Look out for skewed trades

Strategies might be attractive on the surface but fail moving forward. Why? Here we discuss the qualities of effective trading strategies, and the many traps one should avoid.

Look out for skewed trades

Postby Overload » Wed Feb 22, 2006 2:47 pm

This is one of the more common reasons behind a curve-fitted trading system, but skewed trades occur when a few exceptional trades create too much influence in the overall returns. For example, suppose there is a trading system with most trade returns yielding about 5%. But there is just one exceptional trade yielding a 650% return. The trading systems shows a strong 25% APR, but a closer looks shows that it’s this one exceptional trade making all the difference. And without the one exceptional trade, the APR might be just 6%.

There are numerous options for identifying skewed trades. In the Detailed Analysis Charts, the Trade Returns Sorted chart shows a helpful graphic distribution of the trades. The Skew value can also be viewed on the Performance and Summary tabs, where a high Skew number can provide an indication of exceptional skew. As well, the Select Net Profit number, available on the Performance and Summary tabs, shows what the profit would have been without trades that are more than 3 deviations from the average. Thus, a Select Net Profit significantly different than the Net Profit value should generate a red flag.

Skewed trades typically have a small likelihood of being recreated in the future, and therefore are an indication of a trading system that also has small likelihood of performing well into the future.

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