Key Exhaustion Benchmark

Importance of Benchmarking
As traders, we can sometimes fall into the relevancy trap, focusing on and trading only those strategies developed by our own hands. We want our efforts to be rewarded. The best way to do that is to actually trade the strategy. However, for most traders who inadvertently fall into the twin traps of curve fitting and data mining, their best efforts fall far short of what is necessary to succeed in real markets, with real money. This is why it’s always important to benchmark your strategy efforts against well established and robust methodologies. Methodologies that have worked well in the past and in all likelihood will work well into the future. Please refer to the following link to read a more detailed discussion on the importance of benchmarking.

In my opinion, one of the best publicly available strategies to benchmark against is the Turtle strategy. However, the Turtle strategy, being a breakout trend trading methodology is not appropriate for benchmarking a top and bottom picking strategy!

Unfortunately I don’t know of a good publicly available top and bottoming picking methodology to use for benchmarking Key Exhaustion. But be that as it may I’ll still undertake a robustness and performance analysis to hopefully gain some further insight into Key Exhaustion.

Robustness Analysis
A strategy’s robustness is dependent upon its amount of out-of-sample performance, level of curve fitting and degree of data mining.

A robust strategy will generally have plenty of positive out-of-sample performance, little curve fitting and no data mining.

Let’s see how Key Exhaustion holds up?

Proof of Robustness: Out-of-Sample Performance
Key Exhaustion has positive out-of-sample performance since its release in 2010. Its performance since release is proof enough of its robustness. I know its out-of-sample performance pales in comparison to the Turtle strategy (1983) however when you understand that the majority of strategies rarely make it past 20 trades, you’ll appreciate the significance of its performance. 

Proof of Robustness: Absence of Excessive Curve Fitting
Key Exhaustion consists of 4 patterns. Within the patterns there are 5 variables. One variable is for a 4-bar average true range calculation. The other four variables are known only to owners of Key Exhaustion. Key Exhaustion uses the same variable value for all markets and for both buy and sell setups. Being pattern based and using the same variable values irrespective of markets and setup ensures Key Exhaustion is free of excessive “curve fitting”, one of the twin evils faced by all strategy developers.

Proof of Robustness: Absence of Data Mining
When I originally developed Key Exhaustion to trade the currencies I could have been accused of data mining. Yet in my defense I was looking to diversify my portfolio away from indices.  So in that context I didn’t feel like I was deliberately data mining. In hindsight I can see I was, just like with Key Level, Key Breakout and Key Swing. But back then I wanted to broaden my portfolio away from global indices so it didn’t feel like data mining at the time. But be that as it may, due to its sound and robust methodology, I trade Key Exhaustion on my portfolio of diversified markets. Consequently its performance over an out-of-sample portfolio of diversified markets removes Key Exhaustion of any criticism of data mining and adds proof to the robustness of its design.

Proof of Robustness: Achieving the Impossible
Let’s be honest.

I know most people who come to trading prioritize their thoughts and effort on picking tops and bottoms. I know I did.  When I started I spent the first 15 years of my trading attempting to use Elliott Wave, a forward looking theory focusing on turning points. Well I was using it to find turning points.

In my experience it’s almost impossible to pick tops and bottoms. Yet we all attempt to do it and most of us fail attempting it. And most of us fail miserably incurring catastrophic losses trying to hold on to counter-trend positions that we’re convinced will come good, if we can only give the position a little more time, or maybe a lot more time, until that ruin point arrives. If that has been your experience, don’t feel bad because you’re in good company. I’ve been there, done that. Yep. No worries. So don’t feel too bad as there is a way forward. If you’re not too gun shy about picking tops and bottoms then Key Exhaustion can show you a safe way of attempting to catch a falling knife.

Anyway I feel Key Exhaustion’s performance in succeeding where so many fail in picking tops and bottoms provides further evidence of its robustness.

In summary, its minimalist curve fitting, its accidental absence of data mining, its positive out-of-sample performance and its success in an area where so many fail, all up makes Key Exhaustion a robust strategy.

Performance Analysis
If we’re satisfied Key Exhaustion is robust and will (hopefully) continue to enjoy profitability, the next question we have to ask ourselves is whether strategy is worth trading?

For this we need to review the numbers.

My number one objective as a trader isn’t what you’d expect. Yes, I do want to make money. However all my energy and concentration is purely focused on surviving the markets. Nothing else comes a close second. I think of myself as a Risk Manager first and foremost rather then a trader. Anyone can make a profit in trading, what many cannot do is manage a string of losses. Banking profits is effortless as winning trades generally take off, look after themselves and don’t give you any grief. They’re effortless. However losses are a totally different story. Suffering, recording and funding losses is exhausting, both on your trading account and on your confidence, damaging both your mental and trading capital. It damages your trading soul. It’s what can drag you down and cause all sorts of strife. It’s the pain of trading.

So my first priority is to ensure my risk-of-ruin (ROR) is at 0% and that it remains stable. Not fluctuating. Not shifting upwards. In my opinion ROR is the most important concept in trading. Nothing comes a close second. If you’re not familiar with ROR then I’d suggest you stop trading immediately and become familiar with it. A good place to start is my book The Universal Principles of Successful Trading (Wiley 2010).

For Key Exhaustion, 50 units of money combined with a 26% positive expectancy produces a 0%ROR. In addition I believe it’s a robust strategy so in all likelihood its 0% ROR will remain stable and not shift upwards. So a big thumbs up there!

On a single contract basis Key Exhaustion has historically made over $260,000.

Rather then looking at the raw net profit and worst drawdown my focus is always on the old fashion risk/reward trade off. What do I receive for the potential risk? On this measure Key Exhaustion delivers a favourable risk/return ratio of 18:1.

The next insight I’m keen to focus on is the average risk, or average stop per trade. Key Exhaustion’s average is -1.6%, which is low for a strategy looking to pick tops and bottoms.

Efficiency (with Money Management)
IF we survive in trading our second objective is to make money. And since we know the secret behind earning big money is money management we as traders want to know how efficient a strategy is when the money management strategy is applied.

In this example I have applied the Fixed Percentage money management strategy where I’ve assumed a starting account balance of $50,000 where 2% of the account balance is risked per set-up.

As you can see Key Exhaustion, when a conservative 2% Fixed Percentage money management strategy is applied, only manages to make over $4m.

Not impressive.

However, there are two reasons for it;

  1. Lack of trades and
  2. Low average profit

For the mathematics of money management to work a trader needs three things;

  1. Small stops,
  2. Plenty of trades, and
  3. Good average profit.

Key Exhaustion’s average risk per trade of -1.6% is a reasonable amount for what it attempts to do with picking tops and bottoms. Compared to the Turtle strategy’s average risk of -4.5%, Key Exhaustion has small stops.

Unfortunately, due to the unique patterns employed, there are less then 1,700 setups/trades in the portfolio of markets. I wish there were more, however I’d prefer to only attempt to pick tops and bottoms with high probable patterns then utilize inferior patterns to chase setups.

And finally, an important insight to surviving top and bottom picking, is to grab profits quickly. Yes, a good pattern can offer a high probability of success, but at the end of the day top and bottom picking amounts to forecasting and playing God. Well it shouldn’t come as a surprise to learn its very hard playing God. So Key Exhaustion, in respect to the Trading Gods, doesn’t overstay its welcome and is quick to takes profits. As a result it has a low average profit of $157.

A low number of trades when combined with a low average profit make it difficult for any money management strategy to shine and that is why Key Exhaustion, by itself, isn’t efficient at making good money.

However what Key Exhaustion does very well is successfully capture a part of market structure, trend terminations, which is very difficult to do.

Key Exhaustion’s strength is to contribute additional and unique high probability trade setups into a portfolio of strategies, like Universal Trader, that helps to smooth the combined equity curve, dampening drawdown and boosting efficiency and risk/reward payoffs.

So it is very definitely worth trading!

Difficulty in Trading
Key Exhaustion has a very low draw down of less then -$16,000. Out of all my strategies it is the lowest. Combined with a low number of consecutive losing trades Key Exhaustion is not too difficult to trade.

I think the metrics are self explanatory and as you can see with an average length of days in winning trades of 3.6 days Key Exhaustion doesn’t attempt to overstay its welcome.

Although Key Exhaustion has both a low number of trades and low average profit it is a strategy well worth your consideration. It’s particularly hard to stand on rail tracks and lift your hand to stop a locomotive. But Key Exhaustion does. And it does it well enough to enjoy a continuing upward sloping equity curve. Key Exhaustion succeeds where many fail and that alone is reason enough to consider adding it to your portfolio of strategies. To secure your own copy please visit the SHOP.