SAR, the Number , a math not a myth! A Trader's view on What is SAR Trading and How to Trade on SAR system – Post # 4

Click here to check the previous Post # 1,Post # 2,Post # 3 on this series about SAR Trading.

Basement of SAR Trading – “Backtesting”:

To me, back testing is the backbone of the mechanical trading. It’s like sharpening the axe before cutting the tree. Longer and proper you sharpen it, shorter the cutting time. I have seen many traders just blindly following the trading system, which they found on the net, forums and from the textbooks. Of course you can do that but only after a thorough back testing that system. Each trading systems has its own pros and cons, which you will come to know only after back testing. On the first look, everything looks mouthwatering. But only when you do back test, you will understand the nuances in the trading system.

Going for longer and deeper back tests save lot of money and stress.Don’t be optimistic or over-confident when you see good returns in the back test, and don’t think you have got the Holy Grail. Go for real trades only after double/triple checking the back test.

I will consider the following important aspects while carrying out back test.

1.      Test your system at least for a 3-year period data. If you do it only for one year, you might be testing only some trend i.e, you might be only testing bull or bear phase of the market. What the back test shows you may not happen in the next year in real trading if that is sideways market. So, go for at least 3-year period, which has more probability to cover most of the market phases (a bull phase, a bear phase and a sideways phase).

2.      Test your system at least with 3-4 counters across different sectors. Results should be more or less in equal % with all counters. This makes sure that your system is somewhat capable of sensing and following the trend irrespective of individual nature of the stock. This will also help to correct the errors, if any, caused by testing on false data or wrong data by mistake. By doing this, you will get more confidence on reliability of the trading system. 

3.      If you want to go deeper, select multiple contracts, each one or two from equities, indices and commodities and if possible also with currencies. Of course, there will be difference in the returns across different vehicles but you should check if you are getting decent returns from all vehicles. If your system provides such acceptable returns in the back test, then it’s a sign that you have the system ready in hand to start with the real trading.

4.      If you get different returns with different contracts, filter the system only for the similar contracts where you got higher returns. Do not use that system for other contracts. For example, Moving Average based SAR system may show good results with Nifty whereas it may not perform well with Crude oil. I will stick to trade Nifty with MA based system and go for another system for crude oil.  

5.      If you wish to have good success in real trading, then spend at least 3-6 months on back testing. One might think why it needs so much time? Back testing is not merely entering formulas and dragging the values down in the excel sheet or making some code in AFL to check data. It is a process of going through each day’s price action and signals generated. Check every value and make sure that there are no mistakes. 

6.      Very important – Data what you have taken for back testing should be a correct data without any flaws. For example, many false open ticks in any counter can drastically change the value of returns in the back testing. Data might be showing some open high value whereas it could have actually opened with gap down and resulted a loss in real trading. So, always try to get clean data free from false and momentary spikes at open with low volume. Many forums would help you to get such clean data. If you cannot fetch such pure data, I would recommend paying and getting data without any false ticks.

Application of SAR Trading – “Real trading” :

Believe me, this is the easiest part for a true mechanical trader if he has done all his groundwork well. If your back testing is perfect, if you commit yourself 100% to your system without any doubt in mind, real trading is merely a cakewalk with the help of SAR Trading system.

 One should develop following three qualities to succeed in real trading.

1. Strong belief in his trading System.

2. Strict discipline to follow his system irrespective of market condition.

3.  Patience to travel with the system wherever it takes you. Take the lead from the system and never try to lead it.

Essence of SAR Trading – “Sitting tight”:

All the traders know the value of this term “Sitting Tight”. None of the succeeded trader can refuse to concede the importance of this term. I have realized it at least 10 times in the year of 2011. In a sideways market, if I had made 10 trades with 8 losing trades and 2 winning trades, in all the instances 2 winning trades helped me recover the loss from the 8 losing trades and in addition fetched me more profits too. In some cases, it paid me back twice what I have lost in 8 failed trades. But the miserable part is that all of us sleep with all the 8 losing trades without fail but exactly miss part or full of those 2 potential winning trades. Once you book out of a trade, you will never re-enter it. Otherwise, you will get trapped at high (when going long) or low (when going short) of that swing in the process of re-entry. 

It’s a fate of mechanical trading. Your system keeps you engaged in all your failing trades till the Stop Loss hits for reversal. But it will shake you to quit early from winning trades before realizing the full potential of the trade. It is because of the fear in your back of the mind of missing a good trade in the whipsaw. This results in bad returns from the trade.

To stop all these mess, simply SIT TIGHT. Longer you sit tight, quicker you become rich.

Nuisance of SAR Trading – “Whipsaws “:

This is the biggest headache to any mechanical trader and most of his time is spent on to find ways to minimize whipsaws. My advice to the beginners or to the lazy people (like me) is “Accept Whipsaws and don’t fight with it”. Don’t do anything in the initial stage to reduce whipsaws. All your attempts will go in vain and you will end-up with a mess. 

Biggest puzzle is, what should be done when price is beating SAR number quite often during the day?  I’ll reverse the trade on the very first trigger and I have no other thoughts or action for the day. I do not look for volumes, news etc when the price is triggering SAR number. Once reversed, it may retrace back heavily but its ok and situation would be in manageable condition in a day or two. 

Tackling whipsaws is the subject for the succeeded traders and not for the beginners. So, don’t break your head too much on this. Look the whipsaw like a loss in the business. All business is run with profit and loss. All financial statements are having credit and debit columns. Similarly all trading system will have loss by whipsaw trades. You cannot avoid it and should accept it. 

I have carried about 240 trades in 2011. All of my bigger profits came from less than 20 trades. If I delete these 20 trades from my diary, then my trading record shows a huge deficit. To catch these 20 winning trades, I had to participate in all the 240 trades. I did not know which of the trade among the 240 would have got me huge money. One should not omit a single trade due to whipsaw fear. To run the system successfully, you need to accept whipsaws and run with the system. 

Art of surviving whipsaws cannot be taught as it varies among trading system and trading counter. Am sure you will find a way on your own once you dissolve yourself in your trading system. Mom is the best person in the world to know about her kid.

    

     Hindrance of SAR Trading – “Part booking”:

My friend and me trade same trading system. All through the year, I have traded with same quantity. My friend enters into each trade with double the qty than I do. He off loads 50% with some profit and carry remaining position till the next signal. By end of the year, both our trading books stand with more or less same profit. How can it be possible as he made part booking in many trades? Ok, that was one rosy side of the picture.  What about the other side? Whenever we had to reverse the trades with loss or at the time of frequent whipsaws, he had to reverse the trades with double loss than mine.  

I do not mean that part booking should be avoided. It is suitable only for the experienced hands and deeper pockets. To the beginners who trade with small quantities, part booking is a hindrance, as they cannot survive emotional part. They cannot bear the pressure when the loss is maximized with the additional qty and also cannot sit idle when the profit is flying off after the part booking. So, till you become an expert to spot the reversal at resistance and support or to call the trend of the market rightly, do not put your hands in part booking.

“Position Sizing” & “Add-on methods for better performance in SAR Trading” :

In the back test of crude oil, I started the testing with 1 lot and whenever paper showed more profit, I kept adding quantity. After testing one-year trade, I noticed that there were total of 120 lots in trading in the 9^th month but by the 12^th month it got reduced to 4 lots due to the loss incurred between 9^th and 12^th month. Most people say that when you are sure with the trend, add more qty and when you are less sure about it, reduce the exposure. If am able to judge the trend, why would I still be looking for holy grails?

Position sizing cannot be done this way. You mostly end up with loss i.e, your trades are hit badly when you have high exposure and market in favor of you when you are holding small qty.

You need to trade with fixed quantity for fixed time. I normally go for 6 months time frame. One year is far better. Organise the fund, select your trading counters and fix the quantity. At least for a year, never miss a trade and never change the qty. You will for sure feel better after a year. 

Many would get tempted to refer additional tools thinking that it can help to boost gains or reduce loss. But mostly, any additional tool to any mechanical trading system results in an adverse way. One should not attach many tools to his system. It’s like adding more weight to the racing car.

Lesser the weight, better the performance.

Ok, final break before closing this series. Will come up with “aye” and “nay” list for successful SAR Trading in the next post.