The Forex System Switching Trap

Your Forex system loses 3 in a row. You get a new system. It works at first then loses 3 in a row. You choose a new system. You just chose to lose

One of the major stumbling blocks all forex traders face at some time is the nasty habit of switching systems whenever they suffer a string of losses.

It was certainly a problem for me in the past, borne out by the many excellent strategies and systems on this site, that I tried out at one time or another, only to move on when the inevitable losing streak arrived.

Why do we do this? It comes down to what is known as Recency Bias. This concept describes the way we feel about our current trading.

If we’ve just had a string of wins, we are highly likely to consider ourselves Gun Traders who can do no wrong! In this frame of mind we are more likely to stick with the current system we are using.

However, if we have a string of losers, our frame of mind changes radically and rapidly. Doubt sets in, compounded by Fear. Our heart rate elevates, we kick ourselves over trading decisions, and above all we begin to question the validity of the system or strategy we are currently employing. We begin to wonder:

“Hey, it’s just lost five times in a row, that can’t be good! Maybe there’s something out there that hardly ever loses?”

So we go on and do our research, choose another forex system and begin to trade it. At first our suspicions about the last system are confirmed as we rack up a series of wins with the new system. We congratulate ourselves for a wise decision. We are incredibly intelligent for having found this new system that hardly ever loses! Wow, we’ve really arrived as a trader now.…

And of course, when the inevitable string of losses comes along – as it always does with ANY system – the old cycle of doubt and fear sets in once more and we go looking for yet another Holy Grail system to trade. We have sadly and pathetically come to resemble a hamster on a wheel, a long fall from the state of grace of Master Trader!

The way to escape from this horrible cycle is a process of:

1)  Backtesting. What you who are about to test must have shown some kind of promise in backtesting.
Backtesting is a complex concept that’s really outside the scope of this post – which concerns itself with the next step in the process  – but you must have some kind of confidence that the strategy you’re about to test may produce results.

Though backtesting is outside the scope of this post, I will say that I usually just rely on a manual, “eyeball” approach these days, as the parameters I use such as pivots, round numbers, support and resistance levels etc. can be easily plotted on past charts.

Another alternative, or additional way to backtest, is of course through using Forex Tester. It’s a bit of work to set up, but if you’re serious about your backtesting I thoroughly recommend this tool. If you’re interested, check it out: Forex Tester.

2) Forward Testing. Otherwise known as live trading, using either a demo account, or preferably a live micro account (generally speaking, live accounts give more accurate and reliable results).

3) Strategy Verification. We do this by logging the results of all our trades, most commonly in an Excel spreadsheet. I have included an example from my own backtesting verification below.

4) Trade or Discard. Based on our analysis of the trades logged in the above step, we decide whether to persist with the strategy or not.

Note that sometimes even if a forex strategy proves to be profitable over the period of testing and verification, we may choose to discard it anyway. For example, if we chose to test the strategy based on a certain time frame that we were able to trade, and now we are no longer able to trade that timeframe, it would be foolish to persist with the strategy.

Another reason for discarding a profitable forex strategy at this stage is that, though it may have shown a profit, you may judge the return on your effort too poor to continue. This was the case with the strategy depicted in my own trading log below. I’ve included screenshots of the two relevant Excel spreadsheet tabs.

The forex strategy was for an automated system I had devised, based around news trading. In some ways it worked quite well. For example, I was able to leave trades in the market overnight (my time) for news events that occurred in the New York session. Overall, these trades proved profitable, even when I left orders in the market with the automated strategy, just prior to Non-Farm Payrolls data releases.

However, in the end I discarded this strategy because once I had done the 100 trades required to “prove/disprove” the approach, I realised I’d be better off (mostly) if I traded the events manually.

The bottom line is this: never stop trading a forex strategy just because it’s losing. Have some methodology in place that you use with every trade you take, that verifies whether or not the strategy is a loser over the longer term. More on this in subsequent posts.

By the way, just as a point of interest for those who like to read old-fashioned print books, there is one called Secrets of Professional Turf Betting by Robert L Bacon. It is long out of print, but you may be lucky enough to pick up a second-hand copy somewhere. I have one and it’s a treasured item in my collection of trading books.

Though it is to do with Turf betting and not directly related to any issue of trading psychology, the same principles apply. In chapter 4, “Keep out of Those Switches!” Bacon covers exactly the same problems faced by forex traders with regards to switching between one strategy and another when the going gets tough. And his prescription for dealing with the problem neatly parallels the above methodology.

Hope you enjoyed the post. Don’t forget that if you’d like to hear more on the subject, leave a comment below.

In the meantime, best of luck with your trading and KEEP OUT OF THOSE SWITCHES!

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