There’s a slight distinction between switching off and going to cash. All of the systems should eventually go to cash if the market conditions are not suitable, just part of they don’t have any more buy signals, and all of the open trades close out. So, you’re in cash. The switching off is like, “Oh, the system is broken. I need to stop trading that system.” In that case, it’s a bit more complicated because there are several reasons why you might turn a system off. Still, probably the biggest one is that the drawdown you see in live trading in the future is bigger than the historically expected drawdown you got in your back testing.
Let’s say you were running the system and your backtest generates a drawdown of 20%, maybe at 1.25 or 1.5 times the maximum historical drawdown. Therefore, you say, “You know what, something’s wrong. I’m going to suspend the system and investigate.” Then, you turn off the system, close all the positions, and do the investigation. Depending on the environment, I usually do that between about 1.25 or 1.5 times the max historical drawdown because any longside system will have a big drawdown when the market is at all-time highs and turns around and goes straight down. It’s like, “There’s going to be a drawdown, and the system’s not broken.” In fact, COVID was the first time in history ever that the market went from all-time highs straight into a bear market with no rally. It just went straight down from a high, and the system had never had that in backtesting.
My reasoning in that situation was, it’s going to have a bigger drawdown than what it would’ve in the past because there was no chance to get out until everything hit its stops. Thus, my approach was to keep trading it but then learn from that and think about how I would adapt going forward, knowing that we can go from an all-time high straight into a bear market because we’d never seen that before, then you can adapt and learn from it.
The other thing I would say is that as you progress, you will be testing different systems and ideas. If you love this, you will love it, and you will keep playing with system ideas. You might say, “Okay, I’m trading, I’ve got my portfolio, and you find a new system which is better than something you’ve already got.” And so maybe you replace it, and then you find another system that’s better than this one, and you replace it, and your portfolio might get better and better gradually. Thus, you consider two things. You might retire a system because you’ve got something better and don’t need both, or you might retire a system because it’s eroded. But the more systems you’ve got and the more you’re working on it, the more you retire them because you’ve got something better rather than eroded. I haven’t retired that many systems because they’re eroded, a few, but not that many.