I have been reading Fooled by Randomness by Nassim Nicholas Taleb. It’s a challenging read, but worth the effort by anyone that is into system design. I haven’t finished it yet.
To quote p.163;
“Beset with insomnia, the computerized day traders become night testers plowing the data for some of its properties. By dint of throwing monkeys on typewriters, without specifying what book they want their monkey to write, they hit upon hypothetical gold somewhere. Many of them blindly believe in it.”
The reference to “monkeys on typewriters” relates to the theory that if enough monkeys are put in front of typewriters eventually one of them will write War and Peace. I strongly suspect that the number of monkeys required would be impossible to find, let alone feed!
Any results need a good dose of scepticism – even a monkey can write a great novel!?
Trading is not just about making the maximum profit. “The greater the profit the greater the chance of going broke. “ (stevo 2008). Well maybe – I am not really into hard and fast rules. If I try for 100% plus returns using leverage then I might make it 3 out of 4 years, but the 4th year will wipe me out. If I plug for 20% I am less likely to self destruct.
Then there is the ride taken. I did some work on a fairly simple system. The equity curves are shown below. The system was developed using data from 1999 to 2003 so the walk forward equity curve looks pretty good.
Figure 1 Basic System
The first curve is the basic system from 1999 to March 2008. It looks pretty good considering I am not pyramiding profits into the system, just trading with a flat amount. The second equity curve has an index filter added to turn the buy signals off if the market looks weak. The equity curve is still pretty good, but total profits are down compared to the system without the index filter.
Figure 2 With index filter
But when I look at the period from Jan 2007 to current a different picture is painted. Without the index filter the equity curve is south of the zero line for most of the period, whilst the index filter version looks much more tradeable. . I always remember starting up a system back in 2002 and immediately losing money. Startup is always hard! Starting this system up at the beginning of 2007 would have been tough.
Figure 3 Basic system from 2007
Figure 4 With index filter from 2007. Note that a lot of the money was made in just a couple of trades, but at least it wasn’t given back as in the basic system.
Over the last 5 years from 2003 to 2008 turning off a system when the occasional market dip occurred didn’t really help make money. It was better to be in the market all the time.
But it’s not only about CAR (compound annual return) it’s about the ride taken. Measuring the ride can be difficult, but the equity “curve” paints a picture that most people can understand
stevo
