Regarding some questions about the reversion to mean systems and stops yesterday there were some questions from new guys regarding stops etc. I wrote this in response and I also discuss a lot of other things such as emotion and how to think about the systems

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    First off the KISS trend following long only systems use stops - i.e. the DVT's higher low stops. The Breakout system also uses traditional hard stops and trailing stops

    The 21 reversion to mean systems do not use 'INITIAL' traditional hard stops, where you set a hard stop after you enter the trade. An example of these type of systems to think about would be let's say you observe that in the past 30 years when price fell 10 days in a row on the SPX, it always put in a bounce on day 11. Well let's say that condition occurs again and you go long, but instead of price rallying on day 12, it falls again, and now you have a new statistical record.  What you have now is an even more statistically stretched scenario where prices are even more prone to a reversion back to the mean bounce. You could sell and stop out, or you can scale in more assuming that prices will eventually revert back as you now have a statistically more stretched scenario.  Instead of hard stops, the systems whenever they get into a bad trade, they will exit instead after an oversold bounce, vs stopping at at the lows. 

    I tested using initial hard stops on these systems every which way but Sunday and the results were always worse by using initial hard stops rather than letting the systems exit on an oversold bounce instead. Too often your stop would hit at -8% or -10%, 12%, and even bottom tick where you sold the exact low. I found that if you simply let the system exit on its own after a bounce, you might get out with only a -1% or -2% loss or even a winner.  The long systems exit on a bounce, the short systems exit on a pullback. The exceptions are after reversion to mean moves occur if the systems decide to hold for longer, trailing stops may be used or by indicators like the momo changing slope - but realize that's after you got your reversion to mean bounce or pullback already.

    Reversion to the means systems are NOT feel good systems - they can be counter trend trades that are buying into sharp weakness when everything feels the worst, and they also exit or sell when everyone else is buying and it feels the best. This really plays on ones psychology and is hard to get used to.

    I suggest strongly that anyone trading the systems first start off with extremely small position sizes be conservative, don't swing for the fences, because your emotions will get to you if the systems go through what I call an 'ass pucker' trade where they go through some good draw down and multiple entries before they finally get a bounce (for longs) or pullback (for shorts). Do them small until you get a handful of trades under your belt with some profits that can 'buffer' your account and your emotions, before you increase position size. The guys that start off and swing for the fences with too large of a percentage of their account end up failing if their first experience with the systems takes some draw down and they have too much at stake. 

    I'm not an investment adviser and so I cannot give advice, I'm giving you general information to consider in order to make your own decisions. 

    If you really want to set hard stops - you can ask me what the max historical drawdown was for a particular system and one idea would be to set a stop a bit wider than the historical draw down - realize that odds could have the max historical draw down exceeded slightly to stop you out only to reverse and that be the new max historical draw down where you got stopped out at the lows. 

    another thing - the reversion to mean systems usually about once or twice a year go through some of these tough trades. Most of the time 90% it's ho hum and no big deal.  When you first start to trade the systems, you might start at a good time when you get 10 or 20 easy trades before the 'pucker' trade, or as odds have it, you might get stuck with the pucker trade as your first one. 

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