deceivingly simple, yet profoundly helpful functionality to our strategy tester feature. We call it ‘No-Go’ Highlighting and you can learn all about it below!
One of the key differentiators of successful traders is a deep understanding of the strategies they trade. This deep understanding can come in any number of ways, but one of the quickest and easiest ways to know if a strategy really works is to backtest it. If you’ve ever utilized TrendSpider’s Strategy Tester, you know that it provides a wealth of data that a trader can use to determine whether or not a strategy is successful on a given name or time frame. With this update, we’ve taken that data to the next level with the introduction of ‘No Go’ highlighting, as well as convenient copying of Tabular Data.
No-Go Highlighting, Explained
Regardless of the entry and exit criteria, every strategy has its own unique data footprint. Some strategies outperform on particular names or time frames, whereas other strategies tend to work relatively similarly across names and time frames. Regardless of the ticker or the time frame you’re trading, there are key metrics that every trader must keep an eye on to determine whether a strategy is worthy of consistent use. Included in this list are:
- Reward/Risk Ratio – Represents the amount of money risked vs. the amount of money sought to gain, per trade
- Average Return – Represents the average amount of money made or lost, per trade, over the duration of the backtest period
- Win Rate – Represents the percentage of entries that result in a winning trade
- Loss Rate – Represents the percentage of entries that result in a losing trade
- Expectancy – The typical profit value for each trade (If expectancy is .10, then each trade should see, on average, a 10% profit for every $100 spent)
In the best-case scenario, all of the aforementioned items will align; The reward/risk ratio will be high (3/1 or more), the win rate will be above 50%, and the average return and expectancy values will be positive, relative to the trader. However, the best-case scenario is often not the reality. What is more realistic is a mix of favorable and unfavorable readings from these metrics. For instance, one trader may develop a strategy that has a good R/R ratio but a subpar win rate, which could eat away at the expectancy or the average return. Another trader might develop a strategy that has a generous average return, but a much lower win rate, thus leading to underutilization of capital.
The purpose of our new ‘No-Go’ Highlighting feature is to shed light on how these data points affect one another and to allow a trader to quickly scan them without having to weigh the pros and cons of each piece of tabular data. The weighting of the pros and cons is done automatically by the platform, and a red shading is drawn over any data point contained within the tabular data readout that is suboptimal and could lead to longer-term negative returns despite certain data points, like the performance chart value, currently yielding a positive return.
No-Go Highlighting, In Use
To fully understand the functionality of ‘No-Go’ highlighting, let’s dig into a few strategies! We’ll start with a strategy that contains many red flags. In this strategy, we go short when the 5-period SMA crosses down on the 20-period SMA and we exit the position when they cross back. The image below shows the results.
As you can see per the ‘Tabular Data’ area in the far right of the image, there are a few data points that are highlighted in red. When in the platform, a quick scroll over each data point will yield a suggestion as to why it’s highlighted. Not only does this strategy perform poorly against buying and holding, but it also has a low win rate, a negative average return, and a negative expectancy. Now, it could be argued that a low win rate in isolation can be mitigated by a higher return. Unfortunately, in this case, since the average return and the expectancy are negative, this strategy simply cannot be profitable as it is and should be altered or avoided on this name and time frame, altogether.
In the next example, we backtested another simple strategy. In this one, we go long on any of the reversal candles listed, and we close the position when another reversal candle appears.
To an untrained eye, this strategy looks quite good. The performance over the past 4 months has beaten buying and holding to the tune of over 10%. However, there is a fundamental flaw. You’ll notice the red highlight over the win rate. When you hover over that value, you’ll see a prompt that reads; ‘With Reward/Risk ratio of 1.22, you need at least 55.87% of winners in order for this strategy to be sustainable.’ At the current win rate of 49%, this strategy falls just shy of being sustainable per the metrics that it yields. Clearly, we’re closing in on finding a more sustainable strategy, but we’re not quite there yet.
Now that we understand the importance of all of the tabular data aligning when we create a strategy, let’s take a look at an example of a strategy that contains no ‘No Go’ highlighting.
In the example below, we take the reversal candle strategy we just tested and add one additional parameter; an increased RVOL value. By adding RVOL, we’re defining that the reversal candles are occurring on above-average volume, thus giving more confidence to the potential of a true reversal.
The results speak for themselves. The performance of the strategy vs buying and holding is clearly strong, however, note that there are no red highlights. Though the win rate is only 49%, that’s mitigated by the fact that the Reward to Risk ratio is 1.77. With an expectancy of .36, a trader is poised to make $36 for every $100 they spend, on average. This set of tabular data is in alignment, and we have ourselves a strong winning strategy that we can feel confident in using!
How We Calculate Minimal Win Rate
Intuitively, it’s understood that if your Reward/Risk ratio is 3/1, then you only need one successful trade for every three that you take. This will keep your portfolio from going below the value you initially started with. It’s not until you have a third loss in a row that you’ll start losing money. The purpose of an R/R ratio is so that you can understand your minimal win percentage to not lose money.
We have figured that you can easily compute these “minimal Win%” values. We built a simulation and then approximated the result with a regression model. Here’s a chart.
From this chart, you can easily see that with a reward-to-risk ratio of 4.0, your minimal win ratio is ~25%. With an R/R ratio of 1.5, 50% of your trades will need to be successful, and so forth. This model is not strict (we might be off by a few fractions of a percent) but you can use it as a rule of thumb when estimating the quality of your strategy. In the case that your Win% is too low for a given R/R ratio, TrendSpider will tell you so, by highlighting your Win% and making a comment on it.
Copying Tabular Data
As a trader develops their strategy, they might want to store the Tabular Data for the purpose of comparing strategies against each other. With the new addition of a ‘Copy’ button, we’ve made this process dramatically easier.
In the top right-hand corner of the Tabular Data display, you will see two small yellow icons. The icon on the right is the ‘Copy’ icon. When clicked, it presents the option to copy the data as either ‘Two Columns’ or ‘Two Rows’. Once copied, the data can easily be pasted into your favorite spreadsheet software for quick review.
As with all our software updates, we do hope you find this to be useful! If you have any questions for us, feel free to reach out via the ‘Contact Us’ button in the bottom right-hand corner of your chart.
