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Omega Man wrote:
> (1) The problem of price shocks. (Do not think that you can
> avoid them or that you know when they are coming. Price shocks are
> one of the fundamental reasons that systems do not survive long
> term. One bad shock can take away many months (even years) of
> system profits.
And non-system (discretionary) traders are somehow immune to those
price shocks? I don't think so. I know plenty of discretionary
traders who got whacked by the Greenspan eruption last fall.
Price shocks are a fact of life, for system AND discretionary
traders. Discretionary traders may have some advantages, especially
over pure blind mechanical system-followers, since they can stand
aside when "expected" shocks are coming. But so can an intelligent
system trader.
Shocks, by definition, are UNexpected. They're a danger of trading,
no matter HOW you trade. You survive them by trading carefully and
without excess leverage, not by avoiding systems. Even a pure
mechanical system can survive shocks -- most backtested systems had
no provisions to avoid shocks, and the backtests came out OK. As
long as you don't get killed by over-leverage, the shocks will likely
even out with some winners & some losers.
Probably the biggest shock-related risk that's unique to systems is
the danger of curve-fitting **TO** a shock. If there's a huge shock
in your price history, and your system is mediocre *EXCEPT* for a
lucky break on the shock, then you can be fooled into thinking you're
trading a hot system when it actually just had one lucky trade.
That's why you have to look at outliers and see if they should be
discarded.
> (2) The problem of automation. (When we backtest, we look at
> every trade. We act as though some robot would have been trading
> our account and would have taken all of the trades, just as they
> are posted in our testing. But, in the real world, things are
> different!
Here I agree 100%. I've gotten burned by this WAY too many times.
It's hard to avoid this completely, unless you wire your system
directly into TOPS or your broker. In which case you trust your
automation a helluva lot more than I would.
Gaius' solution of trading with a partner is a good one. The trick
then is finding a partner you trust.
Gary
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