The Tone of BS (Part 3)
Posted by Mark on September 5, 2014 at 06:32 | Last modified: April 21, 2015 13:27Last time, I interrupted the analysis with a challenge impossible. I want to elaborate on that today with regard to why we could never prove that institutional traders are more profitable than retail traders (or vice versa).
As a quick review, [2], [3], and [4] all suggest that institutions are profitable whereas retail traders are not. How would we design a study to evaluate that claim?
First, we would need large sample sizes of systems traded by institutions and by retail traders. Given the systems, perhaps we can evaluate them for profitability.
I need not think too hard to realize attaining these samples would be, in and of itself, an impossible feat! I would be hard-pressed to find even one [never mind a “large sample size” of] institution[s] that is willing to share its “secrets.” Many retail traders also feel the same way about their own “proprietary strategies,” which would make it extremely difficult to get the second large sample size, too.
Another problem with this proposition would be the time and money required to do this study. I could be making phone calls to institutions for a long time before ever getting cooperation! With regard to retail traders, how would I even find them? I would also have to operationally define “trading system.” If someone attempted a trade once or a handful of times, would that constitute a “trading system?” Retail traders range drastically from “full-time trading for a living” to “Vegas-style trades for a hobby.” People are not all that open to detailed questions about their financial dealings especially when strangers are doing the asking.
A third problem regards the questionable justification for the immense cost of doing this study. So what if I find institutional or retail traders to be superior as a whole? The answer won’t help anybody. This study would not be actionable to me or any other trader as we continue doing what we do.
Therefore, I’m quite sure no valid study of the sort has ever been done and any claims about the institutional or retail world being more profitable than the other are baseless.
Categories: System Development | Comments (1) | PermalinkThe Tone of BS (Part 2)
Posted by Mark on September 2, 2014 at 07:02 | Last modified: April 21, 2015 13:00In the last post I presented an anonymous opinion from the internet. I numbered paragraphs at the end of each in brackets. I will analyze the opinion one paragraph at a time.
[1] I do not disagree that the institutional world is a secret one. Legends abound and stories recycle. I can hardly imagine what life is like with the professional firms since my background is not in finance. I could try and read financial forums but I don’t know what information there is true reporting from professionals and what is fictional or hyperbole.
[2] The only problem I have with this paragraph is the suggestion that institutional firms trade profitable systems. I believe retail traders have been conditioned to think the institutions consistently make money. How do we know? Certainly funds go out of business all the time due to poor performance. How about just last year, for example? Some funds completely blow up (e.g. LTCM anyone?).
[3] The claim here is that systems in the public domain are not profitable. The only way to know if this were the case would be to live trade book systems or to develop those systems ourselves to see if they still have potential. I certainly don’t think anyone can wave a hand over and say “those systems that didn’t work for the institutions are written up in books, never to work for anyone else either.” How would the author know?
I agree with [4]. The two worlds are very different. Is this relevant to differences in profitability between the two? I do not know. In thinking about what it would take to answer this question, I would argue such a study to be impossible! Can you think of some reasons why?
In four paragraphs, I think I’ve seen all I need to know to determine how I feel about the thesis presented!
For good measure, I will continue this evaluation in the next post.
Categories: System Development | Comments (1) | PermalinkThe Tone of BS (Part 1)
Posted by Mark on August 29, 2014 at 07:43 | Last modified: April 20, 2015 15:06When I first read this a few months ago, it struck me as a load of BS. Today, I’m not so sure. First, I will present the viewpoint. Last, I will analyze it.
——————————-
The dreams of retail traders need to be separated from the secretive and real world of the institutions. [1]
The big guys have the capital, the skills, and the resources to investigate everything. They buy, develop, and test hundreds upon thousands of trading systems. They keep the profitable systems for limited periods before the cycle starts anew. [2]
What with the failing strategies? Some are later published as best-selling books. These make their way to retail traders and become the subject of excitement among people who wish to get rich quick. The disappointment will later set in. [3]
Things are much different in the retail world than the institutional. Retail traders have minimal capital, limited skills, and limited resources (e.g. time, patience, computer processing power). Retail traders also have the huge, pie-in-the-sky dreams. [4]
It would hardly be out of the ordinary to find a promising mechanical trading system that worked very well for United States large capitalization stocks. People would be happy and seeing green! When tested on a foreign market, however, the waterproof system could fail dramatically. [5]
Was this a good or bad system? Depends who you ask and whether they made/lost money, of course. [6]
Personally I prefer high-probability situations to trade in a discretionary manner. “High probability” means technical convergence. Many such examples exist. [7]
[a handful were then given here]
Seasonality is another powerful filter that will reduce exposure and improve performance. Seasonality is still ignored by many. [8]
The easiest way for a trader to make money is to approach the markets in a simple manner and react to them. [9]
You may spend years of research looking for the Holy Grail and forget about the real markets and opportunities passed. [10]
Simple is Beautiful. [11]
Don’t be greedy: look for better odds to gain than odds to lose and take whatever the market gives you. [12]
——————————-
Sleep on that for a bit and I will start to analyze in the next post.
Categories: System Development | Comments (2) | PermalinkCovered Calls and Cash Secured Puts (Part 40)
Posted by Mark on May 5, 2014 at 03:48 | Last modified: March 25, 2014 15:09To implement DCA in a market crash, spare cash would be required. The 15% annualized return MacDuff advertises with the Math Exercise would no longer apply because the deleveraged portfolio would be making less. How does this add up?
More recently, MacDuff has advised being fully invested. This eliminates the possibility of DCA and potentially resolves the discrepancy described above.
What happens when stocks tank?
On the call side I can sell premium at near-the-money strikes, which will enable me to continue generating cash.
What happens when a V-bottom prints (e.g. March 10, 2009) and stocks catapult higher through my lowered strikes?
MacDuff argues we are now better prepared for this situation thanks to narrower strike availability and weekly options that offer the potential for supercharged annualized returns.
What happens when I have to look months to years out in time to roll for a credit? Neither weeklies nor narrower strikes are going to save me.
In some cases, no available options will provide for a credit roll. I cannot take assignment at the [substantially] lowered strike because that would lock in a big loss. In 2009, I suspect this might have described most [if not all] of my positions.
My only other option would be to roll for a debit and hope the market cooperates and allows me to escape whole. “Hope is not a trading strategy” and I cannot begin to imagine my degree of insomnia if most of my positions were in that boat.
Until and unless MacDuff can give me some response to these difficult issues, I will have significant doubts about SysCW. One may argue “no trading system is perfect and losses are a part of the game” but MacDuff never shows any losses in his book nor in his tutorials.
How Madoff-esque is that?
Furthermore, what I have described here is more than “occasional losses.” What I have described is catastrophic loss running rampant across most of the portfolio. This is a risk that deserves a response and a remedy before SysCW qualifies as a viable trading system.
Categories: Option Trading, System Development | Comments (2) | PermalinkCovered Calls and Cash Secured Puts (Part 39)
Posted by Mark on May 2, 2014 at 06:49 | Last modified: March 25, 2014 14:03Once upon a time (one month ago), this space focused specifically about CCs and CSPs. My last post waxed eloquent about some optionScam.com aspects of the industry. Next I want to combine these two branches of inquiry and focus specifically on Rich MacDuff’s SysCW.
One of the biggest problems I have with SysCW is the exclusion of portfolio considerations. The SysCW tutorials and book include tens to hundreds of examples of successful positions.
Some were easy.
Some required more management.
Some involved dollar cost averaging (DCA).
Taken one at a time, MacDuff found a way to make every single position go back to cash profitably. For me, this was the primary appeal of SysCW: management strategies exist to handle most any situation imaginable.
Indeed, SysCW does offer tools to successfully manage most any situation… when looking at positions one at a time.
This is not the case when full attention is paid to portfolio considerations and that, in my opinion, is where SysCW begins to break down. What happens when another 2008-like crash occurs and all positions lose significant value? MacDuff has argued I can close profitable positions and use that money to aid losing ones. By definition, though, correlation goes to one in a severe market crash. No profitable positions are likely to exist in a violent bear market.
In Systematic Covered Writing (2011), MacDuff introduces DCA as a position management tool. Perhaps a market crash will require DCA and to do this I need significant cash on the sidelines. If I have significant cash on the sidelines then I will not realize 15%+ on my entire portfolio, which is what MacDuff repeatedly insists to be possible with the SysCW.
Something just doesn’t add up [yet].
I will continue this discussion in the next post.
Categories: Money Management, Option Trading, System Development | Comments (1) | Permalink2012 Performance Evaluation (Part 10)
Posted by Mark on February 25, 2013 at 06:01 | Last modified: February 13, 2013 05:19In http://www.optionfanatic.com/2013/02/21/2012-performance-evaluation-part-9/, I disclosed a third flaw in my preceding analysis showing potential utility for a LF.
The corrected equity curves and performance results are shown below:
The methodology is still worth researching but a 90% profit is nowhere close to 143%.
I am categorizing this post as optionScam.com (http://www.optionfanatic.com/2012/04/21/optionscam-com/) because I have found deception to be commonplace among newsletter and trader education/mentorship offerings. You should understand the theory behind a proposed system and review the results to see if they are consistent with general tenets of the theory. Furthermore, you should not fall for the “one good example” that might be cherry picked from a population of losers. You should always be thinking about other possible combinations, market environments, and trade situations to evaluate whether an exemplar successful in one situation is likely to be successful in others.
I outperformed with this analysis by going beyond human nature to detect an honest mistake and I believe this is exactly what we need to do as traders to be successful. I really cannot emphasize that enough. Human nature is falling prey to the confirmation bias, as written here:
> The reason confirmation bias can be so deadly to a human is because… we tend to look only
> for information that supports our pre-held beliefs… not only could we be biased about the
> information we do get a hold of, we may completely sidestep vital information in the first
> place, just because we are subconsciously ignoring everything that doesn’t fit in with our
> beliefs.
For the most part, traders maintain hope that a “Holy Grail” exists. Once we get wind of a potential contender, we become captivated. We confirm evidence in support and discard, overlook, or refuse to scrutinize evidence to the contrary. Confirmation bias must be one of the biggest culprits of flawed system development methodology. If left undetected then traders will fall victim (i.e. lose money) to the “scam” perpetrated by another or, even worse, inadvertently by themselves.
Categories: Accountability, optionScam.com, System Development | Comments (0) | PermalinkWalking it Forward with System Validation (Part 6)
Posted by Mark on February 8, 2013 at 02:22 | Last modified: February 1, 2013 03:01My blog series “Lingering Quandaries about System Development” concluded by discussing a paradox with regard to Howard Bandy’s WFA discussion. In http://www.optionfanatic.com/2013/02/07/lingering-quandaries-about-system-development-part-9/, I concluded by suggesting a new and improved WFA that can achieve system development goals.
I recommend not following Bandy’s advice to select periods for IS and OOS data early in the process and retaining them throughout development. Besides effectively burying your head in the sand as described by Example 1 (http://www.optionfanatic.com/2013/01/29/walking-it-forward-with-system-validation-part-1/), you really can’t know what values may or may not work until you actually perform the WFA. Validation is the final step of system development.
Rather, look to perform WFA by optimizing the periods and studying the entire parameter space. Perhaps I will vary IS period from one year to three years by increments of two months. Perhaps I will vary OOS period from one month to six months by increments of one month. I then need to plot values of the subjective function in a three-dimensional space (or in two dimensions with color coding to represent subjective function ranges) to get a feel for where the high plateaus exist. I should then select the time ratio to coincide with the middle of a high plateau and use trading parameters coincident with that combination.
Every time I do a WF iteration, I am selecting WF parameter values and subsequently trading parameter values. The two differ, in effect, by an order of differentiation. That is, the subjective function for the WF optimization coincides with a value for the concatenated equity curve to date. The subjective function for the iteration coincides with a value for the equity curve of the preceding IS period only.
WFA serves to both validate a trading system and to direct trading at the right edge of a chart.
Categories: System Development | Comments (0) | PermalinkLingering Quandaries about System Development (Part 9)
Posted by Mark on February 7, 2013 at 07:54 | Last modified: February 1, 2013 02:36http://www.optionfanatic.com/2013/02/06/lingering-quandaries-about-system-development-part-8/ continued discussion of a third System Development paradox that I have been trying to sort through: Howard Bandy’s handling of WFA. Bandy said to choose periods for IS and OOS data early in the process and then stick with them throughout development.
The more you vary these system parameters, Bandy said, the more the OOS data loses its “out-of-sampleness,” which is why they ought not to be changed. I flat-out disagree with this statement. Varying the time ratio does not change or determine parameter values involved with the trading rules. Varying the time ratio is solely to verify that neighboring values also validate the system. This will remove suspicion of system validation as a fluke occurrence.
One issue that remains unresolved for me is how to conceptualize “varying the time ratios” in a systematic manner that may be plotted. I consider myself spatially challenged so I probably just need to cram into my brain the need to specify a minimum and maximum value for both IS and OOS periods and an increment by which to vary them. I can then make a two-dimensional plot of the subjective function (e.g. RAR/MDD) and perhaps color code the values. This way, I can see if an area of outperformance stands out.
One other issue I wonder about is whether OOS period might be limited by sample size considerations. The OOS period will already be short relative to the IS period. Might I need to be concerned about it being short enough to allow for any trades? The shorter the period, the more total periods I will have in the WFA but if it is too small to allow for trades in any one iteration then I wonder if the entire WFA risks insufficiency.
I will only discover the answer to this question when I start attempting WFA myself.
In my next post, I will summarize the new-and-improved approach to WFA.
Categories: System Development | Comments (1) | PermalinkLingering Quandaries about System Development (Part 8)
Posted by Mark on February 6, 2013 at 05:05 | Last modified: January 31, 2013 13:59In http://www.optionfanatic.com/2013/02/05/lingering-quandaries-about-system-development-part-7/, I introduced the third paradox encountered thus far in my System Development studies–this one having to do with walk-forward analysis (WFA).
As I suggested, something about the validation process Howard Bandy describes seems like curve fitting. A few months ago, a reader asked Bandy in a forum post about the proper time ratio of IS:OOS data to be used in WFA. Bandy did affirm that some time ratios may produce acceptable OOS performance where others may not. His solution was to use whatever works. To me, that sounds like cherry picking the right combination, which is “curve fitting:” the four-letter word of System Development.
Just the other day, I once again directed this question to Bandy on his blog. His response:
> Yes, in-sample and out-of-sample time periods are parameters of the system and they do need to
> be chosen. My recommendation is to choose them (particularly the length of the in-sample period)
> early in the development process, then keep them fixed from that point on… Keep in mind that
> every decision to adjust any component of a system based on examination of out-of-sample results
> reduces the out-of-sampleness of that data and increases the degree that the system is curve-fit to
> the specific data.
As a parameter of the system itself, choosing set values for IS and OOS periods is like Example 1 from http://www.optionfanatic.com/2013/01/29/walking-it-forward-with-system-validation-part-1/. This fails to take into account the shape of the parameter space. I want to see high plateaus of performance rather than peaks. In taking Bandy’s suggestion, I would never study the neighboring values.
I will conclude this discussion in the next post.
Categories: System Development | Comments (1) | Permalink