Posted by Mark on July 1, 2012 at 10:26 | Last modified: July 1, 2012 10:26
In Part V of this series (http://www.optionfanatic.com/2012/06/05/strategies-vs-systems-part-v/), I concluded some commentary on discretionary trading. Today I want to provide some argument for algorithmic (also known as “rules-based” or “systematic”) trading.
Rules-based trading systems may be tested for statistical reliability. Robust systems have proven themselves over extended periods of time and different market environments. This leaves us confident about trading them into an unknown future.
Systematic trading eliminates decision making. An oft-cited quote is “prepare for war in a time of peace.” In the heat of battle, adrenaline kicks in. Decisions are then motivated by survival rather than profit. These are the times when psychic pain causes us to realize huge losses if only to sleep restfully at night. This is not the road to consistent profits over time.
Systematic trading ensures consistent application of trading rules. Rules without enforcement are trades without rules. No longer are we then trading systematically and no longer does our historical backtesting apply. Based on nothing concrete we are now gambling, not trading.
Systematic trading eliminates emotion. We program entries and exits to ensure they occur reliably and according to plan. One of the largest uncertainties of discretionary trading is our emotional reactions to pleasant or unpleasant situations. Systematic trading removes this.
Finally, systematic trading provides continuous risk control. Profit targets and stop-losses were determined through the rigorous system development process yielding potential results with which we feel comfortable. Gone will be the days of “I’ll hold on just a little longer because I think this market is about to reverse.” The trading platform will exit our trades automatically.
In my next post, I will address some potential downside to systematic trading.
Tags: critical thinking | Categories: System Development | | Permalink
Posted by Mark on June 28, 2012 at 12:28 | Last modified: June 28, 2012 12:28
It’s been a busy month!
First week of June involved a scurry of wedding preparation and alignment of all the p’s and q’s.
The big event occurred on June 10.
The following week was kids’ last week of school and visitation with parents.
The following week was camping honeymoon.
This week was good-bye to parents and wife’s surgery/recovery.
I plan to return with more trading-related content very soon.
Categories: About Me | | Permalink
Posted by Mark on June 5, 2012 at 09:29 | Last modified: June 5, 2012 09:30
I’m in the process of breaking down quite the mouthful from Part III of this series (http://www.optionfanatic.com/2012/05/23/strategies-vs-systems-part-iii/):
“If you are a discretionary trader then you have trading strategies with guidelines… [this] relies somewhat on common sense and gut instinct.”
Today I will finish by discussing the latter.
“Gut instinct” is a type of knowledge that may be difficult or impossible to describe as binary statements or programmable criteria. The guidelines are meant to be generalities subject to change depending on what discretionary traders believe to have typically occurred in the past when these observations were made.
Since this does not reduce to programmable criteria, the biggest problem with gut instinct is the inability to backtest trading strategies. Maybe your gut would have proven correct one or two times. Would it have proven correct most times out of a large number of instances, though? These may be hard to determine without using software to scan the universe of markets over long periods of time.
Because it cannot be objectified, gut instinct lends itself to biased thinking. Confirmation bias is the tendency for people to favor information that confirms their beliefs. This leads to overconfidence because it’s not necessarily true that gut instinct has proven itself correct time and time again–it simply has yet to fail.
Gut instinct also falls prey to the availability heuristic, which is when you mistakenly believe something at the forefront of your mind is something that has occurred often. For example, if you recently saw a moving average crossover generate a profitable trade then you may be more likely to trade similar crossovers in the future. One instance does not make for a robust phenomenon; it may simply be good luck.
In the next post, I will break down characteristics and qualities of algorithmic trading.
Tags: critical thinking | Categories: optionScam.com | | Permalink
Posted by Mark on June 4, 2012 at 15:47 | Last modified: June 4, 2012 16:36
In my last post (http://www.optionfanatic.com/2012/05/23/strategies-vs-systems-part-iii/), I said quite a mouthful.
Let’s break it down.
“If you are a discretionary trader then you have trading strategies with guidelines… [this] relies somewhat on common sense and gut instinct.”
Discretionary traders claim to know their market through lengthy study and/or live trading experience. They claim to have a feel for how the market moves–slow or fast, volatile or nonvolatile, cyclical ranges, etc. They claim to have a feel for common price patterns, tendencies, and fake outs. Based on this assumed understanding, discretionary traders develop trading strategies with guidelines.
“Common sense” includes tendencies that sound logical. For example, it sounds logical to reduce exposure to the market ahead of big news announcements or known events when you don’t know how the market might react. Discretionary traders often include logically sounding guidelines in their trading approach regardless of whether these boost or detract from profitability.
The unfortunate fact is that common sense trading guidelines often end up producing unprofitable trades. This is evident in the thousands of trading systems based on common sense criteria that have generated unimpressive results. The only way to know if inclusion of common sense guidelines is beneficial would be to define some trading rules and backtest them. This is more work than most [discretionary traders] are willing or able to do.
In my next post, I will wax eloquent for a while about “gut instinct.”
Tags: critical thinking | Categories: optionScam.com | | Permalink
Posted by Mark on May 23, 2012 at 09:29 | Last modified: May 23, 2012 09:32
In Part II of this series (http://www.optionfanatic.com/2012/05/16/strategies-vs-systems-part-ii/), I continued to argue that trading strategies are optionScam.com. Let’s continue this analysis from another angle.
In the quest for consistent trading profits, traders are commonly discretionary or algorithmic in their approach.
Much ado has been made about the differences between these two. If you are a discretionary trader then you have trading strategies with guidelines. If you are an algorithmic trader then you have trading systems with rules. The former relies somewhat on common sense and gut instinct. The latter depends on programmable criteria that can be evaluated and executed by a computer.
At this point in my trading career, I strongly suspect that through a complex interplay of logic and human psychology including but not limited to the effect of wins and losses on emotions and memory, Maslow’s hierarchy, and ego fulfillment, discretionary trading may be optionScam.com at its finest.
That’s nothing short of a mouthful. In future posts, I will break down each and every one of these elements.
Tags: critical thinking | Categories: optionScam.com | | Permalink
Posted by Mark on May 21, 2012 at 09:51 | Last modified: May 21, 2012 09:51
…the more they stay the same? This excerpt is from Gary Smith’s book Live the Dream by Profitably Trading Stock Futures, which was published 17 years ago:
“There are a handful of vendors that sell hyped and overpriced systems, seminars and trading manuals that purport to teach the public how to day trade the S&P successfully. They recommend trading not only on a daily basis, but even several times during the day. Off the floor it is an almost impossible task to trade profitably this way… I find it interesting that absolutely NONE of these vendors can prove that they are winning traders via multiple-year, real-time brokerage statements. Their trading courses are total illusions. They dazzle you with an array of historical charts and other past data to illustrate the purported validity of their methodology.”
Categories: optionScam.com | | Permalink
Posted by Mark on May 17, 2012 at 06:35 | Last modified: May 17, 2012 06:35
“After the recent major losses at quantitative hedge funds, many people have started to wonder if quantitative trading is viable in the long term. Though the talk of the demise of quantitative strategies appears to be premature at this point, it is still an important question from the perspective of an independent trader. Once you have automated everything and your equity is growing exponentially, can you just sit back, relax, and enjoy your wealth? Unfortunately, experience tells us that strategies do lose their potency over time as more traders catch on to them. It takes ongoing research to supply you with new strategies.
There are always upheavals and major regime changes that may occur once every decade but will nevertheless cause sudden deaths to certain strategies. As with any commercial endeavor, a period of rapid growth will inevitably be followed by the steady if unspectacular returns of a mature business. As long as financial markets demand instant liquidity, however, there will always be a profitable niche for quantitative trading.”
–From Quantitative Trading (2009) by Ernest Chan
Categories: System Development, Wisdom | | Permalink
Posted by Mark on May 16, 2012 at 14:20 | Last modified: May 16, 2012 14:20
In Part I (http://www.optionfanatic.com/2012/05/07/strategies-vs-systems-part-i/) I argued that trading strategies are optionScam.com. A second reason for this claim is because trading strategies often assume you can predict the future.
Many option education programs teach you how to place trades to optimize the current trend of the market. I have subscribed to two of these programs in my trading career at a cost of over $6,000 each. One program teaches “form a market opinion and place a trade to optimize that market trend.” The second program teaches “don’t try to predict market direction” and advises placement of non-directional “income trades” that make money if the market trades up a little, down a little, or sideways.
Although both programs spend hours teaching you how to place the “correct” trades, what actually determines profitability is whether your market expectation is correct. Neither program spends more than a couple hours on this! With regard to placing the trades correctly, I can save you $6,000 by listing a number of books under $30 or free web sites providing this content. The only way to know if your process will sufficiently determine future market direction (sideways included) is to perform a valid backtest.
System development is the real work to be done and these “educational programs” teach nothing about it.
Because your market expectation may be wrong, both programs teach you to trade small to limit risk. Trading small also limits gains, though. The key question is whether these approaches even have positive expectancy. This is a complicated question still up for debate and if the answer is no then at $6,000-a-pop you will be learning nothing more than how to lose all your money slower rather than faster.
Save your retirement account. Give me a couple grand and call it good.
Tags: trader education | Categories: optionScam.com, System Development | | Permalink
Posted by Mark on May 7, 2012 at 23:54 | Last modified: May 8, 2012 10:30
Trading systems are capable of generating consistent profits while trading strategies are optionScam.com (see http://www.optionfanatic.com/2012/04/21/optionscam-com/).
Trading strategies are available everywhere you look. You can find trading strategies in books, through webinars, on internet sites–this list goes on and on. Strategies are often marketed through long advertisements that promise huge ROIs and large compounded returns.
Trading strategies appeal to human greed. They are sought after and commonly sold for hundreds to thousands of dollars. Expensive trader education programs generally teach strategies. If the market is bullish (bearish) then do X (Y) trade. If the market is stagnant then do Z trade. You can spend lots of money learning what kinds of trades will optimize what trends. At the very least, this makes you dangerous although it may not make you profitable.
Trading strategies are well illustrated by single trades in isolation, which is hardly the reality of live trading. By applying the strategy guidelines to a particular trade, you can learn its strengths and weaknesses. Annualize that ROI (as if!) and human nature has already taken over. “Imagine what X%/year can become over the course of decades!” Human nature needs a reality check. The only way to generate consistent income and meaningful growth is to trade as a business, which single trades in isolation are not.
A trading strategy is not a trading system because it lacks detail about money management. Money management addresses Risk of Ruin for the entire portfolio. Making money without studying this is luck at its finest–luck that will eventually run out.
For these reasons, trading strategies are generally not actionable. This makes trading strategies optionScam.com. In future posts I will go into more detail about this important concept.
Tags: critical thinking | Categories: Money Management, optionScam.com | | Permalink
Posted by Mark on May 2, 2012 at 23:34 | Last modified: October 1, 2012 05:52
Sizing Risk is a common trading plan element that can pose a challenge to consistent profitability.
As discussed in Part I (http://www.optionfanatic.com/2012/04/26/sizing-risk-part-i/), these are scaling trading plans with a profit target of 15% and max loss of 20%. Suppose $10,000 is allocated per tranche for up to three tranches. The trade will then profit $1,500, $3,000, or $4,500–fifteen percent–depending on how many tranches are placed. When the trade loses, it will usually be after completely scaling in: 20% of $30,000 is $6,000 lost.
This monthly trade will therefore have to profit at least 75% of the time to be profitable. If the trade wins eight months out of 12 and averages two tranches for each winning month then in one year it will make 8 months * $3,000/month = $24,000 and lose 4 months * $6,000/month = $24,000. If the trade only wins seven months and loses five months then the annual return will be -30%. Should it have a tough year and lose exactly as often as it wins, the annual return will be -60%, which is nothing less than a good recipe for grounding an account into hamburger meat.
As discussed in my posts on the naked put selling strategy (http://www.optionfanatic.com/2012/03/25/the-naked-put-part-iii/), a common worry amongst traders is to have one catastrophic loss that wipes out many profitable months. Sizing Risk teaches us that making too little in the winning months can be just as harmful to overall returns as catastrophic losses but is much more frequently overlooked.
Tags: income trading | Categories: Money Management, Option Trading | | Permalink