Cool New Blog Find: Deep Market

"Somewhere, something incredible is waiting to be known." -- Carl Sagan

Found a very cool blog a few days ago...the Deep Market blog. Check out the post covering Oversimplified Method for Finding Patterns in Stock Charts here. And the follow-up, Correlation Pattern Matching Explained, here. I have never thought to use the correlation function to find setup patterns. I have only used it in the traditional sense...comparing trading instruments and trading system equity curves. Very interesting.

Might be useful to take this idea and apply towards the Melba Toast logic. Hmmm....

Later Trades,

MT

Optimal Risk with Ed Seykota & Dave Druz

"The biggest secret about success is that there isn't any big secret about it, or if there is, then it's a secret from me, too. The idea of searching for some secret for trading success misses the point." -- Ed Seykota

Found an interesting paper from Ed Seykota and Dave Druz written back in 2001. The team test what heat can do to a portfolio's return and drawdown. The test shows that drawdowns will eventually overtake returns if heat is increased too much. Nothing new or exciting...just a confirmation of what I've already found in my system testing. Read the paper here.

For more info on Ed Seykota...read the following interview here. My favorite quote from the interview is...

The idea of searching for some secret for trading success misses the point. It's like golf. Some golfers play to spend time outdoors. They hang out with their cronies, become one with nature, study the greens, reconnect with their muscles, drop into focused concentration and, incidentally, pick up a birdie or two. For others, it's an exercise in finding some new Holy Grail putter. Different strokes for different folks!

Also don't forget to review Donchian's Trading Guides in the back of the interview. Make note of #7 in Donchian's General Guides:

In a market in which upswings are likely to equal or exceed downswings, a heavier position should be taken for the upswings for percentage reasons; a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100%.

For more on David Druz read here, here, and here. I like David's focus on designing a system to handle anything the market that throws at it...instead of designing something for just a particular market condition.

Later Trades,

MT

Quote of the Week

"If I wasn't dyslexic, I probably wouldn't have won the Games. If I had been a better reader, then that would have come easily, sports would have come easily...and I never would have realized that the way you get ahead in life is hard work." -- Bruce Jenner

I can vouch for this. Being dyslexic makes everything hard. But, when you finally learn it and understand it the way you need to understand it...you know it better than anybody.

MT

John Henry's Trading Philosophy

John Henry discusses his trading system design philosophy here. Henry discusses the time period in which he developed his original trend-following system. And offers some great insights such as...

Every time we go through a bad period in our firm, whether it's for two months or for eight months, people ask me have the markets changed. And I always say the same thing. I say, "Yes, the markets are always changing; but people's reaction to change, more or less, remain the same."

I knew I could not predict anything, and that is why we decided to follow trends, and that is why we've been so successful. We simply follow trends. No matter how ridiculous those trends appear to be at the beginning, and no matter how extended or how irrational they seem at the end, we follow trends.

At JWH, we realize that not only is it impossible to foretell the future, it's not necessary. We rely on the fact that other investors are convinced that they can predict the future, and I believe that's where our profits come from.

We may take a small risk in placing a trade initially, but after we have a large profit we risk it, and that's a risk very much worth taking and one we gladly accept.

Suffice it to say that we embrace both volatility and risk and, for us, risk is that we're going to lose if we risk two-tenths of one percent on a particular trade. That is, to us, real risk. Giving back a profit to you probably seems like risk, to us it seems like volatility.

Enjoy the article.

Later Trades,

MT

Interview with the Stock Bandit

Check out this really nice interview with Jeff White over on the Stocktickr blog. Read the interview here.

I like his KISS principles and the fact he doesn't look for the market to do this or that...just takes what the markets brings to him via his setups. Nice.

MT

Quote of the Week

"In fact, the ironic part of system design is if you want to maximize profits, you must be willing to give back a great deal of the profits you have already accumulated." -- Van K. Tharp

There is a fine line between giving away too much of your profits and giving too little room for your positions to grow.

Later Trades,

MT

Quote of the Week

The Six Kase Behavioral Laws of Forecasting

Law Number One: Remember that the objective is profit, not ego-stroking.

Law Number Two: The objective is profitable trading, not proving a thesis or world view.

Law Number Three: When wrong, move on.

Law Number Four: Have confidence in your own intuition. Do not rely on the advice or opinion of others, no matter how well respected they might be.

Law Number Five: Do not read newspaper articles or watch newscasts that discuss the markets in which you have an interest.

Law Number Six: Plan your strategy when the market is closed - when you are rested and thinking clearly.

The above Quote of the Week comes from a new book I'm reading...Trading With The Odds: Using the Power of Probability to Profit in the Futures Market by Cynthia A. Kase.

No doubt, one of the all-time best books I've read on Trading...but I'll warn you...for the experienced system trader only. In other words, I would not have understood many of the fantastic insights offered in this book just a few short years ago.

In fact, while reading this book I was struck with how incredibly difficult it is to become a great system trader. Flourishing as a system trader requires two very different and conflicting mindsets:

#1) A Rule-Follower. Must be a logical thinker willing to break down the most complex of things into a set of rules to follow. And more importantly, be willing to follow the rules you have set. The latter being the hardest part for yours truly.

#2) A Rule-Breaker. In order to grow to higher levels in system trading...you must be willing to break conventional wisdom [rules] in regard to all things people including yourself take for granted. And this where the conflicting mindsets truly come into play. It's very hard to program a set of rules for a system and then allow yourself to see the ways rules can be broken to improve the system. Sounds easy...but very hard. Thinking about this one some more...I believe our true task as a trader is discovering the "real" rules versus the rules we traders have created and hold as "real".

That's what I believe Kase is uncovering in her book...the "real" rules.

Special thanks to Eric for pointing out the Variance Stop technique discussed in Kase's book. Eric's contribution has triggered several exit ideas that I'm currently testing across my systems.

Later Trades,

MT

Nassim Taleb Highlights

Active Trader Magazine interviews Nassim Taleb in the March issue. Here's a few items that Nassim shared:

If you owned an option that was 20 standard deviations out of the money - and I had plenty of those - how many cumulative months of time decay could you sustain if it moved into the money?...it was 67,000 months of time decay.

If you have a 24-sigma even on an option that's 24 standard deviations out of the money, your payoff is 750,000 times your bet.

We're not programmed to deal with variables that can take very large deviations. We tend to not pay at all for things when we don't have reason to pay for them, but overpay when we see a reason.

There's a bit more but for that you'll have to get the magazine. :)

I realize I haven't gone back to the Melba Toast system in quite awhile...it hasn't been forgotten...just been extremely busy. But there is good news...I have made some progress in capturing the dry toast pattern. At first I thought I'd have to use a bit of trig to capture the exact pattern...but from the initial tests it looks like a max/min range divided by ATR might do the trick. Hopefully, I'll get a chance to test this piece out soon and share the results with ya'll.

Until then...

MT

Quote of the Week & Robert Pardo Interview

"Being a scientist can sometimes be depressing. Surrounded by younger versions of yourself, you are constantly confronted by the mismatch between the dreams of youth and the facts of maturity." -- Emanuel Derman, author of My Life as a Quant

One of my favorite quotes and not only applicable to scientists and programmers...but everyone with several years of experience under their belts...and perhaps a few gray hairs to show for it. Heck, even relates to being a parent. Universal theme...I love it!

On to other things...this weekend I found a great interview with Robert Pardo, the author of Design, Testing, and Optimization of Trading Systems. Read the interview here. Some quick highlights:

When I first started getting into systems, I was persistent, objective, and analytical. I've always been willing to say what it is that I do know, and what it is that I don't know. If somebody said to me "this will work" I'd say, "well, why will it work?" What's the proof?"
Great thinking...I believe many of us could apply this type of thinking to our investing strategies.

And Pardo goes on to describe the great Art of Cherry Picking...
They call this sort of thing cherry picking now. So many people, when they're looking at an idea by hand will say, "oh, it worked here, it worked here, it worked there, and boy, did it work great!" They ignore the fact that it had seven losers before this big win, and three more losers before that big win. They're maybe small, but they do add up. They need to be included in the equation.

In a system, risk is uniform and constant. I re-optimize models periodically because conditions and volatility change. You have to adapt to that to get optimal returns. Generally, though, we're risking the same tomorrow that we are today. Most people not only will vary their risk a great deal, but they'll get very skittish when they actually get a profit.
There's a powerful strategy being expressed here. Something Basso mentioned in his Market Wizards interview.

Overall, a great interview and piques my curiosity as to the other interviews covered in the Market Beaters book. I guess another book to buy and read. :)

Also, don't forget...the new issue of Active Trader Magazine contains an interview of Nassim Taleb. Just bought the mag this weekend. So, I'll share some highlights of the interview sometime this week.

Later Trades,

MT

TGIF

Some great quotes from acrary over on the EliteTrader Forum.

"Trading cannot be taught...it has to be caught. By that I mean you must have a perceptive nature. Without it, buy a system and execute it mechanically."

"I've had experience with this problem (self-sabotage). In short, I found if I had a goal that my self-concious believed was not doable, then I'd self-sabotage my trading. Once I realized this and changed my goals, the self-sabotage stopped."

"If you want to remain emotionless during trading, concentrate on the process and let the outcome happen."
** my favorite one **

Now, for some silly Friday quotes...

"Giant oaks do grow from little acorns. But first you must have an acorn."

"Behind every successful man stands a surprised mother-in-law." -- Hubert Humphrey

"Always program as if the person who will be maintaining your program is a violent psychopath that knows where you live." -- Martin Golding

"As soon as we started programming, we found to our surprise that it wasn't as easy to get programs right as we had thought. Debugging had to be discovered. I can remember the exact instant when I realized that a large part of my life from then on was going to be spent in finding mistakes in my own programs." -- Maurice Wilkes

And finally, the always funny Jack Handy...

He was a cowboy, mister, and he loved the land. He loved it so much he made a woman out of dirt and married her. But when he kissed her, she disintegrated. Later, at the funeral, when the preacher said, "Dust to dust," some people laughed, and the cowboy shot them. At his hanging, he told the others, "I'll be waiting for you in heaven--with a gun."

Enjoy your weekend!

MT

Does Trend Following Work on Stocks?

Check out this paper written by Eric Crittenden and Cole Wilcox of Blackstar Funds: Does Trend Following Work on Stocks? There's a lot of great information embedded in this paper. And for equity system traders...much to learn. In fact, so much to learn, that I've exchanged a few emails with one of the coauthors, Eric Crittenden. Before I begin...let it be said that Eric is a very sharp guy and truly understands the system trading world.

One of the great things I found in this paper was finally someone addressed survivorship bias in their system tests. And more importantly discussed the impact of dividend-adjustments. The really surprising point, especially after talking with Eric, was that survivorship-bias doesn't play as much of a role as I thought in backtesting long-term stock trading systems and dividend-adjusted data or lack thereof plays a much larger role than I expected. So much of a role that my first goal after reading the paper and talking with Eric is to obtain dividend-adjusted equities data.

Another dividend, if you will, of dividend-adjusted data is that your system signal's can be applied to a different time series despite the underlying stocks remaining the same. In other words, you may get more trades if you run your system against two sets of data...1) Non dividend-adjusted and 2) Dividend Adjusted. Some stocks that previously looked stale or non-trending may indeed show up in a long-term trending system with dividends factored in.

Re-entry of positions is another very interesting part of this paper. In my current systems I do not have re-entry criteria. If my trailing exit is hit...I'm out of that stock for good...or until my system model captures it again. In the paper you will see stock charts with stocks hitting the ATR trailing stop and then re-entered. This also has made me look to my own systems and possibly adding some type of re-entry logic.

And finally, for those still yearning for more Trailing Stop ideas...the paper provides plenty of discussion on the Average True Range trailing stop technique. Eric has even offered an alternative solution to the ATR trailing exit problem from my Innovating Exits post. His solution involves using the variance of the Average True Range in your trailing stop. I'll discuss more on this in another post.

Finally, I'd like to express my thanks to Eric for kindly responding to my questions and graciously sharing his thoughts and views on system trading. Maybe I can get an interview out of him to share on the site some day.

Until then...

Later Trades,

MT

Quote of the Week

"The whole problem with the world is that fools and fanatics are always so certain of themselves, but wiser people so full of doubts." -- Bertrand Russell

MT

Quote of the Week

"Any time you sincerely want to make a change, the first thing you must do is to raise your standards. When people ask me what really changed my life eight years ago, I tell them that absolutely the most important thing was changing what I demanded of myself. I wrote down all the things I would no longer accept in my life, all the things I would no longer tolerate, and all the things that I aspired to becoming." -- Anthony Robbins

MT

CXOAG System Linkfest!

Did a little digging on CXOAG's blog and found some interesting studies they've performed on the market. Enjoy!

Collective2: A Marketplace of Trading Systems
Culls through the number of systems in Collective2's site and breakdowns the performance of swing trading versus daytrading. Most interesting part? Only 24% of Collective2's systems average 1% or more per week yet all systems exceed winning percentages of 50%.

Update: Cramer Offers You His Protection?
Asks and answers the question, Does Cramer have an edge? Insights shared: There may be some edge in buying the Cramers sells during the immediate negative returns and holding longer than 6 months. And it seems part of Cramer's edge is issuing buys on a rather large number of stocks. This creates a thin red line where the more stocks issued as buys...take him further away from market beating returns.

End-of-Quarter Effect: Window Undressing?
Is there a tradeable event at the end of quarters? This is something I have tested in the past and my results match their findings...expect market strength after the quarter...not before.

A Slinky (Short-term Reversion) Effect?
A study is performed on the cane walkers of Wall Street. After reading this post...I thought why judge the decline absolutely? Judge against volatility instead?

An Out-of-Sample Test
Discusses James O'Shaughnessy's strategies now used by Hennessy Funds. Interesting the Growth strategy beat Value in out-of-sample testing.

Later Trades,

MT

Over My Head...

The article titled, The Use of Hurst and Effective Return in Investing by Andrew Clark, contains much that is over my head. But, that shouldn't dissuade me or you from diving in and learning what we can. Heck, any article that contains the following statement is definitely worth my time...

Ideally, a good performance measure should show high performance when the return on capital is high, when the equity/return curve increases linearly over time, and when loss periods (if any) are not clustered.

In the sentence above, Andrew Clark describes just exactly what all of us are looking for in designing, testing, and evaluating our trading systems.

Sorry for the lack of updates on the Melba Toast System. I've been very busy with other projects. But, haven't stopped dreaming up ways to capture the congestion. Here are just a few ideas that I will test as soon as I get the time:

• What if you count the number of weeks a stock closes above its mean and number of weeks closed below its mean? If the ratio of above to below is close to 1 then does that suggest a congestion range-bound area in the time series?



• Should we look for these congestion areas within a certain percentage from their all-time high? Or all-time low? Or both? Or maybe all-time high is too limited and we just need to look for a certain percentage from their 5-year high and low.



• Could using a stock's beta help identify congestion areas? Does the congestion area exhibit less beta than the market? Speaking of beta...has anyone ever attempted to create an indicator out of beta? Basically, the number of stocks with a beta above 1? If so, please share.

Well, that's it from here...where I'm looking forward to seeing Ricky Bobby on the big screen! Ha ha!

Later Trades,

MT

Quote of the Week

"I'm not smart, but I like to observe. Millions saw the apple fall, but Newton was the one who asked why." -- Bernard M. Baruch

Observation is important but the true key is the ability to open your mind to new possibilities. Without an open mind...you cannot see all that's possible.

Have a great week!

MT

Melba Toast Examples

This page will showcase all stocks that I find exhibiting the Essence of Melba Toast. The more examples I can find of Melba Toast...the better chance I have of identifying the logical conditions present in the pattern. So, this page will evolve as new charts are added.







MT

Quote of the Week

"No question is so difficult to answer as that to which the answer is obvious." -- George Bernard Shaw

Have a great week!

MT

Tom Basso Interview

I haven't fallen off the face of the earth. But, have been extremely busy at my day job. I'm also busy testing various ways to capture the sideways congestion in Melba Toast. The initial rules work to some extent...but after further tests...still don't capture the exact model I'm looking for.

So, I've decided I've got to go old school and start collecting charts of all the sideways congestion examples I'm looking for. I'm going to create a page on the blog and store the charts there. That way I can spend more time checking out the specifics of the moves. And hopefully find a way to logically explain the pattern I'm looking for. I'll post a link to this page in the next few days.

Until then, check out this great little interview of Tom Basso. Read the pdf here. Basso is one of my favorite fund managers in the Market Wizards book series. And in this interview Basso shares some gems.

Back-testing can be useful, but I recommend you go one more step. Print out the gory details.

I look for an indication that a trend either exists or doesn't. I like to look for those markets that aren't currently trending, the ones nobody cares about. Those are the markets that are likely to make a move one way or another.

If you mismatch what you're trying to do to who you are and what skills and resources you have, you're always going to be fighting it and never be in sync with it. If, on the other hand, you match your trading system to yourself, then trading can become as easy as breathing.

And don't miss Basso's famous money management test on a random selection of trades. Profits to losses were setup as a two-to-one ratio and the buys and sells were fed back randomly. The tests showed professionals focused on risk while amateurs focused on gain. Something to think about.

MT

Quote of the Week - Cowboy Up!

"If you're ridin' ahead of the herd, take a look back every now and then to make sure it's still there with ya."

We are so busy blazing our own path through the markets. We often forget what really matters...equity performance. Our job is to wrastle that equity to higher ground. All the talk, debate, yip-yap, and how often you're right isn't worth the bucket it sits on...if your equity isn't still there with ya!

Later Trades,

MT