Lately I watched promotional video by John Locke where he presents his new trade: ‘Super Bull”.
It stroke me that this is good example to share my thoughts about backtesting (BT).
If you are interested, here is link to JL’s presentation. As far as I know there is no claim of Intellectual Property lock on the trade. Watching it is not necessary prior to reading.
Reason that Super Bull is good opportunity lays in it’s simplicity. For purposes of this post I simplified it even more. For clarity purposes, to avoid distractions.
Please, keep in mind that my goal is not to evaluate the trade. My goal also is not to express opinion about this video or JL teaching or his business methodology. I do not know much about those at all. I’m even not sure if misconception I want to talk about is shared by JL. My only goal is to debunk stance (not expressed in video explicitly) that BT is a good, or even ultimate, method to develop and evaluate trading strategies. I suspect majority traders in our community wont agree with me, but also I know I’m not unique in my opinion about validity, or rather lack of it, of BT for mentioned purposes.
Strategy.
Super Bull simplified:
1. Wait for day when 56 DTE expiration in SPX is available
2. Enter (1) 20 pw long call spread where long is about 10 points below the spot and short is 10 points above. Seek to pay 1K for spread (risk/reward is 1:1)
3. Sit on the trade 56 days and do nothing. At expiration take a loss or pocket profit.
4. When new 56 DTE cycle will appear enter new trade, do not wait for previous trade to expire
Difference from JL’s rules is that I hold the trade to the end when JL tries to close first trade for at least break even when entering new trade. As said, for my purposes the simpler strategy the better.
To show that Super Bull is a viable strategy, that the trade makes sense at all, output of BT is presented along with live results for past year.
Here is where I frown. BT is not a good method to validate a trade. BT is not a good method to learn a trade. BT is easy way (in a sense) that does not require much thinking and knowledge from trader – thus is attractive to everyone, but is very time consuming if done manually.
Why is that?
Lets take a look at expiration graph (clip from the presentation):
If you are not complete novice to trading options (in that case this post is not for you) above graph contains all you need to know about Super Bull. Namely: if market goes up you will earn money, if it goes down – you loose. RR is 1:1, so in case of stagnant market you will p&l will be close to break even, in bull market you will be profitable, in bear market – you will be not. Rest of it is just marketing.
Case closed.
-- --
‘But, but…’, you say, ‘this example is to simplistic’. ‘If I want to test more complicated structure BT becomes a must’, you say.
Not at all.
Let’s look at some put BWB below the money we all are familiar with. You do not need to BT to notice that you will start going under if market move down, do you? Loosing all you margin becomes more and more probable with market going lower and lower. So, you implement some kind of adjustment. You close the trade, roll it, hedge it, or whatever. Let’s say you want to see if adding long PS (put spread) when market touches your right strike will work. Way to often the advice you get how to proceed is: backtest it! So, you sit down and backtest, and backtest, and backtest. Different locations of PS, different widths. Eventually you are satisfied. Your equity curve has improved.
For simplicity assume you did test 9 instances of your trade. If you got at least 5 positive outcomes from your adjustment, your final p&l will improve. Your adjustment are now ‘scientifically’ proven to work and properly backtested, so you are confident to implement it live. Congratulations, you learned nothing.
In reality all you did is bet that market conditions will stay the same or improve (for your strategy) in the future. If in live trading your won only 4 times out of 9, your adjustment strategy brought more loses for you. And it wasn’t a fluke from BT results, it was change in market that caused the loss. What you accomplished through BT was the curve fitting of your strategy to the past market conditions. It means you found optimal adjustment that worked in BT’s lookback period. In very time consuming manner (if you did it manually) you found combination of strikes that on average did well in fixed period of time. You learned about BT software but not about trading. Changing lookback periods wont make any difference.
All above could be accomplished in 20 sec look at graph if you understand how PS works.
-- --
Now, I don’t want to be misunderstood. I do not say BT is useless. Not at all. There are situations that BT is very helpful, but thinking about BT as a way to improve trading of average trader is a prevalent misconception that prohibits traders’ growth.
I think this flaw steams out from traders’ laziness. Many of us seek perfect ‘strategy’ that will grow account without taking much risk and without putting much effort and, if possible, avoid any discomfort while in the trade. Did anybody succeed with that?
There is not any Intellectual Property on this post with an exception of spelling and grammar errors. If you want to copy any of them you own me royalties. If you particularly like some of them I suggest subscription with very affordable price $9.99/mo. I expect any other errors to be exposed and crushed.
This is all purpose of this.
It stroke me that this is good example to share my thoughts about backtesting (BT).
If you are interested, here is link to JL’s presentation. As far as I know there is no claim of Intellectual Property lock on the trade. Watching it is not necessary prior to reading.
Reason that Super Bull is good opportunity lays in it’s simplicity. For purposes of this post I simplified it even more. For clarity purposes, to avoid distractions.
Please, keep in mind that my goal is not to evaluate the trade. My goal also is not to express opinion about this video or JL teaching or his business methodology. I do not know much about those at all. I’m even not sure if misconception I want to talk about is shared by JL. My only goal is to debunk stance (not expressed in video explicitly) that BT is a good, or even ultimate, method to develop and evaluate trading strategies. I suspect majority traders in our community wont agree with me, but also I know I’m not unique in my opinion about validity, or rather lack of it, of BT for mentioned purposes.
Strategy.
Super Bull simplified:
1. Wait for day when 56 DTE expiration in SPX is available
2. Enter (1) 20 pw long call spread where long is about 10 points below the spot and short is 10 points above. Seek to pay 1K for spread (risk/reward is 1:1)
3. Sit on the trade 56 days and do nothing. At expiration take a loss or pocket profit.
4. When new 56 DTE cycle will appear enter new trade, do not wait for previous trade to expire
Difference from JL’s rules is that I hold the trade to the end when JL tries to close first trade for at least break even when entering new trade. As said, for my purposes the simpler strategy the better.
To show that Super Bull is a viable strategy, that the trade makes sense at all, output of BT is presented along with live results for past year.
Here is where I frown. BT is not a good method to validate a trade. BT is not a good method to learn a trade. BT is easy way (in a sense) that does not require much thinking and knowledge from trader – thus is attractive to everyone, but is very time consuming if done manually.
Why is that?
Lets take a look at expiration graph (clip from the presentation):
If you are not complete novice to trading options (in that case this post is not for you) above graph contains all you need to know about Super Bull. Namely: if market goes up you will earn money, if it goes down – you loose. RR is 1:1, so in case of stagnant market you will p&l will be close to break even, in bull market you will be profitable, in bear market – you will be not. Rest of it is just marketing.
Case closed.
-- --
‘But, but…’, you say, ‘this example is to simplistic’. ‘If I want to test more complicated structure BT becomes a must’, you say.
Not at all.
Let’s look at some put BWB below the money we all are familiar with. You do not need to BT to notice that you will start going under if market move down, do you? Loosing all you margin becomes more and more probable with market going lower and lower. So, you implement some kind of adjustment. You close the trade, roll it, hedge it, or whatever. Let’s say you want to see if adding long PS (put spread) when market touches your right strike will work. Way to often the advice you get how to proceed is: backtest it! So, you sit down and backtest, and backtest, and backtest. Different locations of PS, different widths. Eventually you are satisfied. Your equity curve has improved.
For simplicity assume you did test 9 instances of your trade. If you got at least 5 positive outcomes from your adjustment, your final p&l will improve. Your adjustment are now ‘scientifically’ proven to work and properly backtested, so you are confident to implement it live. Congratulations, you learned nothing.
In reality all you did is bet that market conditions will stay the same or improve (for your strategy) in the future. If in live trading your won only 4 times out of 9, your adjustment strategy brought more loses for you. And it wasn’t a fluke from BT results, it was change in market that caused the loss. What you accomplished through BT was the curve fitting of your strategy to the past market conditions. It means you found optimal adjustment that worked in BT’s lookback period. In very time consuming manner (if you did it manually) you found combination of strikes that on average did well in fixed period of time. You learned about BT software but not about trading. Changing lookback periods wont make any difference.
All above could be accomplished in 20 sec look at graph if you understand how PS works.
-- --
Now, I don’t want to be misunderstood. I do not say BT is useless. Not at all. There are situations that BT is very helpful, but thinking about BT as a way to improve trading of average trader is a prevalent misconception that prohibits traders’ growth.
I think this flaw steams out from traders’ laziness. Many of us seek perfect ‘strategy’ that will grow account without taking much risk and without putting much effort and, if possible, avoid any discomfort while in the trade. Did anybody succeed with that?
There is not any Intellectual Property on this post with an exception of spelling and grammar errors. If you want to copy any of them you own me royalties. If you particularly like some of them I suggest subscription with very affordable price $9.99/mo. I expect any other errors to be exposed and crushed.
This is all purpose of this.
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