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Three ways to recover when your trading system fails

Three Ways To Recover When Your Trading System Fails:
👉 Start internally – Are you trading on a hunch?
👉 Look at the markets – Figure out what the markets are doing.
👉 Shift gears – Slow down your trading, or scale down your positions. Read on...

A forex trading system forms an integral part of a trader. It is the core around which everything else culminates.

A trader may have one or a few trading systems that they may use. This depends on the markets they are trading (forex, stocks or indices, and metals).

But every now and then, traders come across a scenario when they feel that their forex trading system is failing them. It can be identified by moments when your stops keep getting hit constantly.

The trading system failure may also come on the back of winning trades turning into losing trades. These strings of losses can create doubts in a trader’s mind.

Has the trading system stopped working? Have the markets suddenly become aware of this “trading system”?

In times like these, most traders just discard their existing strategy and move on to hunt for a new one. This can repeat itself again, leaving a trader high and dry.

Does it beg the question as to whether a forex trading system can indeed stop functioning? How does this happen and why does the trading system fail?

Is a trading strategy similar to an object such as a car or an appliance that comes with an expiry date?

Are you such a trader who has experienced trading system failures? If yes, then this article digs into the reasons why a trading system fails.

We will also discuss the ways how you can recover when your trading system just stops working as it used to. By the end of this article, you will learn how to recover from your losses when a trading system stops working.

Why do trading systems or strategies fail?

To answer the question of why trading strategies, fail, you need to understand what it is in the first place.

A trading strategy is merely a combination of indicators. Of course, depending on what trading system you are using, it may be mechanical or discretionary. Still, the common element to all trading strategies is that there are a set of rules in place.

These rules are based on the conditions and determine when to buy or sell.

For example, when you see two moving averages making a bullish crossover, it is a signal to go long. Sounds simple, doesn’t it?

Yet, why do such strategies fail?

Is it because moving averages are no longer applicable? That is not the answer.

A trading system can fail because the markets are changing.

Trends in the currency markets do not remain trending all the time. They shift from periods of trending market movements to periods of ranging or accumulation.

When this happens, the technical setup of the market can fail.

And you can notice this regardless of whether you are a swing trader or a day trader. Just because the markets are shifting, does not disqualify your trading strategy.

It simply means that you need to change your style of trading.

Going back to the above example, a moving average crossover may not work when the markets are ranging. Does this infer that you should discard moving averages completely? That would be incorrect.

A better approach is to take stock of the situation. You should decide whether you need to change your trading strategy or stop trading until the markets settle into a trend.

Three signs that your trading system is failing you

Even before you get to the point of writing off your trading system, the signs are evident. The below three points will help you stay more cautious when it happens.

A trading system failure does not happen overnight. It is a culmination of a series of losing trades, over a period. Hence, if you are aware of what is happening, you may be able to take action early.

This will help you to prevent losing capital a lot quicker and will help you to nip the problem in the bud.

#1. The markets go against your bias on a consistent basis

You may not notice this in the beginning. And many times, this may also raise false flags.

The main gist behind catching a trading system failure early on is to pay attention to your trades. It is important to have a post-trade analysis to understand what went wrong.

The best way to identify this and eliminate false flags is to have some statistics in place. Knowing how many losing trades your trading system generates is important. This will give you a good estimate of whether the current string of failures is in line with the strategy or whether this is abnormal.

The sooner you identify the cause of your losing trades, the better it is for you to act upon it.

By default, when your trading system triggers two consecutive losses, you should immediately scale down your positions. This will ensure that if there is a high probability of a losing trade once again, the losses are minimized.

Greed can play an important role during this phase. The moment you hit a winning trade; you are tempted to increase your position size. This can lead to a false sense of illusion. You need to have at least three consecutive winning trades before scaling up.

Hence, in this context, having a grasp of your trading strategy statistics can help you in the long run.

#2. You are consistently overtrading to recover the losses from previous trades

During a trading system failure, you will notice that you are overtrading.

Overtrading is when you take on an unusually high number of trades. Overtrading happens for two reasons:

  1. You are compensating for the losing trades and hope to overcome this
  2. You are changing your bias all the time. So, when your long is stopped out, you switch to a short position and vice versa.

This constant back and forth of the trades can easily eat into your trading capital. Traders will often notice that this will happen subconsciously. Hence, the sooner you realize this is happening, the better it is for you to clamp it down.

Overtrading also increases the costs of your trading. You end up paying spreads or commissions on trades that are losing. Eventually, it will erode your trading capital steadily.

In the end, you are left with an almost wiped-out trading account.

#3. You end up having multiple positions open

Do you usually stick to one or two open positions? Keeping track of how many instruments you trade is important. It is also essential to understand how many open positions you have in your trading account.

Keeping too many positions open will increase the complexity of risk management.

Furthermore, if your positions are based on a bias in a single currency, it can be even more dangerous.

For example, you may have multiple positions on different instruments open. But the common factor to all these positions is that you are net long or net short on the USD. Or any other currency for that matter.

As long as your bias is right, you may not have to worry about anything. But on the other hand, if you are proven wrong, it can lead to multiple losses.

From the above three points, you can see how things start to build up. Eventually, it comes to a point when you just give up on your trading system.

Three ways to avoid a trading system failure

It is better for a trader to identify the phases behind a trading system failure.

The sooner you realize this, the easier it is for you to handle the situation. After all, to draw an analogy, your trading capital is like fuel to a car.

Once you exhaust the fuel, you will not be able to drive the car anymore. You will certainly have to refuel. But if you do not have any additional capital to risk, then it marks the end.

Hence, traders should always stay cautious when trading. Paying attention to the losing trades can be greatly beneficial for you in the long run. It will help you to take preventive measures to avoid blowing up your forex trading account.

Here are three ways you can avoid a trading system failure. It will help to rescue yourself from a potential blow-out and help you recover.

#1. Start internally – Are you trading on a hunch?

The first place to start is by figuring out how you are trading.

Are your long and short positions coming because of your trading bias? Do you perhaps have some gut feeling that a certain currency is going to rise or fall?

Trading bias plays an important role even if you are strictly following your trading system. On a subconscious level, it will push you into making decisions that validate your bias.

As a result, traders end up looking for validation of these biases. Hence, wrong trading signals are picked up, only because they qualify one’s bias.

Having a conviction about what the markets are going to do is a gamble. You can either be right, or wrong.

In most cases, if you do not have enough familiarity with the markets, you will be proven wrong.

If you notice this, then the best way to deal with your bias is to have a reset. This means closing out all your trading positions and taking a break. Do not follow any market news and do not keep track of the markets.

Disconnecting from the currency markets for a certain period of time will help you to remove that internal bias.

Once you have the reset, you can then begin to approach the market with a fresh mind. This may seem simple. But the fact is that your internal bias or opinion about the market shows in your trading decisions.

#2. Look at the markets – Figure out what the markets are doing

John Maynard Keynes famously said that the markets can remain irrational, much longer than you can remain solvent.

If you try to understand or justify the reasons behind the market movement, it can take you a while. Sometimes, it just won’t make sense. There are times when the forex markets tend to defy logic.

The direction of the currency pairs can change in an instant and continue to move in a new direction. Retracements, which are common in the financial markets, may not happen and it leaves you wondering.

There are also times when the markets end up doing nothing. To understand this, you will need to look at the seasonal behavior in the markets. For example, the summer months are when the markets trade directionless.

Trading activity also slows and becomes a lot more erratic toward the end of the year.

Understanding such characteristics in the forex markets can help traders. It is not the problem of the trading system, but it is the markets behind it.

The next time you find your trading system failing you, take a pause and check what month of the year are you trading. This will clearly point you to clues as to what is happening in the markets.

One should also look at the economic data such as keeping track of the news events. There are periods of a lot of activity and periods of slow activity. This will answer the question as to why your trading system is not working as intended.

#3. Shift gears – Slow down your trading, or scale down your positions

When you notice that your trading system is slowly losing power, the best thing to do is to slow down yourself.

You can do this in different ways.

  • Reduce the contact size of your forex positions when trading by half
  • Leave your real trading account and switch to a demo account temporarily
  • Have at least three or more winning trades before powering up

Among the three, the first thing you should do is to move to a demo trading account.

Traders often think that a demo trading account is for beginners. But this is not the case. A forex demo trading account is like a sandbox.

It helps you to experiment and use it as a practice ground for your trading. Using the demo trading account, you eliminate the risk. But on the other hand, you can continue to remain involved in the markets.

Traders tend to jump to another trading system the moment they hit a string of losses. But this is not the answer.

You should continue with the trading system or use one that is more suited for the current market conditions and keep up with it.

The demo trading account will act as a buffer between you and your trading capital. By eliminating the risk of losing money, the demo trading account helps you to build back your confidence.

Once you start seeing results, you can then slowly move back to using your real trading account.

But do not jump right in! Test the waters by using the smallest contract size you can trade and build upon it steadily.

Recovering from a trading system failure – Final thoughts!

In conclusion, the most important takeaway is that traders should not discard their trading system at the first signs of failure.

This is assuming that you have been using the trading system for a while.

As a trader, it is important that you keep track of the performance of your trading strategy. It will help you to understand your style of trading better.

Statistics can play an important role especially when it comes to troubleshooting issues such as this.

Although many forex traders may not realize, psychology plays an important part in trading. No matter what trading system you use, the results differ from one trader to another.

Forex traders tend to blame their trading strategy rather than anything else. This is because it is easy to jump from one trading system to another.

But by doing so, you end up losing consistency. A new trading system takes time to get familiar with.

Many traders think that a trading system comes with an expiry date, but this is not the case.

The markets you see today, are the same as they were a year or a decade ago. Trading strategies are a simple derivation of the underlying price. Therefore, having this mindset about a trading system not working after a period is wrong.

The sooner one changes the mindset, the better it is for you as a trader to realize the actual problem and address it.

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The information provided is of a general nature and is not intended to be personalised financial advice. The information provided is not intended to be a substitute for professional advice. You may seek appropriate personalised financial advice from a qualified professional to suit your individual circumstances.

Trading in Rockfort Markets derivative products may not be suitable for everyone as derivative products may be considered as high risk. Please ensure that you understand the risks involved. A Product Disclosure Statement can be obtained here and should be considered before trading with us.

William B.

July 22, 2021

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