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Trading Ideas

October 23, 2008


Its a firm belief on my part that, mechanical backtested, contemporary strategies work in a much better way than, discretionary systems. At least when it comes to developing a trading edge.


During the course of this post, I will dabble with a few ideas of my own supporting, discussing and talking in general about trading systems:

The Edge Factor


Consider that an asset market[stocks,bonds,forex] is entirely composed of rational beings. They dont follow their “sixth sense”[which often leaves a trader high and dry] , they dont follow tips and they dont follow fundamentals. They have a strict entry rule. A strict exit rule and a fair positioning rule. The fairness of positioning lies in this fact that, it will differ with volatility[which is a function of price and hence time].


Consider that all these trading systems have a mean performance, around which their performance is distributed. So, the system with the highest performance will ‘feed’ on the system with lower performance, and in turn will feed on worse performing system.


With time, due to limited cash available with each system, the only way to survive is have an edge.
Those who dont have a positive edge difference, are eventually eliminated.This elimination again, raises the mean, which again makes it sure those systems who are below the current performance mean are eliminated.


Who thrives?
Those who survive.


So who survives?
No one unless….


Unless, the trading systems continuously explore newer ideas, better profit generating rules and in short have a continuous performance ‘edge’ over the others.


Hence extending this over to the common day to day stock market, until unless one develops a serious amount of edge over the others, one cannot expect to win.
So, what is the edge? Edge can be anything which promises to improve your trading/investment performance.


Can discretionary systems improve trade performance? Maybe,maybe not. But a mechanical trading system will give returns just because human emotions are taken out of equation.

The Profit Factor


So what does one entail in trading system development? Its a vast topic and I dont intend to talk about it in great detail[sometime in some other post]. But extremely important metric everybody has to take care of in developing a trading strategy is:

  1. MULTICOLLINEARITY
  2. AVERAGE TRADE EXPECTATION
  3. WIN:LOSS RATIO
  4. SHARPE RATIO
  5. MAXIMUM DRAWDOWN


The first four parameters are for better trading performance. It has been found that, bettering #2 and #3 can indeed improve the final profit. But the inclusion of fifth metric is important because when a particular trader involves himself in carrying out/supervising the trades as per the strategy, a higher drawdown will create an extremely wild emotional swing.


Anxiety, Fear and Tension can wreck havoc anyday, anytime in a traders mind. He has to look for it, and as an extension of this he inclines himself to involve a mechanical trading strategy. But if the same strategy proves to be a ‘dog who bit his master’ then its but imperative that the cause was not served.

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