In this episode of 2Traders Podcast, Walter and Darren examine the parallels between trading psychology and Boyd’s Law of Iteration. You will see what this is and this law effects your trading decisions.
Darren and Walter talk about the real essence of testing and why this is important in terms of finding that “perfect” system for you. Walter talks about the 80-20 rule, being open to changes, and tips for going through your testing phase. Darren takes the “engineering” point of view for finding your best trading system.
Also, you will see the similarities between writers and traders. All this and more in this episode…
Download (Duration: 18:15 / 20.8 MB)
In this episode:
00:55 – World War II
02:15 – inferior planes
04:17 – meat of strategy
06:05 – be nimble
08:07 – flashes of inspiration
11:09 – ditching an idea
13:25 – perfect solution
15:11 – old stuff
17:23 – used and new
Walter: In the beginning when you’re building the system there is no award for sticking to your original idea. Don’t do it. Throw it away, tweak it, change it…
Announcer: Two Traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome back to Two Traders. It’s Walter here. Hello, Darren.
Darren: Good evening, Walter.
Walter: I’ve come across this idea and I’ve been thinking about it only just in the last couple of hours actually but I really like it and I think it is applicable to trading. So, I wanted to share it with you and get your thoughts.
This is the Boyd’s Law of Iteration. I’ll put in the shownotes some links so that listeners can read more about it but the basic idea is — I guess this was World War II. It must’ve been World War II right? I am not good at war stuff. So, there’s these two planes, the MiG-15’s and F-86’s. I am pretty sure they’re on World War II but I could be wrong. So, Colonel Boyd, he was interested in these airplane fights or dogfights between the MiG-15’s and the F-86’s.
Now, the MiG-15s were the enemy planes and they were faster. They could climb faster, higher. They could make sharper turns and they had better distance visibility. They could see better but the F-86s had better side visibility and they also had hydraulic flight control which is a fancy way of saying that the stick that the pilot use in the F-86 was hydraulic. It was easier to move around.
Whereas, with the MiG-15, it wasn’t hydraulic and it took more effort so it’s like power steering versus — have you ever driven a car that doesn’t have a power steering? It’s a big deal, right?
Walter: So, that’s basically it and so in the dogfights up in the air, even though the MiG-15s were in essence were superior plane and almost in every respect, the F-86s would win 9 times out of 10.
The question was, how is it that these inferior planes actually win more often? Why is this the case? It turns out that, obviously, it took more energy to get the plane going that the MiGs to get them actually going but once the pilot got them going. It was great.
And so, the F-86s were way a little bit more quicker to react because you can get the plane going where they wanted and they weren’t as fatigued over time. Whereas, the MiG pilots were much more fatigued.
There’s a couple of thoughts about this and when you read about this — and again, like I say and I’ll put a link in the shownotes for people to have a look but people think about this idea which is Boyd’s Law of Iteration is “Speed of Iteration beats quality of iteration.”
So, the speed of the pilot in the inferior F-86 beats the quality of MiG-15 airplane, that’s kind of the idea. For testing like, let’s say that you are testing a trading system — and that is how I see this most applicable. So, if you’re testing a trading system, you should test in units that are small and fast.
So, maybe you’re going to test in units of a 100 trades on every currency pairs and see how things look. I wouldn’t recommend that anybody just test a system on the Euro and then if it doesn’t work out, throw it away.
If you’re going to trade on 25 different pairs, test it on the 25 different pairs but just take a 100 trades, boom! And then, file it away and then go on to the next pair. What you are trying to do here is build up some experience with the system and see how things are going.
I think that this idea, the speed of iteration, is a really good idea in a testing phase but when it comes to live trading, I think that this can get way out of hand and can run you into poor house, really, but that’s my thinking along Boyd’s Law of Iteration, Darren. Do you have any thoughts on this?
Darren: Is this kind of saying that the stuff that’s obvious and comes quickly that is going to be the meat of your strategy? If you’ve got to do 20 years of testing to really find out the good elements, then they’re probably not that good anyway. Is that what we we’re saying?
Walter: Yeah. And, occasionally, I’ll hear from a student-trader who’s going through their testing and they’re saying, “I’m just not comfortable with my win rate on the Big Shadows” or whatever. I’ll say, “Look, you’re missing the point here.”
You are missing the point. The point of backtesting is not to get your win rate as high as you can. The point of backtesting is to confirm that this system will work for you. That you can make it work, historically.
Exactly what you’re saying, Darren. It’s the 80-20 rule. You’re going to make 80% of your profits from 20% of your actions. If that means 20% of your trading systems, that means 20% of the decision points when you’re deciding whether or not to take a trade. It’s the big 80-20 thing. I think people can get — perfectionists — can get caught up in this idea of trying to make it perfect, trying to make it right.
I don’t think that’s really the way to do it. What we need to do is exactly what you say. Sort of be quick and understand that there are very simple, obvious cuts that you can make to your system that are going to give you big gains. Worrying about perfecting it is not something that you should be doing it. It’s not really critical and it’s the road to over optimization like curve fitting. That’s how I see it.
Darren: Yeah. Just looking at Boyd’s Law of Iteration now and it’s functional specifications of best when they are concise and evolving.
Walter: I think what this means is that when you are in your testing phase, when you’re creating your system, you should be nimble and you should be open to changes. For example, in the beginning you might say, “I am going to use an exit where when the moving average, the slope of the moving average changes, I’ll get out of my trade”.
But, maybe you’ll find later that instead of using the slope of the — so if you’re in a buy trade, and the moving average ends up pointing down, then the trade is over, right? So, that’s your trailing exit.
Some people like to use that as a trailing exit but you might find instead of using a different trailing exit, where you just find the lowest low of the last three candles, and you just trail your stop below the lowest low of the last three candles and you’ve got stopped out that way.
You might find that one of them makes more sense to you and so just dump the other one immediately. The other thing is what if you find — midway through your testing like testing out the system and you’ve tested 50 trades and you’re going to make it to a 100 — you find another idea.
You’ve got this other idea. Well, go ahead and do it. Do it. Now is the time because what you want to do is sauce out all of these stuff in the beginning of the testing phase so that you’re not tweaking things when you go live.
That’s how I see it because I think tweaking things when you go live is a huge mistake. I think it ruins a lot of traders. It ruins a lot of trading systems. You get to the point where you do all these testing and then you’ll go live and you’re trading something totally different that you’ve never tested.
So, I think that’s the thing that I’m hanging my hat on the years. It’s okay to fail early and often when you are testing. It’s not okay to do that later. Later, losing trade is fine but that is not failing.
Failing is coming up with a trading system that stinks. You do all that in your backtesting phase when you’re in your research phase. That is how I see Boyd’s Law of Iteration apply here. You are being fast and nimble.
Darren: Yeah. When you’re building a system, if you get a little flashes of inspiration in the process, you shouldn’t stop your rules. You should, “That looks interesting” and you should run with that a little bit and that is how you’re going to find the good stuff. Is that what you’re saying?
Walter: Yeah or at least branch off. You’ll go, “I like this moving average exit where when the moving average turns the other way, I’ll get out of the trade but I also like this idea of using the last three candles so I can test them against each other. So, runs through like a horse race and see which one wins and I run the same trade but then I have two different exit or whatever. “
That’s the time for this. It’s all in this testing phase. It’s the creative phase of trading that I really love. And so, that’s where I think traders get into troubles because they get so bored when they go live and then they want to get creative once they go with their live trading, at least from what I’ve seen.
That can be the tricky part. I think that is why testing is an important part of trading even though you’re not really risking money in your testing phase. You could be, as suppose with the testing account, but I do most of the beginning stuff in forex tester.
That is where you need to be nimble, that is where you need to fail, that is where you make these quick changes. All that stuff is going on really early because once you get going with the system and it goes live, you’re going to be bored because you’ve done it so often and you don’t want to have this unexciting changes during your live trading phase.
Darren: I mix the live and the backtesting together at the same time when I’m working on a new system. I run it live in real time and then, in between that, I’m backtesting as well — obviously with the pennies accounts so it’s no real money at risk but I am getting that experience of time going by and that to wait.
I run and backtest as well and then evolving it and dropping certain ideas and adding new ones too. I find that works really well for me.
Walter: Just a question: when you do that, what percentage roughly would you say of the systems that you do that for and you just end up scrapping them out and throwing them out of the window?
Darren: 9 out 10.
Walter: So, it’s not just me. Okay, good.
Darren: No. And usually, the end system that really starts to click and gets some real purchase is way, way off where I started. It’s like a completely different system. I did one recently where I was looking at price returning to specific levels and then I worked on a specific entry system at those levels.
That entry system became like a bracket entry and then eventually the whole levels element was dropped completely and I just ended up with just a bracket entry. That’s a go-through like week after week of ditching a complete idea and just being left with the one element that was looking good until you end up with something like a complete system.
Walter: It’s funny that you say that because I was part of this group and they were testing this indicator-based EA. I saw these emails flying around and stuff. I wasn’t actually doing it but I saw what was going on.
They were saying based on this indicator because it was like giving them great signals and then in the end they said, “Well, when it changes so it’s like a hedge thing, you hedge it or whatever.”
They were going to test it and see how it goes. They came back and they said, “Okay, the good news is there’s good news and bad news. The bad news is the indicator gave us no edge. The indicator was no good but the good news is this hedge strategy actually works quite well.”
So, they renamed the EA and everything where before it was called something different, now it was like the hedged-whatever. It’s just really funny how, exactly what you say is so true. You start with an idea and then the end result is completely — it’s not even like a cousin, it’s not even related at all.
Darren: I saw a similar thing with regards to engineering where they discovered that when you’re trying to come up with a new solution to a problem rather than saying the example they gave, they were trying to make some sort of nozzle that sprayed a chemical that then turn into a powder.
Their initial approach was to say this is the right sort of shape for a nozzle to do this. This is the perfect opening and this is the perfect temperature to do that and they did all of that and it was crap. It didn’t work at all.
The other approach was just to say, “Just make it any shape and then squirt it through that, see what it does. Okay that was good but needs to be finer so we’ll make it a little bit smaller.” So, they just went through a series of trial and errors.
Each stage, they chopped away the bit that wasn’t working and very quickly they found the perfect solution. I think that’s the same thing, isn’t it?
Walter: It’s exactly the same thing and I think that this is the approach that you should take to your backtesting. Don’t feel like you’re tied to your original idea, as Darren and I have just talked about. As these engineers have discovered, it’s not about some sort of… You’re not going to win an award for sticking out to your original idea and testing it through all the currency pairs and doing that whole thing.
There’s no stamina award for the trader that backtest a system that’s crap into the ground. That does not count, right? The point of backtesting and the point of the creative phase of trading is to figure things out, tweak them quickly, and be really active in terms of what you cut. That sort of thing.
There’s an old adage for writers, it’s that “Most of writing is editing.” Most of what you do as a writer is you edit because you get all these stuff down, you write all these stuff, and then you end up just cutting stuff out.
You’ll write 80% and then cut some out. You write 100% of the blurb, then you end up re-arranging and cutting out 80% of it because that’s what writing is all about and it’s true with trading too. This idea that in the beginning when you are building the system, there is no award for sticking to your original idea. Don’t do it. Throw it away, tweak it, change it.
For example, I like to trade Kangaroo Tails and I say that the Kangaroo Tails is when the open and close of the candle from bullish Kangaroo Tails is in the top third of the candle. That doesn’t really matter. It could be the top 25% or top 20% or whatever.
Change the parameters. Change the things that you originally start with and see if that makes sense and it’s okay. If it looks like they should be something better then roll with it, throw away the old stuff. That’s the main point. I guess that hit me when I’ve read about this Boyd’s Law of Iteration.
Darren: I experienced it myself this year. I changed the way I decide my positions size and manage my money and it made a big difference to my trading. I can’t put my finger on exactly what’s different but it seems to be working better.
It was an idea that I fought against for a long time because I had it in my head that my way of doing it was the best way to do it. In the end I just took the idea onboard and it just started to work for me.
Walter: That’s pretty cool. Is there anything that you think that this would not apply to you, these quick iterations? I think it applies to a trading system that you’ve gone live with, that you believe in, that you’ve tested. I think that’s when we throw this Law of Iteration in the toilet like that, doesn’t work then. Do you agree that it’s a pretty good principle?
Darren: I think so. Generally, you should always be working on new systems even if you have a system that’s working because that may not be suited to a particular market condition or you might just be passing up the opportunity to find something that works better.
I wouldn’t say that I’m continually looking for new trading systems not half as much as I was but I’m always questioning what my beliefs and particular system. Just always keeping an eye on, “Okay, this is how I manage my trades but, what’s happening in the background if I’ve been managing them in a different way?” I’m always keeping my eye on that.
Walter: I think that is a good way to go. I like thinking about the traders on the other side of the trade. Like, when I take a trade, it’s kind of like the same idea. You don’t want to get stuck in that cycle of just paying attention to stuff that you keep patting yourself in the back and say how good you are. You really don’t want to get into that thing where you’re just… You are only looking at stuff that supports your point of view. I think you need to look at the other stuff.
Darren: Yeah and you need to be careful not to be confusing used and a new innovative idea and just changing your system because you had a bad week which is the trap you could fall into. You have particularly bad week and you suddenly decide that, “Oh, it’s to do with this.” You change your system based on a loss, basically.
Walter: Yeah, absolutely. That’s the one that sends everyone. That is the hamster wheel that you just never get off. Once you start doing that, it’s over. Alright, Darren, thanks so much for your time. I really appreciate it and we’ll see you in the next episode.
Darren: Cool, Walter. I will see you next week.