CHAPTER 4
Risk
Ionce stumbled upon an Internet site dedicated to systems trading and design. The
site presented a mailing list, with various postings from systems traders asking for
and giving each other advice on various topics regarding this intricate subject. As
I was sitting there skimming through the messages, a new message came in from
a guy who asked all the other traders frequenting the site to join forces with him
to build a truly professional system—a system unlike the ridiculous systems they
all were trading right now, with back-tested profit factors (the gross profit divid-
ed by the gross loss) ranging from about two to four. Together, they should be
clever enough, he reasoned, to come up with a system that had a profit factor of at
least seven—just like the professionals.
I am sorry to say that this guy has it all wrong. There probably is no such
thing as a trading system with a back-tested profit factor of seven that has contin-
ued to stay profitable at all in real-life trading, and there most definitely is no pro-
fessional money manager trading such a system. A professional and successful
money manager knows better than to fall into that trap, which unfortunately can’t
be said about many of the system vendors hawking their stuff to guys like the one
who posted the message.
In fact, many system vendors and so-called trading experts don’t want you to
trade a system with a back-tested profit factor below three (the higher the better,
they reason), because they know from experience with their own systems that the
profit factor will decrease considerably when the system is traded live on unseen
data. The only reason for this recommendation is that they do not understand how
to build a robust trading strategy in the first place, which becomes painfully evi-
dent when they continue to use the total net profit and drawdowns as their most
important performance evaluators.
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