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Recently, I ran into a good example of how a mathematical formula
isn't an accurate representation of what really happens in markets.
I took 44 years of annual returns in the SP500, then got the median
of those returns (12.15%) and the standard deviation of those returns
(15.69%).
The standard deviation tells you the volatility of the returns in the
security being traded, for anyone who isn't geeky that way.:)
Taking the 12.15% median annual return and subtracting the standard
deviation of 15.69% gives you -3.54%. Adding the median return to
the standard deviation gives you +27.84%. What this tells you is
that 2/3 of the time, the annual return on the SP500 should fall
within a range of -3.54% and +27.84%. Only 1/3 of the time should
returns fall outside of this range, 1/6 of the occurrences lower and
1/6 higher.
With 44 years of data, according to the math, there should be 7 years
(44/6, rounded off) when the annual return would be less than -3.54%
and 7 years when it would be more than +27.84%.
What ACTUALLY occurred was that there were 11 years when the annual
return was below the range and only 3 years when it was above.
Thinking about WHY that happened and what it means is how you come up
with great trading concepts that nobody relying heavily on brute-
force number-crunching will ever "get." Your understanding of what's
happening and why not only gives you an "edge" but also saves you
from having to do massive amounts of computer back-testing that may
or may not tell you anything you can use.
JMO and FWIW.
Luck,
Sebastian
--- In equismetastock@xxxxxxxxxxxxxxx, "rdb104" <richandellen@xxxx>
wrote:
> I haven't done your Freeburg research but from experience I agree
totally.
> There is always uncertainty..and most of these guys think you
can 'find' the grail when dealing
> with randomness most of the time. I don't know why anyone thinks
that fear and greed driven by emotion
> can fit neatly into some mathematical formula(s).
> ----- Original Message -----
> From: superfragalist
> To: equismetastock@xxxxxxxxxxxxxxx
> Sent: Monday, September 05, 2005 8:58 PM
> Subject: [EquisMetaStock Group] Trading ain't gambling, is it?
>
>
> Well, I guess we have somewhat different opinions MG.
>
> I've got a pile of research that I'm going through right now from
> Nelson Freeburg. I think he would disagree with some of your
points.
> He's done many thousands of tests over the last 13 years. He has
> trading systems that have traded only 9 or 10 times over 20 years
but
> have beaten buy and hold by a few percentage points. Some of those
> systems have winning trade percentages as high as 80%. There's
nothing
> academic about them.
>
> A system making only 9 trades in 20 years says nothing about how
long
> a trade lasts. It says nothing about the cost of margin, or the
amount
> of money someone can make. Some of Freeburg's systems have
benefited
> from margin and some haven't.
>
> He also has several systems that have been backtested for periods
of
> 20 to 50 years. During that time, they showed consistent
performance
> but in the late 90's the systems started to drop off sharply in
> performance, and some failed completely.
>
> I'm not going to speculate on whether gambling is a sin, but many
> types of gambling such as poker have the elements of luck, skill
and
> probabilities as their components. In the hands of a truly skilled
> player, which there are very few, the odds are on the side of the
> player. Based on my perspective, and not yours, trading is
exactly the
> same thing. You have to be lucky, skilled and have probabilities
on
> your side.
>
> If you look at the top poker players over the last 20 years, none
of
> them made money consistently every year, but over the 20 years
they
> did very well. They also had some losing years and some big
winning
> years.
>
> Trading got popular when it was advertised and talked about all
over
> television. Poker is now popular for the same reasons. Every
> once-in-a-while someone without truly good skills can get lucky
and
> win big. That's why a lot of people take up trading who don't
have a
> clue as to what it takes to be consistently good at it, and it's
the
> same reason people start playing internet poker and then throw
down
> $10,000 to play in a tournament. It's takes about $500,000 in
front
> money to play most of the world poker tour. How many players make
more
> than it cost them to play? How many traders make more than it
costs
> them to play? The drop out rate is about the same.
>
> I use some of the same systems that Freeburg has been working
with as
> part of my market conditions barometer, which improves my winning
> percentages as I've written about before. I'm hoping that some of
the
> improvements I've come up with to these systems will increase the
> returns that Freeburg has shown over long periods of time. I don't
> know yet. The couple that I have worked on so far have had very
good
> test results.
>
> In my trading I stay keenly aware that on any day, I may not win.
I've
> educated myself to as high a level as possible regarding the game
I
> play. I've tested and retested everything I do so I know the
> probabilities. I've practiced and practiced and practiced many
> thousands of times before stepping up to table to play with real
> money. Now I've played it live for several years, and I know
pretty
> well what I can expect to earn. However, I also know that when I'm
> lucky, I make more money than when I'm not. I know the market is
> unpredictable and may not deal me the cards I need, even when the
> probabilities are 99 to 1.
>
> Basically I make highly educated, well thought out, good
probability
> guesses. Well, now I'm guessing that if that's not gambling, it's
> really really close.
>
>
>
>
>
>
>
>
>
>
>
> --- In equismetastock@xxxxxxxxxxxxxxx, mgf_za_1999
<no_reply@xxxx> wrote:
> > If your system trades 9 times in 20 years, either give the
money to
> > some index manager, or put it in the bank. You are not
trading, you
> > are buying and holding or investing. If you add any conceivable
> > gearing then either you will run out of margin, or pay through
your
> > ears in carry over the 20 years with just 9 trades.
> >
> > Anyhow, 9 trades in 20 years sounds academic to me - 30 trades
plus
> > degrees of freedom sounds practical to me.
> >
> > I do use such long term, 9-trades-in-20-years systems to
extract the
> > long term trend from a ticker. But I do not use that as a
trading
> > decision - just as part of the input.
> >
> > Yes I agree with you, trading is not investing. But I
certainly don't
> > think trading is gambling. It is gambling if you don't know
what you
> > are doing, probably with much worse odds than you'd get in a
gambling
> > house. Trading is buying and selling of financial instruments
with a
> > view to making a speculative profit while gambling is
statistical and,
> > given the odds, a sin!
> >
> > Regards
> > MG Ferreira
> > TsaTsa EOD Programmer and trading model builder
> > http://www.ferra4models.com
> > http://fun.ferra4models.com
> >
> > --- In equismetastock@xxxxxxxxxxxxxxx, superfragalist
<no_reply@xxxx>
> > wrote:
> > > Your premise is from a purely mathematical view, specifically
> > > statistical. However, the market doesn't always supply data
in a
> > > complete packages ready for statistical testing and
inference.
> > >
> > > Suppose we have a market timing system that has made only 9
trades in
> > > the last 20 years and all of the trades have been highly
profitable.
> > > Do we use the system or not? There are not enough trades to
validate
> > > the results.
> > >
> > > We can wait another 40 years or so and we'll probably have
enough data
> > > and enough trades to make statistically meaningful
inferences.
> > >
> > > None of this is neat, precise or absolute. And there are no
hard and
> > > fast rules for how many trades a system needs to give good
test
> > > results. There are approaches which are better than others
like this
> > > one by MG, but there is no one correct answer to the question.
> > >
> > > After many millions of systems tests and a lot of trading
years in the
> > > markets, no one has come with a trading system, a timing
system or any
> > > other system that works consistently over long periods of
market
> > history.
> > >
> > > Trading is not investing, it's gambling with an edge to the
player if
> > > the player is an expert at that game. However, the house is
always
> > > changing a little something here or there that changes the
> > > probabilities of events just enough to change the game. It's
the
> > > players job to stay up with these changes and adapt well
enough to
> > > keep the edge on the house.
> > >
> > > Newbie's just don't get how long it takes and how hard it is
to get
> > > the edge consistently and over long periods of time. A newbie
thinks
> > > if they make money one year, they're going to be a successful
trader
> > > every year. Call me in twenty years with your track record
and if it
> > > measures up, I'll send you your certificate of validation.
> > >
> > >
> > >
> > >
> > >
> > >
> > >
> > >
> > > --- In equismetastock@xxxxxxxxxxxxxxx, mgf_za_1999
<no_reply@xxxx>
> > wrote:
> > > > The 30 trades is based on the central limit theorem - after
about 30
> > > > observations things settle down if the mean of random
samples
> follows
> > > > a normal distribution. There are several assumptions in
this
> > > > approach, but it should give a good idea. I'd push it up a
bit, say
> > > > to 35 or 40. Also, you need to adjust for degrees of
freedom if you
> > > > do any optimisation. Suppose your system is driven by 1
parameter,
> > > > then you must add this to the 30. Suppose you have a big
system
> that
> > > > uses say 10 parametrs - then you need at least 40 trades.
> Especially
> > > > if the system gets bigger, it needs more trades to give any
> > > > confidence, and I will feel better if such a system
produced good
> > > > results in 50 or more trades.
> > > >
> > > > Another, excellent way to test is to use a hold out sample.
> Build the
> > > > system on a portion of the data, say an 80% sample. Then
test it on
> > > > the rest and you can see if you have a winner or fools
gold. The
> > > > *proper* way to do this is to segment the sample in say 10
> blocks (of
> > > > 10% of the data each). Now you choose randomly any 8
blocks,
> optimise
> > > > the parameters of the system on it, and test it on the
remaining 2.
> > > > Then you choose another 8 blocks randomly, optimise the
system, test
> > > > it on the remaining 2 and so on. After you've done this
say 100
> > > > times, you test the results.
> > > >
> > > > For this you need special software - one good example can be
> found at
> > > >
> > > > http://weka.sf.net
> > > >
> > > > In practise, just chop off the most recent 20% and you'd
get a good
> > > > idea if the system will work or not.
> > > >
> > > > Regards
> > > > MG Ferreira
> > > > TsaTsa EOD Programmer and trading model builder
> > > > http://www.ferra4models.com
> > > > http://fun.ferra4models.com
> > > >
> > > >
> > > > --- In equismetastock@xxxxxxxxxxxxxxx, "rvalue1"
<rvalue1@xxxx>
> wrote:
> > > > > I would contend that if you generated >30 trades in the up
> > direction
> > > > > for a sufficiently long period 2 years or so, you would
have
> > > > > confidence that the system does well in the up direction.
Same
> for
> > > > > down and catch the sideways as it transitions. Very
unusual to
> > find
> > > > > a great system up, down and sideways!! If you have one,
let me
> > know.
> > > > >
> > > > > If you are waiting for 1000 trades, you must trade very
often.
> > > > >
> > > > > --- In equismetastock@xxxxxxxxxxxxxxx, "Ed Hoopes"
> > > > > <reefbreak_sd@xxxx> wrote:
> > > > > > I recently attended a lecture by Keith Fitchen, the
author of
> > > > > several
> > > > > > successful trading systems most notably Aberration. He
says
> that
> > > > > > statistics on more than 1000 trades must be compiled
before the
> > > > > > results can be considered valid.
> > > > > >
> > > > > > Ed Hoopes
> > > > > >
> > > > > > --- In equismetastock@xxxxxxxxxxxxxxx, chichungchoi
> > <no_reply@xxxx>
> > > > > wrote:
> > > > > > > Does anyone know how many trades the evaluation needs
to be
> > sound
> > > > > > > statistically?
> > > > > > > Thank you in advance
> > > > > > > Eric
>
>
>
>
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