Building Effective Entries and Exits – Kevin Davey

Episode 162

Andrew: Hi, Kevin, welcome to the show. It's really great to have you here again.

Kevin: Well, it's great to talk to you, Andrew.

Andrew: Now you've been on this podcast a number of times already and it's always really good to have
a chat with you, plus I think the topics that were going to discuss today will really interest a lot
of traders, but before we even get to that, I'm sure most listeners already know who you are
and are aware of your work, but just to give us a little bit of context and for any new listeners,
can you give us a quick background on yourself?

Kevin: Sure. I'm in the US and I've been trading for, probably, over 25 years now. A lot of that was on a
part-time basis, kind of a hobby trader, then about a ... Think it was about 11 or might be even
12 years ago now, I was able to make that leap from part-time trader to full-time trader, and
part of the reason I was able to do that was because I had success in a trading contest, a
worldwide trading contest, where I was up against some really good traders, and I was able to
finish in first or second place three years in a row. One year I won first place and in the other
two years I came in second place, and that kind of convinced me that, hey, maybe I could do
this full-time. I was lucky enough to have a supportive spouse who said, "Yeah, that's okay. You
can quit your job and become a full-time trader," so I was able to do that and I've been doing
that ever since.

In 2014, so almost five years ago, I had a book come out. It was called “Building Winning
Algorithmic Trading Systems”, which kind of documented my whole testing and development
process for building strategies, and based on that book, I had a lot of people contact me and
say, "Wow, can you teach this?" So then I started teaching people how to build their own
trading systems, and so in addition to my own trading, which is probably my main focus, I also
do quite a bit of teaching of others, and since that point in 2014, I've released a couple more
books, shorter books on different aspects of algo trading, and I continue to trade today and
continue to also help people kind of improve their own trading.

Andrew: Now speaking of books, one of the reasons why you're here today is that you've recently
released a new book that we're going to talk a little bit about, and the title of the book is “Entry
and Exit Confessions Of A Champion Trader: 52 Ways A Professional Speculator Gets In And Out
Of The Stock, Futures And Forex Markets”. So, why did you decide to publish a book on entries
and exits?

Kevin: A couple of reasons. One thing is I always look at the feedback that people give me, both via
email and review sites, so for example, Amazon, people that review my book, and what came
through when people reviewed the first book is, "Well, hey, it's nice, it gives us the process, but

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 it'd be nice if there were some examples and more ideas out there of what we can build
systems with." And I get a lot of that too with students who take my workshop. The biggest
thing that people come into it lacking are ideas, and people just say, "Oh, I can't come up with
ideas. I don't know what to test," and, "What do I use for an entry? What do I use for an exit?"

And so this book really was geared towards those people, so it kind of works for beginning
traders who want to test some things that had worked for me in the past, and it also is for more
advanced traders who already have tested a lot of things, but might be running dry of some
ideas and they want to get some fresh ideas in there, and that's kind of what this book is all
about. It's more than a book that you read and put away, it's more of a kind of workbook or a
reference guide where you can keep going back to it and, for example, test a different entry or
exit pretty much every week. If you do one a week, you'll take a year to get through this book.

Andrew: One of the things I really liked about the book is that you included exits in the book, and I think
there seems to be so much focus on entries and not so much on exits. Why do you think entries
are so popular compared to exits?

Kevin: Well, the big reason, I think, is because entries are really the only thing that, as a trader, we can
control, or at least we feel we can control, and what I mean by that is you can be looking at the
market and say, "Well, hey, I'm not going long until the moving average is like this and the
closing price does this, and I see this candlestick pattern," or, "There could be a whole bunch of
different things potentially, but when I see all those things, then I know it's time to buy, and I'm
not going to do it unless that happens, and you get a feeling of control, right, because you
think, "Hey, I'm making the market do what I want." Where with the exits it's a little bit
different. You're in the trade already and the trade, you know, you kind of feel, "Well, it's going
to what it's going to do," and you don't have as much control. At least, that's kind of my
thought process.

But, you know, people just like entries better, and in the book, the entries outnumber the exits
by about four to one. I think I had 40 something entries and 10 or 11 exits, I believe, and the
reason is people just like entries a lot more.

Andrew: Now for entries, do you think that they need to have a logical reason behind them? Do they
have to actually make sense to be a good entry?

Kevin: I personally like that, when it has some logical basis. A lot of people use machine learning or
some of this software that's out there that will just randomly pick indicators and build systems,
and it'll tell them that, "Hey, if the 22 period moving average is greater than the 49 period
moving average, oh it's a great time to buy." Well, yeah, some of that, maybe that's real, maybe
it's not, but some of that is just data, you know, it's just going to happen in data where you just
get these spurious things happening that have no meaning, and that's why I prefer to have
something where you actually think about it and kind of makes logical sense. So whenever I
look at entries or exits, if I see something where the, for an exit for example, the stop-loss is
$862, I get a little scared, but if I see it's 750 or 1000, then I'm like, "Okay, well you probably
didn't optimize it," because one of the fears is if you optimize enough things, you're going to

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 find something that works really well, but it doesn't mean it actually is going to work going
forward.

I tend to like things that make logical sense, but that being said, a lot of the things I think make
sense just don't work, they just don't test good, and that's the ultimate proof. And sometimes
things that I think, "Oh, this makes tons of sense," the exact opposite actually works better. So
it's nice to have a reason because it gives you some confidence, but the same time, sometimes
that's not always possible.

Andrew: So talking about those entries then that you've tested and perhaps have not worked so well or
have worked the opposite to what you expected, is there any that stand out in your mind that
have surprised you or given you the complete opposite result to what you thought?

Kevin: Probably the ones that have surprised me the most are ones I program and it works, and I think,
"Oh, yeah, hey, I'm a genius. What I thought would work, would work." And then I go back a
little bit later and find that there was a coding mistake and it works in spite of what I thought
was going to work. For whatever reason, I made an error, and you could say, "Oh, well,
subconsciously you knew that it was greater than instead of less than," I don't know. But those
are the weird ones where ... And then, of course, you're left with, "Well, it works and it passed
all my tests, what do I do with it now?"

My tendency usually is, when I see that kind of thing, I'll still let it prove itself in real time,
because that's the ultimate test. You can do all kinds of back testing, add in-sample, walk
forward and do all that, but, ultimately, it's that live market that ... There's no way to know
what the data's going to look like, and if it still holds up, that's the ultimate test.

Andrew: Yeah. Now, obviously, you've tested a lot of entries. For people who have a look in your book,
there's quite a few in there. Now, you've already mentioned a couple of examples, like moving
average crosses or candlestick patterns and things like that. Have you found any specific type of
indicators work better than others? For example, indicators versus price action or chart
patterns? Are any more robust than others?

Kevin: That's a good question. I guess in certain cases, yes, but in a lot of cases, no. So, what I mean by
that is, for example, in the book I probably have momentum, you know, the close minus the
close so many bars ago. That tends to be a pretty good indicator or measure, whatever you
want to call it. RSI also tends to be pretty decent. And then on the pattern side, I've also seem
some patterns that tend to work pretty well in different instruments, different bar sizes, so
different time frames, but by the same token, there's always, with any of those, there's always
a ton of places where it doesn't work.

There's a lot of people who say, "Oh, hey, I need this to work on every single market." I always
tell them, "Good luck with that," because it's just hard to find something that's a universal type
thing. It's near impossible and you'll pull your hair out doing it, but it is nice to actually
sometimes have that validation where, oh, it works with the Japanese yen and it also works
with crude oil. That certainly gives you more confidence in it, but I've never treated that as, kind

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 of, oh, hey, it's got to work in these different markets. Or at least I don't now. There was a time
where I was probably more that way, but I realized it's just harder to find things, and at some
point you have to kind of balance, hey, how difficult is something versus how many systems can
I create if I relax or just have slightly different standards? And, again, either way, if you still
prove it in real time, that's your true validation, so that's kind of the way I look at it.

Andrew: And I guess as well it probably comes into optimization a little bit, because you're probably
likely to have more perimeters to optimize if you've got an indicator versus perhaps a pattern
that has no optimized parameters, so I think that kind of goes back into the point you were
making earlier about being careful about optimizing.

Kevin: Right, right, exactly, yeah. The really bad thing about indicators is you've usually got lookback
periods and thresholds for values and they can all be optimized, and, unfortunately, what a lot
of people do is they think if it can be optimized, it must be optimized, and that's a terrible way
of thinking, but we all, to a degree, fall for it, myself included. There'll be times where I have to
catch myself and I'm like, "Wait a minute, I'm trying to do a little too much here," and I think
that's just part of as you get experience, you start to realize, "Hey, the less I do, the better,"
and, ideally, you'd do none, but that's, for most of us, it's pretty unrealistic.

Andrew: Yeah. So earlier you mentioned that you like to let your strategies play out a little bit, just to see
how they go in the markets, but if you just wanted to test the effectiveness of an entry, and
obviously there are so many different components to a trading strategy that can impact the
performance of that strategy, is there a way that you can test the effectiveness of an entry on
its own?

Kevin: Yeah, there's a couple ways I would do that. One way is to actually just try it with an exit where
you exit after a certain number of bars, so let's just say you say 10 bars, and you just track how
profitable the strategy was after bar one, after bar two, after bar three, and that will give you
sense of, you know, is it never profitable, or is it always profitable, or does it ramp up and then
kind of die off, which I think a lot of strategies do. That would be one way to do it. What you'll
find, unfortunately, is I think a lot of entries will be profitable one or two or three bars after the
signal, but the problem is, when you factor in commissions and slippage, a lot of times, even
though they're showing, hey, it's profitable, after costs are added in, they're not profitable
enough to actually be worthwhile.

So there's obviously a persistence with an entry signal. It doesn't ... If I get an entry signal today
to go long, it doesn't mean it's good for the next year, but at the same time, those shorter
periods of time, you have less time to overcome the slippage and commission, and then that
kind of kills a lot of entries. It's funny, I remember once doing a study where I looked at a whole
bunch of indicators, and, roughly, they're anywhere 45 to 55% accurate over a certain
timeframe with no costs added in, so some of them were good, some of them were not good,
but when you added real trading costs into it, most indicators just lost money, they just weren't
good.

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 That's not to say you can't then take a couple of them and combine them, or use them in
certain situations, but just means, by and large, a lot of this is just kind of breakeven at best
case, and, usually, losing after slippage and commission. That's what makes it so hard.

Andrew: So if you're doing this test of an entry and you see ... So you're testing it over the following 10
bars, and you notice that the first two or three bars it's not actually very effective, which you
can often see breakouts that pull back a little bit just after they've broken out before they move
on. Would you then adjust the logic of the entry to take that into account, or do you think that's
starting to get too close to curve fitting? How would you treat an entry if you saw it perform
like that?

Kevin: I have done that, so where I actually just built in a delay where I get the signal today or this bar
today, but maybe I don't take it until a couple bars later. I have done that at times and I've kind
of had mixed results with that. It didn't quite work out the way you'd think where, hey, you
delayed a couple of days and you get rid of those first few bad days, it doesn't necessarily work
that way. I'd have to really dig into it to recall all the details about it, but, I mean, that's
something you could do. Obviously, it just complicates it, and, like you said, now it adds another
variable, at least one. So you have your entry, but then you would have your delay on your
entry, and so, yeah, you're probably going to be able to optimize it even a little bit and get
something better, but it may or may not work going forward.

Andrew: So what if you're building a strategy that goes long and short, do you like to see symmetry in
the entries, perhaps opposite logic or something like that? Is that something that you aim for
when you're using specific entries?

Kevin: Yeah, and that it's in the book. Most of the strategies I have do that. I like symmetry, only
because a lot of markets can go up and down, and people can argue, "Well, hey, it should be
different, because the markets can collapse faster than they rise," and that's true to a degree
on a lot of markets, but the only real set of markets are stock indices, where the symmetry
probably doesn't hold as well. But even with those, I still like to have the symmetry, if for no
other reason than it helps prevent me from curve fitting, because if I have a, let's just say it's a
10 day or 10 bar breakout for long trades, and then it's oh, well maybe it's only a six for short
trades... Now, instead of one perimeter, I've doubled my perimeters, I have two, and, you
know, is it good? I don't know. Could it be curve fitting? You're starting to get closer there.

So I always like to limit the amount of things, but, unfortunately, that means your back test
doesn't look as good and you don't get as excited about it. But that's just part of it. It took me a
long time to realize that building great looking back tests was not the goal. It might happen, but
if that's your goal, you're probably going to be disappointed, because ... In real time. You won't
be disappointed in building the system, because you can create great looking back tests and
that's fairly easy, but to do it you usually make a lot of mistakes.

Andrew: Have you done any work in classifying entries in different market environments or different
market conditions? So, for example, perhaps taking a breakout when the market is

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 consolidating might not perform as well as when it's trending and retraced. So, do you ever
look at entries in the context of broader market environments?

Kevin: You know, other than sometimes putting a filter on it to say if price is above the 200 bar moving
average for example, then only take long trades and vice versa, I'll do some of that, but the
problem once you start to break the market down into different regimes, like Van Tharp for
example, talks about, I think, six different market regimes. He says, "Well, hey, just trade the
system. That works best in that regime."

It's a great theory. I mean, it sounds really cool. Oh, yeah, I'm only going to trade my volatile
bull systems in a volatile bull market, okay? But the problem is in setting up what is a volatile
bull market? What is a range bound bear market or a low volatility bear market? When does
that get triggered? So you end up having to spend a lot of time creating models that just
describe what zone you're in, and, usually, from what I've seen, people in bull markets are
usually late by about the first 20%, so meaning they miss about the first 20% of a bull market,
and then they stay too long. It's you're having a party and you had some guests who arrived late
and you don't like that, and then you have other guests who won't leave, and they stay way late
and you want to go to sleep. You lose on that end.

So out of that 100% of that whole bull market move, you might have missed the first 20% and
the last 20%, and so you're left with 60%. And it really isn't even that good, because it's not like
you just caught the 60%. Don't forget, when the 20 in the beginning and 20 in the end you were
probably the opposite, so not only weren't you in the bull market, you were still thinking it was
a bear market at the time, because your indicators or whatever measurements you use hadn't
turned yet. So that's the big problem with it, and, of course, now you've added a lot of
complexity to your models by putting in this bull or bear overlay and there's perimeters that
can be optimized and everything, and, you know, do you benefit enough from that enhanced
model to make up for it? Maybe yes, maybe no.

My experience is that's never ... I've tried it sometimes, and it's never really helped that much.
Yeah, others, I'm sure, would disagree, and maybe it's just the way I'm doing it, but, you know,
I'm always kind of leery of that kind of thing.

Andrew: Well, up until now we've kind of really focused on entries, but I'd like to ask you a little bit
about exits as well. I think they're very important. There are obviously some very common exits
that people use, like fixed stop and target, but, looking through your book, there's obviously a
lot more to it than just these simple things, especially around using entry logic as exits. Can you
share a little bit about what you've found in your research with exits?

Kevin: Yeah. That was kind of interesting. I run an online workshop, but one of the things I did a little
over ... It'll be two years ago. I had some of those students flew into Cleveland where I'm at for
a weekend of building systems, and one of the things we did was ... Obviously people could
build entries, whatever you want, exits, whatever you want, but one exercise I actually had
them specifically use typical entry conditions as exits. Not just stop and reverse, but just as an
exit, so if, for example, if it was a 10-bar breakout high, normally you'd buy, okay? Well, I said,

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 "Well, make that an exit." Or any short trades, if you hit a 10-bar high, you just exit, you don't
necessarily go short.

I didn't really know what to expect when I asked that, but what we found was some of the best
exits were those entries, you know, just configured just the exit position, not necessarily to
reverse or anything like that, it was just to exit, which kind of opens up the door for all the
entries I have in the book. Hey, you can use those as exits too, which then, you know, people's
heads start spinning, because then you're like, "Oh, my gosh, now I got 52 ways to enter and
exit, but then plus I got another whole bunch more ways to exit," but it's something I had never
really done in my own trading, and based on what we found, there was a group of about 30 of
us who did all kinds of testing on that weekend, I started to do that more in some of my own
systems, and it's kind of been interesting to do that, kind of look at things a little bit differently.

Andrew: Do you think then that the exits need to match the type of entry? So, for example, you're using
maybe a moving average entry, do you think it's wise to use a moving average exit as well, or do
some exits work better with some entries and not others?

Kevin: Well, definitely some would work better than with others, but I can't say I've ever looked and
said put a certain class of entries should only be used with these kind of exits. I've never gotten
to that detail, but, I mean, I've definitely found where some indicator-based entries, for
example, could work with other indicator-based exits or pattern-based exits. You almost never
know until you test it, and for somebody listening to think, "Oh, well, Kevin said, 'Never do
this,'" my recommendation is always to test. Don't listen to me, don't listen to anybody else tell
you this is the way to do something, as far as, "Oh, you got to use this exit, got to use this
entry."

What I'm saying is test it yourself and verify it, because I think all of us who have bought trading
books, we've tested ideas and the author gets one set of results and we get something
completely different, and you're scratching your head, you're like, "Why?" Well, hey, data is
different, especially with futures with continuous contracts, or if you're trading with Forex,
different brokers will have different data and that could lead to differences, and, hey, maybe
they're starting a different time.

I once ran into a problem with TradeStation where somebody was getting results that were
completely different than mine, and we finally tracked it down to how they were building their
bars. They were building their bars based on time of day, so let's say that they were hour bars,
it would be 6:00, 7:00, 8:00, 9:00, top of the hour, but the way I was looking at it was based on
session hours where it was 7:30, 8:30, 9:30, and you'd be surprised how much different a
system can be when you test on one type of bar versus another. They're still 60-minute bars,
they're a half hour offset.

So I always recommend that people, you test it for yourself, and if you have a solid way of
testing and you believe in your results, which means you've probably traded or at least there's a
way you verify that what you're doing is right, that's the best way to see it for some of this
yourself.

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Andrew: Earlier you mentioned a technique we can use to test the effectiveness of entries just by
looking at the performance over the next X number of bars. Can you also use that technique for
exits as well?

Kevin: Yeah, you could. I think the problem though, it's probably more entry dependent, so, for
example, if you just wanted to ... Yeah, you'd kind of have to work backwards, because a lot of
people just use typical stop-loss and profit targets and that's kind of hard to do that sort of bars
back or bars into entry kind of thing. I mean, you could do it. I can't say I've ever done it and
that's why I'm struggling with an answer here. And the other thing to keep in mind for
everybody listening is you can test exits by themselves, you can test entries by themselves, but
a lot of times what's really important is the interaction of the two.

I mean, I've had entries that look great with one particular exit and look terrible with a different
exit, and then I think, "Oh, it's the exit," but that exit will work great with something else, and,
again, it's something you'll see when you start testing.

Andrew: What about combining different types exits, say a fixed stop and maybe an indicator-based exit
and a profit target? What are the types of things you look for when you're combining exits? Is
there anything we need to be careful of when we're combining different exit types?

Kevin: Yeah, I mean, the biggest thing to be careful about when combining them is just doing too
many. You could have ... I've seen people do this where they have a stop-loss and then they
have a trailing stop, then they have a profit target and they also have a breakeven stop, so for
each of those you have different perimeters you can set and you can quickly overwhelm
yourself with it. And what I've found a lot of times, the easiest and simplest systems tend to be
the best ones. So a lot of systems I have, I won't have a profit target, I won't have a trailing
stop, I'll just have a simple stop-loss and that's it. Some of them I don't even have that, I just use
the reverse of the entry, it's just a stop and reverse system, so I'm always in the market one
way or another.

Sometimes that works the best, but I'm always really cognizant of having too many things, too
many perimeters that you could optimize, because even if you tell yourself you're not going to
optimize it, "Oh, hey, I'm going to put this $500 stop-loss. I'm never changing it." You can tell
yourself that at the beginning, but as you kind of go through and you're looking for ways to
improve your system, all of a sudden that $500, "Oh, what if I made that $1500? What happens
then?" And, "It's better. Oh, well, I got to use that, right, because it's better now." And that's
the biggest thing is your exits can be super complicated, but there's usually a price to pay with
that.

But I understand a lot of people like that, because, again, it goes back to having great looking
back tests. Everybody wants a back test that looks great, because they're putting their money
on the line and why put your money on the line with something that doesn't great to begin
with? And that's kind of the tough part.

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Andrew: Yeah, and I think one of the challenges with optimizing exits that maybe traders miss
sometimes is that if you're ... Say you're optimizing for a specific stop-loss, like a $500 stop-loss,
or a profit target, sometimes the optimization process can actually just remove that one big loss
or include that one big trade, and it's not really impacting much else, but traders are making
decisions based on these optimization results that perhaps aren't really robust because they're
only impacting a small number of the samples. Is that something that you look out for or that
you've seen other traders get caught out by?

Kevin: Yeah, I mean, definitely you can get caught up with it. The way I tend to build systems, I kind of
build in some safeguards to kind of prevent that. I don't want to say eliminate it, because it's
not something I specifically look for to say, "Oh, hey, when I change this stop, for example, how
many trades did it actually impact?" But I do know people who do that and, no, it definitely
makes sense that you might want to take a look at that kind of thing, but, yeah, it's not
something I necessarily do consciously, but sort of the way my process is set up, it kind of
accounts for some of that.

Andrew: And I guess as well, as you mentioned earlier, over time with experience you kind of get a
feeling for if you're going a little bit too far with this type of stuff and you can rein it back.

Kevin: Yeah. The good rule of thumb, I always tell people, is if you ever ... It's hard to know when
you've optimized too much, right? But if you ever get to the point where you feel like maybe
you have, or maybe you question, "Hey, maybe I've optimized too much," when you get to that
point, you're already past it. When you ask yourself the question, you're already past it, and
what I've found myself over the years is that I start asking that question of myself a lot sooner
than I did 10 or 15 years ago. Maybe back then I was doing thousands of iterations, and now, if
I'm doing a hundred, I'm still freaking out a little bit, because I'm like, "Ooh, maybe a hundred's
too many."

That's why I always love people who are, "I got to get the fastest computer possible because I
need to run these optimizations as quickly as I can," and my response usually is, "Maybe you're
trying to solve the wrong problem. It's not computer speed that's your problem, maybe it's the
way you've set everything up in the first place that you think you need that kind of speed."
That's one way to look at it.

Andrew: Okay, well, I'm conscious of our time here, Kevin, so I'll just start wrapping up. So where can
people learn more from you, or even get in touch with you?

Kevin: Sure. If you go to my website, kjtradingsystems.com, there's some contact forms there where
you can email me and I'll get it, and, also, there's a ton of stuff on my website. You can sign up
for an email list, get some free material, a lot of webinars and that kind of thing. So I'm pretty
easy to get a hold of. I'm usually hanging around some of the trading forums too, either
futures.io or the TradeStation forum. I'm a TradeStation guy, so you'll see me on there.
Kevinkdog is my nickname I think in both places, so I'm pretty easy to get to reach, if you want
to reach me.

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Andrew: Yeah. And what about your book? I assume you've probably got some links on your website for
the book?

Kevin: Yeah, definitely. If you go to my website, there's a menu item that says my book or my books,
and you can just click on that and read about my books, and there'll also be a direct link to
Amazon. And, you know, for people who just want to go to Amazon, just search for my first
name, last name and up should pop a few books, and hopefully you'll like what you see.

Andrew: Yeah, cool. Awesome, Kevin. Well it's always great to chat with you and, once again, we had a
great time talking, this time about entries and exits. Was there anything else that you'd like to
mention before we finish up here?

Kevin: No, other than just want to caution people that, especially with my last book, which just gives
entries and exits, it's a good resource guide, but just don't go crazy with optimizing. I mean,
don't think that just taking what I've done and just optimizing it like crazy on a whole bunch of
different markets is going to get you the right results. You really have to have a good
development process to use these properly. So that's probably the big key, so I just want to
warn people about that.

Andrew: Thanks a lot for spending time with us today. It was great chatting to you, all the best.

Kevin: All right. Well thanks, Andrew, thanks for having me on. Bye.

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