Orderflow trading in a nutshell:
1)Find the stops and fade them.
2)Find the barrier options and push into them.
3)Find pockets with a lack of open interest and gap them.
4)Find a sequence of stops spaced 10-25 pips apart and prepare to put your kids through college.
What you need? A prime broker currenex/ebs account, IFR, Oanda open interest, some friends on the inside of a large bank or brokerage, a proper understanding of risk management, and most importantly; your psychological issues completely resolved.
Its not an EA type of system. Even having the above, your still going to fail until you have developed a keen sense of the market. Intuition plays a huge part so if your stuck in the mathematical world of EA's and if-then-else logic, don't waste your time. Trading is an art, not a science.
Why am I telling you this? I really don't know, but I won't be giving you any more. Ever.
Do with it what you will.
http://www.forexfactory.com/showpost.php?p=3095398&postcount=643
середа, 23 березня 2011 р.
the truth about profitable trading
This is my first post, and I don't foresee myself becoming a regular poster (although I wouldn't bet against it either). That said, I have learned a great deal from this place and the realizations that it has helped elucidate, that I felt it incumbent upon myself to share some of the some of my conceptual beliefs.
As with any good disclaimer, please note that these are only my views, and that many may find success or failure doing drastically different things. I am by no means making categorical statements, but merely expounding on some of my market beliefs. Some may find them trite, some may find them helpful, and some may find them ludicrous. Also, I am not interested in sharing my systems, or any of the specific methods that I use. As with most areas of life, I find it very gratifying to help steer motivated people to viable sources of information that will positively impact their learning, but very much resent doing the work for them.
I think that it is impossible to ever 'predict' the movements of the market. Its funny, when people ask me something like "what do you think the dollar is going to do in whatever period of time", I always say that I have no idea. This sometimes causes people to look at me with disbelief, presumably wondering how someone who seemingly has such impressive returns knows so little about what the market may do. Ironically, it was that very realization - and figuring out to how translate that into a practicable, mechanical format - that finally afforded the kind of profitability that I wanted. And this is a statement that many, many traders would disagree with, which is precisely why I think that the vast majority fail to make significant money, and why the analysts seem wrong nearly as often as they are right. When you first see that certain technical trading setups go a certain direction more often than not, you start to subconsciously believe that any such setup WILL or SHOULD go in that direction, instead of that it merely has a slightly higher than x% chance of going in that direction. It is a key distinction that most traders - including many great technical guys that I have known, who are able to expertly read the complexities of price movements, and who sometimes even give theoretical lipservice to these very concepts - fail to ever substantively realize, or at least effectively put into practice.
It is ultimately about ego. So many get caught up in trying to be so clever with their charts and indicators, in an effort to win all the time. I certainty did myself, revelling in my winning trades and chastising myself for the losers. "I should have seen the resistance at 1.3729, and it was obviously breaking out of the trendline, espechially when I draw it like that. How could I have missed that factor - I'll never make that mistake again." This, however, implicitly assumes you are somehow responsible for that loss; that you were somehow ever actually in control of what the market was going to do. It is a dangerous mentality to have, and one that is unfortunately born from the equally instrumental realization that you can actually make money from trading the market. I even think the basic tool of drawing a support or resistance line on a chart is potentially hazardous, as its exact placement is really so arbitrary, but once you put it there it suddenly seems so authoritative - like a constraint that you have craftily imposed upon the market. I prefer to passively OBSERVE concepts like support and resistance in the functioning of my systems, rather than trading based on my imperfect, arbitrary, and surely biased understanding of their specific placements. Unlike many traders, I don't even set targets for trades, since I believe that even that would be forecasting. I exit the trade reactively when the market tells me to. It could be at a large profit, a small profit, breakeven, or a small loss - and I couldn't care less about which one it turns out to be on any given trade; only that the statistical outcome over many, many trades is within the appropriate range. One of the shrewdest statements that I ever heard on this was that the only way to make a million dollars in trading (as opposed to investing) is to make 10 million dollars and lose 9 million dollars (in concept, at least: some of you may well be making 10 million and losing only 8, or 7, or 6.2...)
In essence, one could view this as a debate between proactive and reactive modes of thinking. In many - if not most - areas of life, proactive behaviors are rewarded. CEOs and heads of industry are generally proactive people - decision makers who exercise control over their situations and environments. It is the reactive people that society generally doesn't reward: the guy who waits for life to present him an opportunity rather than actively trying to create one. I myself am a control freak - a trait which served me well in life until I encountered the insanity of the markets. I wanted so desperately to control them - to be smart, to be right, to win, to see the complexities in a movement that others 'foolishly' missed and bask in the resulting accolades - and nearly drove myself crazy in the process. My closing advice is not to do this, although I think it is almost an inevitability of the learning process - I am forever envious of those that don't have to go through this, or who can somehow consistantly profit from it. In short, it is understanding that randomness and making money from the market aren't nearly as mutually exclusive as it would intuitively seem. To the diversified 'buy and hold' guys as to many an active trader, they are seemingly incommensurable opinions - but I have found that it is a complete surrender to the randomness of any one trade that allows for a grounded confidence in a statistically significant outcome over many instances.
As with any good disclaimer, please note that these are only my views, and that many may find success or failure doing drastically different things. I am by no means making categorical statements, but merely expounding on some of my market beliefs. Some may find them trite, some may find them helpful, and some may find them ludicrous. Also, I am not interested in sharing my systems, or any of the specific methods that I use. As with most areas of life, I find it very gratifying to help steer motivated people to viable sources of information that will positively impact their learning, but very much resent doing the work for them.
I think that it is impossible to ever 'predict' the movements of the market. Its funny, when people ask me something like "what do you think the dollar is going to do in whatever period of time", I always say that I have no idea. This sometimes causes people to look at me with disbelief, presumably wondering how someone who seemingly has such impressive returns knows so little about what the market may do. Ironically, it was that very realization - and figuring out to how translate that into a practicable, mechanical format - that finally afforded the kind of profitability that I wanted. And this is a statement that many, many traders would disagree with, which is precisely why I think that the vast majority fail to make significant money, and why the analysts seem wrong nearly as often as they are right. When you first see that certain technical trading setups go a certain direction more often than not, you start to subconsciously believe that any such setup WILL or SHOULD go in that direction, instead of that it merely has a slightly higher than x% chance of going in that direction. It is a key distinction that most traders - including many great technical guys that I have known, who are able to expertly read the complexities of price movements, and who sometimes even give theoretical lipservice to these very concepts - fail to ever substantively realize, or at least effectively put into practice.
It is ultimately about ego. So many get caught up in trying to be so clever with their charts and indicators, in an effort to win all the time. I certainty did myself, revelling in my winning trades and chastising myself for the losers. "I should have seen the resistance at 1.3729, and it was obviously breaking out of the trendline, espechially when I draw it like that. How could I have missed that factor - I'll never make that mistake again." This, however, implicitly assumes you are somehow responsible for that loss; that you were somehow ever actually in control of what the market was going to do. It is a dangerous mentality to have, and one that is unfortunately born from the equally instrumental realization that you can actually make money from trading the market. I even think the basic tool of drawing a support or resistance line on a chart is potentially hazardous, as its exact placement is really so arbitrary, but once you put it there it suddenly seems so authoritative - like a constraint that you have craftily imposed upon the market. I prefer to passively OBSERVE concepts like support and resistance in the functioning of my systems, rather than trading based on my imperfect, arbitrary, and surely biased understanding of their specific placements. Unlike many traders, I don't even set targets for trades, since I believe that even that would be forecasting. I exit the trade reactively when the market tells me to. It could be at a large profit, a small profit, breakeven, or a small loss - and I couldn't care less about which one it turns out to be on any given trade; only that the statistical outcome over many, many trades is within the appropriate range. One of the shrewdest statements that I ever heard on this was that the only way to make a million dollars in trading (as opposed to investing) is to make 10 million dollars and lose 9 million dollars (in concept, at least: some of you may well be making 10 million and losing only 8, or 7, or 6.2...)
In essence, one could view this as a debate between proactive and reactive modes of thinking. In many - if not most - areas of life, proactive behaviors are rewarded. CEOs and heads of industry are generally proactive people - decision makers who exercise control over their situations and environments. It is the reactive people that society generally doesn't reward: the guy who waits for life to present him an opportunity rather than actively trying to create one. I myself am a control freak - a trait which served me well in life until I encountered the insanity of the markets. I wanted so desperately to control them - to be smart, to be right, to win, to see the complexities in a movement that others 'foolishly' missed and bask in the resulting accolades - and nearly drove myself crazy in the process. My closing advice is not to do this, although I think it is almost an inevitability of the learning process - I am forever envious of those that don't have to go through this, or who can somehow consistantly profit from it. In short, it is understanding that randomness and making money from the market aren't nearly as mutually exclusive as it would intuitively seem. To the diversified 'buy and hold' guys as to many an active trader, they are seemingly incommensurable opinions - but I have found that it is a complete surrender to the randomness of any one trade that allows for a grounded confidence in a statistically significant outcome over many instances.
edge and luck
That is certainly a fair point. Obviously the question of what even constitutes a recovery sequence (or necessary percentage return) where you would resume live/full risk trading is debatable. Again, this will largely be an issue of risk tolerance, but one would presumably need to see a recovery that would be statistically similar to how your system would perform if your edge was still functioning. For me, I would want to see a new equity high in the paper traded results. Moreover, I would be concerned not only with the the account reaching a hypothetical new account high, but equally with the specific makeup of the trades and the time required to achieve it. All of this would be important in making a determination of whether your system was still operating with an edge.
Of course, this could take a long time, or perhaps never happen at all. If your edge had deteriorated or never existed, then you would paper trade the system into further drawdown and never trade it live again.
But, to your example, imagine that the system completely recovered on a paper traded basis - complete with every statistical verification that would give confidence that your edge was still functioning. Then imagine that when you resumed live trading you hit another drawdown that was outside of expectation. What then? Well, in that situation I would again stop at a preconceived point, and would be very weary about continuing to trade that system again. Yes, you could always reach that point of drawdown, stop live trading, paper trade a subsequent recovery, resume live trading only to have another drawdown that was statistically unsound. That system, at its most catastrophic, would have lost the trader x% from the first drawdown and a subsequent x% from the second drawdown. It would be very unpleasant, but at least it would be controlled, and certainly not catastrophic. The more conservative your risk management, the less you could potentially lose even in both drawdowns. If, say, 20% was your statistical cut off, you would lose a worst case total of 36% from your peak equity. If this occurred on day 1 (just to make the example even more improbable) you would have lost 36% of your principal, rather than merely giving back profits.
If it sounds like I am agreeing with you, it is because I am - its just that it doesn't really agitate me. Sure, it could happen, but with a good edge, a good system, enough data to formulate reasonable expectations, and conservative enough position risk, it becomes increasingly unlikely. The trader that prepares himself properly and still completely fails - having been slowly bled from unsound drawdown after unsound drawdown, only to devise new systems and have it happen all over again until he is broke - would be extremely unlucky indeed. So, there you go, you need some luck, but adequate preparation surely negates the need for a constant fixation on it. Most who fail in this industry are not like the unfortunate character I just described above; they fail for a myraid of other more inane reasons. And most that do meet those characteristics, I would imagine, haven't failed - or at least not yet...
http://www.forexfactory.com/showpost.php?p=2506456&postcount=578
Of course, this could take a long time, or perhaps never happen at all. If your edge had deteriorated or never existed, then you would paper trade the system into further drawdown and never trade it live again.
But, to your example, imagine that the system completely recovered on a paper traded basis - complete with every statistical verification that would give confidence that your edge was still functioning. Then imagine that when you resumed live trading you hit another drawdown that was outside of expectation. What then? Well, in that situation I would again stop at a preconceived point, and would be very weary about continuing to trade that system again. Yes, you could always reach that point of drawdown, stop live trading, paper trade a subsequent recovery, resume live trading only to have another drawdown that was statistically unsound. That system, at its most catastrophic, would have lost the trader x% from the first drawdown and a subsequent x% from the second drawdown. It would be very unpleasant, but at least it would be controlled, and certainly not catastrophic. The more conservative your risk management, the less you could potentially lose even in both drawdowns. If, say, 20% was your statistical cut off, you would lose a worst case total of 36% from your peak equity. If this occurred on day 1 (just to make the example even more improbable) you would have lost 36% of your principal, rather than merely giving back profits.
If it sounds like I am agreeing with you, it is because I am - its just that it doesn't really agitate me. Sure, it could happen, but with a good edge, a good system, enough data to formulate reasonable expectations, and conservative enough position risk, it becomes increasingly unlikely. The trader that prepares himself properly and still completely fails - having been slowly bled from unsound drawdown after unsound drawdown, only to devise new systems and have it happen all over again until he is broke - would be extremely unlucky indeed. So, there you go, you need some luck, but adequate preparation surely negates the need for a constant fixation on it. Most who fail in this industry are not like the unfortunate character I just described above; they fail for a myraid of other more inane reasons. And most that do meet those characteristics, I would imagine, haven't failed - or at least not yet...
http://www.forexfactory.com/showpost.php?p=2506456&postcount=578
Drawdown in MTS trading
Every trading methodology has a point where if there are x consecutive loses, the account will either be wiped out or the drawdown will be so large that the return required to recover would be unpalatable (50% drawdown requiring 100% return, for instance - although this is largely personal). As Hanover points out, the length of this potential sequence is purely a function of position risk.
Regardless, no amount of money management can prevent this unlucky series of trades; it can only decrease the probability of its occurrence. However, if one has a comprehensive understanding of their strategy - including statistical data based on a large enough sample size - it doesn't need to feel like this fearful quest to maximize profits before the impending catastrophe. For example, lets say you have a trading system, with thousands of trades worth of data, where based on Monte carlo simulations you find a 99% confidence level of not exceeding a 25% drawdown. Could you exceed 25% drawdown at any given time? Sure. Assuming that you trade your system over an infinite period of time it will almost certainly fail completely, but what is the 'likely' time frame for such a failure? Within 5 years, 10 years, 100 years? The probability, and thus the length, of a sequence necessary to destroy one's account is completely under the trader's control. At certain position sizing levels, the likelihood of it occurring within a trader's lifetime can be extremely small - at such small levels, the chance of your edge deteriorating (or your system's ability to adaptively capture it) becomes a much more likely culprit for eventual failure than that unlucky sequence...
The bottom line is that we can never deal in certainty. Anything can always happen, and things can suddenly change in unforeseen ways. This is the case with most things in life that, unlike casinos, aren't confined to static probabilities. The casino could theoretically fail if that extremely low probability (in the casino's case) losing streak was to occur; as traders, we could fail either as a result of:
1) a functioning edge but detrimental losing streak
2) no edge/diminishing edge.
What matters is that you are aware of this, and know what you would do in any potential situation. You would know that when you reach a certain drawdown level you are outside of expectation and should either stop trading completely or cut risk significantly while you continue to at least paper trade the strategy to see if it does ultimately recover. If it does, then you can resume trading; if not, thnn at least you only lost x% of your account, and hopefully achieved significant net profit regardless. Use position sizing to trade a system that has drawdown expectations that are tolerable for you; then, even if you exceed them in that catastrophic event - be it an unlucky sequence or a failed/non-existent edge - you haven't lost something that you weren't prepared to lose.
Personally, I tend to be more conservative, and like to have the probability of even a 15% drawdown be very low, but this is obviously just my comfort zone. I find it fascinating how different traders approach this question. I remember a certain fairly prominent trader on this forum who allegedly ran up an account 1000% in a year, risking - if I remember correctly - 8% on each trade. He was so immodestly certain that, based on testing, his system would continue to work - even though during testing it had some incredible drawdowns. I didn't even doubt the quality of his testing, but his certitude was ridiculous, especially after the live year. At 8% risk, you don't need THAT many losing trades to destroy you. Of course, it all crashed and burned, and his future posts were somewhat more humble.
I think that is really what Tdion is getting at: that sense of certainty that many seem to have, and how it is completely unfounded. I get that and I agree. At the same time, the hysteria surrounding luck in trading is overdone. Know what to expect as an acceptable worst-case, the likelihood of it happening, and what to do if it does happen within your trading career.
Regardless, no amount of money management can prevent this unlucky series of trades; it can only decrease the probability of its occurrence. However, if one has a comprehensive understanding of their strategy - including statistical data based on a large enough sample size - it doesn't need to feel like this fearful quest to maximize profits before the impending catastrophe. For example, lets say you have a trading system, with thousands of trades worth of data, where based on Monte carlo simulations you find a 99% confidence level of not exceeding a 25% drawdown. Could you exceed 25% drawdown at any given time? Sure. Assuming that you trade your system over an infinite period of time it will almost certainly fail completely, but what is the 'likely' time frame for such a failure? Within 5 years, 10 years, 100 years? The probability, and thus the length, of a sequence necessary to destroy one's account is completely under the trader's control. At certain position sizing levels, the likelihood of it occurring within a trader's lifetime can be extremely small - at such small levels, the chance of your edge deteriorating (or your system's ability to adaptively capture it) becomes a much more likely culprit for eventual failure than that unlucky sequence...
The bottom line is that we can never deal in certainty. Anything can always happen, and things can suddenly change in unforeseen ways. This is the case with most things in life that, unlike casinos, aren't confined to static probabilities. The casino could theoretically fail if that extremely low probability (in the casino's case) losing streak was to occur; as traders, we could fail either as a result of:
1) a functioning edge but detrimental losing streak
2) no edge/diminishing edge.
What matters is that you are aware of this, and know what you would do in any potential situation. You would know that when you reach a certain drawdown level you are outside of expectation and should either stop trading completely or cut risk significantly while you continue to at least paper trade the strategy to see if it does ultimately recover. If it does, then you can resume trading; if not, thnn at least you only lost x% of your account, and hopefully achieved significant net profit regardless. Use position sizing to trade a system that has drawdown expectations that are tolerable for you; then, even if you exceed them in that catastrophic event - be it an unlucky sequence or a failed/non-existent edge - you haven't lost something that you weren't prepared to lose.
Personally, I tend to be more conservative, and like to have the probability of even a 15% drawdown be very low, but this is obviously just my comfort zone. I find it fascinating how different traders approach this question. I remember a certain fairly prominent trader on this forum who allegedly ran up an account 1000% in a year, risking - if I remember correctly - 8% on each trade. He was so immodestly certain that, based on testing, his system would continue to work - even though during testing it had some incredible drawdowns. I didn't even doubt the quality of his testing, but his certitude was ridiculous, especially after the live year. At 8% risk, you don't need THAT many losing trades to destroy you. Of course, it all crashed and burned, and his future posts were somewhat more humble.
I think that is really what Tdion is getting at: that sense of certainty that many seem to have, and how it is completely unfounded. I get that and I agree. At the same time, the hysteria surrounding luck in trading is overdone. Know what to expect as an acceptable worst-case, the likelihood of it happening, and what to do if it does happen within your trading career.
Trading system design
Lucky...That would be far more exciting.
I rarely post on the FF, but I have seen a lot of these posts recently - questioning (or, in some cases, audaciously claiming) that it is impossible to trade successfully in the long term, or that any long-term prospect of success is weighted far more towards luck than a sound trading practice. Let me address this as thoroughly as possible, hopefully in a somewhat logical order.
The time-frames that are you trading on (1m, 5m, etc) will undoubtedly be exposed to a significant amount of noise - news releases or other liquidity spikes will be much more likely to stop you out if you hold tight-stopped, short-term positions. I am NOT saying that is it impossible to trade smaller time frames, but just for someone that is worried (and seemingly overwhelmed) by the numerous factors that effect the market, I think larger timeframes would be a better bet.
I will now run through the process that I personally use to construct trading systems. Yes, I only ever trade a system with a strong statistical basis, since trading anything other than that would be impossible for me to put any long-standing faith in, and subsequently impossible to mentally stick with in times of greater drawdown. Even an EA that I hadn't PERSONALLY tested and judged to be statistically significant in its expectation would be very difficult to stick with during losing streaks. But I digress...
The first step of the process is to identify variables that you believe create a slight statistical edge - where given 1000s of incidents of that variable occurring, you would expect the chance of "something" occurring slightly more 50/50 (the greater the ratio, the greater the edge of that particular variable). Once you have that variable, you look for other variables that can be used in conjunction to further increase your statistical outcome through filtering out some of the initial trades. Eventually, you have an entry condition that could be expressed as an if statement: if x=3 and y=5 and z=10 then you place a buy stop/sell stop at a certain predefined point (the numbers and variables used are completely arbitrary, so don't pm me asking how I defined z...). On that note, to truly create a system that you have any statistical confidence in, everything - every single possible action that you take entering, existing or modifying a position - has to be 100% defined.
So at this point, what do you have? You essentially only have an entry condition where you are confident that when x,y and z align in a certain way the outcome over many instances should be within some statistical expectation. Does this mean you have a winning system and can conquer the world? If only it were so easy...
At this point - which honestly is the point that many traders stop at, if they even define things so precisely at all - you simply know when to enter the market. That’s it. You have no concept of money management, stop placement (fixed pip or varying based on recent volatility), or exit conditions. How do you go about defining those? In much the same way as you defined the entry. By looking at 1000s of occurrences where your system produced an entry, and then meticulously testing variations of all of the above. Sounds pretty tedious right? Well, it is, but it is double for those with patience and reasonable logical faculties.
Let me give you an example. (Disclaimer: this is by no means an actual system - I am literally making this up right now with no basis in anything. I will sell it to you though…) Say you have defined your timeframe as the daily charts. The entry condition that you have defined is that when the RSI 96 is above 50 AND when you have an inside bar AND when the price breaks the inside bar by at least 15 pips (through the use of a buy). Your stop lose is based on some consistent measure of recent volatility (ATR, etc), and you are using fixed fractional position sizing for your MM. Your exit is defined as whenever the move reaches 1.5R in profit. You also mechanically cut loses depending on other x,y,z factors that you observe at the end of a given period (at the end of the day, in this case). All trading actions are taken at the end of the period, and only at the end of the period, to remain 100% statistically consistent.
So, now you have a system that is completely defined, but does it work? The only way to answer that (aside from live trading, of course), is to first backtest it over 1000s of occurrences. Another point is that in a statistically based system, you have to take EVERY SINGLE INCIDENCE of a trade that aligns with your variables, making it more difficult to do on lower time frames without an EA unless you want to watch the monitor at the end of every period like a crazy insomniac. Backtesting over a large sample size with 100% defined trading rules will allow you to see how your system would have performed over a certain time period.
To make it clear, when I say backtest, I don't mean what I think many in this forum do: looking at their chart over a couple of years (or months - or even weeks...) and gleefully counting in their head "winner, winner, winner, winner, loser, winner, winner, loser, winner", while half-focusing on the finishings on next year's 200 foot mega yacht. The testing should be nothing less than scientific. You are a market scientist, trying to create a market theory, so every stage of the process needs to be defined and testable. You will know that you are doing this right when you aren't thinking of all the money you are going to make but instead simply recording, in thorough detail, all of the data that you are going to need to properly formulate a compelling theory; as a side benefit, you will also limit testing bias, since you will no longer TRYING to prove anything, but simply testing to see if it could be a tenable theory.
Lets say you do this, and you find that your system over 5000 consecutive trades would have produced a win rate of 55% and a average win/average lose ratio, as a percentage of R, of 1.3/1. As a brief aside, for those that haven't done this before, constructing a system is always a balancing of two often-competing factors: win rate and ave win/ave lose ratio. Generally they are inversely correlated to a degree. A trend following system, where you typically have high R multiple winners will typically have a high ave win/ave lose ratio, but a lower win rate (often below 50%). A scalping system, on the other hand, where you are quicker to take profits, will typically have a higher win rate, but a lower ave win/ave lose ratio, since, well, you are quicker to take profits and therefore don't capitalize on those large R moves. It is the balance of these two factors that creates your expectancy - and, if you have developed a good edge, hopefully a positive one.
So are we done yet? Haha - not quite. Those two factors are only a small measure of a system's success. Ultimately you should focus on the biggest factor that will determine your system's biggest success: its annual return/worst annual drawdown. And the ratio itself is only part of the battle. Sure, you can have a 50/1 ratio, but if you have a max drawdown of 60% than the ratio is somewhat misleading, even with that 3000% return. You can of course decrease the drawdown by decreasing your position risk, but that will also exponentially decrease the ratio due to less compounding on the upside. Ultimately, you are looking for a decent ratio - but more importantly, a reasonable drawdown that is psychologically palatable for you, and which your system can reasonably recover from.
After that you have that, for an extra measure of confidence, you should perform a monte carlo test on your 1000s of results. You want to make sure that 1,000,000s of permutations of the results are consistent, and that the results that you obtained were not just the product of 'lucky' historical sequencing.
Finally, once you have all of that, then you are finally ready to...forward test. How glamorous, huh? So, you forward test the system over a couple of months, and if it clearly performs within statistical expectation, then, and only then, are you ready to go live.
Some other notes on system development:
1. Make sure that your sample size is suitably large. Constructing a system over 50-100 or so trades is complete foolishness, and 'curve-fitting', in the negative sense of the word (with the arduous strategy above being in the more positive sense). You are a scientist, and you need enough results to formulate a plausible market theory.
2. Make sure that EVERYTHING is measurable and defined. If not, then your system will have elements of inconsistency. Wishful thinking prays on these little pockets of testing-inconsistency, and can significantly distort your statistical expectation if you allow it to leak into a system that is crafted with anything less than 100% precision.
3. Make sure that your testing period includes diverse markets, and preferably functions over numerous market conditions and many years. Even better if it broadly functions across different currencies, but this is not essential. Essentially, you want to limit the myopic curve-fitting experience, where your system is highly calibrated to a rigid set of market parameters. If for instance, your system works great in 2008, make sure that is works well in 200x, since 2008 is not necessarily broadly representative.
4. Always remember that there will be testing inaccuracies. Be it that certain positions were different/entered/not entered based on spread changes, charting errors (hopefully not if you choose a good feed) and the tendency for human positive bias (mitigated by 100% rigid testing parameters). Generally, a shorter time-frame system will be affected more my the spread change issue than a longer-term one.
Whew! So there you have it: a system that you can put a fair degree of faith in moving forward. And that, ladies and gentlemen, is about all you can ever hope for in trading. Why? Well, to finally address the initial question in the thread, because you can never, ever, ever get away from the fact that the market is uncertain, and that at any moment in the future it can behave completely differently from any way that it has behaved before. So is that luck then? Only if you define luck as the market consistently behaving based on robust expectation. At that point it just becomes a question of semantics.
One thing that certainly isn't luck, though, are the long-term track records of the successful few; that type of legacy is the product of systematically superimposing robust constraints on the markets. But what about when the systems stop working - does that not then negate the proceeding accomplishments and make it all a lucky ride? Not in the slightest. For one, the more robust and broadly functioning the system, the less likelihood that it will stop working - which, of course, is a design feature that has nothing to do with luck.
Sure, Chris, but even THOSE can stop working too - isn't that luck? Well, yes, in that very rigid sense I suppose that you could define this inextricable luck component as the "duration of time that a particular robust system functions before it no longer functions". I will concede that limited point, but again, I more than accept that as inevitable uncertainty, that you will necessary have in any endeavor that you peruse. You could start an orange juice company that does great year after year for 20 years until the FDA comes out and says that orange juice knocks 10 years off the average life, and the market completely shrivels up. I never look at any system I develop as a sure thing, or something where I can simply press play, go into a 50-year coma, and wake up the richest man in the world. Again, this is where long-term success should not be confused with luck. There are always exogenous uncontrollables (black swans, as it were), but the part that isn't lucky is having a feedback mechanism to recognize when one has happened, and having a plan in place for when it does.
To bring it back to the example, say the system that you designed had a maximum drawdown, over a 15-year period, of 20%. With monte carlo analysis, over millions of permutations based on 1000s of initial observations, you conclude that you have a 95% confidence of never dropping below a 25% drawdown. Does this mean that it will never happen - is this the certainty that you were looking for? No way. It very well may happen; in fact, I would postulate that given enough time it will happen, since, after all, it is only a 95% confidence. Even a 100% confidence would still be based on only x thousands of occurrences, never escaping the uncertainty of what may come.
What you do know, however, is that if you drop below 25% drawdown then you are starting to venture outside of statistical expectation. So you make a fail safe. You write it on your wall and you stick to it no matter what. If the system ever breaches x% drawdown, then I will stop trading until I am again assured that it is operating within expectation, and that the drawdown was merely a standard deviation event; if, however, it doesn't resume its normal functioning - if it doesn't recover from the drawdown based on a reasonable logarithmic expectation - then it is time to go back to the drawing board, figure out what changed, modify your variables accordingly, and strive to develop a version of your system that incorporates all of your previous 1000s of occurrences AND the new ones that had previously thrown it off. Curve-fitting? Sure, but again over many, many occurrences so that it is broadly functioning. The more robust your model in the first place, the fewer changes that you will likely have to make, and it will be easier to integrate them without a complete overhaul.
Well, that’s about it from me for today. I hope this was helpful. I obviously know that it can appear overwhelming, but this is simply the reality that has allowed me to be consistently successful. Stop looking for certainty, stop worrying about luck and designing something that will prove to be infinitely viable. Become a market scientist, create a viable market theory, play it out until it stops working (hopefully, if it is exceedingly robust, you will be dead long before that happens), and then have a feedback mechanism ready so that you can roll with the punches, make your adjustments, and continue moving forward. And specifically for the initial poster, don’t worry so much about all the millions of factors that move the market. Stop trying to know and control everything - you can’t and you don’t need to.
Best,
Chris
The time-frames that are you trading on (1m, 5m, etc) will undoubtedly be exposed to a significant amount of noise - news releases or other liquidity spikes will be much more likely to stop you out if you hold tight-stopped, short-term positions. I am NOT saying that is it impossible to trade smaller time frames, but just for someone that is worried (and seemingly overwhelmed) by the numerous factors that effect the market, I think larger timeframes would be a better bet.
I will now run through the process that I personally use to construct trading systems. Yes, I only ever trade a system with a strong statistical basis, since trading anything other than that would be impossible for me to put any long-standing faith in, and subsequently impossible to mentally stick with in times of greater drawdown. Even an EA that I hadn't PERSONALLY tested and judged to be statistically significant in its expectation would be very difficult to stick with during losing streaks. But I digress...
The first step of the process is to identify variables that you believe create a slight statistical edge - where given 1000s of incidents of that variable occurring, you would expect the chance of "something" occurring slightly more 50/50 (the greater the ratio, the greater the edge of that particular variable). Once you have that variable, you look for other variables that can be used in conjunction to further increase your statistical outcome through filtering out some of the initial trades. Eventually, you have an entry condition that could be expressed as an if statement: if x=3 and y=5 and z=10 then you place a buy stop/sell stop at a certain predefined point (the numbers and variables used are completely arbitrary, so don't pm me asking how I defined z...). On that note, to truly create a system that you have any statistical confidence in, everything - every single possible action that you take entering, existing or modifying a position - has to be 100% defined.
So at this point, what do you have? You essentially only have an entry condition where you are confident that when x,y and z align in a certain way the outcome over many instances should be within some statistical expectation. Does this mean you have a winning system and can conquer the world? If only it were so easy...
At this point - which honestly is the point that many traders stop at, if they even define things so precisely at all - you simply know when to enter the market. That’s it. You have no concept of money management, stop placement (fixed pip or varying based on recent volatility), or exit conditions. How do you go about defining those? In much the same way as you defined the entry. By looking at 1000s of occurrences where your system produced an entry, and then meticulously testing variations of all of the above. Sounds pretty tedious right? Well, it is, but it is double for those with patience and reasonable logical faculties.
Let me give you an example. (Disclaimer: this is by no means an actual system - I am literally making this up right now with no basis in anything. I will sell it to you though…) Say you have defined your timeframe as the daily charts. The entry condition that you have defined is that when the RSI 96 is above 50 AND when you have an inside bar AND when the price breaks the inside bar by at least 15 pips (through the use of a buy). Your stop lose is based on some consistent measure of recent volatility (ATR, etc), and you are using fixed fractional position sizing for your MM. Your exit is defined as whenever the move reaches 1.5R in profit. You also mechanically cut loses depending on other x,y,z factors that you observe at the end of a given period (at the end of the day, in this case). All trading actions are taken at the end of the period, and only at the end of the period, to remain 100% statistically consistent.
So, now you have a system that is completely defined, but does it work? The only way to answer that (aside from live trading, of course), is to first backtest it over 1000s of occurrences. Another point is that in a statistically based system, you have to take EVERY SINGLE INCIDENCE of a trade that aligns with your variables, making it more difficult to do on lower time frames without an EA unless you want to watch the monitor at the end of every period like a crazy insomniac. Backtesting over a large sample size with 100% defined trading rules will allow you to see how your system would have performed over a certain time period.
To make it clear, when I say backtest, I don't mean what I think many in this forum do: looking at their chart over a couple of years (or months - or even weeks...) and gleefully counting in their head "winner, winner, winner, winner, loser, winner, winner, loser, winner", while half-focusing on the finishings on next year's 200 foot mega yacht. The testing should be nothing less than scientific. You are a market scientist, trying to create a market theory, so every stage of the process needs to be defined and testable. You will know that you are doing this right when you aren't thinking of all the money you are going to make but instead simply recording, in thorough detail, all of the data that you are going to need to properly formulate a compelling theory; as a side benefit, you will also limit testing bias, since you will no longer TRYING to prove anything, but simply testing to see if it could be a tenable theory.
Lets say you do this, and you find that your system over 5000 consecutive trades would have produced a win rate of 55% and a average win/average lose ratio, as a percentage of R, of 1.3/1. As a brief aside, for those that haven't done this before, constructing a system is always a balancing of two often-competing factors: win rate and ave win/ave lose ratio. Generally they are inversely correlated to a degree. A trend following system, where you typically have high R multiple winners will typically have a high ave win/ave lose ratio, but a lower win rate (often below 50%). A scalping system, on the other hand, where you are quicker to take profits, will typically have a higher win rate, but a lower ave win/ave lose ratio, since, well, you are quicker to take profits and therefore don't capitalize on those large R moves. It is the balance of these two factors that creates your expectancy - and, if you have developed a good edge, hopefully a positive one.
So are we done yet? Haha - not quite. Those two factors are only a small measure of a system's success. Ultimately you should focus on the biggest factor that will determine your system's biggest success: its annual return/worst annual drawdown. And the ratio itself is only part of the battle. Sure, you can have a 50/1 ratio, but if you have a max drawdown of 60% than the ratio is somewhat misleading, even with that 3000% return. You can of course decrease the drawdown by decreasing your position risk, but that will also exponentially decrease the ratio due to less compounding on the upside. Ultimately, you are looking for a decent ratio - but more importantly, a reasonable drawdown that is psychologically palatable for you, and which your system can reasonably recover from.
After that you have that, for an extra measure of confidence, you should perform a monte carlo test on your 1000s of results. You want to make sure that 1,000,000s of permutations of the results are consistent, and that the results that you obtained were not just the product of 'lucky' historical sequencing.
Finally, once you have all of that, then you are finally ready to...forward test. How glamorous, huh? So, you forward test the system over a couple of months, and if it clearly performs within statistical expectation, then, and only then, are you ready to go live.
Some other notes on system development:
1. Make sure that your sample size is suitably large. Constructing a system over 50-100 or so trades is complete foolishness, and 'curve-fitting', in the negative sense of the word (with the arduous strategy above being in the more positive sense). You are a scientist, and you need enough results to formulate a plausible market theory.
2. Make sure that EVERYTHING is measurable and defined. If not, then your system will have elements of inconsistency. Wishful thinking prays on these little pockets of testing-inconsistency, and can significantly distort your statistical expectation if you allow it to leak into a system that is crafted with anything less than 100% precision.
3. Make sure that your testing period includes diverse markets, and preferably functions over numerous market conditions and many years. Even better if it broadly functions across different currencies, but this is not essential. Essentially, you want to limit the myopic curve-fitting experience, where your system is highly calibrated to a rigid set of market parameters. If for instance, your system works great in 2008, make sure that is works well in 200x, since 2008 is not necessarily broadly representative.
4. Always remember that there will be testing inaccuracies. Be it that certain positions were different/entered/not entered based on spread changes, charting errors (hopefully not if you choose a good feed) and the tendency for human positive bias (mitigated by 100% rigid testing parameters). Generally, a shorter time-frame system will be affected more my the spread change issue than a longer-term one.
Whew! So there you have it: a system that you can put a fair degree of faith in moving forward. And that, ladies and gentlemen, is about all you can ever hope for in trading. Why? Well, to finally address the initial question in the thread, because you can never, ever, ever get away from the fact that the market is uncertain, and that at any moment in the future it can behave completely differently from any way that it has behaved before. So is that luck then? Only if you define luck as the market consistently behaving based on robust expectation. At that point it just becomes a question of semantics.
One thing that certainly isn't luck, though, are the long-term track records of the successful few; that type of legacy is the product of systematically superimposing robust constraints on the markets. But what about when the systems stop working - does that not then negate the proceeding accomplishments and make it all a lucky ride? Not in the slightest. For one, the more robust and broadly functioning the system, the less likelihood that it will stop working - which, of course, is a design feature that has nothing to do with luck.
Sure, Chris, but even THOSE can stop working too - isn't that luck? Well, yes, in that very rigid sense I suppose that you could define this inextricable luck component as the "duration of time that a particular robust system functions before it no longer functions". I will concede that limited point, but again, I more than accept that as inevitable uncertainty, that you will necessary have in any endeavor that you peruse. You could start an orange juice company that does great year after year for 20 years until the FDA comes out and says that orange juice knocks 10 years off the average life, and the market completely shrivels up. I never look at any system I develop as a sure thing, or something where I can simply press play, go into a 50-year coma, and wake up the richest man in the world. Again, this is where long-term success should not be confused with luck. There are always exogenous uncontrollables (black swans, as it were), but the part that isn't lucky is having a feedback mechanism to recognize when one has happened, and having a plan in place for when it does.
To bring it back to the example, say the system that you designed had a maximum drawdown, over a 15-year period, of 20%. With monte carlo analysis, over millions of permutations based on 1000s of initial observations, you conclude that you have a 95% confidence of never dropping below a 25% drawdown. Does this mean that it will never happen - is this the certainty that you were looking for? No way. It very well may happen; in fact, I would postulate that given enough time it will happen, since, after all, it is only a 95% confidence. Even a 100% confidence would still be based on only x thousands of occurrences, never escaping the uncertainty of what may come.
What you do know, however, is that if you drop below 25% drawdown then you are starting to venture outside of statistical expectation. So you make a fail safe. You write it on your wall and you stick to it no matter what. If the system ever breaches x% drawdown, then I will stop trading until I am again assured that it is operating within expectation, and that the drawdown was merely a standard deviation event; if, however, it doesn't resume its normal functioning - if it doesn't recover from the drawdown based on a reasonable logarithmic expectation - then it is time to go back to the drawing board, figure out what changed, modify your variables accordingly, and strive to develop a version of your system that incorporates all of your previous 1000s of occurrences AND the new ones that had previously thrown it off. Curve-fitting? Sure, but again over many, many occurrences so that it is broadly functioning. The more robust your model in the first place, the fewer changes that you will likely have to make, and it will be easier to integrate them without a complete overhaul.
Well, that’s about it from me for today. I hope this was helpful. I obviously know that it can appear overwhelming, but this is simply the reality that has allowed me to be consistently successful. Stop looking for certainty, stop worrying about luck and designing something that will prove to be infinitely viable. Become a market scientist, create a viable market theory, play it out until it stops working (hopefully, if it is exceedingly robust, you will be dead long before that happens), and then have a feedback mechanism ready so that you can roll with the punches, make your adjustments, and continue moving forward. And specifically for the initial poster, don’t worry so much about all the millions of factors that move the market. Stop trying to know and control everything - you can’t and you don’t need to.
Best,
Chris
http://www.forexfactory.com/showpost.php?p=2212020&postcount=12
You need a rules
No problem, Leon. Glad to know that I have helped at least give you some ideas.
As for your question, you are asking if you sat me down in front of some naked charts and said "trade away Chris" if I would be able to be consistently profitable. Haha - while I would love to think so it is highly doubtful. And not because I wouldn't have winning trades; I'm sure that I would have many, and probably even some decent streaks. However, I would likely fail in the longer-term for several reasons:
1. I would be lacking the precision that I find necessary in my trading to properly exploit an edge. Looking at a naked chart would force my process to become discretionary, which would distort the integrity of my exits and position risk adjustment, etc.
2. I would almost certainly lose faith in my 'strategy' when I went into drawdown, since I would have no statistical drawdown expectations to help ground my battered confidence.
3. I would undoubtedly get caught up in the emotion of trading again, which is never something that has made me successful. Overconfidence or fear would inevitably erode my capital.
I do want to make it clear, though, that my only input is price. I don't use volume or any sort of fundamental analysis. I don't want to give you the idea that my screen is cluttered with a million lines and indicators; at the same time, I follow carefully constructed rules that cover every potential occurrence. I never even contemplate whether or not to enter a position: it is a given based on my rules, as is every single action that I could possibly take with that position as a reaction to the market.
To put it simply, there is no thinking involved in any of my trading decisions; in fact, I wouldn't even really call them decisions, since they were decided along time ago. Now they are simply givens. All of the thinking (discretion) went into creating the strategy, following it is simply about discipline. Discipline only ever wavers during drawdowns, and even then it is kept in check by more rules. Rules, rules, rules - they are what keep me confident enough to follow a strategy consistently; sane enough to live everyday without a frenetic fixation on the market; and humble enough to know that the outcome of any single trade - or series of trades - is completely out of my control. After all, I'm just following orders. Just make sure that those orders are grounded on a tenable foundation - that you actually have a solid edge at the core of the entire process.
Good luck,
http://www.forexfactory.com/showpost.php?p=2385007&postcount=72
As for your question, you are asking if you sat me down in front of some naked charts and said "trade away Chris" if I would be able to be consistently profitable. Haha - while I would love to think so it is highly doubtful. And not because I wouldn't have winning trades; I'm sure that I would have many, and probably even some decent streaks. However, I would likely fail in the longer-term for several reasons:
1. I would be lacking the precision that I find necessary in my trading to properly exploit an edge. Looking at a naked chart would force my process to become discretionary, which would distort the integrity of my exits and position risk adjustment, etc.
2. I would almost certainly lose faith in my 'strategy' when I went into drawdown, since I would have no statistical drawdown expectations to help ground my battered confidence.
3. I would undoubtedly get caught up in the emotion of trading again, which is never something that has made me successful. Overconfidence or fear would inevitably erode my capital.
I do want to make it clear, though, that my only input is price. I don't use volume or any sort of fundamental analysis. I don't want to give you the idea that my screen is cluttered with a million lines and indicators; at the same time, I follow carefully constructed rules that cover every potential occurrence. I never even contemplate whether or not to enter a position: it is a given based on my rules, as is every single action that I could possibly take with that position as a reaction to the market.
To put it simply, there is no thinking involved in any of my trading decisions; in fact, I wouldn't even really call them decisions, since they were decided along time ago. Now they are simply givens. All of the thinking (discretion) went into creating the strategy, following it is simply about discipline. Discipline only ever wavers during drawdowns, and even then it is kept in check by more rules. Rules, rules, rules - they are what keep me confident enough to follow a strategy consistently; sane enough to live everyday without a frenetic fixation on the market; and humble enough to know that the outcome of any single trade - or series of trades - is completely out of my control. After all, I'm just following orders. Just make sure that those orders are grounded on a tenable foundation - that you actually have a solid edge at the core of the entire process.
Good luck,
http://www.forexfactory.com/showpost.php?p=2385007&postcount=72
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