:eek: Long Post!
I am working on an automated money management system and this concept has arise from the idea of trading out of an engine that produces random signals in a couple of extremely liquid instruments, ie the ES, ESTX50, EUR, etc.
You must be LOL by this time, but you know, this is part of an endeavor to understand how much edge a trader gets from the typical pattern rules (chart, pairs, and other pseudo arb strategies that are so common these days in the hedge fund industry) and how much derives solely from adequate money management.
While it is true that most liquid instruments clearly show certain patterns that could be translated into an edge, the fact is, however, these patterns are only valid when signaling powerful trends that are always backed by market sentiment factors. So, in fact, I might argue, market sentiment produces such signals, while the signals itself are worthless.
My goal, though, was to analyze short term behavior in these contracts and more specifically understand whether some of the typical pattern analysis would contribute to sustain some edge in these time frames. The answer was NO. Most of the patterns the trader is trained to detect, will not work in this environment, because most of the movement is due to noise trading. From time to time a trend backed by sentiment may form, which will lead to another trend and then the noise resumes. The average noise-to-trend is way up, in fact is so high that is very difficult to keep any good pattern based ATS afloat in noisy environment. Most likely the bot will do great as long as the trend keeps on and bleed during the rest of the time. I am sure all of you have seen this before.
There is plenty of bots out there that are specifically turned on and off when the manager thinks or at least whishes the conditions are met or not. However, predicting when the conditions are met is as difficult as predicting the S&P closing price for tomorrow, because the market is a complex adaptive system that constantly evolves. IMO, the success of any bot out there is pretty much about profiting from noisy environment because, most of the time, thatâs what it gets (I am talking about bots that do intraday trading, because the longer term ones might bypass noise by trading every once in a while).
So, how to become profitable in a noisy environment then?
According to my analysis, the eventual edge that any ATS (or manual trader) gets from this trading derives mostly from money management. In particular, using 10 year historical data, I have found that, with a complete random signal generation method (i.e. using random trade generator engine provided by excel), one would end up above breakeven provided it used some baseline rules:
- never use trailing stops - the noisy market is always chasing desperate to exit orders and most if its movement follow the trail of these stops.
- use pyramiding - most prof traders will tell you shouldn't do this and that's because you are probably risking too much in each lot. However, if you enter just one fifth lot size and then pyramid it until you reach the full lot, you have much better odds to break even or end up winning.
- use a profit target exit - that will allow to limit the exposure while assuring your equity curve keeps raising. This works with pyramiding very well, since it allows to rapidly stop the bleeding or recoup losses due to the added leverage.
- stop loss - might be important to draw lines in the sand. Say, if something surfaces in the market that chances the balance of market forces, you would benefit by having some threshold upon which, you need to reassess the situation. However, this is shouldn't be triggered unless there's really a shift in market forces, otherwise it will interfere with your trading setup and most likely sunk your overall expectancy.
- sterling ratio (Rp/max.dd)- manage your equity curve on a drawdown basis. Add risk when you're up, reduce risk when you're are close to your max drawdown. This makes the slope your equity curve to behave properly.
Let me know your opinions. :eek:
I am working on an automated money management system and this concept has arise from the idea of trading out of an engine that produces random signals in a couple of extremely liquid instruments, ie the ES, ESTX50, EUR, etc.
You must be LOL by this time, but you know, this is part of an endeavor to understand how much edge a trader gets from the typical pattern rules (chart, pairs, and other pseudo arb strategies that are so common these days in the hedge fund industry) and how much derives solely from adequate money management.
While it is true that most liquid instruments clearly show certain patterns that could be translated into an edge, the fact is, however, these patterns are only valid when signaling powerful trends that are always backed by market sentiment factors. So, in fact, I might argue, market sentiment produces such signals, while the signals itself are worthless.
My goal, though, was to analyze short term behavior in these contracts and more specifically understand whether some of the typical pattern analysis would contribute to sustain some edge in these time frames. The answer was NO. Most of the patterns the trader is trained to detect, will not work in this environment, because most of the movement is due to noise trading. From time to time a trend backed by sentiment may form, which will lead to another trend and then the noise resumes. The average noise-to-trend is way up, in fact is so high that is very difficult to keep any good pattern based ATS afloat in noisy environment. Most likely the bot will do great as long as the trend keeps on and bleed during the rest of the time. I am sure all of you have seen this before.
There is plenty of bots out there that are specifically turned on and off when the manager thinks or at least whishes the conditions are met or not. However, predicting when the conditions are met is as difficult as predicting the S&P closing price for tomorrow, because the market is a complex adaptive system that constantly evolves. IMO, the success of any bot out there is pretty much about profiting from noisy environment because, most of the time, thatâs what it gets (I am talking about bots that do intraday trading, because the longer term ones might bypass noise by trading every once in a while).
So, how to become profitable in a noisy environment then?
According to my analysis, the eventual edge that any ATS (or manual trader) gets from this trading derives mostly from money management. In particular, using 10 year historical data, I have found that, with a complete random signal generation method (i.e. using random trade generator engine provided by excel), one would end up above breakeven provided it used some baseline rules:
- never use trailing stops - the noisy market is always chasing desperate to exit orders and most if its movement follow the trail of these stops.
- use pyramiding - most prof traders will tell you shouldn't do this and that's because you are probably risking too much in each lot. However, if you enter just one fifth lot size and then pyramid it until you reach the full lot, you have much better odds to break even or end up winning.
- use a profit target exit - that will allow to limit the exposure while assuring your equity curve keeps raising. This works with pyramiding very well, since it allows to rapidly stop the bleeding or recoup losses due to the added leverage.
- stop loss - might be important to draw lines in the sand. Say, if something surfaces in the market that chances the balance of market forces, you would benefit by having some threshold upon which, you need to reassess the situation. However, this is shouldn't be triggered unless there's really a shift in market forces, otherwise it will interfere with your trading setup and most likely sunk your overall expectancy.
- sterling ratio (Rp/max.dd)- manage your equity curve on a drawdown basis. Add risk when you're up, reduce risk when you're are close to your max drawdown. This makes the slope your equity curve to behave properly.
Let me know your opinions. :eek: