"What are your standards for a trading strategy?"
By Dave Mabe
SMB Capital recently invited me to give a talk on systematic trading to their interns.
We didn't have time to get to all the questions, so I suggested they email me additional ones.
Here's one of the follow-up questions from Asad R. (name used with permission):
Asad R.:
What are your standards for an individual trading strategy?
Would you consider the whole system as a strategy to be evaluated?
Do your standards change when analyzing an individual strategy vs. 5 or 6 uncorrelated trading strategies traded together?
Dave:
You should consider a variety of metrics/standards to determine if a strategy is good enough to trade.
If you optimize just on one metric, you'll have blind spots (e.g., looking at total profit, but neglecting drawdowns).
The main "standard" I use isn't a metric, per se: the equity curve.
The equity curve paints a fantastic picture of what it'll actually feel like to trade the strategy live.
Here's a great example I shared a few days ago.
If you only looked at the total profit, Strategy 1 would win by a country mile.
But with one glance at the equity curve, it's easy to see Strategy 2 is better and actually tradeable by mere mortals.
In addition to the equity curve, the other metrics I consider are:
Total Profit
Win Rate
Profit Factor
Trades per day (important!)
Calmar
(notice the vastly overrated Sharpe ratio is missing from the list)
The last question is super important, and I think my philosophy differs from most systematic traders.
I don't relax my standards just because I already have strategies I'm running live.
I also don't lower my standards for a strategy just because it happens to be grouped with other strategies, for example, going long gaps up and shorting gaps down.
Each of your strategies should be good enough to stand on its own if it were the only one you traded.
Keep your bar high!
Your standards should rise over time, not creep down.
Good question, Asad, and great meeting you.
-Dave
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