Hi Keith -- I agree that there is no certainty, but at the point where a system has been designed, tested, and subjected to statistical tests of validity, a person can have confidence that a system is profitable. I would make the point that it is necessary for a trading system developer to believe that his or her system is profitable and is likely to continue to be profitable. The backtesting and validation not only shows that the system was profitable in the past, as you state, but if the testing was done properly, it also tells us that it is likely to be profitable in the future. There is no need to guess -- we can quantify the likelihood of future profitability and other trading metrics. There is no doubt that the characteristics of the price series being modeled can and will change over time, and the system will eventually become unprofitable. But continued monitoring of the system in real time can tell us whether the system continues to perform as expected and can tell us when the system has bitten the dust.
I see the issue about scaling in a different light than you suggest. When scaling is a component of a trading system, the effect of the scaling is analyzed over the period the system is developed. It is a component of the entry logic, or the exit logic, or both. I do not see scaling as a technique that is applied only in real time and only as a protection from loss -- if that were the case, how could the effectiveness of a scaling method be tested? Without testing, and analysis of the results of the testing, how could a trader have confidence to implement a technique in an unknown situation? To trade a losing system? I don't know anyone who will knowingly make real-money trades with a system that is known to lose. (Let's agree to defer discussion of the possible equity-smoothing effect of adding a losing, but inversely correlated, system to a winning, but volatile, system.) To test a losing system? Of course we do -- at least I do most of the time. I have an idea, try it, and find that it fails in some area. I begin the process of studying it, learning about it, tweaking it, testing it, and repeat the tweaking and testing until the system looks promising. Most of the alternative systems tested during that process would be described as losing. The final step is always the same -- subject the system to tests of validity, robustness, and confidence. If it passes these, it is a candidate for trading, and I consider it to be a profitable system. Thanks for listening, Howard On Sat, Jul 31, 2010 at 5:14 PM, Keith McCombs <kmcco...@engineer.com>wrote: > > > Howard -- > I take issue with your statement, "*Think about it this way -- You have a > profitable system. If you reduce your position size when trades have some > profit and, on average, the trades go on to be more profitable, you forfeit > some of the potential profit. If you reduce your position size when trades > have some profit and, on average, the trades go on to become losers, your > exit logic needs to be revised.*". > > Nobody HAS a profitable system. One may have traded or tested a system > that WAS profitable. But that does not mean the system IS profitable. > Therefore, the fact that profits were reduced in the past from a > historically profitable system, has very little meaning, as to what it tells > us about the future, if/when it bites the dust. If a system that was > profitable in the past becomes unprofitable when it is traded in the future, > scaling (and for that matter using stops) may protect one from larger > losses, or even complete financial calamity. > > In order to test if a system might be helped by scaling or stops, one > should, I guess, test one that was unprofitable in the past. Of course, > nobody wants to test a loosing system! > > The purpose of scaling and stops is to protect ones financial well being > from what we do not know. No matter how well we design anything, including > especially trading systems, there are always unknowns. > > Please realize that I am not saying that scaling and/or stops are > advisable. I am just saying that it is very difficult to prove that they > are not useful. > > Personally, I rarely use either scaling or stops. And when I do, it is not > because of any analysis. But only because it makes me feel safer. > -- Keith > > > On 7/30/2010 10:37, Howard B wrote: > > > > Greetings -- > > Sohamdas wrote: > "Dr Bandy, what you said is true, about the second alternative. The risk > conditions are violated, with further scale-ins,when we double up etc. > > But consider, if with each scale-in, we also move the stop loss point.In > that scenario, the situation can morph into one, where the risk doesnt > increase linearly with position,it increases slower than the growth of > positions." > > ------------------- > > I agree that the risk calculations change as the price moves in the > direction that gives profit. But in order to keep to the original risk > profile, the amount of the scale in is limited to the amount of the gain. > That is, before scaling in, recalculate the position size permitted and > scale in by that amount. The amount of additional position size allowed is > usually much less than the original position was. > > My argument against scaling in is with schemes that take a full position at > entry, then add an amount that is large relative to the initial position > (100%, 50%, 33%, or 25% are typical). Unless the open profit supports the > new position size of 200%, 150%, etc, the risk is now higher than originally > permitted. It is OK to do this if you realize that by doing so you are > using aggressive position sizing and have worked through the consequences. > > The original position could be taken at a position size that anticipates > all of the scale in trades will be taken. This assures that risk will > remain limited. But for those trades when the conditions necessary to add a > scale in position do not occur, only a portion of the funds have been > committed to the trade and the profit is less than it would have been if a > full position was taken at the original signal. > > I think it is better to treat each signal -- the original and each scale in > -- as a unique trading system. Work through the design, testing, and > validation of each separately, then apply position sizing to each and to the > portfolio that results from trading all of them. Be aware that all of these > systems will be trading the same data series in the same direction, and an > adverse price move will effect them all the same, increasing the risk rather > than diversifying it. > > Think about it this way -- You have a profitable system with logic that > gives you good entry signals. If you wait until the trade shows a profit to > add to the position, you forfeit the profit from the funds that were not > used at the initial signal. If the scale in portion gives better results > than the original signal, then the entry logic needs to be revised. > > ------------ > > The same situation occurs at scale out. A commonly described technique is > to take partial profits and reset the stop when some condition is met. In > almost all of the tests I have run using this technique, the performance of > the system over a period of many trades is poorer than if the entire > position is held until the final exit signal. > > Think about it this way -- You have a profitable system. If you reduce > your position size when trades have some profit and, on average, the trades > go on to be more profitable, you forfeit some of the potential profit. If > you reduce your position size when trades have some profit and, on average, > the trades go on to become losers, your exit logic needs to be revised. > > Thanks, > Howard > > >
