What does not kill us can serve as excellent evolutionary opportunities as traders. 2012, despite its harsh challenges, brought forth the UVXY volatility model. After making necessary adjustments, the model has scored well over its last 4 signals. It is a volatile model so small positions are essential
Q: You place importance on back testing. What in your opinion is the proper way to back test a trading idea?
A: The most important rule in developing a trading strategy: Do not make postdictive errors by overfitting the curve, then your system predicts the past but not the future.
Backtesting is necessary but:
1) Make sure you test in completely different eras to insure your system is robust.
2) Understand why the worst drawdowns occurred in your system. See you can fine-tune without overfitting the curve.
A sound strategy must have inherent logic behind it.
Understand that markets are fluid and subject to inherent change so in exercising your strategy, always understand why it's misfiring. If it is just a temporary aberration in the market, then no fine-tuning is necessary. Some make the mistake of fine-tuning when it is unnecessary, such that when conditions return to normal, their trading strategy no longer works as well as it did, or fails to work at all.
The markets of 2011-2012 have been unpredecented in terms of trendless, gap-up, gap-down volatility, thus long standing market veterans with top trading records have been collectively down in both years, an unprecedented occurrence: http://www.automated-trading-system.com/trend-following-wizards-september-2012/
That said, our Market Direction Model well outperformed the major averages in 2011 https://www.virtueofselfishinvesting.com/results and while 2012 is the toughest year in the long history of the model, new trends begin when least expected. Because I understand this intellectually and emotionally, it allows me to take the bumps and bruises along the way without abandoning my model.
Q: Have market conditions changed for good?
A: Some question whether conditions have permanently changed due to high frequency trading, dark pools, and the like. My response is that historically, when many think "this time is different", new trends always begin. It is a matter of being patient. It is a matter of withstanding the drawdowns. It is a matter of understanding the risks associated with the strategy so you can position size without exiting your position(s) prematurely.
My models trade in real-time thus are quick to recognize if a material change has indeed occurred in the markets. 2009 was one such year due to the advent of quantitative easing, thus the model accounted for this and was able to perform well in the periods that followed.