Price filters in SAR trading - Gain or Pain!

There is always a struggle in mechanical trader’s mind as what kind of filter he should use on the sideways market to get away from whipsaws. Simple truth is "no filter value" can benefit in the long run. I personally  experienced the fact that most of the trades gets whipsawed even though the price filters are applied before reversing the trade. Whatever can be the filter value, but price will go there to kiss your SAR order and pull back:)

I hope many mechanical trading system followers would have experienced this.I definitely agree that few trades might survive from whipsaws due to application of price filters. But that's once in many trades. If you run the check with your old trade log, you will realise that there is no point in the fixed price filters.

They are actually a  pain to your mechanical trading system.How?

Look at the below table from my records.

Now, below is the small brief to understand the difference between the returns shown above.

Total trades in a year – 96

Say, we keep filter of 0.1% which is around 5 points per trade (considering average price of crude oil as 5000).So, when you place a order for reversal, you place 5 points above or below your actual SAR value.

Let us assume that we are reversing one short position into long with a loss. We place the order 5 points above the SAR level to enter into long position. One has to understand that we have straight away included loss of 10 points in the above trade. That is, we extend the loss of the existing trade by 5 points as well as we reduce the profit from the next trade also by 5 points with the lateral entry.

It is obvious that you are making loss of 10 points in every trade and if you zoom this calculation in to 1 year period, you lose 960 points ( 96 trades as i shown in table) in the name of filters. It is absolute 384% of returns you have lost by using filters. Even if your system do not generate any major gains for the year, if you would have saved this 384%, that is more than enough for any trader with any system.

Caution : My entire explanation is based on commodities and especially from my testing with crude oil. This cannot be considered as is for trading other contracts for eg, Nifty, without proper testing. And, my system is different and the effectiveness of filter might change among different trading vehicles.Check every contract you trade before making a decision.

My note # 1 : If one is already trading with filters, there is no need to immediately skip the filters. Try to reduce the filter size gradually. It can be flexible and worked based on some important TA levels placed around SAR price.This would work.

My note # 2 : I have stopped trading nifty and don't have the updated data. But I can do a approximate math with my experience in Nifty. If we assume that we execute around 75 trades in a year, then trading Nifty using a SAR system with 10 points of filter will lead to the invisible loss of  75x10x2 = 1500 points  which is 300% ROI. Am I correct?

Bottom line of this post is to highlight the invisible slow poison which dilutes your capital.So, keep a check on that!