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The Costanza effect
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The Costanza effect

  #1 (permalink)
Elite Member
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The Costanza effect

Nearly all strategies I've back tested in NT return negative results. Often the direction predicted ends up being correct, but I'm either stopped out or the exit is triggered before I make any money. Also, the percent profitable is low even when the strategy turns a profit, resulting in BIG draw downs.

I was thinking about this the other day while watching a Seinfeld rerun. George was complaining about his life as usual and Jerry said: "If every instinct you have is wrong, then the opposite would have to be right." Not only that, but I had just finished reading the "Turtle Soup Strategy", which counts on the Donchian channel breakout to usually be the opposite of what the Turtle Strategy predicts.

I edited my strategies in NT: where I initially went long I went short, where I exited long, I exited short, etc. ALL of the strategies, each and every one, went from losers to winners. The attachments (sorry for the poor quality) are of a Twiggs Money Flow zero line cross strategy. Before "Costanzanization" the best profitable percent was just under 40%; after, the worst was nearly 61% (data is EOD).

The attachments back tested to 2002 if I remember correctly. I checked other time periods and the Costanzized strategy outperforms the original. I checked most of the other strategies I created with similar results.

Weird. Like the SMA crossover: Go Long when 10 dma crosses below the 20 with price below the 200 outperforms by a wide margin the 10 dma crossing above the 20 and price above the 200.

I'm very interested in hearing everyone's opinion on this.

Not wanting to get all tin foil hat on this, but one theory I have is that, for most simple strategies, everyone is doing the same thing. Knowing this, professional traders set traps for folks like me.

What do you think?

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The Costanza effect-twiggs-before.png   The Costanza effect-twiggs-after.png  
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A strategy with no edge will not produce consistent profitable results, no matter if you do the opposite or not, just keep this in mind.

That said, there are some logical reasons to do the opposite of what comes naturally.

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Ghostland View Post

Weird. Like the SMA crossover: Go Long when 10 dma crosses below the 20 with price below the 200 outperforms by a wide margin the 10 dma crossing above the 20 and price above the 200.

The reason is if you buy when the 10 dma crosses below the 20 and sell at the opposite, it means that over time you are buying low and selling high, make sense? It works the same for combination indicator systems, e.g. buying when the rsi is below 30, the stochastics is below 20, and the MACD is below the signal and 0 line, will work better over time than selling. But there is no edge to these types of systems after you factor slippage, commissions, and lack of consistency (see draw down figures).

If you want to build a mechanical or automated system, focus on real time price action, e.g. price in relation to moving averages, pivots, highs, lows, etc., and filtering based upon times of the day, current market sentiment, significant news events, etc. Just understand, even if they are profitable over time, most mechanical and automated systems will still have periods of significant drawdowns.

Also, make sure that you are testing your systems correctly. Here is a link to a video that explains it pretty well. You have to register for a free account, but if you are just starting out, I highly recommend you watch it before you spend a lot of time on this.
The Truth About Drawdowns - Trader Kingdom

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I always try this with a failed strategy, but every time I recall it's also failed in reverse. When that happens I conclude the entry criteria is no better than random and the money management can't overcome the slippage of having no 'edge'.

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Thanks everyone.

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