For the first time, I am releasing the performance of one of the main unleveraged accounts I am managing. This performance doesn’t include any leverage and the graph is scaled to an initial equity of 100,000. The management started around 4 months back, 25th of March to be precise.

Technically, the profit shown here is the bare minimum, “open-for-audit-if-you-want-it”, type of profit. Includes friction and all the costs  a real trading account will face. But in its reality the real profits are slightly more than this. The extra component comes from a few option trades I have taken to run a side speculation via one of the other systems I designed recently. Quite notable was the option trade on June 8th, where I loaded up 4400-4500 puts, quite heavily, to see their price shoot through the roofs, 10 days later. Also involves a few duds, like the one I am currently in, where I loaded up 4400 calls, at 150, but still couldnt show a very encouraging trade[ as I am writing, it tanked from around 250 to 139ish levels in 2 hours straight, Nifty falls 4%]

The Profit Curve

Till date, the return shown is 37%[since March].

Quite some time back, I posted an article here, with this title, “Developing a Trading System”. It discussed on the psychological implications of trading a system. It never asked about the profitability[as in hard $] of a system, but instead asked some hard questions about its drawdowns, losing streak and average MAE. That post is more of an end stage question rather than a first step method.

This time, I am concentrating on something which comes right in the first steps. How do you really go about  fiddling with an idea to the first steps of investigating it seriously? And what next?

Before, I begin, I would like to reiterate an analogy. There is a striking similarity between markets and ecosystem. The trading systems being hunters, chasing limited $$$ for survival. If that is so, which animal should a trading system represent? Elephant[Fundamental Investing, might be, not sure, slow,regal,patient and huge]? Jaguar?

The issue is, your trading system can  be any one of them, yet in the situation of meteoric catastrophe, most of them would be wiped out. Save one.
The Cockroach.

A cockroach can survive even a nuclear holocaust, its cretin shells robust enough to save it from most of the catastrophes, man made or natural. Their hardiness, can keep them alive without food or water upto a month, and can survive on limited resources like glue off a postage stamp, the sebum left in a fingerprint.

The final idea is this, you want your trading system to be as hardy as the cockroach, surviving and treading a wide range of markets and market situation well enough, so that any change, catastrophic or gradual doesn’t do any harm to its tradeability.

And this forms the crux of the post. You have got an idea, say,  a simple day trading trend following idea, like go long when the price shoots above the previous day high, with stop as that bar’s low and short when the price shoots below the previous day low and with stop as that bar’s high. Once you get the idea and you code it, the first temptation is to check if its profitable, how much it is, etc etc etc.
Well not yet. Don’t do that, now. Instead what is suggestible is run the vary same strategy over a wide range of price series. Not all will be profitable, right now. Some will be, some will be not. But that’s okay, its a good idea to keep the profitable to non profitable markets ratio somewhere between 40% to as high as 60%.

Yet, look for the risk adjusted returns in all the markets in the sample set. None should stick out, individually. What effectively we are looking for is not a specialised animal but a ever flexible, hardy, strategy to deliver the returns. Why? Because specialisation is the mother of death!

When one day, the underlying fundamentals change as for sure they will, you will be gasping for a hardy, flexible strategy[a la Swiss Knife] and not a lean, mean, high specialised hack saw blade.The idea being,when one of the profiting markets turn mellow, we can “hope” that one of the earlier non profiting markets pick up and return some of the lost luster and sheen.

We often make decisions based on how much dollars is being returned. Thats a wrong move. You should be instead looking for a homogeniety in the results. A band of acceptability with none of them, sticking out.Probably some might give upside returns of 1.5-2σ away from the average. There is nothing to be really emphatic about. Your system will soon mean revert, and that part where you will try to lock in profits, will be handled by the money management part. For example strategies like Exposure Reduction, Staying Out of the Market, Equity Curve Trading etc etc.Because all we have in our hand is to reduce our drawdowns and manage our risks.

Till the next time,
Trade Well,
Soham

Off late, I had been experimenting quite a bit with how multiple systems interact with each other, on a portfolio level to deliver returns.

The reason, I am dealing with this, is because incorporating a strategy of just one flavour can severly hamper the equity curve’s quality. The right way is in mixing systems of various flavours and possibly some special strategies on specific instruments so that equity curve has a more smooth output.

If I want to test a trend following system on all the stocks of SPX but a counter-trend system on the index itself, together,common sense tells us, that the resultant equity curve will be the linear combination of seperate equity curve of the two strategies. But this is flawed reasoning. There is something called Synergetic Effect and Antagonistic Effect in nature. As the name says, synergetic effect means, the resultant being better than the sum of individual components. And by analogy the antagonistic effect. As a trader/fund manager, its imperative that a system hedge is performed. Meaning, a system is hedged by another system thus making the equity curve better, not only in terms of drawdowns, but also in terms of returns.

Consider I have 100 bucks in my account and I have allocated 60%-40% ratio to a trend following system and a counter trend following system. Assuming their drawdowns are not in sync, then we can have a compelling case of higher returns. How ?It effectively has an effect of compounding faster than any single strategy, with lesser drawdown[only if the equity curve have a phase difference, a lead or a lag]. Thus increasing the CAGR/Max DD ratio.

So in this quest, I went to Amibroker, one of the softwares I avidly use.I use it mostly for coding my systems, but what irks me, is its absolute apathy towards multi-strategy testing.You cannot run a combination of two or more strategies together. And what surprises me is the lack of such feature even in Wealth Lab. I mostly am at a loss of overcoming this drawback. Possibly, one idea I can get is, catch hold of the two equity curves, and scale the curves for the beginning of each month, at the end of the month, the returns they will be showing, pool it back, and again scale the curves, show the returns. And the effective summation of their scaled returns of the equity curve might give it a good chance of simulating the same in real life.

Sigh!

Soham

Information Theory has come a long way since Shannon’s Channel Coding Theorem. The beauty of Information Theory in giving a totally new understanding of the world as it is, is humbling. I have not done much reading on Fractals[ Most of my education were because of books which were not in my course , no wonder my dad always had to hide his face, whenever the sem exams ended ], but I distinctly remember a warning on a book of Fractals which also served as a “hook”. It read, “Beware before turning the page, for your vision of nature’s beauty can change forever”.

It was intriguing, and though it was a clever “hook”, I always felt the overlap of Information Theory with so vast and diverse playing field was awe-inspiring.

In the book, “Elements of Information Theory”, Thomas Cover there is an image which shows, the overlap of IT with almost all the modern sciences right from computational complexity, to stock markets to digital communication.

If amongst my reader, I do have anybody who nurtures a slight academic bent, he might find this paper[link below] helpful in building up his information theoretic approach to capital markets. The paper is a student project and is formed on the basis of “Elements of Information Theory” , the book which I just mentioned. Introduced from bottom up, you might like to give it a read.

Information Theory and Portfolio Management by Efe Aksuyek

This story has an interesting background. A few days back, I was trying to render my services to one of those Portfolio Management Services, showing my experience as a semi-quant guy, plus my experience in system development.

Well, it run up quite a bit. At the beginning they said, I didnt have much fundamental analysis competencies I gagged but well, filled it up. But I was very wary of such a professional asset management system where FA is given such a huge emphasis. Then well, they oversaw my graduation degree and said, “Sorry bro, no go.. You aint got an MBA”

Well, in a way I am thanking my stars. I think, I would not have really fitted well, with my hedge fund oriented thinking of absolute returns in an environment of relative returns. Active fund management as is practiced in India, is a poor cousin of that being practiced in West.

Today I came across, an article on Economic Times, which talks about the recent predicament/problem of the asset managers. In order to provide the clients with a return greater than risk free rate, they seem to be selling their rather overcharged service. Given this, I am forced to rethink and evaluate the potential market for more sophisticated and active wealth management like Hedge Funds. I am quoting a few lines.. but do give the entire article a read. Here

“Softening interest rates have made it tougher for capital protection schemes, run by portfolio management service (PMS) providers, to have an edge over fixed income instruments. Capital protection products invest most of their money in fixed income instruments to preserve capital while using remaining funds to trade in equity options to deliver better returns than debt.”

Around a year back, in the sweltering heat of Chennai, I wrote a piece at this very same place, about the problems and possible solutions for Indian Education in this article.

Strangely, a year has passed and with it many changes have come. So rapid had been these changes that in a way, they were quite unceremonious. A new government, 100 days agenda, a new HRD and increasingly louder calls for education reforms and finally the much touted reforms. Still we have a long way to go, but I am quite satisfied that a policy initiative has been taken in an ardent and honest way.

How do you propose to do that? Will the Right to Education Bill come through in the Budget session?

That’s a priority. It’ll come through, hopefully, and many other things are going to happen, and I’ll make an announcement very soon of my 100-day agenda and the agenda for five years. But at the heart of it would be to open up the entire education sector to greater investment and to allow children to go to the school that they want to, without any concern about where the money is going to come from, because we’ll have to put in place a loan scheme, both in higher education as well as public education. If somebody wants to go to a private school, he should be entitled to go to a private school as long as he gets a loan.

How do you make the education delivery mechanism efficient and accountable?

Well, we are actually doing it. We have, in fact, over the last five years, employed some nine lakh teachers (and) lots of schools are being built. You know our problem is (that) this is not something that can be done overnight. We have to have a long-term solution. There are different issues at different levels, there is the primary school and the secondary school issue, there is the higher education issue, there is the teacher-training issue, there is the research issue, there is an issue of skilled development, there is an issue of educational reforms across the board. So, first we need to have a national road map.

The entire interview of HRD Minister Kapil Sibal is here

If you decide you dont have to get A’s , you can learn an enormous amount in college

-I.I Rabi

The Nobel Prize page about I.I. Rabi is here

In the previous post, “Implications of Sharpe Ratio” I redirected to a paper, a pretty recent one at that, which discussed about the apparent divorce of interests between the fund manager and a client when their intended time horizon is different.

Often in professional money management environment, there is a theory called “tournament view”. The thumb rule says, managers after a bad first half yearly performance tend to get aggressive while the managers after a topline half yearly performance tend to get mellow in risk taking. The reason explained was because they are competing for the same funds, and they have to show some comparable results when pitted against each other.

The paper doesnt this deny, but offers a more mathematically rigorous explanation for this phenomenon.

The authors hit in one of the basic points of Sharpe Ratio and its implications. It argues, that SR creates a tension between the long term goals and the short term goals. The goals can belong to either of the two- manager or the client.

Considering returns are independent,identically distributed, then if there are two cases of management where one of them intends to maximise the long term Sharpe Ratio while the other intends to maximise the short term Sharpe Ratio, say six months SR. The difference in returns visible are extremely drastic in shocking after a respectable amount of time has passed. It varies from even 35%-80% difference, depending on the strategy employed, trend following or mean reverting.

Whats striking is, the authors argue that in case a firm has lower than expected return in the first half, to maximise the short term SR, they would go aggressive in the second term and vice versa to protect their returns for those who have done well in the first half.

Interestingly, a chunk of the paper is devoted to the continous time series optimisation of Sharpe Ratio.

So, if you ask me, I think keeping a two year lock in period [which is prevalent in present day Hedge Funds] is acceptable, for a near-optimal returns.

Keeping in tune with bringing a quantitative ‘edge’ to this blog as well as giving a close look to the fine art of money management, I hereby give you, this recent paper [2007] written by three gentlemen.

The name of the paper is : Implications of the Sharpe Ratio as a Performance Measure in Multiperiod Settings

I will be soon discussing the paper and try to come out with my own interpretations and observations. Till then do give it a read, and when we meet next time, do enrich the idea exchange.

The following paragraph is being requoted,reproduced and reblogged in its entirety because of the ramifications of dollar, crude,economics and the lesser mistress politics. With some of the right wing non observing fellows coming left,right and square at me and asking me how I should join their band of Obama bashing  for his Cairo speech.

Read it, its good:

With California entering bankruptcy and Brazil, China and Russia unleashing the whip on the reserve currency and treasury bulls, a new financial age has begun.

The sole reserve currency status was mainly maintained by the low oil price and an artifical oil-peg which could be viewed as an oil standard, indeed. Rather than Gold, the Dollar was backed by foreign oil. But this relationship is very fragile. And how fragile it has become was demonstrated by President Obamas attempt to smooth tensions with the Arab world within his speach given in Kairo.

But it revealed that politics now enter a phase of extreme difficulty. The same conflict which had been maintained in order to control oil producing countries, the same conflict now turns against the policy it was created to support. How difficult things are was shown by the actions taken by President Obama during the last weeks. For the first time in many years, an US president was slightly critizising his allies; a very difficult task, especially as many of his supporters at home might have been offended by this move. In order to make up for this, he had to visit Buchenwald, in Germany, and give a new speach in order to gain acceptance from his home support base. But when he visited Germany, he did not reach out hands nor did he visit Germany! Many Germans were deeply offended by President Obama, and they asked themselves how a president who keeps torture camps in Guantanamo and Afghanistan, how the same president could dare to educate the world about the “bad Germans”. Some asked how US citizens would feel, if the German Chancellor would visit a native american reservation, without visiting Washington. Certainly they would not be amused.

Now, turning back to the viewpoint of economy it shows the dilemma for the US eonomy. The existing alliances do not serve any longer in order to stabilize the US Dollar. That will increase geopolitical tensions as existing Alliances will be broken and new ones will be created. In the midst of this crisis, the oil peg starts to fail and so does the US Dollar. China, Brazil and Russia are now strating to sell off treasuries and soon the marketplace will be oversupplied and become illiquide.

The last days of the sole reserve currency have started. The free fall of the Dollar will come along with it. Will it be smooth? Or will it come overnight? that is the last question, to which no one has an answer, yet.

via The Financial Crisis Blog