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Great follow up Gary.
RE: << what systematic approaches DO work well in a large portfolio
approach? Are "black swan" wins an absolute requirement, in which case (by
my definition) you're forced into trend-following? Or can you get a
high-enough expectancy in a 100-market system to succeed without the outlier
wins? >>
Part of the answer is to not consider "entry point" quite so literally as we
used to. Instead, we consider a portfolio as a weighted statistical entity.
We periodically "rebalance" as we go along with no absolute entries or
exits, although it is possible for some symbols to have 0 weight.
Instead of trying to define (locally optimize, whatever) a "parameter" for
each symbol or groups of symbols, we look more globally at whatever it takes
to treat the entire portfolio as a multi-dimensional pattern (whether that
pattern is price based, a synthetic of price, a combination of price and
derivatives, etc.). Once we begin thinking in these terms, then there are
various schemes to apply, from stat arbitrage (done to death already), to
very involved pattern prediction that would have been impossible without
current generation 8-way servers (and a cluster of them at that).
In these cases Gary, "minor" Black Swans (2001 - 2002, or 2007 - ?) tend to
come and go without the terrible effects on the total equity curve.
As far as options trading, it's no great secret that Interactive Brokers was
(and still is) one of the most successful prop automated options traders on
the planet, and oh-by-the-way we're a broker too. It always helps if you can
be on the Sell Side. :-)
Best regards,
Gene Pope
-----Original Message-----
From: Gary Fritz [mailto:fritz@xxxxxxxx]
Sent: Wednesday, April 16, 2008 1:29 PM
To: omega-List
Subject: Re: Position trading 100+ futures markets times 8 systems
Great post, Mark. I agree with your and Bob's comments: basic portfolio
theory says the Sharpe ratio will increase as the square root of the number
of market/systems being traded. So, assuming you have a system that is at
least modestly profitable, trading it in many markets can smooth out the
equity gyrations and make for a less stressful trading experience.
Of course, as Mark said, managing hundreds of open positions is a
challenge in itself, even if you have the capital necessary to hold
positions in
so many markets. But the fundamental requirement is to have a system that
is at least "modestly profitable" in virtually all markets.
I'd like to comment on one of Mark's "research points:"
> 6. What five-letter word, often used in discussions
> of trading methodology, is completely absent from this posting?
I'll hazard a guess that the word starts with "T." And ends with "rend."
:-)
Mark implied to me that his trading approach is not a trend-follower. I'm
wondering how you can trade all these markets with any other approach.
By "trend-following" I'm not referring to a specific trend-catching
methodology, but merely the idea of catching broad moves in the market. It
seems to me there are a limited number of systematic approaches:
* Trend-following: jumping on a market move and riding it. This assumes
that a market in motion will tend to remain in motion in the same direction.
I
would call any trading approach that rides a move as long as possible,
regardless of its entry method, to be a trend follower. Obviously this
works
best in trending markets, and not all markets satisfy this criterion.
* Counter-trend or mean-reversion: assuming that a market in motion will
tend to REVERSE. These systems enter when the market is "out of
balance" and exit when the market returns to "balance."
* Volatility trading: assuming that volatility is mean-reverting, and
looking for
extremes of volatility for trading opportunities. E.g. finding a market
that has
gone sideways for a while, and jumping on a breakout.
I think these are the major fundamental classes of trading systems, at least
if
we look only at price and maybe volume. Have I missed any? There are
other approaches such as option strategies, but I'm going to assume for the
moment that we aren't talking about that type of system.
There are obviously many entry techniques that can be applied to these
broad system classes. For example, you might have a system that enters
counter-trend (at a support/resistance level or other inflection point), but
rides a trend once it's in. Even the volatility-breakout system is really
just an
entry technique, and it probably uses trend-following methods to manage
open trades.
So: if we accept those as the major classes of systems, which of them
would be suitable for trading in a large basket?
Portfolio trading like this tends to live or die by its trading costs. With
typically low win percentages, and the need to roll contracts every 60 bars,
you need a fairly large average trade to come out ahead. Classic
turtle-style
trend-followers tend to suck wind most of the time, but the occasional
outlier
win is big enough to pull the overall results into profitable territory.
Turtles
*depend* on those "black swans," and I suspect most other trend-followers
do too.
Mean-reversion systems, almost by definition, have fairly small winning
trades. They can't get those outsized "black swan" trades that trend
followers rely on. Even in reverse-y markets like stocks, the win % is
likely to
be small enough to make it difficult to win long-term.
I don't know about volatility-breakout systems. Those may provide good
enough trade size to work, and could potentially get you the outsized wins.
But I suspect you get a lot of whipsaws from false breakouts.
I would think the only way to succeed without the "black swan" wins is to
have a very accurate and high-expectancy system. Which seems to me to
be nearly impossible in a system that trades 100 markets with the same
parameters.
So (finally! :-) my questions: what systematic approaches DO work well in a
large portfolio approach? Are "black swan" wins an absolute requirement, in
which case (by my definition) you're forced into trend-following? Or can
you
get a high-enough expectancy in a 100-market system to succeed without
the outlier wins?
Can you trade a portfolio successfully with price-based systems, or will you
have better success with other techniques such as options, inter-market
analysis, or ...? Is it even possible/practical to manage an options
spread-
trading system, or an inter-market analysis system, in 100 markets!?
Gary
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