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Trading Blog May 2006
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 Trading Blog May 2006
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Paul King May 31st 2006

Some things in trading just aren't possible.  Maybe a car analogy will help.  Imagine for a moment you are designing a car and it has to have the following characteristics:

  • 0-60 miles per hour in 6 seconds
  • Top speed of 180 miles per hour

So it's a fast sports car at the high end of performance.  Now you have a couple more required characteristics:

  • Carry 7 passengers in comfort
  • Do 40 miles on a gallon of gas

If you know anything about physics and conservation of energy you will quickly realize that these 4 characteristics would be virtually impossible to embody into one vehicle (with current technology).  You have 2 main choices - compromise on some of the requirements, or design 3 cars (a sports car, an SUV, and a compact).


What has this got to do with trading?  Well a lot of the time people are trying to design the 'Holy Grail' system that has the following characteristics:

  • High win%
  • High average winner size to loser size
  • High frequency
  • High return
  • Low drawdown
  • Low slippage
  • Low implementation costs

Just like the car design where some of the characteristics have an inverse relationship (e.g. top speed to fuel economy) trading systems exhibit similar behavior.  High win%, for example, is usually inversely proportional to both trade frequency and average size of winners compared to losers.


When you are attempting to design a trading system it is important that you make sure you don't have an 'impossible specification' for what you want to achieve because you don't clearly understand the relationships between the various system components and characteristics.  Otherwise the only thing you'll achieve is frustration.



Don't be the Sucker
Paul King May 22nd 2006

There was an interesting story recently on a forum I contribute to regularly and it is worth further investigation here.  The story went something like this:


“My experiences with the markets are like a recent tag sale event where people were selling children’s tents for $10 and they sold like hot cakes and many parents went home disappointed.  I returned the next week to find the prices at $11 so I bought as many as I could only to find no buyers and having to ultimately sell them at a loss for whatever I could get”.

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Paul King May 16th 2006

As anticipated on May 13th 2006, the S&P 500 moved down significantly to confirm the start of Wave A of a correction.  The close of 1270 today would be an excellent place to add to the short position we established on 5/15/6, or to initiate one if you didn't enter then but waited for the given confirmation (of a close below 1285).  The current trailing stop for this new position would be at 1297.

Beliefs Come First
Paul King May 12th 2006

Some people believe that an entry signal is the first (and only sometimes!) step in trading system development.  In my experience this is a very short-sighted approach.  For me, beliefs about yourself, the markets, and the objectives for your trading all come before any actual system design takes place.


The first 7 items in system development that I use are:


  • Beliefs – your interpretation of ‘reality’ that you will base your trading on
  • Objectives – what you want a trading system to achieve
  • Hypothesis – an idea about how a trading system could work
  • Market Selection – what market will your system be implemented in
  • Instrument Filter – which instruments within the chosen market(s) you feel are ‘tradable’
  • Setup – conditions that determine a trade is possible
  • Entry Signal – conditions that determine it is time to enter a position

Note that 6 major items come before you even get to an entry signal!  Also note that the objectives you have for your trading system come before development not as a result of it.  If you don’t know what you are trying to achieve how can you design a system that meets you goals?


Because you need to design a system to meet specific objectives (how else can you determine if it is working or not) it is very important to make sure those objectives are realistic and can probably be achieved with enough hard work.  Expecting to double your account every month with only 10% draw-downs is never going to happen (although I have encountered ‘traders’ who wanted to achieve these kinds of results).


You may be thinking “How do I know what’s reasonable/achievable/sensible for me?” and I can’t answer that question in a blog – it depends on how much time you have to design, develop, and implement your trading system and what your level of expertise it right now.  I recommend you get professional help/advice to guide you through this process rather than “taking a shot in the dark” or “setting yourself up for a big disappointment”.



Paul King May 8th 2006

OK, so I was dead wrong on my monthly S&P Market Perspective from 4/16/6 and I got stopped out today. In trading being wrong 50% (or more) of the time is a normal part of the game. The important thing is to always, always have a price defined (before you enter a trade) that ‘proves’ you are wrong, invalidates your assumptions for entering the position in the first place, and tells you to cut your losses short and get out of the position.

Also, it is important not to hold onto beliefs about how ‘right’ a position is after it has been proved ‘wrong’ by the market you are trading. Trades are either winner or losers right now and which type they are is completely defined by the price now compared to your entry price. It’s not hard to spot a losing trade – it has an open loss instead of a profit.

Trading a system that relies on a high win percentage (i.e. being right a lot) rather than a high win size to lose size ratio (i.e. having a reasonable number of trading opportunities) may be psychologically more pleasant to trade, but what makes you think that it is not a short-term anomaly or pattern that can’t switch round the other way and become a high loser system (usually overnight)?

Remember that the number one priority in trading should be to make money (not be right or comfortable). If this isn’t your number one priority, then trading is a hobby for you and therefore should be viewed as a money-spending activity not a money-making one.

View my latest S&P Market Perspective (which is estimated to be wrong about 50% of the time) here. _______________________________________________________________________________________

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