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« The Usefulness of Forward Earnings | Main | Amusing Links »

February 17, 2007

Comments

oldprof

Bill and Wilson --

Thanks for the comments. While I have not done much discussion of our own short-term trading methods, we obviously follow a careful backtesting approach and consider position size as a function of expected return and possible drawdown.

Wilson has outlined the method for doing this and provided some great additional references. I plan to highlight this issue in a future post.

Thanks again!

Jeff

Wilson M

Interesting story - while trading systems offer a consistent approach if nothing else, the task of creating one should not be approached lightly. One definitely has to be aware of assumptions made and performance monitoring required. While his story has the benefit of hindsight, many lessons can be learned.

With what seems like a martingale sizing mean-reversion strategy, to have 1:1 profit/stop exits one has to have at least 50% win rate to even break even... and if one is scaling in, this win rate has to increase even more to compensate. With many mean reversion strategies, if the trade diverges, one has to also look into fundamental shifts to see if an assumption is no longer true (RE: New Zealand announcement). Again, with assumptions, backtesting should be done in a very pessimistic way so as to be aggressive with slippage and spreads.

Finally, much of this possibly may have been avoided if he did a walk-forward test to see how the system performs on simulated money in realtime, in order to hammer out the kinks.


I would also add to the list, 'Evidence-Based Technical Analysis' by David Aronson and 'The Encyclopedia of Trading Strategies' by Katz & McCormick. I've found both to be very useful and relevant in the area of systems development.

Bill aka NO DooDahs!

"going carefully" and "2% positions" don't belong in the same sentence. It wouldn't take a terribly long losing streak at 2% of equity per each loss to create an account-damaging and will-destroying drawdown.

Tested drawdowns, monte carlo simulation, and some odds being run on binomial distribution approximations for losing streaks of various magnitude are an essential part of system design.

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