Thoughts on "The A to Z of trading career - musings of a professional trader !!"

[ncube]

Madan sir !!!

Your help (reply to my post about all in and add on) has relieved a lot with respective to trading plan,as i'm much more comfortable with all in rather with add on ,before that i also suffered a bit ,you can say it hesitation ,confusion with regard to trade qty...now that part is completely covered... moving in peaceful manner in all three (intra/swing/positional)

@XRAY27 Good to know bro... Just to add... thinking in terms of total risk allocation will help in controlling/managing our overall portfolio risk and give us peaceful sleep... We always allocate risk not capital (lots/capital) and add on's generally bring in more complextity in risk calculation unless we use automation. When one is at peace with total risk it will automatically start reflecting in our trading performance.

Though the message was directed to Madan, I felt happy to know that you are now doing fine in all three types of trading and I could not stop expressing myself..hope you dont mind..

 

[ncube]

Is it possible to combine perceptions with system i.e If i trade 4 Lots & i feel i should reverse however my system says to keep 4 lot long & i acknowledge the perception but at the same time follow the system by keeping 1Lot long instead of 4Lots.
I am a hardcore algo trader positionally however the trouble is only in intraday where perceptions interfere.

I believe its very difficult to be consistent in long run with perceptions/gut based trades as it depends on individuals emotional state and it will not be same every time.I suggest you need to first assess if your algo trading on positional is giving you consistent success and do you have full confidence in its mechanical process. If yes then what is preventing you from applying the same mechanical approach in day trading. If you are able to execute trades without discretion for positional trades based on algo triggers then try to build a similar approach for day trading. You just need to ensure that you have a statistical edge to give you the required confidence in your system.

 

[madank]

Is it possible to combine perceptions with system i.e If i trade 4 Lots & i feel i should reverse however my system says to keep 4 lot long & i acknowledge the perception but at the same time follow the system by keeping 1Lot long instead of 4Lots.
I am a hardcore algo trader positionally however the trouble is only in intraday where perceptions interfere.

Well Nikhil - you are confusing money mgmt with emotions. With this message, i guess you are hellbent to follow the instincts Fair enough. It's your money and your choice but i still don't see any merit in your idea. It is just my opinion and am known to be wrong more than rights.

May i ask you this question - what is prompting you to take gut trades? Lack of success in positional trades or just to quench your mental stimulation? So, Mark asks this question all the time - "are you in this game for money or thrill or to prove your intellectual worth"? The answer to this question will open up pandora box of answers and will vary widely from person to person. Please ask yourself and answer them. I have mentioned this quote earlier from Ed Seykota - 'market gives everyone what they want'. This statement might look superfluous and even downright cocky but think about it. It cannot get deeper than this. But looking at your signature, you seem to hate quotes . Jokes aside, think hard and come up with a solution to this issue. When you reach the bottom of it, hope its not too late.

Coming back to your example - What if market moves according to your system (say 200 points intra) with 1 lot instead of 4 lots? We cannot afford to have ambiguity in rules (let alone anything that can trigger emotional roller-coaster) and gut-based trades are reserved for experienced/discretionary traders. When you are an hardcore algo guy (mechanical trading) in positional, am not sure where this urge is coming from. Time to introspect, Nikhil

Madan sir !!!

Your help (reply to my post about all in and add on) has relieved a lot with respective to trading plan,as i'm much more comfortable with all in rather with add on ,before that i also suffered a bit ,you can say it hesitation ,confusion with regard to trade qty...now that part is completely covered... moving in peaceful manner in all three (intra/swing/positional)

Glad to hear that XRAY27. Awesome. Keep going !!

So, if someone starts out small and looking for some help from ‘compounding’ to grow the account big, this DD part will play a big role..Smaller DD will allow faster compounding (with relatively reasonable risk of ruin). We could have discussions about this in the discussion thread.

Have met many traders in India/US and the common thread seem to be small trading size (lots in single digits). Many traders struggle to increase their size and honestly, was expecting some discussion on trading sizes. Guess, folks missed this point from Week 2 post. Do you get the drift here - smaller DD will allow faster compounding? Very important point but was hidden nicely in some innocuous pointer

 

[ncube]

Do you get the drift here - smaller DD will allow faster compounding? Very important point but was hidden nicely in some innocuous pointer

Interesting point, very important to understand for successful trading. Let me make it more interesting & complex by sharing some of my backtesting conclusions (I may be wrong..comments welcome...

1. Drawdown is directly proportional to Risk. I.e Higher Risk = Higer Return = Higher Drawdown and Lower risk = Lower Return = Lower Drawdown.
2. Drawdown is directly proportional to System Expectancy. I.e Higer System Expectancy = Higher Drawdown and vice versa
3. System Expectancy is inversely proportional to Trade Signal Frequency. I.e Higher System Expectancy = Lower Trade Signals
4. Drawdown Duration is inversely proportional to Trade Signal Frequency. I.e Higher Trade signals = Lower Drawdown Duration.

Now the challenge is to develop a robust system which gives smaller DD and at the same time balances the above 4 points...so how robust is your system..?

BTW, as per my analysis the quickest and easiest way to compound/increase account size and reduce drawdown is by using dynamic risk allocation (risk based position sizing) and regular risk based portfolio rebalance (Only if you have a portfolio) . I.e increase the risk as your account size increases and reduce risk as account size reduces during drawdown.

 

[ncube]

How to evaluate the robustness of a system:
1. We begin with an idea or ideas which we want to evaluate. This idea could be a popular system which we learn in forum or read about it in some book.
2. For each Idea, we need to measure the following 5 parameters by backtesting for a predefined period of time say 5/10yrs:

• System Expectancy
• Trade Signal Frequency
• System Drawdown
• System Drawdown duration.
• Total Return

3. Note its very clear that these 5 parameters are system dependent and not under our control. So on what basis do we measure these?
4. The only way we can influence these parameters is by our "RISK" value. By controling Risk we can control the outcome of these 5 parameters.
5. Hence its now easy for us, we just play around with Risk value to make our decisions.

To identify the best System among multiple systems:
1. Start by keeping the Risk value contant across all the systems under test and measure the 5 parameter values for 5/10yrs period.
2. Prepare a matrix of system (Column) vs parameters (Rows) and highlight/rate the best parameter value in each row.
3. Select the system with balanced parameter values as per our risk appetite & psychology

To identify the optimum risk value for the selected system:
1. Once the system is selected, we will use the same matrix for the selected system but with varying risk values (Columns) vs parameter values (Rows).
2. Measure the 5 parameter values for each of the risk values selected for the system through backtesting for 5/10 yrs.
3. Select the Risk Value which gives the optimum return & DD based on our risk appetite & psychology.

Thats it...a very easy & simple process..

 

[lemondew]

BTW, as per my analysis the quickest and easiest way to compound/increase account size and reduce drawdown is by using dynamic risk allocation (risk based position sizing) and regular risk based portfolio rebalance (Only if you have a portfolio) . I.e increase the risk as your account size increases and reduce risk as account size reduces during drawdown.

Was thinking and discussing with my friend along the same lines.
2 other parameters I considered is to use multiple trading systems. (System 1,system2, system3) all having positive results after an interval.
When theres no trade in your primary system 1, Trade system2,system 3. In that way the funds are never idle. Aiming for funds to be always deployed in trading.

It would be useful to have a cumulative measure of points by end of day of all 3 systems. Its not easy to have a constant R per trade for swing as gap downs can change the equation. Also one may have a different SL for each trade based on S/R and so on.

Things that can happen with this are.

1) Multiple systems should increase the average daily/monthly returns with same investment.
2) It may increase max drawdown point. A mix of some systems may actually reduce it as well
3) It should decrease the underwater time or turnaround to profit time.

A cumulative analysis of backtest of multiple systems would also be good fun.

 

[madank]

Interesting point, very important to understand for successful trading. Let me make it more interesting & complex by sharing some of my backtesting conclusions (I may be wrong..comments welcome...

1. Drawdown is directly proportional to Risk. I.e Higher Risk = Higer Return = Higher Drawdown and Lower risk = Lower Return = Lower Drawdown.
2. Drawdown is directly proportional to System Expectancy. I.e Higer System Expectancy = Higher Drawdown and vice versa
3. System Expectancy is inversely proportional to Trade Signal Frequency. I.e Higher System Expectancy = Lower Trade Signals
4. Drawdown Duration is inversely proportional to Trade Signal Frequency. I.e Higher Trade signals = Lower Drawdown Duration.

Now the challenge is to develop a robust system which gives smaller DD and at the same time balances the above 4 points...so how robust is your system..?

BTW, as per my analysis the quickest and easiest way to compound/increase account size and reduce drawdown is by using dynamic risk allocation (risk based position sizing) and regular risk based portfolio rebalance (Only if you have a portfolio) . I.e increase the risk as your account size increases and reduce risk as account size reduces during drawdown.

ncube,

Your post reminded me of my high school math teacher ...with all the 'directly/inversely' proportional pointers

Yes - basically, winning percentage and Reward:Risk decides the system DD w.r.t money and trade signal freq determine the time taken to come out of it. Higher the winning percentage + lower RR or lower winning percentage + Higher RR seems to be the combination. But, most of us, keep trying to get higher winning percentage + higher RR and the elusive search continues. We cant have the cake and eat it too, right ?

Having said all these things, i brought up the lower DD/compounding pointer to drive a point home. General parameter consensus falls along these lines - for intraday system, max DD : yearly return should be atleast 1:7 or something like (1:8, 1:9 or 1:10). For swing/positional systems, it should be atleast 1:5. For example, if one is doing intra in NF, if the max DD of their system is 200, atleast 1400 points should be the average yearly points. Please dont kill me for quoting this measly yearly return points. But, let me assure you a fact- the above-mentioned DD/return numbers can set you free in 3-4 years. We dont need 200-300 points in NF every month on an average. Even 100 points with this kind of low DD is more than what we can eat. Icing on the cake is that this kind of DD can be easily recoverable and also paves a nice way for compounding the account. So, next time when you see a new idea/system, think in those lines.

There are two ways of increasing account size - bringing in more money when you win (but most traders bring in more money after they lose) or compound the account(conservatively or aggressively). In my opinion, once a trader gets past the usual problems of trading, his energy should be largely focused on how to move onto the next level w.r.t trading size. After all, 20 percent return on 10 lacs is much different than 20 pct return on 5 crores.

1) Multiple systems should increase the average daily/monthly returns with same investment.
2) It may increase max drawdown point. A mix of some systems may actually reduce it as well
3) It should decrease the underwater time or turnaround to profit time.

A cumulative analysis of backtest of multiple systems would also be good fun.

lemondew,

Thanks for sharing your view

1. Not necessarily. It will just smooth out the equity curve if underlying principle of the systems are tangentially different or systems trade non-correlated instruments. Actually, it might reduce the average return. On the other hand, the anomaly months(outliers) will be reduced.
2. Yes - both are possible
3. Quite possible - but again depends on the underlying principle of the system or the instruments traded. Almost, all the hedge funds employ multiple systems(sometimes, more than 10) to smooth out the equity curve and improve Risk adjusted returns.

If you get to do cumulative analysis of multiple systems, please post the results here. It would be a great learning for us !!

 

[lemondew]

ncube,
for intraday system, max DD : yearly return should be atleast 1:7 or something like (1:8, 1:9 or 1:10). For swing/positional systems, it should be atleast 1:5. For example,

Thanks for the thread.
Nice pointer. whatever is the ratio 1:5 or 1:3. It gives us an idea that after the worst drawdown that happened (in last x years of backtesting) how long did it take to gain back the lost amount and get into profits.

Arent all these stats an approximation and based on assumption that the future will unfold in a way similar to the past.

We hopefully never face the worst drawdown till we make lots and lots of money. A drawdown after we made a good deal of money is OK.

 

[madank]

Arent all these stats an approximation and based on assumption that the future will unfold in a way similar to the past.

Exactly. As a matter of fact, most of the times, real trades follow fat tail distribution and not normal distribution (meaning - the worst case scenario seen in the past might not be worst after-all as the distribution can get fat-tails). So, i always advocate to keep the worst case as twice the maximum DD we see in backtesting and basing the trade risk on that number.

As Michael Moubassin pointed out in one of his books - "Substantial empirical evidence shows that price changes do not fall along a normal distribution. Actual distributions contain many more small change observations and many more large moves than the simple distribution predicts."

A drawdown after we made a good deal of money is OK.

How does it matter if DD happens now or later, lemondew? One incontrovertible fact of this profession is that "drawdowns are inevitable" . Accepting drawdown as natural aspect of trading will take us long way in this profession. As i always mention, longevity is the key. To survive longer, risk management is the only tool we can use and if we focus on the big picture, other aspects of trading gets lost in distant oblivion compared to 'risk management' !!

 

[stoch]

Ok trying to get into specifics what are the key thing we need to follow to survive in the long run. Which period is defined as long-run? Should I set some monthly or yearly profit/loss targets or focus on short-term trading plan. You know the longer is stretch of time you try to include in the plan, the higher is factor of uncertainty that can spoil even immaculate trading strategy. Sometimes black swan events happen like it was with SNB currency peg removal and if you consider long-run there is higher chances to stumble upon such events where no money management works.