Line Your Own Pockets

Michael: 00:00

Okay, everyone. Welcome back to another episode of Line Your Own Pockets, while we continue to do this little mini series about, you know, systematic trading and backtesting, and having a really good time there. Last time we talked a lot about, you know, being stuck in backtest world and and kind of what would be needed to get out of backtest world and get into the real world. In this episode, we're gonna talk about, okay, so what happens if you get there? And it's not at all like backtest world.

Michael: 00:26

What could have possibly go wrong, things to look at, potentially things to to help yourself out with. So, Dave, I'll let you lead off with probably what will be the most obvious answer. So you gotta backtest, the backtest looks great, you go to trade it live, completely falls apart or at least in part falls apart, what's the first thing you go and look at?

Dave: 00:46

Yeah. Well, just to set the stage a little more, this is the point in which most traders workflow where they pay the most tuition. And by tuition, I mean, losses.

Michael: 01:00

And

Dave: 01:00

that's because think about your back test and at that very point where you're done with your back test, right? You're so confident in your strategy. You look at this equity curve, like, how can this possible? Like, I have, I've, I've made it, I've done it. You know, it's time to start raking in the bucks, right?

Dave: 01:20

So you're super confident at that point. And when you go live, it often takes time for that confidence to erode. And the more experience you have with this and the more you understand what can go wrong when you go live, the better off you're going to be and the less tuition you're going to be. When I think back on my career, think the part where I've had the most losses is at this point where you've done a great, what looks like a great backtest, you can't possibly go wrong. And then you start trading it live and you either forget about it or a little too much time goes by before you realize, okay, it's not what I thought it was going be.

Dave: 02:07

So it's really important to have a process for doing this and have this phase where you're not trying to make money. You're trying to gather more data and understand how your system's going to work. That's the really important thing. Most people are at this point and they're like, all right, how can I make money with this? And that's really, of course, trading is about making money but at this point, it's not about making money and it's very tempting for it to be for for that to be the thought going through your head.

Michael: 02:42

Oh, yeah.

Dave: 02:43

As we get into these, it's so important to think about this ahead of time. We talked last week about the pre mortem, Andy Duke's concept for predicting why this thing might fail beforehand. The better you get at this, the better you're going to get at trading in general. I encourage everybody to listen to this whole episode. We're going to go through a lot of different things to understand why a strategy might fail that you can know about ahead of time.

Dave: 03:12

I think this is gonna be one of our most valuable ones.

Michael: 03:14

Well, and and we talk a lot about binary events versus, you know, events on on more of a gradient or more granular. And this is this is a binary one. I think you have to pay more attention to those where you have gone from, you know, a complete la la wonderland where everything could be fantastic to real money on the line. It if the strategy is going to just completely implode and go from something that the equity curve in your back test is is up into the right and something that just falls apart and and goes down into the right, it's probably gonna happen like right now. So, yeah, there's no other, more important time in my opinion just to really make sure you're you're focusing and you're you're going back and and testing and and, you know, doing reconciliations and kind of refining the strategy because, yeah, this is it.

Michael: 04:03

Right? It's it's either gonna live or die kind of in this moment. Because there are a couple things, again, that we'll we'll talk about here that could go horribly wrong, that you did probably something wrong in your back test or or something like that, and that you should, you know, really make sure that you're you're looking at and and you're kind of figuring out here. So, yeah, this is it's huge, huge importance. Some of these are gonna be obvious, to a lot of people, and I think some of them might be a little bit surprising.

Dave: 04:31

Yeah. I I like the way you say that. Yeah. It is a binary event. Like, yes, you weren't trading it with any money before.

Dave: 04:38

Now you're trading it with something above zero. So yeah, it is a binary event. But it is a binary event. But there's a lot of things you can do once you identify some of the shortfalls that could happen that you could go and apply to the strategy to alleviate them or minimize the impact. So in that sense, there's no sense in saying that, ah, the actual trades don't measure up to the back test, man, what a crappy strategy that is, or a crappy back test, right?

Dave: 05:14

This is terrible. I'm throw up my hands. Almost in every case, there are ways you can tweak something about the strategy to make it work once you realize what the shortfall is and what you need to do to fix it. So yeah, this is kind of a nitty gritty thing. But the better you are at this, the quicker you're going to understand what's going on and the quicker you can improve your strategy.

Dave: 05:45

And then for the next strategy, you'll be able to know ahead of time and you will be able to predict what's going to happen. You can put that earlier in your process and you're going to have a more robust strategy out of the gate for the next time.

Michael: 06:01

Absolutely. So, yeah, let's get some of the the more obvious ones out of the way and just go, okay. I have come to you, Dave, and, you know, I'm not me, but I'm someone who might be newer to trading or newer to systematic trading. And I say, man, I had this good thing in backtest, and in the real world, it's just not working. Right?

Michael: 06:19

What's the first thing you go to and say, right, check this. Right? Because it's, in most cases, probably gonna be bad.

Dave: 06:27

Yeah. Well, the first thing I do is I say, okay, what does the backtest look like? Because some people aren't even checking the backtest. And that's the first thing you should do. I mean, just think you've created this entire strategy based on the backtest.

Dave: 06:44

So all of a sudden people go out of backtest world into live trading. To have that disconnect where you're not looking at the backtest still, that's a big mistake. This is what sets great traders apart from other traders. You've got this backtest. You've got this awesome reference that you can use going forward to figure out what's going on.

Dave: 07:10

Otherwise, if you didn't have the back test, you would be completely rudderless. It would take a long period of time for you to understand, well, okay, this strategy is just not working. If you get that back test, you can find out real fast what's going on. I mean, just in a day or two, if you've got enough trades in it to see, okay. The biggest thing that causes live trading to not measure up to the backtest is missing big profitable trades.

Dave: 07:49

That's like the number one reason. And if you miss those, the strategy will fall apart really fast.

Michael: 07:58

Really fast, yeah.

Dave: 07:59

So that's the most important thing to watch for and understand, okay, what's happening here with the big winners? Am I catching those? Am I missing those? If I'm missing them, why? That's the first question.

Dave: 08:16

At the big trades, the big profitable trades that the backtest thinks it can get and make sure you're getting those in life.

Michael: 08:26

Yeah. And that's, you know, to kind of bury bury the leader or to to start with it anyways, that that that's the whole gonna be the whole point here. Right? Like, talk we joked a little bit about on on Reddit where people, you know, will say, hey, is this a good back test or is this a bad back test? And then the top answer is always go train it and find out.

Michael: 08:44

In this case, what we're saying is you have to go back to the the back test just to know if it's a normal thing or not. Right? So it's first defining what is not working, for lack of a better term. Right? Is not working just, okay, I turned on the system and it started to lose money.

Michael: 09:02

Well, go back to the backtest. If your backtest is losing the exact same amount of money, well, then it's it's acting perfectly as intended. And then it it gets to kind of diving under the hood. Is it that you're, you're missing every trade? Is it a liquidity problem where, you know, every single trade is just a little bit worse than you expected?

Michael: 09:21

And that's what's dragging it down. Or like Dave was saying, is it the fact that, you know, maybe the system's designed to have 10 trades and nine of them are just whatever mediocre, and then there's one big one, and you're constantly missing that one big one. So Yeah. The the biggest tip I think anyone can give is is this is the time you should always be reconciling to the backtest. But this is the most important time to do it ever, where every day when I'm running something new, if it's a daily strategy, I am downloading.

Michael: 09:51

This is what the backtest should have said. This is what I actually have. And just there's a lot of ways to kind of, you know, systematize this and and to to make it faster and to cheat it. But I think especially at the beginning, this is just a a line by line. Right?

Michael: 10:04

You look at the entry of one trade and then the exit and then the entry and then the exit, because it's you're almost like an accountant at this point. Your job is is like like a tax accountant. You have to go and figure out what's that difference because that's the place that you're really going to have to dive into. And it's not the most fun work in trading, but it's brushing your teeth. You have to do it.

Dave: 10:26

Yeah. And we talked about ChatGPT a couple of weeks ago. This is tailor made. This problem is tailor made for ChatGPT because it can so I've got automation for doing this reconciliation. And the very first thing I'm looking for is, Okay, what trades did I not take that the backtest did take?

Dave: 10:49

And you could do a quick I've got a quick Python script that just does that and spits it right out. Here's the ones you missed. And then I'll look at if there are ones I'm missing, I want to go back and see why I'm missing them. What's my entry order there? And go and figure out, okay, can I make my entry order a little bit more aggressive to catch these?

Dave: 11:17

And a really important tool to do this, which I don't think a lot of traders use, is time and sales.

Michael: 11:30

I was going to bring that up.

Dave: 11:35

If you go to time and sales, most trading platforms, most brokers give you access to it. It's basically a historical view of the bid and the ask and the trades as they happened. So if you think about that data, it's an immense amount of data. So it's really important to get good at figuring out, okay, what was my order at the time? What was the bid and the ask at the time?

Dave: 12:07

What were the trades happening at the time? What would it have taken for my order to have executed at that time? Yeah. And you can go back and use time and sales to figure that out.

Michael: 12:20

Yeah. And you don't need to a lot of people will look at that and they'll see the time and sales for the day. Of course, you don't care about the whole day. Right? You're caring about so you need to just pull that out in that specific point in time, around the fill.

Michael: 12:33

I've also found that, you know, for fast scanning, obviously, time and sales dig in. Fast scanning, find like a really short term chart, even like a tick chart or something and zooming into that time, can give you somewhat of an understanding of what the liquidity was at that time. But yeah, the time and sales will tell you exactly what you needed to get filled at the exact second that your order went out. If you're buying, where was the ask? Right?

Michael: 12:57

Was it too far away? How fast was it moving? Right? So look at the the speed from print to print. Is it, you know, is it moving 10¢ every print?

Michael: 13:06

Is it moving 20¢ every print? That would be a more aggressive order because, again, in most scenarios, if your back test is not working and, you know, I think we're kind of glossing over, you just did a bad back test that had forward looking bias or something in it like that. But in the scenario that your back test was clean and you did everything right, then, yeah, the the issue generally lies in your fill. So you have to be able to zoom into that period of time and say, what did the market look like? I also think there's a huge advantage of watching live still, especially when the strategy is just getting off the ground, is looking at the order the second it went there and and clicking on it there and bringing up that stock and saying, okay, what does the stock look like right now?

Michael: 13:50

It's not as scientific, but it can sometimes give you a pretty good feel of, okay, this is how the stock was moving at the time that I was trying to get my fill.

Dave: 13:59

Yeah. I mean, a lot of these scenarios, you don't have to actually trade live to understand. So you can just watch it play out in real time, even though you're not trading it or paper trading it. And a lot of stuff will There'll be some moments there because you realize, oh, okay, well, backtest couldn't capture the thing I just saw there. There is, speaking of time and sales, there is a tool that I have access to from NASDAQ that gives you an awesome visualization of time and sales.

Dave: 14:39

And it's really good because time and sales, if you go into like an interactive brokers, it's kind of a pain to look at. There's an immense amount of data in there. It's all line by line when the bid and the ask change and a trade comes through. But this tool from NASDAQ is a really awesome visualization of exactly what's going on and you can see it. It's a very, very helpful.

Dave: 15:05

It's expensive. I subscribe to it and I give the traders that I work with a view into it and use of it. It's it's a really powerful tool. We'll put a link to it in the show notes if you're interested.

Michael: 15:19

Yeah. Because yeah. Again, whether however you get it, I I it's it's super important. Right? For me, I think it's one of those, you can find a lot of, freer versions that you're right, it's gonna not be nearly as nice to look through.

Michael: 15:34

You're gonna have to kind of export something into Excel and then zoom into that time and and kinda scroll through. So, you know, it's one of those that's the the cost is not an excuse because you you can certainly do it anyway, but, yeah, there's definitely better ways to do it. I've even seen, charting platforms out there. I wonder if TradingView can do it. I'm not too sure.

Michael: 15:54

That actually charts out the bid and the ask and moves the the bid and the ask, like, two kind of line charts separate. So you could go to that point in time and kind of watch it and see what would have happened at that time. But, yeah, there's gonna be tons of ways to do it. Everyone's gonna have their own kind of cool way to take a look at it, but, absolutely. So let's say let's say it was liquidity.

Michael: 16:18

Right? Let's say liquidity was the problem. So you kind of said everything is repairable. What does the person do? Do they go to their back test and they crank up the liquidity and see what happens if they're trading higher liquid stocks?

Michael: 16:33

Do they go over to, maybe looking at trying to get a better fill on the fill side of things? Like, which side do you try to fix first? The backtest or the the actual live world?

Dave: 16:46

Yeah. That's a good question. I would first look at the I'm looking at the time and sales and I'm looking at, okay, what would my price have needed to have been in my order to get this fill at this time? And that's kind of a painstaking process. And a lot of times you can glean some things there that you can go back and apply to the backtest.

Dave: 17:17

So let's say you find some big winning trades that you missed because of your entry order, and you think that you could make your order, let's say, zero five more aggressive so that you can get some of those fills. Well, you could go back to the backtest and extrapolate that and say, okay, well, what happens to my back test if all my fills are $05 worse? Does it fall apart? Those are the questions you need to ask yourself. And usually usually, you've got some buffer in there to that that your strategy can be profitable with this buffer in place.

Dave: 18:06

So after many years of doing this, I always have some threshold that I know that this shortfall is going to be. And I include that mentally in the back of my mind in a back test. So I know that, Okay, I'm not going to get exactly what's in the back test in terms of profit. Not going get 100% of that. But I'm going to get 70% of it.

Dave: 18:34

So I know that I can figure that out ahead of time. So I know that as part of my optimization process, I can have that in the back of my mind. So I know that I need to get beyond what it seems like I should be to make my strategy a little bit better, knowing that, okay, I'm going to lose a lot to all the things we're talking about here, missed trades, slippage due to liquidity, all these types of things. So I think about that ahead of time.

Michael: 19:11

Well, wouldn't even just think about it, right? You should probably be programmed program some of that in as well, right? So, that's part of the stress testing that I do for a lot of my systems where you build a slippage factor, and then you start to kinda crank that up and just see at what point is that, is that problematic. And then I know at least in real tests, I'm sure you can probably do this in in a lot of the back testers too. You there's a a skip random trades function.

Michael: 19:42

And right? So I will run the script or run the back test, you know, maybe five or six times over, skipping random trades just to see how much there would be a different effect there because that's part of the, part of the testing and part of the reason a lot of people do Monte Carlo stuff even though I'm I'm usually not super excited about it. But the idea is that if you can randomize the trades that you miss and you run that five or 10 times and you get kinda some understanding of, okay, I'm gonna miss x percentage of trades. Does my system hold up in the long run? That's great.

Michael: 20:17

So that should be part of, the stress testing, but you're a 100% right where you can't plan it perfectly. Right? You you you don't know until you actually go in. But just a nice little tip to say, hey, when you're back testing, make sure you're doing some of that. If one little variable like that just kind of breaks your system, your system's not really that great, right?

Michael: 20:38

So make sure it can stand up to some kind of robustness and some things going wrong.

Dave: 20:42

Yeah. There's also some other things you can do to try to capture some of these trades. So you could use a different entry order. There are some situations where you can use a different order type and get the fill. For example, if your trade is close to the open and you can create an on open order, there's a lot more liquidity in those on open orders than there are in just regular limit orders in the market.

Dave: 21:20

So I'm sure a lot of the listeners and you, Michael, if you saw some of the fills I get for some of the the strategies that run, your stomach would drop because there's some pretty light, there would, the names that and symbols that get in are pretty light, surprisingly light for a lot of traders, I would think.

Michael: 21:42

Well, and I think, but that also comes to position sizing in those different symbols, right? It's, it's it's a lot easier to stomach taking a, a very low volume symbol and trying to work an order here or there when you've already kind of baked in a lot of the the problems that could occur and you're okay with that. Right? You you understand that slippage can happen and, right, if you had to get out of the position, you're gonna take way more of a stop loss or way more of a hit, than you could imagine. I think a lot of that is is fine, but, yeah, especially for new traders, think.

Michael: 22:17

Right? They go in especially, there's, some brokers out there that will do p and l based off of bid ask as opposed to last. And, right, sometimes if the the bid ask really opens up, they go, holy smokes. I just got into the trade and I'm down x. Yeah.

Michael: 22:33

That could definitely be definitely be worrisome for a lot of people for sure.

Dave: 22:36

Yeah. I work with a lot of traders to, modify their strategies so that they can get some fills with some smaller names. There's a lot. So if you think about it, that's your big advantage as a retail trader is being able to trade strategies that trade some of these low volume names compared to the big boys. A lot of big hedge funds and mutual funds, they couldn't even consider trading some of the strategies that I trade and other traders trade just because they're so much bigger.

Dave: 23:22

They have so much more money to put at work that they have to put to work for it to even be meaningful. Even if you've got a really big account for a retail trader, you're still a drop in the bucket compared to the big players. That's where your advantage is really going to come from.

Michael: 23:42

Well, and I always look at it. It's, liquidity equals efficiency and, right, efficiency is kind of the enemy of edge. Right? So this is why if you're trading futures, the edge you're looking for is is going to be smaller. It doesn't mean it's not there, and there's still some advantage to trading higher liquid names even for small edges, generally speaking, when it comes to access to buying power, access to external funds, things like that.

Michael: 24:10

But, yeah, you gotta look at it as a a continuum. Right? If you're trading incredibly illiquid names, there's gonna be way more edge in there than trading, you know, Apples and Googles and then Nvidia's of the world because, yeah, it's it's just the way it works. It's the more it's I always look at it as, like, if you're trading, you know, x y z company that's gonna do $2,030,000 shares that day, you're not fighting Goldman Sachs. Right?

Michael: 24:34

If you're trading Nvidia, you're you're fighting Goldman Sachs. You're in the same arena as these people, which is why a lot of people as, you know, HFT and algo trading became more prominent, they either went to these lower float and smaller type names to avoid the big guys out there, the Goldman Sachs and all that, or they went higher in time frame where the these games don't get played as much. So, yeah, it's just look at it. If you're someone who's trading forex, right, I think is probably the ultimate liquidity and therefore the ultimate lack of edge, then you have to go in somewhere else. And that's, I guess, also something to look at when you're looking at what's wrong with your backtest to your real world.

Michael: 25:16

If you are trading something like forex and there is slippage, something has gone horribly wrong. Whereas if you're trading, you know, a low float, smaller names, you know, less recognized stock name, it's probably more of a chance that it is. So that might be a good way to zoom out and say, okay, let me quickly see what's wrong with what I'm doing. Again, if if you're missing your fills on forex, it's probably not liquidity. It's probably something to do with how fast you're getting your signal to your order getting hit or or, you know, you're trading around a news event or something like that.

Michael: 25:47

Because as someone who's traded forex, it's insanely liquid. You could put $20,000,000 through on a trade, and you're not you're not even gonna budge the market at all.

Dave: 25:57

Yeah. So that reminds me of another thing you can do to get some of these fills. So when you think about your back test, your back test is assuming that you're going to get that fill in that exact instance. But in the real world, one of the things you could do, in some cases, you don't need to be in immediately. You might be able to put an order out there and leave it out there for a little bit.

Dave: 26:30

And a lot of times, the price will come back and you'll get a fill maybe a minute or two later at the price that you want. So that's another thing you can do to sort of match the backtest. Even if the backtest got in here, you got in at x plus two minutes, but at the same price, that's a that's a that could be a win for you and your strategy.

Michael: 26:55

Yeah. As long as no profit target or anything was hit within that time, who Yeah. Who really cares, right? If it's, you know, if it's between your stop loss and your profit target and you're just waiting to get in. And that's something that I do all the time where my orders for a lot of the day trading stuff I'm doing are alive all day.

Michael: 27:11

Right? Because they just put the orders out there and and away they go. When it comes to, you know, things like, routing, like different, you know, I know, like, IEX was a big one for a while and all these different routes. You find have you ever found any advantage in changing your routing option, or do you just simply use, I think, Interactive Brokers calls it their smart, where they just get you whatever they think is best at the time. I know some people really ask about that.

Michael: 27:39

If I'm on a different exchange, does it somehow make it easier for me to get a fill?

Dave: 27:44

Yeah, I think it definitely does. And yeah, the more you can understand that, the better off you'll be. It depends a lot on the strategy and how you're getting in. But yeah, there's most brokerages have a smart route and I mean, go look at the fees that you get charged for the smart route versus a direct route on IB. And just you can do the quick math and see, okay, well, it is to IB's advantage for you to be using the smart route.

Michael: 28:21

That's why

Dave: 28:22

There's gotta be some money there.

Michael: 28:23

Yeah. And all that.

Dave: 28:24

Yeah. There's gotta be some money in doing a direct route. So for sure, there's definitely some advantage to be had in certain strategies for doing a direct route, yes.

Michael: 28:37

And that's well, that's something just to hit on a little more that most traders might not know about. So make sure you're you're spending some time and just looking at things like order routing with your particular broker. You know, I this all the way goes back to where I was propped for firm trading for a living, and we did a lot of this, like, credit trading where you could actually get paid to to place trades and all that kind of all that kind of stuff. No need to go too deep down the rabbit hole. Just do a quick e c ECN is the best thing to Google.

Michael: 29:09

Like, what is an ECN and different ways into the market and get yourself familiarized with it. This isn't going to be a massive make or break, but, you know, you're you're playing around the edges. And and sometimes, you know, if you can make a strategy 1% better by playing around the edges, that's gonna add up in the long run. So take some time to definitely take a look at those.

Dave: 29:29

Yeah. I think with the routing, also with commissions, you're not going to make a terrible strategy great by eliminating those or minimizing those things. And if that's the case, you can come up with a better strategy to begin with. But once you have something that's working and once you dive in and understand how the routing works, understand and look at your commissions and how they're and your fees, then you could make some adjustments at that point. And it can make a big difference.

Dave: 30:10

I mean, I remember there were some really I started noticing how much commission I was paying to Interactive Brokers. There were some years where I don't know, was in the 6 figures. And if you just step back and think about that, that's a lot of money. I think I was paying more in commission than I was making from trade ideas for a couple of years there. So I was like, wow, okay.

Dave: 30:42

There's a lot to be made here if I make some adjustments. But even then, it still wasn't gonna be the thing that made my strategy work or not work. So it's still just around the margins.

Michael: 30:58

Should we rant a little bit or at all about how zero commission brokers are are not saving you from this because that's that's I just I foresee the comment in chat and again or in the in the description. We love the comments. We love talking, but I just I I always wanna head that off because I always hear that as a rebuttal, say, oh, well, I'm with Robinhood and they're not charging me commissions and blah blah. And it's like, yes, they are. They're not allowing you to trade out of the kindness of their heart that it's not altruistic that they're they're letting you trade.

Michael: 31:34

What they're doing is they're essentially selling your order flow. Generally speaking, your fills will be a little bit worse over time. Yeah. Might even out to be the same if you wanna be charitable, maybe maybe and I'm not even one that I'm, like, super anti payment for order flow. If you're the guy who you wanna just, you know, put some money into Apple every week or buy the S and P 500 and walk away, absolutely, these brokers are fine.

Michael: 31:58

If you are a serious trader who wants to make sure that, you know, you're getting the best fills and all of this, you should be using a broker that doesn't sell your order flow and in turn is you're paying a commission. At least it just feels more honest that way where it's like, you are offering this service and I'm paying you this amount of money even if it's a lot. I know what I'm paying you. If you're doing a zero commission broker, you're paying. It's just not a line item you can kind of see anywhere.

Michael: 32:25

Right?

Dave: 32:26

Yeah. And often you're going to get what you pay for. And you have to do this reconciliation to understand and to figure out. But yeah, you're going to get what you're paying for and the fills are going to be poorer. And there's just no question.

Dave: 32:45

And, yeah, that's, like I said, you're gonna get what you pay for.

Michael: 32:51

Yeah. And it's it's the kindness of your own heart thing is just, I think, helps out a lot of people and say, why do you think they're giving you free commissions? Right? They're they're not. They're giving you they're making their money.

Michael: 33:04

They're just making it somewhere else so they can kind of hide it as a line item so you don't feel like you're getting charged. Yeah. You're still you're still getting charged. And I just wanted to kind of front run that again. Our audience may already know this, but some people really do think that they're saving a lot because they're not looking at the at the dollar amount that they're trading at the end of the day.

Michael: 33:23

But believe me, Robinhood's getting its money. I'm just look down at the stock. It's hitting all time highs. They're doing fantastic financially, and they wouldn't be if they were actually giving you kind of free free routing and and good fills and all that kind of They wouldn't be a couple billion dollar company at this point.

Dave: 33:44

Yeah. Alright. So let's go on to another reason that a backtest or your live trading might fall short of the backtest. Another good one is you might have more trades than you can actually take. So you may have more signals than you can process.

Dave: 34:05

So sort of like the old I Love Lucy with Lucille Ball where she's on the chocolate factory this conveyor belt's coming and things are fine for a while, but then it comes at too faster rate and she kind of throws up her hands and it's of funny. That could be the same thing in live trading that you can't really see in your backtest. Your backtest, it's not coming in in real time, so it's going to get all the trades. So that's another thing that you can work on your process and figure out how you can take more trades. That might be introduce automation.

Dave: 34:47

And that's a big reason that I created the robot that I trade with is specifically for this. And that opens up a whole new set of strategies that you can trade if you're able to do that. Imagine if you know, let's say the most you can take manually now is what, one trade every minute or two? Well, what if you could take 10 trades a minute? What if you could take more?

Dave: 35:19

Then, all of a sudden, there's a lot more strategies that are available to you that you can trade profitably.

Michael: 35:27

Well, and that just opens up the the broader topic of of why your backtest could be falling apart in the real world if we just kinda classify all that as human error. Right? That's another thing that if you are Yeah. Placing the trades yourself, you're placing the trades manually, that has to be an item in in kind of your reconciliation processes. You know, maybe you miscalculated a size or you you typed in a wrong number or you were just slow to the draw or or any number of things that us, you know, humans, can do is to to do that.

Michael: 36:02

Now, I'm for one that, you know, me and Dave been talking all the time that, the only time that day trading interests me at all is when I can kind of push off the responsibility of that kind of stuff to the bot, because I know personally I am really bad at that. I'm really bad at, you know, rogue trading, and I'm really bad at at revenge stuff, and, even just not being able to think that's fast on the fly, putting in wrong orders, doing all that. But that when I am trading, that is definitely part of my reconciliation. Is was the problem that the alert came through, and by the time I put in the trade, I couldn't get the fill? That's one problem.

Michael: 36:41

That's like a liquidity, a speed thing, that kind of thing. Is it the fact that I miscalculated something? That's a completely different problem. That's something that is, again, human error and has to be looked at differently. One is, you know, maybe you redesign the way you're putting out orders or maybe you redesign your strategy.

Michael: 36:57

The other one is just more of, you know, you have to find a way to systematize. So for example, in TradingView, I've got one strategy that I still kind of run manually as a day trading strategy, but I kept messing up the position sizing. So I just built a little box that hovers on my chart that I click on it and it just updates and says this is the share size you take. And little things like that can certainly help to a degree. Right?

Michael: 37:21

I still have to type in the, you know, the share size and and do things like that, but start to think about that as well. If there is human error, you have to account for that, and you can't just imagine that it's gonna go away some someday unless you're going to use a robot to trade for you. You know, it's just finding out how much is that human error costing me, what can I do to help mitigate that or, you know, remove it entirely?

Dave: 37:45

Yeah. Well, you know, you I've heard you say before that you feel like you're particularly bad at day trading or you're everybody is. Right? There there's no everybody is bad at this in the moment, right? Yep.

Dave: 37:58

Everybody lets emotion get in the way. It's not unique to you, Michael. Every trader is like this. And if you're not systematizing your routines and automating stuff you do, yeah, you're gonna make mistakes and they're gonna be very frustrating. One thing that I did do at one point in my career before I was starting to automate stuff I was doing is I would have recordings taking taken of my screen as I was trading.

Dave: 38:33

So, I was trading the first half hour of the of the day. I was trading a specific strategy. I was getting signals and had windows set up in a certain way so I could see exactly what I wanted to do and then enter the trades manually. I would take a video of my screen and then go back and look afterwards and see sort of like a neutral observer where you're looking and saying, okay, well, here's where the signal came in. Here's what I did.

Dave: 39:04

And I could see when I'm in this mode, oh, okay. Well, could move the alert window to a different place and I would be less likely to have missed that trade. It looks like I'm spending a lot of time entering these orders and I'm making mistakes there. How can So when you look at it in this way, there's some things that are going to stick out and you can really improve what you're doing by doing this. Yeah.

Dave: 39:34

Was very helpful for me.

Michael: 39:36

Small edges, right, that we talk about. You know, for example, I know a lot of traders that won't don't use things like hockey's or or things like that. Right? And as funny as when I trade it, professionally at the prop firm before there was HFTs and all this kind of stuff, you weren't given a mouse for the first, like, three months of trading. They just they unplugged it.

Michael: 39:57

You'd start up your computer in the morning. You'd do whatever you need to do with the mouse to sign in. They'd unplug it, they'd take it from you because the idea was, using hotkeys are are way more efficient than than something else now. Yeah. Obviously, it's 2025, and I think that everybody, every order should probably be placed with robot at some point.

Michael: 40:14

But even if you're not there yet, I think a nice baby step is to program some hotkeys for maybe even different strategies where, you know, you know this strategy, you're gonna take roughly this amount and and things like that, and that will really help out. And these are these are marginal benefits. But now that we're talking about trading in the real world and we're hoping, you know, your back test is is does have an edge and you have an edge in the system, now it's about kinda milking every last percentage point of edge that you can get out of because, you know, say your your system makes 1% a month. Well, if that goes to one and a half percent a month at the end of the year in in any kind of compounding, you can do the math how how different that is. So when you're trading at these very, very small changes, very, very small edges will add up in a year dramatically.

Michael: 41:03

In ten years, it will be it will be huge.

Dave: 41:07

Yeah. I can as a software developer, you know, I was the CTO of Trade Ideas for many years. It's always surprising to me when I go and look and see the extent that hot keys are available in a lot of these platforms. I can tell it was a huge engineering effort to implement a lot of these hotkeys or have this functionality in there. And I think it's way underutilized.

Dave: 41:35

If you haven't looked closely at your hotkey configuration for the platform you use to trade, go take a look because there are a lot of capabilities there. And with just a little bit of ingenuity, you could create some really cool stuff for your workflow. And that's really the first step toward automation. Getting some of these hot keys where maybe it's not quite automation, but you press one key and your entry recorder goes in at exactly the right point. It automatically includes some stops along with it.

Dave: 42:10

So there are some really cool stuff you could do with hot keys. Some of the capabilities I look at from a software development perspective and think, man, okay, this was a huge project to create this. And I know a lot of traders don't even consider using it. But, yeah, you should.

Michael: 42:29

Yeah. The again, the the prop firm back in the day, they would take your your mouse away, but there was no buttons on the platform either. There was not a buy or a sell button. Every order had to be entered with the keyboard. And what do it was kinda cool to see because you'd walk into the room and there's a bunch of dudes, you know, it's all, you know, college age or slightly above dudes, and they're all hunched on their keyboard.

Michael: 42:51

They've got, like, weird claw grips on their keyboard because Yeah. You know, they could take this again, before HFTs, we were kind of the HFT systems at the time. They were taking hundreds of trades a day, and they just had this whole, you know, keyboard they were investing in, you know, gamer keyboards with macro keys. And, this is twenty years ago. Right?

Michael: 43:10

So that's that's, you know, Doom was probably the craziest game out there. And, yeah, just just by doing all this stuff or or mice with, a thousand keys on them and things like this. But, yeah, definitely, on the edges, but a a way to deal with that. Because as we mentioned, most of the time, your problem is going to be your back test said you should have got filled at $10 and you got filled at $10.25 or didn't get filled at all, and it was an amazing trade. So, you know, ways that you can shrink this, again, at the end of the day, fully systematic, like, the the alert sent and order sent, that's the way to go.

Michael: 43:46

But, you know, steps along the way, I think, certainly can help.

Dave: 43:49

Did, did I ever tell you about my, the keyboard that I use? I've been using this style keyboard for probably twenty five years now. It has no labels on the keys.

Michael: 44:03

Oh, I've seen some of those. Yeah.

Dave: 44:05

So it forced like, there's no reason to look at the keyboard Mhmm. If there's no labels on the keys. So it forces you to be a better typist, to know exactly where those keys are, and to not look at the keyboard. Because if you look at the keyboard, that takes time. And I knew at that point that I wanted to be faster with what I was doing.

Dave: 44:31

And I use VI for my text editing. I use a keyboard with no labels on the keys. And I wanted to do that to force myself. And I've been using that for twenty years. It's made a huge difference, I think.

Dave: 44:48

I just think about the time I've saved with Keystrokes over the years and using VI as my code editor for all these years. It's not going to add up hour by hour or day by day, but if you look at the aggregate over many years, it's enormous.

Michael: 45:06

Well, know this is probably going to go down as the nerdiest podcast out there, but it's 100% true. I've read studies about how just the amount of time you can summarize from someone taking their hand from their keyboard to their mouse, periodically throughout the day, and it was actually it was I think it would end up being, over an hour within, like, weeks. It wasn't wasn't it was way more than I thought it would be and just utilizing things like this because, yes, I don't know. There's you talk about all the time that people are going to quit trading during a drawdown. And the reason I think that we're harping so much on this this jump from backtest to the real world is because this can be the biggest, like, dopamine dump letdown of all time is if you've worked days or weeks or even months to get something and it works and it goes to backtest, and then you go to trade it and it's an instant letdown.

Michael: 46:01

Yeah. You know, I I think not only for the you built you spent the time, you want system to work, but just for your mental benefit overall, you kind of need that to start doing something in a positive direction even if there you know, you made a whole bunch of mistakes back testing and the returns are 50% of what you thought they were. If they're positive at all, then it's proved to yourself that you can you can do this process, and then it's just about doing it again. So that's why I think what we're talking about is just so insanely important because it I've done that before where I've I've made a mistake in the backtest about fees or commission or slippage or something, and I go to trade the thing and then you just realize the amount of time that you've wasted. And if it especially if it's your first time doing it, you may think that the whole process is just a a waste of time.

Michael: 46:48

And that might be a time that a lot of traders walk away when they're really they're they're so much closer than they've ever been before. There's just a couple things they have to figure out.

Dave: 46:57

That is a great point, Michael. I love that you brought that up because that's totally true. That's a little bit what I was saying before is you're so optimistic at that point. You're at the most your optimism is at an all time high. If you think about the lifetime of a strategy, and you're primed for disappointment at this point.

Dave: 47:19

So yeah, I always encourage people. That's why I always say, you're not at the end, you're at the very beginning. And the stuff that you learn from that point forward, that's how you get better. That's how you get great as a trader is understanding how that strategy falls short of the backtest, why, what you can do to improve your backtest going forward, that's how you get better. A lot of traders don't even get to that point or they throw their hands up in the air saying, well, the backtest sucks or whatever.

Dave: 47:54

That's a missed opportunity.

Michael: 47:56

Well, and just to go back to the again, Reddit that we keep trolling on, there's so many people that you can see that when you're reading that that are just jaded on the whole process of back testing. Yeah. And I feel like that's probably what happened to them is they had a back test that looks great, then they went and they tested in the real world, and it just failed miserably. And you almost want to, like, you know, grab them and say, you know, all is not lost. You you either learn something through your back test being horrible, or there's just a a missing link that you then have to go fix.

Michael: 48:28

And, you know, to to lose hope again at this moment, I think really sucks. There's a lot of times in trading to lose hope. So there seems like always the the next time is to lose hope. But to do so just then, before you've seen any benefit, think is the worst because it's a lot easier. You say even only have, you know, six months of good six months and then something happens in the market and your system stops working as well.

Michael: 48:54

The fact that you've kind of tasted a bit of success, I think it's a lot easier to motivate yourself to kind of get back to work to see that success again. Whereas if you lose it at that very moment, you know, you you spent all that time and all it did was cost you some money when you went live. That to me is just it's very, very unfortunate.

Dave: 49:12

Yeah. And the traders that really turn the corner are the ones that in that moment where you could throw up your hands, you could blame the back tester, you could blame the market, you could blame anybody else but yourself. The traders that really do well turn the corner, it's in that moment when they understand that there's nobody else to blame but themselves. You can do it, but there's nobody out there that's going to You have to do it yourself and you have to take full control and full responsibility of your trading. And that involves understanding the constraints, understanding what you can control about the market and what you can't.

Dave: 50:00

And really diving into that and like I said, taking full honest responsibility for what you're doing, that's when traders really turn the corner.

Michael: 50:11

Yeah. Alright. Dave, do you have any other final words about we went this was a very rant nerd version of this, but I like it. But just before we leave, is there any one piece of advice that you would give, something that we may have missed talking about?

Dave: 50:30

I think the main takeaway here is when you get to that point, you're at the beginning, not the end. Understand that you're at your most optimistic point, So take that into account and understand that there's a lot to learn from that point forward. And if you go in with that mindset, I think you're primed for learning rather than primed for, okay, here's where all the profits start coming in and I can go rest on easy street.

Michael: 51:00

Yeah. And the the only thing I'll add to that is that kind of just to reiterate in a different way of what you just said there is that you are not you're not trading you're not going to trade live at that point. I think that's kind of a mental, game that you can play with yourself. And you said at the beginning of the podcast is that you are just gathering more information. And that's how I try to look at it.

Michael: 51:23

It's like, okay, I've I've done the backtest. A lot of people think, okay, my job's done. It's time to trade alive. In my head, I just kind of frame it as, okay, now it's time for just more data. I think this is why I always joke about why we call it forward testing when it's just trading.

Michael: 51:38

But I think there might actually be a good idea to frame it, to call it that in in your head, at least call it forward testing. Because that's essentially what you're doing is you're just saying, okay, now I'm just testing still. I'm just doing it with real money and then go from there because, yeah, I think, again, a lot of people get into a lot of problems by saying, okay, now I'm done. And I I can I I'm trading now? Good for me.

Michael: 52:01

I'm a trader as opposed to I just have more testing to do.

Dave: 52:04

Yeah. The the way I like to frame it is this point is you're getting feedback from the best traders in the world for free. When you take a strategy live, you're getting honest feedback from the best traders in the world at that moment. So that's the mindset to be in when you're when you do it.

Michael: 52:26

Oh, I like that. I think that's great. I think that's a good place to end it. Again, we have no idea how long this miniseries is gonna go, but I'm having a great time. So we're just gonna keep going as long as we we believe it to be the best thing to do, and I hope you guys are appreciating it as well.

Michael: 52:40

We see all the comments. We see all that stuff, and we absolutely love it. But until next time. I'm Michael Noss.

Dave: 52:46

And I'm Dave May. We'll talk to you next week on Line Your Own Pockets.