Using Regime Filters in a Strategy

What is a regime filter and is it useful?

That's the question we discussed on this episode - Michael and Dave have completely different approaches.

Here are links to articles referenced in the episode:
Why I Ignore The Overall Market When I Trade
Why I Avoid Overall Market Filters in Strategies
Is The Market Really More Likely To Continue As The Gap Is Bigger?

Creators & Guests

Host

Dave Mabe

Host

Michael Nauss

What is Line Your Own Pockets?

A weekly show for systematic traders who want to make more money from their trading strategies.

Michael: 00:00

Okay, everyone. Welcome back to another episode of Line Your Own Pockets. Today, I actually had to interrupt a conversation me and Dave were having in the green room there and said we gotta turn on the cameras for this because it was already getting a little bit interesting. We're answering another question that we got from Twitter from a gentleman called Day Trading Zoo, who is actually commenting on one of my videos about how to potentially change position size when strategies are doing well and doing poorly. And, yeah, as I mentioned, we were talking about as we're getting ready for this, we're already starting to have some disagreements and and chat about it.

Michael: 00:35

So I think this is gonna be interesting. So first of all, what do you think of the comment? And and then we'll kind of dive in from there.

Dave: 00:44

Yeah. I thought it was a great comment. It's a very common thing among traders, especially systematic traders, because there's a tendency to look at the overall market and figure out some correlation with a specific strategy. So for example yeah. I've looked at this a ton over the years.

Dave: 01:03

So I've I've was trading or still trade a gap strategy. So sometimes I'll go long with the gap, sometimes I'll go short with the gap. And there's a tendency for traders to look at, okay, well, let me just see what the overall market is doing, and maybe I'll turn off or on, the long side or the short side depending on what the overall market's doing. So it's very tempting to look at that and think that there's gonna be an awesome correlation and rule that you could apply to your strategy to improve it and, you know, the game's over. But it's much harder than, it seems like it should be, and there's a whole lot of caveats that come with it even if you find some way to logically turn off and on a strategy based on the overall market.

Dave: 01:55

So it's something I've thought a lot about, and I'm sure we're gonna have some agreements here. But

Michael: 02:02

Oh, yeah.

Dave: 02:02

So I'm curious about this conversation.

Michael: 02:05

I'm excited for it. Right? So just to really break down the question. Basically, the the the gentleman was saying he's a fully systematic trader. And what he's finding is that, you know, there's periods of time where some strategies would do well, and there's periods of time where some strategies do poorly.

Michael: 02:20

And was basically saying, when do I, you know, potentially size up in a strategy that's outperforming, size down in a strategy that's underperforming? Performing. And it's interesting because I think what our difference is gonna be when we're when we're having this conversation, and everyone has to keep in mind, is that Dave is primarily a day trader. Right? In and out well, I'd say exclusively a day trader.

Michael: 02:42

I am primarily a swing trader and and trying to branch out into the day trading world. So that's kind of the first differentiation I think you're gonna have to pay attention to because I my argument is going to be that someone who has back test and run a lot of systems, especially long only trend following systems, if you're trying to take part in a long only trend of a stock breaking out during 2,000, 2008, right, even, some 2022, 2023 action where the market was primarily down, those systems dramatically underperform. Where you have other systems like mean reversion type systems that dramatically outperform. So the complexity, and I think where the where the back and forth is gonna happen is the ability to predict when and if those things are gonna happen. So I'm gonna say that I am pro regime filter as long as we're talking swing trading or longer and as long as it's an easily definable thing.

Michael: 03:42

So for example, some of my trend following strategies will just say, if the S and P 500 is below its 200 day moving average, don't trade. Right? Now does that make sense to you? And that's I if you were more of a swing trader, is that something that you would kind of reopen your eyes to, or would you just still be dogmatic about not doing it?

Dave: 04:05

Dogmatics is a strong word there, but I think it's not that I'm fundamentally opposed to using a market filter. It's that I think with my strategies, I feel like I can do better than to resort to using a market. If I have to resort to reuse using a market filter or a regime filter, to me, that means the system that I've designed is too reliant on the overall market happen to be happening to be in some arbitrary situation for it to work. Mhmm. When I design a system, I want the signals to be strong and unusual.

Dave: 04:51

And if if for those to work, it needs the market to be in this precarious specific situation, then I feel like I haven't done my job in creating a signal that's strong enough. That that system should be able to stand on its own, and that signal should be strong enough and unusual enough to stand on its own without relying on the overall market to to be doing a certain thing.

Michael: 05:24

And from a day trading point of view, I think that makes sense. Right? Because when generally speaking, when you're day trading, you need your instrument to move, as you mentioned, in some sort of a way. So that's generally a news event, large volume coming in, a gap, something like that. When you're trading a little bit longer term, the correlations, I think, increase.

Michael: 05:48

So I I think I think basically what's happening is that you're looking for shock events that break the correlation between whatever instrument you're trading in the overall market. When it comes to longer term in nature, those shocks even out. Right? I don't care if you have, the best company in the world. You can use an Apple, for example.

Michael: 06:07

Right? It's during a bear market. There's going to be some some degradation there, which again makes perfect sense. Now the question I would have, again, from a day trading standpoint is what if the data was really extreme? Like, what if you had 10,000 trades in in your back test and you noticed if the market's gapping up, every single time you trade, it's wrong.

Michael: 06:30

And when you the market's gapping down every single and, you know, the data sets robust, it goes back in time, it goes is there any amount of, like, binary type data like that that you'd go, okay, there's definitely something going on. Or would you just say, maybe I should just trade the the overall market with the strategy?

Dave: 06:49

Of course. I mean, if I saw if I saw correlations that great, of course, I would use it. And the the the reason I don't is because those don't exist. And I've found more rules that I can apply to a strategy that that actually makes sense and are are very much correlated with the signal itself and, and have and make sense compare you know, when you consider the signal itself, which is a huge part of why you make a rule in the first place in a trading strategy. It has to make sense.

Dave: 07:26

It has to it has to tell a coherent story along with the signal itself. And to me, it's a it's a big leap to say, okay. The signal is such and such, but the overall market has to be doing this. That all of a sudden, that's not as a coherent story that I can tell myself and then I can really get behind for that signal.

Michael: 07:53

So And I think

Dave: 07:55

I think Of course. If there was if there was perfect data out there and and, that would perfectly correlate it with the system, of course, I would trade that rule, but that doesn't exist, and that's the problem.

Michael: 08:06

Well yeah. And I just asked that question just because, hey, I knew the answer just to show the audience that it's not that, you know, there there is some sort of a you have an aversion to it in some way. It's just that I like the idea of the story. And this is something that, I talk about all the time when I'm talking to traders who run back tests and do that is that you need to make sure that whatever you're adding to your system or subtracting your system, you could sit down and kind of explain to yourself. Like, it doesn't matter if the the numbers are saying, hey, you know, add a MACD to it.

Michael: 08:41

If you're like, well, it's not a trend. You know, it doesn't make sense if you can't justify it to yourself. So I think that's kind of the first thing to to answer this question is when do you size up and down on a position? Well, it shouldn't be kind of arbitrary based on the market. For my example of a long trend following system doing well when the market is trending higher, That makes sense.

Michael: 09:05

Right? Yeah. Leaning on a mean reversion or or pullback type system if the VIX is higher. That makes sense. Right?

Michael: 09:12

Because you're going to have more of that action. So if you're looking to size up or down in certain positions, I would say that would that looking at the individual filters would make more sense than looking at a regime filter overall for for day trading, which based off this username, I think he's talked about day trading. What I would think it would make the most sense to look at is other related patterns on when systems are, getting through these drawdowns. So for example, are you someone who's trading a lot of earnings events? And when earning season is more slow, right, there's not really a no earning season.

Michael: 09:51

It's like earnings always reporting. But there's times where there's a lot of earnings and there's times where there's a little bit. Is it something like that that makes more sense as opposed to what direction the market's doing or or what each individual name's doing?

Dave: 10:05

Yeah. I use, earnings filters in lots of my strategies. So that that's that that doesn't that doesn't fall into the bucket here of what I'm referring to of overall market, like what the SPY is doing today. Right. And and, you know, here's a question for you, Michael.

Dave: 10:22

You said in your example where you got a trend following system, you're holding many days, It's long. Of course, that's gonna be correlated with the market. The the more days you hold, the more it's gonna be the more it makes a coherent story to do what the market's doing, which is gonna overall, it's gonna be going up over time. Do you do any do you have any short trend following systems that you do something similar with? I mean, I I think that would be much harder since bias for the market is up the longer you know, the more you zoom out.

Michael: 10:56

Yeah. I've I have yet to find, a swing trading system that I like from the short side, because my thinking behind it is that not only do I need to find something that has a positive expectancy that I can back test for a long period of time, it has to make me comfortable with the overnight short risk. Right? Which, you know, everyone knows stock can only go to 0 if you're splitting your name, if you're splitting your portfolio like I do into 2015 to 20 stocks. If one of them goes to 0 overnight, that sucks, but it's not a massive unrecoverable hit.

Michael: 11:29

The inverse can happen where a stock I mean, look at the, like, drug or whatever happened recently. The stock went from a dollar to $50. I don't wanna do that. So for me to find something from a short side of things, I need to really make sure that I'm covering that additional risk with additional gain. So it's why I'm actually kind of interested, and and I'm sure we're gonna do more on this going forward.

Michael: 11:53

My my exploration back into systematic day trading, I'm interested for the from the short side, because holistically, that would make a lot of sense for me if I'm, specifically focusing on intraday shorts and then at the same time I'm doing daily and long term long positions. I think that would kind of hedge my overall life. But, yeah, I haven't been able to find. So for me and just to bring it back to the question, I think for me it's more of an on off filter makes way more sense than potentially a long short filter. So with this particular strategy, it is, again, simple, a weekly close below the 200 day moving average on the spy.

Michael: 12:32

Don't trade this strategy until it until it recovers.

Dave: 12:36

Yeah. Well, so if I were to use a rule like that, I would wanna go and test the heck out of it to see. I mean, that's not it's like a it's a question you can get the answer to. Right? You can do a back test and see exactly that.

Dave: 12:49

And when you do that, here's probably the main reason I don't use market filters. When you go and do that back test, and let's say you come up with a rule that says, okay. You know, VIX over such and such, turn the system on. You're gonna have weeks, months perhaps, where your system is not trading at all just for some arbitrary rule. There's gonna be trades that would have happened in there if you didn't have the rule that were profitable.

Dave: 13:25

But I'm just uncomfortable turning a system off like that based on what I think is a pretty arbitrary rule. And, you know, I want systems that trade frequently, every day, hopefully, and, that are not correlated with the overall market. So I you know, part of my process is thinking about that from the very beginning. And every rule I apply to a system, I'm thinking about that. I I don't want to have to look at the overall market.

Dave: 14:00

In fact, I don't even have a chart of the SPY or the overall market at all on my on my computer at any moment. People ask me, what the market did today, and I'm like, I don't know. I don't care. It's just it's just nice to be able to do that. Like, there's this other factor that I can it's not easy, but I've worked hard to be able to avoid that.

Dave: 14:22

Because the same sort of, discretionary decisions you make or you end up making and threw things up, I feel like I would do that with the overall market. There's always some sort of story you can convince yourself that, oh, the overall market's doing this. Better turn my stuff off or, you know, it's just it just all seems so arbitrary to me.

Michael: 14:47

Well, so for your example of when you turn a system off, it's no longer trading. But what if and this is I just use this because it's my example, what I do. You have other systems that will flick on during that time. Right? So the idea is to use your VIX example.

Michael: 15:03

You know, VIX over 20, I'm no longer trading a trend following system, but I replace it with this system instead. Or, again, like the question mentioned, maybe size up in different systems. Right? So, if it's not a binary on off, does it make sense or would you ever consider a maybe a risk allocation change? So, you know, I have 3 systems.

Michael: 15:28

Maybe I know these two systems work really well in gap down markets. So I'm gonna maybe apply a little bit more of my buying power to those and a little bit less of my buying power to this one. Does that make any sense to you? Or there's, you know, maybe you're you've got a limited amount of buying power. And if if the listeners are just envisioning like a pie chart, right, and that's your buying power and you're just opening up different parts of the buyer of the pie chart based off what you kind of see based off the volatility or or something that's occurring out there.

Dave: 15:59

So there's a couple things you said there that, in theory, if it worked out that way, yeah, that'd be great. You could have this magical thing where you you know, it it turned these on, but these off. Like, when you go and look at those strategies and do the analysis to figure out what that overall market filter would be in theory, you're gonna find that there's not one level that works perfectly for all the strategies. So there's not gonna be this one magical level. They're all gonna be very different when you look at each strategy.

Dave: 16:33

Mhmm. Which is another reason why is that really a coherent story? I don't think so. But and the other thing you said was, is there really a difference between sizing a strategy up versus back down a little bit, or a regime filter where you're literally turning something off and turning another system on. And to me, that's pretty much this exact same thing.

Dave: 17:01

Right? When you have a regime filter, you are sizing your positions differently. This the position size is just 0, right, instead of what the what it normally would be. So I think those are two sides of the same coin, and it's like I like you like you the example you posed to me about, you know, in theory, if you could figure out that this filter worked perfectly, would I be opposed to it? No.

Dave: 17:30

Of course, I won't be opposed to it. But in reality, I just have too much experience looking at these systems and and trying to find something like this that would work well. It's I I just there's so many downsides to to even finding one that works. There's there's trade offs there. So, I'm just being realistic about it, I feel like.

Michael: 17:54

So, the other question that I'll I'll propose because this is something that I actually heard. I was hanging out in the real test forms, which is we'll get to, you know, the back tester that I use. And they were talking there about potentially using something like the equity curve itself, as a sign whether or not to trade or not trade the equity curve or, to size up or down. Like, so, for example, I've heard people say I'm going to, you know, put a 50 period moving average on my own equity curve. And when it's under that, I'm going to flip that off and say, hey, it's not performing well right now and then flip it back on.

Michael: 18:33

That to me at least seems more systematic, but I really haven't thought too much about it. At first glance, I'm like, that seems a little wacky. I don't know if that makes any sense. But have you ever explored that in any way? The I guess, just to explain it further for the listeners, you you would run your back test every day as normal, and you would chart the equity curve of that back test, and you would you would put a a moving average on that chart.

Michael: 18:55

And when the back test looks like it's degrading and doing worse than what it does on average, you would either assign less capital or turn it off. And then when it looks like it's performing well again, you would turn it back on. Any thought to that? Or

Dave: 19:09

Yeah. I've actually I've actually wrote an article about this, several months ago. I'm totally opposed to the idea. Yeah? It doesn't make any sense to me at all.

Dave: 19:22

Like, these if you design a system well, the signals don't care what your equity curve looks like. Right? Mhmm. It's completely arbitrary, even more arbitrary than the overall market itself. So I it it just you know, we we talk a lot about keeping systems simple, just simple is better.

Dave: 19:46

This is a huge step in the wrong direction. You're you're you're shoehorning some arbitrary result into these into your system for no good reason. Yeah. It just seems completely arbitrary. It's sort of like, you know, you hear some people look at or think about freaks in their system.

Dave: 20:12

So if there's a certain streak, you'll turn it off. Like, if it does really well, maybe maybe you know, you know, it's not gonna do well likely in the future, so you turn it off or you reduce size. Yeah. Completely arbitrary. Like, if you look at the numbers, like, it's it's completely quantifiable.

Dave: 20:29

You can go test it and see if how streaky your strategy is and test it and see. And there's I found very little evidence of any streakiness that can be exploited in any way in any of my system.

Michael: 20:46

Yeah. I'm and I'm just gonna agree. I just thought it was it's interesting, but I'm gonna agree full highly. For me, it it kinda seemed like betting heads on a coin flip because the last 5 were tails. It's like there there's a human inclination to go, okay.

Michael: 20:59

Well, you know, this thing's occurred, but it's like that that coin flip is just as random as any of the other ones. So why why bet this? Because those those other, right, are going to rule out. We'll go, oh, look. It was black, you know, 10 times in a row.

Michael: 21:13

It's gotta be red at some point. You know, the martingale strategy, for example, and then all these things that we know that just mathematically just don't work over time. So I guess that would lead to and this is I don't know. Maybe this will be a giant, topic for another one. But there at some point has to be a kill switch for a strategy.

Michael: 21:32

Like, at some extreme level, there has to be I always like to bring up the example of the odds lot indicator. I don't know if I explained that already before, but back in the day, they could use this indicator and say retail's buying this stock, not institutions. And this was a very classic and and did well as a systematic trading strategy, then at some point, just stopped working. Right? Hedge funds and institutions caught on and just broke down entirely, and it will never come back.

Michael: 22:01

So I guess when do you know that that has occurred? And what is the cutoff? Or is there even something that you can use systematically to say my strategy is dead? It's time to move on. Or is it just something that you have to kind of just feel for a long time and have it draw down and go, okay.

Michael: 22:21

I need to I need to do something else?

Dave: 22:23

Yeah. It's so I went into a drawdown several years ago, which completely sucks, and it gave me the motivation to come up with completely different workflow for answering this question. And what I came up with was, you know, a way to optimize my strategies much quicker than I have before. And as part of that, I come up with a road map for myself for each strategy. So I have different rules that I apply to the strategy.

Dave: 23:03

And when I get to the point where I'm ready to go live with it, I don't stop there. I create a couple more rules that I sorta hold in reserve that I know I'll be able to go back to in the event that it draws down and I'll that I can apply to the strategy to improve it a little bit further, but reduce the number of trades in the system. And it's it's incredibly valuable because you avoid the situation where you feel like you're in a dead end and there's nowhere to go, and you feel like you wanna quit. When when a strategy goes into drawdown, you're kinda out of ideas. This avoids that situation because you sort of hold these rules out and and have a plan for it when a drawdown comes.

Dave: 23:48

So it's just a way a a way better way to do it because that decision you're talking about, turning a strategy off or abandoning it, that's a very difficult thing to do, and it's a very you know, a lot of systematic traders think you can avoid emotion, but this, that, the decision you're talking about right there is a very emotional decision. It's probably more emotional than any decision to take a trade or not in any on any given trading day. I mean, it's a very emotional system. That's you know, making that decision is it's almost like an identity crisis. Right?

Dave: 24:27

It's it's a very personal, very, difficult decision to make. So I wanna be prepared for that and sorta have a plan in place that I can go back to and sort of continue the optimization process for each system I have.

Michael: 24:44

Yeah. Makes sense? Yeah. And it's a lot that you know, there's the sunk cost fallacy with it. Right?

Michael: 24:48

I've spent so much time and energy building and refining and and trading and testing this that it's time to go. But I like the idea of always just holding something in reserve because what you'll find is as you become more systematic trading is that, you know, you're running everything as normal. That's just continuing to go, but your brain never stops. So you're always thinking of new ideas of ways things that you could do that strategy. So you kind of use if it ain't broke, don't fix it to to simplify it.

Michael: 25:20

I have, you know, you you say, okay. I've got these three ideas that I think could make the system better. But instead of implementing them right now, I'm gonna wait till, you know, the system is doing great now. I'm gonna leave it alone and just and let it work. And then if it starts hurting me in any way, then I'm gonna try rule number 1 and see if that fixes it and try rule 2 or rule 3.

Michael: 25:39

I guess the only thing is, like but if you could make the system that much better right away, that would have to be very tempting to just go and implement those immediately.

Dave: 25:49

Yeah. Well, there's a, before I forget, there's a great quote that, I just heard recently based on what you said. You you said, if it ain't broke, don't fix it. Mhmm. The quote I heard was from Paul Tagliabue.

Dave: 26:00

I think he was a NFL commissioner for many years. He said, if it ain't broke, fix it anyway. And that's a good way to look at your systems. It's you know, a lot of these decisions about when a strategy is ready to trade or not are very personal decisions based on your risk, based on the other strategies you trade, based on your experience. So there's not it's not gonna be there's not gonna be this right answer that you come across and that's the right answer.

Dave: 26:32

Like, you get the you get an a on the test. You're never gonna know that the rule you're putting in place is the optimal rule because it's that varies. It changes over time. It Mhmm. You know, based on your risk profile, etcetera.

Dave: 26:45

So, there is no right answer, which is what makes trading hard, but it also is what makes it fun.

Michael: 26:53

Well, that's yeah. Because it's as ever going problem. The last thing I wanted to I wanted to, just talk about when you were the statement you made previously about the emotions is that a lot of people I find that I've talked to more and more approach systematic trader trading because they say, I want to remove the motions from trading. And they also I think there's some perception that it's less work. And although I'd say it's way less screen time, I would say neither of those are are technically true.

Michael: 27:21

They're kind of true. Right? So the emotion of every single trade goes away because you're not there for it. Right? A system's handling it.

Michael: 27:29

But the emotions of still seeing draw downs and the ability to stick with the system even after a period of of of losses and things like that, there's still a lot of emotions that go through. You know, you you you look at your p and l at the end of the week and and maybe it's red. You there's a temptation to go in and change things and tweak things, but maybe you go back and you look at your system, you say this is just par for the course. It's just just what happens. Right?

Michael: 27:54

So you continue. So there's emotions there. Right? And then the work, although you're not sitting and staring at a 1000000 charts and hitting buttons to to buy and sell on every tick, the work is still there. Right?

Michael: 28:06

Still gonna take you, you know, probably maybe a couple some time in the morning to set it up and some time in the evening to review it. But then what you'll find is if this is something you're truly passionate about, you're always thinking about it. You're always, you know, wanting to come up with new ideas and learning new things and do all that. So, just because you mentioned that emotion there, I wanna say that in some respects, systematic trading removes emotions, but it just kind of puts those emotional decisions somewhere else. You have more time to make them, so maybe it's a little bit easier in that respect, but it just moves them moves them down the line a little bit.

Dave: 28:41

Yeah. I think you're exactly right. You spend a lot a lot less time making decisions during the trading day and a lot more work outside of market hours to, you know, design systems and think about them and which is which is easier. Right? It's you have all the time in the world after hours, and there's no there's no data coming in that you have to react in a certain amount of time.

Dave: 29:02

So it's it's a you know, for for a certain kind of person, that's definitely the right move, and it's a lot easier and, you know, more logical way to think about the markets.

Michael: 29:15

Yeah. It's less of a a pressure. I have to do this thing right now and more of, oh, man. I gotta sit, well, by my thinking spot in the woods for 2 hours and just, you know, contemplate what I do. So Yeah.

Michael: 29:26

But, yeah, still emotional. It's still, I'd say, the same amount of of effort required. It's just different. So, I just wanted to touch about that, and I'll probably do that a few times just because I I hear so much people saying, oh, I wanna get into systematic trading because I'm a very emotional person. I wanna remove that.

Michael: 29:42

I just wanna go, okay. You can change that, but, you know, you're still a human. So you're you're still gonna be emotional about certain things. It's just gonna be a little bit different.

Dave: 29:49

Yeah. Yeah. So one one I'm reminded I was just looking at my notes here, and I wanted to get in one more thing. Part of the reason that I feel this way about overall market filters is I've spent a lot of time a few years ago trying to come up with a system that traded the e mini, so the S and P e mini contract.

Michael: 30:12

Mhmm.

Dave: 30:13

And I looked at, you know, 20 years of 1 minute bars. And even when you look at that much data, my conclusion was, even then, like, every day is pretty unique when you look at a single contract. There's not I think there's a lot fewer patterns that generalize. So my my conclusion was, you know, it's even more arbitrary. Like, I I it made it clear that this is sorta arbitrary.

Dave: 30:49

There's not repeatable, common, predictable, profitable patterns to look at versus looking at the overall US equities and and trading a strategy based on that. So as part of that process of diving deep into that for a good while, it gave it a good effort. And there it wasn't like there was there weren't profitable strategies to find there, but they were they traded infrequently, and there wasn't a lot of data back to back up any specific setup because the days are and those setups are pretty unique when you drill down far enough. So it it became I don't know. It sort of got a little bit disillusioned with it because of the data was telling me that.

Michael: 31:39

Well, yeah, if you can't find an edge in the thing you're trying to make a regime filter off of, then it doesn't make sense for it to be a regime filter. And that makes perfect sense. Right? If I'm using, you know, if I'm trying to predict x using y, well, if I can't predict y, then I can't use it to predict x. It's just it just won't it won't make sense.

Michael: 32:01

But Yeah. And you can see how the how that would be different, which I think, you know, we we've just realized that the difference is basically just time frame. For me, you can see there's many historical bear markets that have happened through time, and they all, you know, first, the stock has to break down the 200 day moving average so that that would make a little bit more sense. But intraday, the market is more erratic, and I would just say it's because it's more efficient. Right?

Michael: 32:27

What we're trying to do is exploit inefficiencies in in some way. So if you're dealing with a market like the S and P 500, which has to be one of the most liquid and efficient markets on planet Earth, it's gonna be harder to do some sort of prediction on that. And then that's gonna be harder to kind of translate that prediction down to, to to using it as some sort of filter to help predict overall stock prices.

Dave: 32:48

Yeah. For sure. It reminds me of one other situation I wanna touch on, which is, so in my Gap system, you know, looking what the overall market does, thinking about turning off the longs or turning on the shorts based on what the overall market's doing, and, say, like, the gap in the overall market, it was completely arbitrary. Like, you could you could come up with a story that said when the the spy is gapping up, well, longs are more likely or less likely to work, right, if there's a big gap at the spy. And some days, the longs would work better.

Dave: 33:32

Some days, the longs would work worse. And, you know, sometimes when the market gaps up, it fades. Sometimes, it continues. So it all, like it it just seemed to confuse things a lot more and not really bring clarity to any sort of rules. So it just again, just more arbitrary arbitrariness that seem to overcomplicate the systems.

Michael: 34:00

Yeah. So at the end of it, it's got to be a story that you could explain in some way. I remember when I first started to learn to trade discretionarily at the prop firm, the one of my mentors always said you should be able to explain your trade to a 5 year old of why you bought and and why you sold in some way. And it's kind of the same way. If you're saying you can't explain why this particular filter would make sense, you you could make, you know, 5 different stories, and they'd all end up making sense of what you're doing.

Michael: 34:30

Well, then you you haven't really achieved that goal. You haven't narrowed that you haven't narrowed that in place.

Dave: 34:37

Yeah. I like that that concept being able to explain it simply to 5th grader or maybe even better, like a skeptical trader.

Michael: 34:47

Mhmm.

Dave: 34:48

I think that would be a good person to have to explain it to. And if that person doesn't think it's a a coherent story, then you should probably think twice about the rule.

Michael: 35:02

Well yeah. And he would, this particular the the gentleman who ran this prop firm, he would do that. He would walk up and tap you on the shoulder and he'd point in a position. He'd say, why you're in there. And if you couldn't very succinctly explain, well, you know, stocks capping up, it put in this tight opening range, I think the news is good and blah blah.

Michael: 35:21

If you couldn't do that within a couple seconds, he'd make you close it down and go home for the day. So end up being a pretty good, teaching tool as well because he could it was very easy to enforce. So it might be an interesting exercise for yourself if you're building a system, you know, try to explain to the wife who, you know, or someone you know who isn't familiar with the world and say, oh, I think I it makes sense. This is why this is why I'm trying to do this certain thing because, right, you know, the stocks get too oversold and people think it's a good price and they buy them. And right.

Michael: 35:53

That's my mean reversion system or the stock did very well last week and it's pulling back this week. That's like a pullback system. Right. These type of things that you could look at, in order to make sure that whatever you're doing kinda has some sort of cohesive sense.

Dave: 36:09

Yep. Yeah. I love it. Alright. Alright.

Dave: 36:11

Is that a good place to wrap it up here, you think?

Michael: 36:13

I think that's great for this week. I start to hear a child screaming in the background. Absolutely. It's just part of my life as a stay at home dad with a sick kid. So I think it's probably a good time to wrap it there.

Dave: 36:25

Okay. I've got a couple links to some articles I've written for my newsletter that, apply to this topic. We'll put those in the show notes. And, yeah, I I love this topic. I think it hits home for a lot of traders because I I know that as soon as you start to think about a system, you're eventually gonna consider this.

Dave: 36:46

So I'm glad we covered this topic, and and I think we covered it well. And thanks to Day Trading Zoo for the question to make us think about this topic. So, yeah, I appreciate that.

Michael: 36:56

Yeah. We always appreciate all the user feedback we get because we read it, and sometimes it it helps us, figure what to talk about this week. So I love it because, yeah, it made both of us kinda chat about it and then think and then bring it to you guys. So thank you all for tuning in, and I'll talk to you next week.

Dave: 37:13

See you next week. Don't line your own pockets.