Quote of the Week

"Believe nothing, no matter where you read it,
or who said it, no matter if i have said it,
unless it agrees with your own reason
and your own common sense."
-- Buddha

Nice quote, huh? But, it could be better. Instead of following one's own reason and common sense....one should believe something only after careful observation and analysis. Then perhaps adjust your common sense to those findings.

Really sorry for the lack of system trading posts these past few weeks. Doesn't mean I've changed focus...just means I've been extremely busy in system development work. I'm building several tools to aid in my trading idea validations. Along with tools to aid in identifying the core components that lead to success in my current systems. Needless to say, it has been a learning experience. For one, this work has led me to understand more about the systems I trade. And secondly, has driven home the importance of keeping systems simple.

I see I'm not the only one reviewing trades and trying to uncover opportunities for improvement. Read TraderMike's Path to 100 R in Profits here. One suggestion I'd make in analyzing one's trades is to break your trade history into 3 groups:
Group 1 - The Great Performers
Group 2 - The Churners
Group 3 - The Lousy Losers

Spend time trying to understand Group 3's Lousy Losers. What caused those really awful losses?

But don't forget to check out Group 2's Churners. The trades that didn't do anything for your bottom line still have a cost...they tie up valuable capital and keep those brokers fat and happy.

And of course, don't forget to take a look or two at Group 1's Great Performers. That's where your Gordon Gekko personality needs to kick in and ask yourself...Could I have made more?

Later Trades,

MT

Thread of the Week - Discipline

"Success is the sum of small efforts, repeated day in and day out." -- Robert Collier

Acrary posted a great topic on overcoming discipline problems here. Acrary really nailed it on the head with the following statements:

"To overcome my discipline problems, I've been programming my life to achieve the results I desire."

"Anytime I want to consciously achieve a goal, I figure out how I can setup a process so it would be hard to fail."

Much to learn...

MT

Quote of the Week

“The real voyage of discovery consists not in seeking new landscapes but in having new eyes.” -- Marcel Proust

How much time and effort do you spend on identifying the characteristics that produce winning trades? If you're like me...a lot! But, have you ever thought about increasing your time allocation to identifying the characteristics of losing trades? More importantly...the really awful ones?

Based on Pareto's Law and more specifically Sturgeon's Revelation:
If 90% of everything is crud then 100% of our investing returns come from 10% of the trades. And if 90% of our trades are indeed crud...then it follows that 90% of that is most likely crap. Which means a little over 80% of our total trades are full of crap. :)

Formula:
crud = trades * 0.90
crap = crud * 0.90
% total crap = (crap / trades) * 100

Example:
trades = 100
crud = 100 * 0.90 = 90
crap = 90 * 0.90 = 81
% total crap = (81 / 100) * 100 = 81%

Later Trades,

MT

Amortization in Google

If you didn't know this...the Google search bar is also a calculator...and pretty good one I might add.

Here's an example amortization formula you can cut & paste into Google's search bar to obtain the loan's monthly payment amount:
20000 * ((6 / (12 * 100) / (1 - (1 + (6 / (12 * 100))) ^ -(5*12))))This will return a monthly payment of 386.656031 that corresponds to a $20,000.00 loan at 6% interest for 5 years in length.

To get a better understanding of the loan amortization payment formula...see below:
i = interest rate ex. 6 for 6%
n = number of years ex. 5 for 5 years
p = loan amount ex. 20000 for a $20,000 car loan
m = monthly payment
m = p * ((i / (12 * 100) / (1 - (1 + (i / (12 * 100))) ^ -(n*12))))

A big thanks to Hugh Chou for kindly supplying the amortization formula on his site. Please check out his site for further information regarding amortization formulas.

MT

Friday Links

Interesting article on Risk Homeostasis here.

"...human beings have a target level of risk with which they are most comfortable. When a given activity exceeds their comfort level, people will modify their behavior to reduce their risk until they are comfortable with their level of danger.....if a given person’s level of risk drops too far below their comfort level, they will again modify their behavior. This time though, they will increase their level of risk until they are once again in their target zone."

Can we create systems from this idea? The first question we'd have to answer is what constitutes risk for the average investor in the stock market? Is market volatility considered risk to an investor? I'm not sure many thought so at the time back in the late 90's. What if we examine only the downside portion of market volatility? Hmmmm...

The Five Truths About Code Optimization here. Great tips that relate to designing and more importantly optimizing your trading systems. Here are just a few:

"You are looking to answer two questions. First, did my change actually help? If the change did speed things up, is there now a new bottleneck? Some part of our program is always going to be the limiting factor -- otherwise your code would be infinitely fast. As you optimize things, it is quite likely that the part you sped up will fade into the background and some other section of the code will become the new bottleneck."

"I don't care if your idea is so brilliantly efficient that it can't possibly not speed things up. If Mother Nature doesn't agree, Take It Out."

"The trouble with optimization is there is no end to it."

And finally...check out the new Adam Sandler movie coming soon to a theatre near you: Click. I want one of those remotes! Ha ha.

That's it from here...where I'll be spending the weekend cleaning up the house in anticipation of the stork's delivery in the next few weeks.

Later Trades,

MT

Thread of the Week

What's the Thread of the Week you ask? Well, each week I'll try to post an interesting thread from one of the many trading forums out here on the wild & woolly Internet. The thread could be of value to your trading...or just a good old laugh. So, enjoy!

This week's thread is a very funny topic posted on the EliteTrader boards: "Altucher guesses: trend funds to disappear within the next 10 years..." You would think the thread would actually hold some value considering James Altucher and Victor Niederhoffer are some of the posters. But, the thread mostly ends up as an ideology debate similar to my football team is better than yours.

You do have to give the originator of the thread some credit...the opening post below sure did the job of drawing many traders into the fire:

"successful hedge fund manager and author, james althucher, states in his new book--"super cash"---- that the trend following funds will be history within the next 10 years. he cites the dismal performance of the major trend funds over the last several years, over leverage, and investors pulling out. his new book is fantastic reading into the cutting edge of hedge funds. definitely check it out!" -- marketsurfer

Even I had to post a few comments. See if you recognize which ones those were.

As a follow-up to the thread...check out Niederhoffer's post on his DailySpeculations site here. You'll have to search down for the following post, Comments on a Trend Following Discussion, dated 12-Apr-2006.



Later Trades,

MT

Quote of the Week

"Man with one clock always know time. Man with two clocks never sure." -- Chinese Proverb

Later Trades,

MT

Quote of the Week

"Aim for success, not perfection. Never give up your right to be wrong, because then you will lose the ability to learn new things and move forward with your life." -- Dr. David M. Burns

MT

Quote of the Week

"Why do they always teach us that it's easy and evil to do what we want and that we need discipline to restrain ourselves? It's the hardest thing in the world -- to do what we want. And it takes the greatest kind of courage. I mean, what we really want." - Ayn Rand

MT

The One Thing...

Curly: "I'll tell you the secret to life. This one thing. Just this one thing. You stick to that and everything else don't mean sh*t."
Billy: "What's the one thing?"
Curly: "That's what you've got to figure out."
City Slickers, the movie

I was a golfer growing up. A good one. Good enough to win a few tournaments in high school and be offered a full-ride in college. But, I burned out before I ever got there. Wanna know why?

I couldn't get to the next level...the pro-level. What do I mean by the pro-level? Well, I could outdrive anyone and post great scores...especially in the clutch (never lost a playoff match). But, I couldn't do it day after day. Know why? Because I thought there was a skill level that I could only achieve if I perfected my swing. I would read magazine articles, study the best player's swings, and practice 14 hour days in the East Texas humid summer heat. All in the hopes of finding that one thing that would take me to the next level. And sadly, I never found it.

The worst part...everyone else thought I was great...but I didn't. So, I gave up my talents and offers and began living life as a typical young person. Always keeping this failure in the back of my mind...the what if?

Isn't it amazing that it took trading to teach me that "magic" next level? In fact, learning to trade has been eerily similar to my golf experience. Reading trading books and studying the best charts for many endless nights than I care to share. Searching and searching for that one thing...that one edge that would take me to the next level.

I assumed that talent and a perfect edge is what would take me to the next level both in golf and now trading. Thankfully, I have finally found the one thing that can take you to the next level. And I'll even be so gracious to share it with you...

There really isn't a next level. There isn't a level where everything all of a sudden gets easy. A place where you always have your "A" game. Everyday is different. In golf...you might wake up and your wrist bothers you a bit...so you naturally compensate for this condition and fight your swing for 18 holes. There's nothing you can do about this but adapt. Find a swing that you can be comfortable with...not one that is perfect....or hits that drive 30 yards further...but a swing that gets the job done whether you feel like a million bucks or have the avian flu. Learn just what that swing can and can't do...and then play golf! Day in day out...play your game. Don't worry about the dude that can drive 50 yards past you or the guy putting the lights out in Memphis. Play your game day in and day out with the knowledge that some days it will rain, your body will not be 100%, you're moods will change, people will change, and courses will change. And if you can stick to your game despite all these changing conditions...you'll find the so-called magic next level. Same goes with trading...

Find a strategy that gets the job done...might not belt out 50% annualized returns with 10% drawdowns...but works for you...and more importantly fits you. Don't worry about what anyone else is doing...just trade your strategy day in and day out. You'll never get to a point where the profits are easy and you can just print money at will. Realize that. The best you can hope for is you'll get to a place where you'll know your system and what it can and can't do...and you'll follow it. Simple as that. Some days...you'll look like an idiot...and other days a genius...and understand that's what it's all about. It took me all these years to figure that out. Crazy, isn't it?

This "one thing" can be applied to many aspects of trading. For example, in your backtests...do you optimize parameters on your entire trade set? If so, that's a perfect world that will never happen again. Throw out the best 5% - 10% of trades from the set before you begin tinkering. That way you're designing a system built on a bit more realistic data.

Same goes with golf...do you play that par 5 as something you can reach in 2 on your best day...everyday? Hmmm...

Side note:
Several years later after my burnout I did pick golf back up again...won several local tournaments...only to hit the wall again. And haven't really played since...that's been about 5 years ago.

Later Trades,

MT

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