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Sometimes, I find it
difficult to write everything that I am thinking on a complex
subject. I would like to take another shot at why I think it is
better, for backtesting & evaluation purposes, to use profits to increase
the number of positions rather than the size of each trade.
I feel that all we can do
when developing a system is to try to pick stocks (or other
instruments) that are going to move in a particular
direction. IMO, it is only luck that a
particular stock might go up geometrically instead of just a few
percentage points. Generally, I'm trying to develop
systems that pick a stock to go up. I've never been able to pick
stocks that are going to go up the most. This is largely due to the
fact that I don't know that the whole market is going to get overheated over the
next few days or weeks. I didn't know that 9/11 was going to
happen, but my systems sure made a lot of money on the short side.
Due to the disastrous effect of that event on so many people, I would hate to
call this "luck", but it was as far as trading systems are
concerned.
Based on hundreds of
systems and thousands of trades, I know that on average I'm going to have
48% to 52% winners with an average net profit of 4%
to 6%. The last thing I want to see in my research is a system that
doesn't trade very often and accidentally picks a winner that makes
2000%. I definitely don't want this outlier to be exaggerated
by coming along right after a big profit in another stock and using that profit
to buy more of the second stock. To me, this is "luck".
It certainly has nothing to do with the merits of the
system.
<FONT
face=Arial>Therefore,
When evaluating the merits
of a system, I don't want to see any compounding of profits.
If I want to see how much
money the system might have made for me, I would use the profits to increase the
number of positions.
I cannot think of a single
reason why I would want to see compounding of position size in my backtesting
results.
But, that's just
me.
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