Am I on the right track?

Quote from lost dilettante:

I have been dipping my toes into the trading water as a bit of a hobby and like most new people doing badly. I have so far been 100% correct on the ultimate direction of my trades, but totally off in the timing - I guess this is a fancy way of same as saying I have been 100% wrong :(

Rather than continue down this path I have stopped, read and thought - probably something I should have done this before starting :D

Here are is what I have come up with so far. I would really like some feedback to see if I am on the track.

1. You need to find an edge to trade successfully long term. I suppose this is obvious, but the problem is how do you know that you have found a real edge and have not just data mined out a set of rules that seem to work? After all even if a movement series is truly random (eg radioactive decay), if you try enough rules combinations then you will find a set that appear to predict movement direction.

2. Any rule to future price correlation that can be mined out at a statistically valid level is obvious and has been arbed away. If I go data mining through millions of rules looking for a correlation with future price movements, then the p value of the null hypothesis would have to be so tiny that the rule would stick out like a sore thumb. This is similar to the same problem pharmaceutical companies face when they go data mining through the results of failed drug trial. It is very easy if you do this to find a "result" that shows the drug had an effect on some sub-population that appears to be statically valid, even when the drug is a sugar pill! It is for this reason that the FDA insists that any correlation result mined out of a drug trial are tested in an new independent trial before approval.

3. Rather than looking for correlations between market data and future prices I need to find the causes of price movements. Once a cause is found then a rule can be constructed and tested to see if it is statistically valid.

4. All publicly available causal data is already being used by at least one trader and so any edge that can be constructed from the data is already taken.

5. Finding an new edge require finding one or more unique data sets that are causal (or at least moved by the same underlying cause) of price movements. This might be best explained with an example. Imagine that I count the number of cars on each day in the car park of store and use this to predict the future earnings of the store. While earnings would not be perfectly correlated with the number of cars present, it is easy to see that if the car park is empty then there will be no customers and earnings will be poor. In reverse, if the car park is full of customers then sales will be good and earnings likewise all things being equal. Assuming that car counting is statically predictive of store future earnings, and earnings drive price movements, then I will have found a real edge.

The major problem I can see with this approach is the either the predictive value of any unique data set will be so low that transaction costs will eat up any trading advantage, or the cost of gathering the data is so high that they exceed the possible extractable trading profits. The major advantage is I at least have a chance of finding a true edge not being exploited by anyone else. What are peoples thoughts?
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Your post has a certain beauty to it, the way you put together the problem of how to trade the markets in such a clear, logical and scientific fashion.

The "edge" of how to trade the markets has always been there, it's just a matter of the individual trader learning how to find it, and then trade it successfully.

MIT Blackjack Team

The essence of their strategy was to only place bets (make trades) when the odds of sccess were overwhelmingly in their favor.

Those "rules of gambling" apply to trading as well, you just have to figure-out when those situations exist in the markets, and place your bet accordingly.
 
Quote from Topper:

Here's a way to develop a trading edge-

Watch a stock 6.5 hours a day, 5 days a week, for weeks. Soon you will start to get a good feel for the 'personality' of it. Things like how the market makers or specialists trade it and the average type of trading activity, as well as how it reacts to anything and everything will become familiar to you... kinda like a family member or friend! Being familiar with a stock's movements 'is' a trading edge that increases your probabilities.
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What worries me about this approach is you are basically data mining the market using your brain rather than a computer. In the process of watching the market and trying to work out what is causing price movements you will develop and test tens of thousands of hypotheses (some consciously, but most unconsciously). You will "pick" out of all these hypotheses a few that seem to work. The risk is that the vast majority of rules you pick will be false and will only appear to work because of chance. If this is the case you might as well take all your money and go to the casino - at least you will get a free drink :D
 
Quote from MandelbrotSet:

Your post has a certain beauty to it, the way you put together the problem of how to trade the markets in such a clear, logical and scientific fashion.

The "edge" of how to trade the markets has always been there, it's just a matter of the individual trader learning how to find it, and then trade it successfully.

MIT Blackjack Team

The essence of their strategy was to only place bets (make trades) when the odds of sccess were overwhelmingly in their favor.

Those "rules of gambling" apply to trading as well, you just have to figure-out when those situations exist in the markets, and place your bet accordingly.
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Thanks for the complement. I don't expect that trading is easy, or the skills required to be successful are easily acquired, but I have learnt from my day job (analysing complex data sets and predicting outcomes) that only by understanding the underlying physical causes do you have any chance of predicting anything. It is really easy to mine out "rules" that appear to work if you study the data long enough, but which have absolutely no long term predictive value. The human mind is really good at finding patterns in data even where none exist (eg faces in clouds, mythical figures in the arrangement of the stars, monsters in the shadows, etc).
 
I remember reading in Gary Smith's book about right-brained and left-brained people when it comes to trading. Left-brained people attempt to quantify the market and apply a set of mechanical rules, while right-brained people are more discretionary traders.

I'm definitely a right-brained discretionary trader, so I am not qualified to comment about quantitative trading. There are multiple ways to pull money out of the markets. However, as a profitable trader on multiple timeframes I am proof that a quantitative approach is not necessary. Regardless of the path though, know that it will take lots of time. Topper and illiquid have already summarized the rest of my thoughts on this matter.

Good luck!
 
Quote from piezoe:

You may be thinking a little too much. But your post interests me.

My remarks, which are nothing but personal opinions formed by years of involvement with the markets, pertain mostly to what is called discretionary intraday trading. I regularly trade the emini S&P intraday, and have lost enough money doing so from time to time to get quite an education. I also trade options and stocks but seldom intraday.

For the typical retail trader with no inside information, no ability to make prices move in one direction or the other, and no ability to regularly buy on the bid and sell on the ask (or inside of these), short term trading is gambling. Although there is a difference between market gambling and casino gambling.

In the casino it is impossible to turn the odds in your favor, but this is not true of gambling in the markets where there are times when the odds are in your favor. To succeed one has to be able to recognize these times and trade accordingly.

The stock market has its own nature, Traditionally the market is a place for charlatans and hucksters of all sorts. This is as true today as it was a hundred years ago. Consequently, one has to look at short term price movements not as you would in an honest market that simply reflects natural supply and demand, but rather as in a dishonest market influenced by liars and cheats, all perfectly legal, though we have had plenty of the illegal sorts also. Consequently expect price movements to be quite often deceptive, and intentionally so.

Major market participants with access to millions, or even billions, of capital, and using huge leverage with tiny per share, or per contract, trading costs regularly drive prices first one way and then another, and they do so in a deceiving manner. They know where the market is headed because they are going to make it head there. Your job as a retail trader is to determine what they are doing and jump aboard and get off at the nearest station (usually).

As an example of how practical experience, as opposed to intellectual thought, can lead to an "edge" with a known cause, and thus to successful trades, I'll mention one little practical matter that all successful intraday traders are aware of and exploit. That is the matter of running stops. This is a very important aspect of emini trading but occurs in all short term trading. If you familiarize yourself with where many traders place their stop orders you will know ahead of time that when the market starts to move toward these locations with a certain gusto that it is very likely to continue on until the stops are taken out. You will naturally take advantage of this in both placing high probability "bets" and in avoiding bad places to place your own stops.

So in summary, I would say that successful trading is more a matter of experience, patience and discipline than it is of intellect. It doesn't take a rocket scientist.

There is tremendous interest in automated trading that has the huge advantage of removing human emotions from trading decisions. There are apparently two main types of autotrading going on. In one it is assumed that there are rules that can be applied mechanically and will lead, on average, to profits. Some traders seem to have success with this approach and that clearly implies some degree of regularity to the markets.

The other type of automated trading is apparently based on automated market manipulation. Basically doing what major market participants have always done but refined and automated.

There may even be a third category of automated trading, "high frequency trading." I know nothing about it except what i've read here on ET. Apparently it involves large numbers of trades for very small profits, and according to some here on ET, it involves jumping in front of orders, which would be "front running" which i always naively thought to be illegal.

You may be the kind of person with a very analytical mind that could make a success out of autotrading. But either way you must approach short term price movements in the markets as being driven by fear, greed, market maker hype and legal manipulation -- not by any textbook theory or logical response to innate values of the underlyings being traded.
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piezoe you da man. I agree 100%. In fact all my pathetic postings on ET where I try to explain my take on trading, should be scratch and replaced by this post. Very well said indeed.
 
Quote from lindq:

That's correct. That should be your starting point.

Cause and affect. Nothing happens without a reason.

Mining data without first thinking about cause is a waste of time, and is the ruin of most new traders.
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Absolutely!

Regards

Johno
 
Since some people seem to have found my post entertaining I will continue :)

I have been thinking more about the trading strategies that are used. Assuming that most traders (even the successful ones) are actually using random strategies that they have either mined out of back testing, or from staring at the screen for years, then the effect on the market would be to add what is effectively noise to the price signal. I guess another way to look at this is what would happen to the market if traders started using trading rules selected from the toss of coin. If true random strategies were being predominately used, then even if there once was a predictive signal present in the price data, it would be lost in the noise coming from the "random" traders.

This random trading hypothesis has two interesting predictions:

1. Trader's profits and losses will be normally distributed assuming trading cost are ignored.

2. The price predictive signals embedded in a price data series will be less noisy the fewer trades have been made.

Both of these predictions are worth looking at further. Starting with the first, the distribution of earnings is not normal. Some traders make or lose more than would be predicted from a random strategy (ie there are fat tails on the earning distribution). This implies that there must be a way of predicting price movements within a market (ie trading can work). While this might seem obvious to the everyone here it does question the efficient market hypothesis.

The second prediction is more subtle and probably best illustrated with an example. Imagine Trader A buys a stock based on inside knowledge of an upcoming profit that will significantly exceed market expectations. They will buy the stock, increasing its price from the level it would have been at in the absence of this knowledge. This is a predictive signal to future prices (ie the price movement caused by Trader A is in the direction the stock will take once the news become public). In the absence of other traders in the market, Trader B could use this price movement to predict future prices. If on the other hand the market is dominated by traders applying random trading strategies, then the price signal from Trader A will become lost since the smallest signal that can be detected is limited by the noise caused by all the other traders. In other words, the random trades will swamp the predictive price signal coming from the advance knowledge trades.

The second prediction has another interesting aspect, that is, the price prediction signal will be greater for those securities with higher volumes of insider trading. A security dominated by insider trading would reflected very quickly and strongly the future price movements based on the news becoming public. A security where nobody traded on private knowledge would have no future price signal embedded in the past price data (ie all news would be unexpected). Since it is possible to retrospectively identify those securities that do show evidence of insider or private knowledge trading by looking for significant price movements before announcements, it should be possible to identify those securities where current price movement is most predictive of future movement. While the average investor wants to avoid those stocks where the insiders are trading on their knowledge, traders would be best to trade those stocks where lots of insider trading is going on - I guess this would be a "jump on the crooks band wagon" strategy :)
 
"Am I on the right track?"

No, most probably not, if you would have to ask someone else for confirmation! :D

PS: Not actually finished reading most of your posts yet! :p
 
you are thinking way too much and wtf is this shit with some validity level.

What you want is profitability. To achieve that you need positive expectancy. Most likely you will eventually want to achieve it trough moderate win-% and high RR.

Another story is the tactics ie. different setups to achieve the positive expectancy.
 
Quote from lost dilettante:

Since some people seem to have found my post entertaining I will continue :)

I have been thinking more about the trading strategies that are used. Assuming that most traders (even the successful ones) are actually using random strategies that they have either mined out of back testing, or from staring at the screen for years, then the effect on the market would be to add what is effectively noise to the price signal. I guess another way to look at this is what would happen to the market if traders started using trading rules selected from the toss of coin. If true random strategies were being predominately used, then even if there once was a predictive signal present in the price data, it would be lost in the noise coming from the "random" traders.

This random trading hypothesis has two interesting predictions:

1. Trader's profits and losses will be normally distributed assuming trading cost are ignored.

2. The price predictive signals embedded in a price data series will be less noisy the fewer trades have been made.

Both of these predictions are worth looking at further. Starting with the first, the distribution of earnings is not normal. Some traders make or lose more than would be predicted from a random strategy (ie there are fat tails on the earning distribution). This implies that there must be a way of predicting price movements within a market (ie trading can work). While this might seem obvious to the everyone here it does question the efficient market hypothesis.

The second prediction is more subtle and probably best illustrated with an example. Imagine Trader A buys a stock based on inside knowledge of an upcoming profit that will significantly exceed market expectations. They will buy the stock, increasing its price from the level it would have been at in the absence of this knowledge. This is a predictive signal to future prices (ie the price movement caused by Trader A is in the direction the stock will take once the news become public). In the absence of other traders in the market, Trader B could use this price movement to predict future prices. If on the other hand the market is dominated by traders applying random trading strategies, then the price signal from Trader A will become lost since the smallest signal that can be detected is limited by the noise caused by all the other traders. In other words, the random trades will swamp the predictive price signal coming from the advance knowledge trades.

The second prediction has another interesting aspect, that is, the price prediction signal will be greater for those securities with higher volumes of insider trading. A security dominated by insider trading would reflected very quickly and strongly the future price movements based on the news becoming public. A security where nobody traded on private knowledge would have no future price signal embedded in the past price data (ie all news would be unexpected). Since it is possible to retrospectively identify those securities that do show evidence of insider or private knowledge trading by looking for significant price movements before announcements, it should be possible to identify those securities where current price movement is most predictive of future movement. While the average investor wants to avoid those stocks where the insiders are trading on their knowledge, traders would be best to trade those stocks where lots of insider trading is going on - I guess this would be a "jump on the crooks band wagon" strategy :)
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Can you propose how a price/time chart would look for a stock where the big majority (80-90%) of the traders are insiders?

Do you assume that all insiders act on the same knowledge?

Do you assume that all insiders get the knowledge at the same time?

Do you assume that all insiders will act on the knowledge at the same time? Can you accept that some insiders will act sooner than others?

Is it possible that some of the insiders might be involved in creating the knowledge?

Is it possible that some insiders might not buy into the knowledge 100% and have some doubts?

Do you assume that all insiders have the same goals?

Do you assume that all insiders have the same levels of greed and fear levels?

Will the bigger insiders make their purchases at once moving the price to a new level, or will they try to get as much of the purchase on a lower level by making smaller purchases over some time?

Can you accept that some of the insiders will start faking their intentions? Selling when they intend to buy?

It seems to me that stocks traded mostly by insiders will show some level of noise that we as traders will need to interpret and bet on.
 
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