Traders make money from fluctuations in price levels. By using leverage, traders can maximize return on capital. Leverage involves using margin to make more money than you can with your own funds.
Margin trading provides high rewards when you are right, but may also cause huge losses if you are wrong.
Traders are then confronted with some confusion: Leverage or margin trading can enhance return but carries high risk. This becomes a difficult decision since traders should not go for any increase in risk, but should at all times try to leverage their money for more profits.How can these two opposing viewpoints be reconciled.
The Answer:
If margin trading can be used with an always known and strictly limited risk, it becomes High Leverage with Low risk. (HLLR).
The instruments of HLLR are Put and Call options.
Buyers of puts and calls gain an enormous amount of leverage while applying only a small amount of capital. They also have limited and well defined risk.
Advantages of Option buying:
You do not have to possess large amounts of capital. (Remember, all trading activities require that you should be well capitalized.)
As an option buyer you enjoy all the benefits of margin trading when your are right, without the risk associated with leverage, if you are wrong.
Total risk is always known and limited. The maximum risk is the cost of your option.
A Trading Plan:
Successful trading depends on knowledge, courage of conviction, the discipline to execute your plan, and hard work required to develop the knowledge, courage & discipline.
In trading options, you must have the financial and the psychological strength to face adverse situations when they arise. (This applies to all trading methods).
Thursday, November 19, 2009
Improve the performance of your Trading System
Trading Systems offer profitable opportunities for making money. The Profit Test feature in Trend Mechanic allows you to test and them implement systems in real time trading. But, all systems go through periods of drawdowns. Often, the periods of drawdown are so severe that the trader abandons the system, or even system trading. While losses are inevitable, here are some suggestions to change the trading style to that we can remain in the business. There are two aspects to trading systems which can be adjusted to increase our chances of winning consistently.
First, we can try to reduce losing trades. This is not possible in a casino, but trading is a mind game, so it is possible in trading. We can try to identify conditions that are more favorable to our winners and include them in our system. We should also identify circumstances where a loser is more likely, and skip those trades. For example, if we notice that most of our winners are entered on days where the overall market has moved in the same direction as our trade, then only enter trades when the overall market is moving in the correct direction. This means that our trade is in the same direction of the overall market, rather than against it.
Another example might be that trades that are entered just before major news announcements, like the union budget or quarterly earnings, often get stopped out as losers due to increased volatility, so you should skip those trades. A study of past trades can be rewarding. It should be possible to identify many patterns of profitable & losing trades.
Second, we try to improve the average size of winners versus losers. Increasing the ratio of profits to losses so that the winners win more on average than the losers lose depends on the way you handle your stops. Having large winners in relation to losers can make up for a low win percentage, and mean that you will still make money playing the game. One method is to have a trailing stop that moves up as a trade becomes a winner. If you have fixed stops for losing trades that limit losses, but trailing stops for winning ones that allow winners to grow, then you are increasing your chances of your average winner being larger than your average loser. Generally it is better to be strict on losers by having ttighter stops that keep losses to a minimum and generous with winners by having stops that allow profits to grow. In any case you want to make losers small and winners large, so never add to a losing trade – that would be doing the opposite of what you want to achieve.
As traders, we should do whatever we can to improve the performance of our trading system, in the manner described here.
First, we can try to reduce losing trades. This is not possible in a casino, but trading is a mind game, so it is possible in trading. We can try to identify conditions that are more favorable to our winners and include them in our system. We should also identify circumstances where a loser is more likely, and skip those trades. For example, if we notice that most of our winners are entered on days where the overall market has moved in the same direction as our trade, then only enter trades when the overall market is moving in the correct direction. This means that our trade is in the same direction of the overall market, rather than against it.
Another example might be that trades that are entered just before major news announcements, like the union budget or quarterly earnings, often get stopped out as losers due to increased volatility, so you should skip those trades. A study of past trades can be rewarding. It should be possible to identify many patterns of profitable & losing trades.
Second, we try to improve the average size of winners versus losers. Increasing the ratio of profits to losses so that the winners win more on average than the losers lose depends on the way you handle your stops. Having large winners in relation to losers can make up for a low win percentage, and mean that you will still make money playing the game. One method is to have a trailing stop that moves up as a trade becomes a winner. If you have fixed stops for losing trades that limit losses, but trailing stops for winning ones that allow winners to grow, then you are increasing your chances of your average winner being larger than your average loser. Generally it is better to be strict on losers by having ttighter stops that keep losses to a minimum and generous with winners by having stops that allow profits to grow. In any case you want to make losers small and winners large, so never add to a losing trade – that would be doing the opposite of what you want to achieve.
As traders, we should do whatever we can to improve the performance of our trading system, in the manner described here.
Advantages of Systematic Trading
Advantages of Systems Trading:
There are many reasons why futures traders are turning to mechanical trading systems as their primary trading style. One of the biggest mistakes traders make is allowing emotions, excitement or fear, to overpower their logic and control over their trading. With systems trading, the trader relies on the system to select the trades; thus, freeing the trader from the burden of emotional fear and greed decisions.
Why there is NO Perfect System:
Selecting a trading system can be a difficult task. All system results are hypothetical, because they are based on past results and have the huge benefit of hindsight. The disclaimer for hypothetical results typically reads: “Past Performance does not guarantee future results.” Many trading systems seem too good to be true. Smart consumers know that when something looks too good to be true, it usually is.
Although trading systems are designed to select the most statistically desirable trades, they cannot completely or accurately predict market trends and cannot guarantee success. Countless factors contribute to market changes: price, volatility, news, shortages, wars, interest rates, increasing or decreasing money supply, etc. While some systems work in a bull market, some in a bear market, others do best during a choppy market.
What Goes Up Must Come Down:
While there is no system that can consistently assures success, that does not imply that systems trading is never profitable. Trading systems may deliver large profits during certain phases and then provide large losses later. Newton’s law of Gravity tells us that: “What goes up must come down.” Financial markets mimic this by having Bull markets and Bear Markets. Market prices will never continuously move in an upward trend. In the same way, the equity curve of any trading system will never continuously move positively. The equity curve for any high risk investment will fluctuate up and down; there will be winning and losing periods for any system.
While every trader will find himself in a losing period at times, there are strategic moves to attempt to minimize losses. A common strategy is diversification. By utilizing multiple trading systems, the trader is acknowledging that there is no trading system that can consistently make a profit. Many traders choose to use multiple automated systems, so that when one begins to lose during a certain market period, another may profit. The overall performance is not tied to only one set of rules.
Basic Techniques for Multiple Systems Trading: Portfolio vs. Selective
With portfolio systems trading, the “portfolio trader” runs multiple trading systems at the same time. The idea behind this style of multiple systems trading is that if one system suffers a loss then another system will hopefully receive a gain, thus minimizing or eliminating the loss. However, this style not only minimizes losses, but also minimizes profits: if one system is trending upward and profiting while another system is losing, then the losing system will reduce or eliminate the profit. The minimum account size for an individual trader using “portfolio trading” tends to be relatively high, because each system is trading a separate set of contracts each with margin requirements, thus portfolio system trading tends to be used primarily by high volume or high net worth traders.
The selective style falls into the category of multiple systems trading, because the trader utilizes several different systems, one at a time. Selective systems trading is designed to improve the trading performance of the systems based on modifications to the “working time” of any given system in the Market. The basic idea is to switch (turn one system off; turn a different system on) a trading system when the equity curve is expected to stop rising. While the strategy of the “portfolio trader” is to avoid taking major losses by balancing losing trades on one system with winning trades on another, the “selective trader” replaces a system that is losing or predicted to stop winning with a different system. There is no perfect method for predicting downward trends and ensuring consistent profit; profit cannot exist without loss. The process of predicting a downward trend in selective system trading is very complicated and will never be perfect; the goal is to minimize extended losing periods. A hypothetical example is detailed below.
Example: Hypothetical Selective Systems Trading Strategy for Determining when to Change Systems
Basic guidelines:
Switch system when the account has an overall daily loss at the close of the trading day.
Switch system after the account has a 5 consecutive days of overall daily profit.
Conclusion
While there are many advantages to systems trading, it must be acknowledged that there is no perfect system. While we would all like to hope that technology will advance to the point where a perfect system can be created, we must accept that the day may never come. Until that day, we feel the that the best approach is through the simultaneous use of multiple systems with a selective timing approach, so that if one system is not performing the other systems in the portfolio have an opportunity to potentially compensate and make for a smoother equity curve.
Risk Disclosure: Futures, and options trading contains substantial risk, is not for every trader, and only risk capital should be used. Any form of trading, including forex, options, hedging and spreads contains risk. Past performance is not indicative of future results. No representation is being made that any account will or is likely to achieve profits or losses. There have been no promises, assurances or warranties suggesting that any trading will result in a profit or will not result in a loss. Because there are no actual trading results to compare to the hypothetical performance results customers should be particularly wary of placing undue reliance on these hypothetical performance results.
There are many reasons why futures traders are turning to mechanical trading systems as their primary trading style. One of the biggest mistakes traders make is allowing emotions, excitement or fear, to overpower their logic and control over their trading. With systems trading, the trader relies on the system to select the trades; thus, freeing the trader from the burden of emotional fear and greed decisions.
Why there is NO Perfect System:
Selecting a trading system can be a difficult task. All system results are hypothetical, because they are based on past results and have the huge benefit of hindsight. The disclaimer for hypothetical results typically reads: “Past Performance does not guarantee future results.” Many trading systems seem too good to be true. Smart consumers know that when something looks too good to be true, it usually is.
Although trading systems are designed to select the most statistically desirable trades, they cannot completely or accurately predict market trends and cannot guarantee success. Countless factors contribute to market changes: price, volatility, news, shortages, wars, interest rates, increasing or decreasing money supply, etc. While some systems work in a bull market, some in a bear market, others do best during a choppy market.
What Goes Up Must Come Down:
While there is no system that can consistently assures success, that does not imply that systems trading is never profitable. Trading systems may deliver large profits during certain phases and then provide large losses later. Newton’s law of Gravity tells us that: “What goes up must come down.” Financial markets mimic this by having Bull markets and Bear Markets. Market prices will never continuously move in an upward trend. In the same way, the equity curve of any trading system will never continuously move positively. The equity curve for any high risk investment will fluctuate up and down; there will be winning and losing periods for any system.
While every trader will find himself in a losing period at times, there are strategic moves to attempt to minimize losses. A common strategy is diversification. By utilizing multiple trading systems, the trader is acknowledging that there is no trading system that can consistently make a profit. Many traders choose to use multiple automated systems, so that when one begins to lose during a certain market period, another may profit. The overall performance is not tied to only one set of rules.
Basic Techniques for Multiple Systems Trading: Portfolio vs. Selective
With portfolio systems trading, the “portfolio trader” runs multiple trading systems at the same time. The idea behind this style of multiple systems trading is that if one system suffers a loss then another system will hopefully receive a gain, thus minimizing or eliminating the loss. However, this style not only minimizes losses, but also minimizes profits: if one system is trending upward and profiting while another system is losing, then the losing system will reduce or eliminate the profit. The minimum account size for an individual trader using “portfolio trading” tends to be relatively high, because each system is trading a separate set of contracts each with margin requirements, thus portfolio system trading tends to be used primarily by high volume or high net worth traders.
The selective style falls into the category of multiple systems trading, because the trader utilizes several different systems, one at a time. Selective systems trading is designed to improve the trading performance of the systems based on modifications to the “working time” of any given system in the Market. The basic idea is to switch (turn one system off; turn a different system on) a trading system when the equity curve is expected to stop rising. While the strategy of the “portfolio trader” is to avoid taking major losses by balancing losing trades on one system with winning trades on another, the “selective trader” replaces a system that is losing or predicted to stop winning with a different system. There is no perfect method for predicting downward trends and ensuring consistent profit; profit cannot exist without loss. The process of predicting a downward trend in selective system trading is very complicated and will never be perfect; the goal is to minimize extended losing periods. A hypothetical example is detailed below.
Example: Hypothetical Selective Systems Trading Strategy for Determining when to Change Systems
Basic guidelines:
Switch system when the account has an overall daily loss at the close of the trading day.
Switch system after the account has a 5 consecutive days of overall daily profit.
Conclusion
While there are many advantages to systems trading, it must be acknowledged that there is no perfect system. While we would all like to hope that technology will advance to the point where a perfect system can be created, we must accept that the day may never come. Until that day, we feel the that the best approach is through the simultaneous use of multiple systems with a selective timing approach, so that if one system is not performing the other systems in the portfolio have an opportunity to potentially compensate and make for a smoother equity curve.
Risk Disclosure: Futures, and options trading contains substantial risk, is not for every trader, and only risk capital should be used. Any form of trading, including forex, options, hedging and spreads contains risk. Past performance is not indicative of future results. No representation is being made that any account will or is likely to achieve profits or losses. There have been no promises, assurances or warranties suggesting that any trading will result in a profit or will not result in a loss. Because there are no actual trading results to compare to the hypothetical performance results customers should be particularly wary of placing undue reliance on these hypothetical performance results.
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