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At 8:31 PM -0400 7/7/00, Ronald McEwan wrote:
>Hi Bob, I am not sure about the meaning you attach to
>"Transformation"? could you expand on this some more. One of the
>thoughts I had when doing this is that it could be an approximation
>for a "worst case scenario". This could help in deciding how much to
>risk before trading the security.
>
>Also your comment on the distribution of a portfolio and the
>underlying market was a very important point to consider in trading.
An example is probably the easiest way to understand this.
If you look at the of week-to-week changes in the market price you do
see a near "normal" (or log-normal over a long period) distribution
but with "fatter" than normal tails. This is also what the
distribution of your account equity curve would look like if you were
a buy/hold investor.
But if you had a "perfect timing" trading system that put you long
during the up weeks and short during the down weeks, you can see that
the distribution of the account equity would be much different than
that of the underlying market. This "perfect timing" system would
invert the negative side of the market distribution, reflecting and
superimposing it back over the positive side of the equity curve.
And then if your system caused you to exit on a profit target, you
might even be out of the market during the long-tail market events,
further modifying the distribution.
So I find it helpful to look at a trading system as a
"transformation" device that transforms the distribution of market
changes into our account equity curve changes.
Bob Fulks
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