Some time ago I wrote a post where I repented for the sins I committed as a system trader. This prompted Gio to title the post “Confession of a System Trader.” I liked the sound of it and so here is the first installment of Confessions of a System Trader.
3/17/09
The last three weeks have been very difficult. The market is stretching itself first to the downside and now to the upside in a way that makes it challenging to profit from being a contrarian. Independent auditing began on the primary system last week with the first tracked trade being on the short side. The system has a 60% success rate with short trades, over the past 15 years. That’s not a colossal winning percentage but I was hoping to be on the right side of it for the first real-time tracked trade.
The past 5 days of the market have made me really miss my early days of discretionary trading, when I would trade breakouts and chase momentum. Oh, to just place a bunch of trades, never keeping good records, just looking only at the profit/loss column. Not having studied much about market history, it was easy to throw money into trades, with nary a thought of an exit strategy, with outsized positions. I made money. It was fun. If something didn’t seem to be working, I just didn’t do it anymore. I did more of what worked. With system trading, even if something does not seem to be working, I have to keep doing it. Over, and over, and over.
Bloody hell it is so hard to just sit here and do nothing while everyone gets drunk and buys stocks. I feel like one man alone on a deserted and windy patch of earth, who can hear faint sounds of glasses clinking, laughter, and celebration. He wants to find the celebration, seek fellowship, and join the fold, but never sets out to find it as he knows that he will arrive too late to enjoy the festivities. Instead, he sits alone, listening to the sounds, thinking, “all this time has passed. Had I left earlier, I would probably already be there, celebrating.”
What are the chances, after working with a partner for many months on a system, that as soon as we feel it is ready and we are ready for it, it just quits working? I mean, traders are forever buying at highs and selling at lows. What if it is no different with system trading? What if my primary system peaked two trades before I began trading it by the book?
Just like Tuesday of last week (March 10th), when the Citibank news shocked the markets out of an awfully persistent 3-week downtrend, there is surely some news out there that will reverse this current rally, at least for a pullback, right? Right?
One thing I have learned about trading systems is that when the trade finally moves from a rather large loss to a small loss, or from a loss to a profit, it seems almost like magic, even though I may have spent half-a-year studying the system inside and out.
Maybe it will be a good thing to hit a good 10-20% drawdown right away, in the same way that chemotherapy can eliminate the cancer while simultaneously sickening the patient. What doesn’t kill me will make me stronger.
“What doesn’t kill me will make me stronger.”
with all due respect, that’s bullshit. i know, from experience, and i think you know that too.
no one, and i mean no one is right all the time. you my friend, had been calling this market pretty damn right, and you will get back on track. at least you have not been short since the bottom and adding all the way up. you have kept your discipline.
the only bloggers in this site that can afford to ignore stops and play loose sometimes are Fly and Alpha, just because of their experience and deep pockets.
Chivas, I didn’t mean it literally…I meant that when a system trader becomes fearful and irrational that his psychology will destroy him from within.
If he starts a new system, immediately encounters a large drawdown and can successfully follow the system through it, that it will be very difficult at first but eventually that fear-based mindset will be conquered.
The hoped-for outcome is that after trading a system through a drawdown, that one does not fear the next one nearly as much as he feared the first one.
This system does not use stops, at least not in the traditional sense.
Damn good post.
Woody,
please forgive my fucking stupidity.
Chivas, love ya man. Let me know when you begin fading this rally.
Thanks Contractor.
Great post.
Yep…Short term emotional memory sucks. I would assume that there were similiar blips in your backtesting that were much easier to overlook, because you didn’t have to live through them.
will do
Drink, for you are alive. There’s nothing but the living to be done anyhow. So, live the life, it is as full as a bite of pie. And, think not much at all can be added to it. For example, you could be dragged along on a 4 sigma once in a century lurch skyward of a sea of bubbles, when the man with the hand comes around to keep the cards stacked. There’s just too many numbers Wood, in this ridiculous machine. Equities are a drop in the bucket of world wealth. Today is not yesterday. And yet wood, the element, with benevolence, brings wisdom still.
Absolutely Shaz. There are always blips. Trading through them, robot-like, stoic and unconcerned, is the key.
Woodshedder, stay away from the inside of your mind, its a dangerous place.
By the way I dropped a note in Todd Harrison’s post on Minyanville reference Sedacca and mentioned your name and extended it to some of the people at IBC.
… took the words right out of my mouth.
My experience is the same, Wood. When times are good, they’re real good. When they’re bad, well, you know… Anyway, that’s why it’s good to have multiple systems you can rely on. It is a rare system, indeed, that can be optimized to every conceivable market condition, no? The system(s) and position sizing is what keeps you honest. I do not belive in the concept of “system death”, only in “system coma”; temporarily malfunctional or non-functional, but just biding it’s time, waiting to rise from the ashes with hell-bent fury, hungry to bring the anvil down with violent rage on those who doubted it’s robustness. The key is to know when it is showing signs of weakness, so it can be idled until conditions ripe for it’s utility return. For those like myself, whose brain functions akin to a activities of a freshman coed; ready to drop the panties at the first kegger of the sememster when emotions become uncontrollable; system trading is my chastity belt, keeping untrained dicks and unwanted communicable diseases at bay. Like Bill Clinton, I feel your pain. Indeud…
Much appreciated Mustard!
Wow Junk, thats a lotta information!
PS Kegger Friday @ 7
Interesting Junk, or should I call you Junkette? 😉
Multiple systems are key.
The next one under development actually covered this morning and went long. I think they will work well together.
Wood, do not be confused by my metaphor. Had you forgotten already, women do not trade as they are incapable of understanding even it’s most basic tenets. Witness the paucity of comments regarding feelings, puppies, and Dr. Phil on this site. Had there been a suitable male equivalent to the chastity belt, I surely would have used it. Sadly, there is not…
Well we will see what happens tomorrow, the great savior China just got a revision downward on GDP growth
http://www.cnbc.com/id/29747024
So much for China is gonna lead the world outta this shit.
Junk, I know you are being sarcastic, but I feel compelled to note that the bulk of the research shows women to be better traders than men.
Wood, I know you are being sarcastic. Surely you know that women have underdeveloped brains, making them most suitable for getting my dinner ready, scooping the litter boxes, and working evenings at the corner diner to finance my lavish lifestyle, do you not? 😉
P.S. I believe that bulk of research you reference was conducted by women, so there is a clear and present bias, no?
lol…I must have gotten very lucky then. My wife is very smart, and she still makes dinner, cleans up, and runs her LLC.
That is probably why she could use some of that “Bitch & Complain Out” that you picked up this evening for your wife.
Junk,
Don’t forget that early morning paper route, it provides us that Mad Money through the week, especially Sundays’s subscribers
Wood, how is your wife’s friend’s kid that is sick?
CA, Isa is not doing well. Prognosis went from pretty good to pretty bad. I’ll get a new post up over the weekend.
Good post Wood. The bit about the party going on in the background with clinking glasses was spot on. Thanks
I’m reading Ernest Chan’s book Quantitative Trading: How to Build Your Own Algorithmic Trading Business and I have been thinking about what he says regarding ‘regime changes’.
Essentially, I’m slowly coming to the point of opinion that the market is done, temporarily with volatility.
For example, the UUP is mean-reverting along a longer term trend upwards around the 80-88 daily moving average.
Have you thought about backtesting any of your other strategies against the last sixty days and see if they are experiencing the same kind of drawdowns?
Cuervo: Marty at StockTiming says the VIX is finishing a wedge started in september. He says to expect increased volatility as we approach the apex and then a BIG whoosh one way or the other.
Wood: AGAIN, i shorted too early at 10am yesterday and I got killed EOD. Wanted to bail today as one of the stocks was off by 9%, but i held on for the easy down opening today and now my picks are golden.
So I am coming to the realization that you should not necessarily allow yourself to get stopped out at a 5% loss and to hold on if the TA indicates you are likely correct but early to the mean reversion. And early is wrong but shit happens.
I’d like to see an article on the dialectic between conservative stop losses versus the RISK of hanging on through stormy days til profits appear.
Sitting tight builds character.
Cuervos has an important point. If you go back to 2003-2005, and then look at the most recent 3-6 months, the time base for nearly all common indicators has changed significantly.
Cuervo, over the last 60 days, the systems have outperformed. The last 3 weeks though have been difficult mainly the market has stretched itself severely on the up and down sides.
I think volatility will stay elevated over the next 3-5 years. As you know, 2004-2007 was an historically low period for volatility, likely as all the hedgies and quants were running mean reversion trades.
We have been working more on control charts (I need to send you some progress for your review) and those will help going forward evaluation system health.
Cebu, you’ve posed some excellent questions over the last 2 days that I want to answer in depth in the near future.
Scam, agreed.
Manual, not sure I understand.
Wood,
Hey!. . it’s not you or your system. . .it’s the market. Many of the daily bar systems that I’ve profiled in the recent month that have performed well over the past 16 months now show a flattening equity curve. Even though I continue to test a variety of non-correlated system inputs, the flattening equity curve is the common denominator. This situation falls under the category “when good indicators go bad” and is surely frustrating and contra-profitable for many traders using any variety of systems. Whether this technical mayhem is indicative of an emerging new trading paradigm remains to be seen.
I just deleted several or more comments.
We’ll chalk it up to a misunderstanding.
Great post & comments!
Shed —
Viva la Revolucion, mothahflickahs!!
I didn’t even get to see his response… 😉
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What’s C up on his GE bet? $4 million as of today?
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This is just the beginning of the flood of liquidity that govts. around the world are going to infuse into the system.
woops–meant to post that at fly’s. oh well.
i think part of the issue at hand is that mean reversion does not behave the same in bear markets as it does in bull markets.
In bull markets when prices get ahead of themselves there are plenty of people that would take profit quickly, as most people cannot handle letting their winners run. Similarly, market makers shake out weak hands by inducing shallow pull backs in uptrends. thus prices do not sway too far off the mean before correcting.
In bear markets sell offs are mostly due to forced liquidations and rallies are due to short coverings. thus both can be very sharp and last much longer (in percentage if not in time).
I think it may work best in bear markets to take fewer signals, waiting for the eventual bear market rally and then to try to stick with the position for “longer” than your current system merits, as the rally would typically last longer (in terms of %) than you anticipate.
Born2, my research honestly shows the exact opposite. During bull markets, you tend to see back to back to back days of overbought conditions, and then a quick selloff. During bear markets, as soon as conditions get overbought, you get sellers flooding in, and instead, conditions stay oversold for much longer.
My experience is that mean-reversion works best during the volatile bear.
Maybe I’ll post some charts and equity curves in the near future so you can see what I’m talking about.
And to boot: Mean Reversion is getting stronger
HT to Dr. Chan