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There is a difference between trading and investing. Trading is being in business
and there should be a business plan. It includes money management as well as a
trading methodology. Show me a business without a financial plan and I will show you
a failure. Compare Dell with Commodore Pet. It wasn't all technology it was
planning. Safeway makes 1% profit on a zillion items and Cray makes a fortune on
only a few. Who is right? Make a little on a lot of trades or a lot on a few
trades.
If you are testing systems blindly then your system will eventually fail. Back
testing tells you that you have fitted a system to the past, not one that will work
in all markets in the future. Look at the Moore report. Every month the time frames
for the stochastic change and they are different for up and down markets. (unless
they have changed in last year or two). A fallacy, for that is not how stochastic
was designed to be used. Whether you read the tape, look at shapes and trend
lines, use indicators, candlesticks, check the astrological charts, the full moon,
count bars or throw darts at the financial page your system will eventually fail if
you don't understand how the parts function and what they are supposed to show you
as a trader.
Will the past truly foretell the future. If we didn't believe that, technicians
would be out on the street with a cup and pencils. Granted some are. The same would
go for fundamentals. Can anyone say that today's fundamentals are the same as 10,
20 or 50 years ago. More pencils and more cups for the fundamentalist that are
inflexible. So nothing stays the same and therefor logic says that any system, that
is to have longevity, must be able to be adjusted to the underlying being traded,
and the publics perception and sensitivity to fear and greed which effects the price
movement.
I firmly believe that everything pertinent is shown on the chart and that if the
trader uses the correct tools he/she can be successful. It is using and
understanding the tools. As I have said many times. Knowledge is power, but
understanding how to use that knowledge is what leads one to success.
One of the best money management systems I have seen in a long time was written by
John Moore. I down loaded from the net. I don't know if it was from this site or
elsewhere. If anyone is interested, let me know. If only a few are interested I will
send it privately. If I get a slew of replies I will post it in the group. It is
detailed and very well done. He has far greater ability in the literary area then
I do.
Kevin Morgan wrote:
> A few questions and comments on Peter's stuff:
>
> > I wanted to make a point about how a trading system is really just a
> > small fraction of the story. Many traders have probably done a good
> > deal of backtesting or system development and many traders have also
> > probably tried to find a system that would give them 50% profitable
> > trades with a 2:1 r:r. When they found this system, they probably took
> > a couple of trades and had some mediocre results and probably looked for
> > another system where they could achieve better results(Story of the
> > average trader).
>
> This raises the EXTREMELY interesting question:
>
> When do we know (when should we conclude) that our system that has been
> working in the past is no longer working and should be abandoned?
>
> Yes it's common for traders to conclude this after the first bad spell,
> even if the run of losers is no greater than the greatest over all backtested
> history. But when should we conclude "it's broken now, behavior has changed
> and this no longer is working, time to switch"? Ralph Vince suggests it is
> when the greatest ever maximum historical intraday drawdown is exceeded, and
> trading should be (could be) resumed when new system equity highs are
> re-achieved (it's proven itself again). Another way I suppose would be to
> utilize some factor (i.e., >1.5x) of the largest ever experienced maximum
> number of losses.
>
> I'm interested in any insights on possible answers to this fundamental
> question. I don't think it an area that has been properly explored in
> trading science.
>
> > Until recently, I was of the belief that it was really important to have
> > 60-70% of your trades go your way, but now I realize that this is so NOT
> > important. Sure, if you want to scalp the futures for a living you
>
> Ignoring the need to have steady income, I've found systems that perform
> reasonably well across extreme ranges of percent winners versus win
> size/loss size ratios. However, I've NOT found that the spread of results
> is uniform. My general experience is that the highest profitability
> systems (highest average return per trade across all trades, winners and losers)
> are frequently the ones with very high winning percentages (80% or higher),
> and win size/loss size ratios that are less than 1.0 (average winner is
> smaller than average loser). Excellent systems of this type give me
> average trade returns of 700-1200 (single contract).
>
> Trend following systems usually have the opposite characteristic: low
> percent winners (20-35%), and win size/loss size ratios that are large
> (2:1-4:1 or more). But I can't get such systems to give me large average
> trade returns, the "good" systems are still down in the few hundred per
> trade. And the consistency of return is awful; the drawdowns are much
> more severe and the equity curve is choppy as all get out. As a result,
> I've pretty much stopped bothering working on trend following system
> development. (I may still use trend as a component, but "letting winners
> run" and "cutting losses short" as a basis for system design...nope, I've
> given up on that.)
>
> (I have to say that coffee is an exception when assessed over the last
> 5 or so years, due to the extreme runups/downs it's had. Can we really
> trust it will do that again soon? Here again is something I don't like
> about trend following: a few big trends in history can lead us to conclude
> that we like trend following, but a few big trends isn't really statistically
> significant, and the odds of a new one in the reasonable future are pretty
> much unknown.)
>
> Could just be I'm a poor system designer in the area of trend following
> approaches, and if someone has an approach that scores >500 per trade
> on average on a specific market, I'd like to see it. (The S&P is also an
> exception because it's such an enormously upward biased market; as long
> as stops are reasonably deep a system will show piles of profit in the
> past in the S&P, and arguable, if we have deep enough pockets, it is the
> most awesomely trended market in history and we are insane to not trend
> ride it...right?)
>
> > The reason I believe this is because they have mastered
> > the art of money management. The world's best traders will have their
> > biggest positions on when the market is going in their favor and their
> > smallest positions on when their is no trend. "Varying the bet size" as
> > they call it is the SINGLE MOST IMPORTANT INGREDIENT TO SUCCESS. I
> > emphasize this because over and over again I read about or hear about
> > traders who are going into the markets looking to scalp money out of
> > these volatile markets and are losing because of: a) the increased
> > slippage, b) their own emotional and psychological limitations; c) poor
> > money management; d) no real plan on how to increase their position size
> > when the market moves into a trending mode.
>
> Your assessment of money management as pyramiding while riding a trend
> is all wrapped the fundamental idea that we're trading a trend following
> system. I don't for the reasons explained above. All my systems that I'm
> trading now (3) either exit with profits on a time fuse (i.e., "exit in
> 3 days" or "exit on first profitable close") or exit on a profit target
> ("exit when profits = $2100"). No trend riding.
>
> For me, money management is all about compounding position size in a
> rational and apppropriately aggressive way from trade to trade, as I
> have more or less equity to work with. There is no question that money
> management (=varying position size) is key to taking any small pile into
> a very big pile (i.e, 50-100x larger). There's nothing wrong with NOT
> doing this and taking steady profits (nice work if we can get it). But
> the way I view it:
>
> - my system isn't going to work well forever;
> - I should maximize my return now while it is working well;
> - I should go for a profit target aggressively (via compounding position
> sizes) and then STOP TRADING to secure my wealth;
> - once secured, start over with a new small pile and try to do it again.
>
> In this sense, running a system is kindof like a macro version of running
> a trade. The key point of my logic is that we can't trust our system
> to be nicely profitable forever, so we should try to maximize our profits
> in as short a time as we can, take alot of risk along the way in doing so
> (in order to minimize the time component), then tuck those profits into a
> nice safe low yielding account, or real estate, or whatever diversification
> is your bag.
>
> No right or wrong here, just my experiences and learnings and personal
> conclusions.
>
> -Kevin
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