Trading Strategies - The Problem and Solution

Please bear in mind that when I posted the performance summary report that showed losing money on a common use of RSI(14) counter-trend strategy backtested on FKLI, it doesn't mean that RSI as a counter-trend generally or the strategy spesifically cannot be used at all.  It may be possible to achieve a robust and working system by combining the strategy with some static or dynamic Stops as well as Exits.  You just have to test each hypothesis.

What I wish to point out here is that although trading is very simple; just Entries and Exits only, it is not easy to implement a long-term profitable trading strategy whether the strategy is discretionary or systematic.

Why is it so?  In my opinion, trading is just like the nature, a balancing act between two different forces and there is no such things as definite right or wrong.  You may be thinking of winning trades and losing trades but you are missing the bigger picture, winning and losing trades are just the result of our trading strategy which is in turn, the reflection of our internal believe system and wisdom. 

The right starting point to the solution is to realise that Entries and Exits represent the two different opposite sides of human nature.  If you are of the type that seeks instant gratifications or pleasures (majority of us) then you will most likely prefer to go Short when the market goes higher and higher or buy when the market kept dropping lower and lower as that is common instinct.  We are merely reacting to our basic needs.  If you analyse closely, this is just counter-trend Entry!  Where is the Exit?  How do you do it?  Most people have no clue.

As I've said before, counter-trend Entry is just one side of ourself that seeks instant pleasure, it usually is easy, we just do it.  If that is the case, the other oppsosite side would represent the one that is most difficult or challenging to us (remember two opposite forces), the Exit.  In counter-trend trading, it is counter logic to exit with a loss when after you have Shorted, the market goes higher and higher, as the price is even more attractive to add Shorts than to buy and cut your losing positions!  The reverse is also true for Longs.  When the market goes lower and lower, human nature is such that it is even cheaper to buy more, rather than to cut the Longs by going counter logic which is Sell to cut loss!  If most products are trending(over long-term), then you will have a problem with your Exit strategy.  You can't afford to win small(5 points) 4 times and lose big(25 points) merely 1 time consistantly!  You would have negative expectancy in your trading strategy, hoping will never change your odds.

That is the reason why trading is simple, but not easy.  And that is also why most successful traders (<5%) tend to be trend-follower as solving and implementing counter-trend exits(when most products tend to trend) represent a more difficult challenge than choosing trend-following which is counter logic and harder on Entry (buy when price goes higher) but relatively easier on the Exit as taking profit when the price goes even higher when we go Long or goes lower after we have Shorted (this generalization although is dangerous, but is true as long as most product tend to trend).  Furthermore, the logic for Exit is consistant with the logic for Entry in trend-following systems!

That's why most people choose the easier way to start, which is to Sell when they see market goes higher and higher or to Buy when the market drops lower and lower, which by itself is not the problem, but have no clue about how to Exit when the price goes against them and that is the biggest problem.  Who in the right mind would counter their own logic of Entry and willingly buy when the price goes higher after they have shorted? 

The conflict of logic between Entry and Exit in addition of no Exit plans at times caught them off-guard and delay the cutting loss process, especially when market move fast against them.  At the end they tend to close the positions unwillingly (always a sign of problem)!  And the cycle repeats again.  That's why not many people can implement trend-following strategy which is more difficult to start a trade.  It is human nature to give up too easily or listen to so call "expert"'s advice as they don't have to learn and bear the painful responsibility of admitting that their decisions were wrong.

Personally, the right Exit in trend-following strategy is even harder as one needs to withhold the temptations to take profits early.  That is however, entirely different topic.

Please bear in mind that the relationship between Entries and Exits in counter-trend and trend-following would have changed side if suddenly most products starts ranging all the time.  The Exit for counter-trend would become easy as taking profit to exit Shorts by buying when the market drop and selling to take profit when the market goes higher seems in sync with our instinct and logic! 

Until that day arrives, we'll need wisdom to defer our instant pleasure-seeking nature, the need to be validated by others, the need to prove that we are correct all the time(therefore focussing on short-term result) and go Trend-Following, although not easy, but easier than finding a good exit solution for counter-trend trading strategies that consistantly work and has a good risk-to-reward ratio in a trending environment.  At the same time, you must remain sensitive to market paradigm shift and if needed to, change your approach accordingly to match the ever changing environment.   Good luck and Happy trading!