Timing Luck

I need to interrupt my overview of trading system development in order to discuss a concept called timing luck.

The more traditional concept of timing luck is subject of a post by Corey Hoffstein called “The Luck of the Rebalance Timing.” He addresses the difference in equity curves resulting from rebalancing on different days of the month. As discussed here, I think awareness of all possible curves is important just like awareness of all possible trade results based on the surrounding parameter space. In other contexts, timing luck can apply to taking trades on different days of the week, days of the month, or option trades on particular days to expiration.

Most backtesting software I have seen allows for no more than one open position at a time. For any given trading strategy, though, number of trade triggers is greater than or equal to total number of trades. If a trade is open and a trigger occurs, then nothing happens.

The particular sequence of trades may depend on the backtest starting date. Imagine two triggers occurring one week apart with trades lasting 20 days. If the first trade is taken then the next trigger will be skipped. If I start the backtest a few days later then the second trade will be taken and the first trade skipped (backtest had not yet begun).

The essence of timing luck is that the exact sequence of trades determines the equity curve. With more trade triggers than total number of trades, multiple potential equity curves exist. Why should one equity curve blindly constitute the backtest when it may not be typical of the distribution of all equity curves? Better than average performance may be fortuitous and due to nothing repeatable going forward (i.e. not signal but noise, to which I do not want to fit).

With options, I developed a backtesting approach to solve the timing luck conundrum. Rather than backtesting one open trade at a time, I opened positions on every trading day and tracked them all in a spreadsheet. Unfortunately it took months for me to run one of these backtests, which is why I wrote about serial vs. multiple/overlapping trades here and here.

I think one could make a case for a multiple/overlapping-trade backtesting being just as important as the more common, serial approach. The former factors in all potential trade triggers similar to a Monte Carlo simulation taking into account many more potential equity curves than that generated by one particular backtest.

Monte Carlo simulation is part of my trading system development process, which I will be writing more about in future posts.