HOW TO BUILD A PROFITABLE TRADING SYSTEM PART 2: ANTIFRAGILE TRADING SYSTEM
Wind extinguishes a candle and energizes fire.
Likewise with randomness, uncertainty and chaos: you want to use them, not hide from them.
We don’t want our trading systems to only survive uncertainty, just about making it. We want our systems to dominate the inexplicable, conquer the unseen.
The market is laden with shocks, volatility, randomness, disorder, stressors, risk and uncertainty.
Yet, nearly every trader is trying to remove the unremovable by building fragile trading systems that cannot handle these shocks, volatilities or stressors. Their trading systems break in the first unexpected market event as they are made to work only in a specific market, during particular market conditions; they are overfitted to old data with overcomplicated rules.
Instead, you need to develop trading systems that don’t just look beautiful in a backtest with a perfect Sharpe ratio and zero volatility– you need to build trading systems that can perform well no matter what the future brings. Ironically, you will find that your trading performance becomes more predictable when you build a trading system that accepts the unknowns of the market, that uses simple rules and a simple framework that fit many asset classes, market conditions and time frames. The reason for this is simple: if your trading system is built on the premise that the future is unknowable, you are assured that the future will bring conditions that your trading system anticipated. In contrast, a trading system that is built on the assumption of a specific market characteristic will suffer if the conditions on which the system are based are not present.
SO HOW DO YOU DEVELOP A TRADING SYSTEM THAT IS NOT DEPENDENT ON PARTICULAR MARKET CONDITIONS?
A system that goes beyond resilience or robustness? You want a trading system that not just resists the shocks and stays the same, but one that gets better when it’s exposed to shocks, volatility, randomness, disorder, stressors and risk and uncertainty – an antifragile* trading system.
THERE ARE 3 PARTS OF DESIGNING AN ANTIFRAGILE TRADING SYSTEM:
Diversify – Design a system that can work on any market, during any time frame in any conditions. When you trade and test more markets you increase the chance that you will encounter different market conditions – both favorable and unfavorable. Exposing your system to multiple uncorrelated markets and seeing positive results across them give you the first sign that you’re embracing antifragility.
Simplify – Create trading rules that are simple and use fewer variables and indicators. Keep the rules consistent throughout your system’s development and testing process and do not change your rules for different markets (overfitting). Simple rules make systems antifragile because those rules work in a greater variety of circumstances and can adapt to various market conditions as the markets change.
Fail a lot – Ironically the more you allow your system to fail, the better it gets. Similar to humans, machines also learn from their mistakes and get better. Allow your system to have plenty of losers so that the algorithm can learn to anticipate them. The more data the algorithm gathers on losing trades the better the algorithm will get in avoiding them in the future.
THESE ARE THE CHARACTERISTICS OF ANTIFRAGILE AND FRAGILE TRADING SYSTEMS:
If you want to survive the markets and have a long trading career, you must build simple and antifragile trading systems rather than complex and fragile ones.
*The term Antifragile was created by an author and options trader Nassim Nicholas Taleb
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