Perversion in odds and values

Dan Gilbert talks about mistaken expectations. What he talks about have everything to do with trading. Our innate tendency to misjudge odds and values is one of the reasons why I use a statistical approach to assess market anomalies.

One year down, nineteen more to go until I can trade for a living

Early in 2010, I discussed about my plan to [grow my trading accounts organically and eventually trade for a living][] (i.e. live and breath in the market 24/7). Now that the first whole year of my long term plan has passed, I can update my visualization table as shown. 2010 was a good year. My starting capital for 2011 is 63% more than expected. This is mostly due to the \$13,000 prize money from winning six of nine Dukascopy automated trading contests. On the contrary to my fortuitous success, I revised some of my estimations noted in the table to be even more conservative. In particular, I reduced my annual deposit to reflect real bookkeeping data in 2010 and lowered my investment yield expectation based on my performance data throughout the past 10 years of my trading. To mitigate these reductions, I expect to continue depositing funds while I receive a salaried income rather than stop mid-way as originally proposed. The effect of inflation is deliberately ignored in this table because I'm discounting its effect in my investment yield estimate rather than adding more columns. It's all guess work for now anyway. Nineteen years is indeed a long time. It is a worst case scenario assuming that I will grow my accounts organically and not do anything else. I doubt I will need that much time as there are means other than trading a personal account to achieve trading for a living. I might discuss more about this later in the year once something materialize. My focus this year is to finish developing my proprietary Java trading platform with my partner and put it to good use in the forex market. Nineteen years or not, the fact that trading for a living is even possible for a self-taught amateur such as myself is testament to these incredible times that we're living in. I fully intend to enjoy every second of it.

[grow my trading accounts organically and eventually trade for a living]:

Making the best use of my time

I pondered over this issue over the holiday as I'm finding myself juggling too many tasks. I was participating in two trading contests, developing an automated trading system with a team, managing an open-source project, actively trading, and writing this blog, all on top of a full time job. I got greedy in what I wanted to accomplish and it is negatively affecting my performance. The first symptom popped up in my trading, not surprisingly. I made a bad call and missed a long-awaited opportunity. This was a wakeup call as the performance statistics from my recent trades is showing statistically significant deviations (I will publish the data soon). So before anything gets out of hand, I've decided to manage my time more professionally rather than just do what needs to be done. Taking a page from my professional work, I will prioritize my trading and development work using the Eisenhower Method. Basically, I mentally stamp an importance and urgentness ranking to each of my tasks. Then I will work on the important and urgent tasks first and leave the rest til later in order of the ranking criteria. For example, the automated contest is important and urgent because I've won over USD\$10,000 in 2010 and there's a monthly deadline for it. So I work on it first if there's work to do, which isn't much. The manual trading contest, on the other hand, is urgent but not so important. If I were to participate in it seriously, I would need to allocate an hour or so each night to trade. This is time that I would rather spend working on other stuff. On the other end of the importance/urgentness spectrum is my equities trading. I am rating it as an unimportant and non-urgent task. Although I've written the most about it and that my account has been up 21% in 2010, it takes a lot of my time and the absoluate return is small. That is because my equities account is the smallest of my various trading accounts. So 21% profit of a small account is still very small. Thus, this account isn't worth devoting too much time for now. My plan is to use a beta strategy for my equities account. I already have some ideas on what to do with it. This will be discussed in another post. Ultimately, here's an excerpt of my priority list:

  1. trading system development
  2. automated trading contest
  3. quant research
  4. documentation and blog posting
  5. trading strategy R&D
  6. manual trading contest
  7. equities trading

What this means to you as a reader is that there will be fewer charts and more technical discussion. My goal for 2011 is to post something at least once a week. This is a good time to subscribe to my RSS feed to have new posts delivered to you rather than having to keep checking here for updates.

What is a trading system?

For some traders, building a trading system means that they focus on finding the best indicators they could get their hands on or the one trading setup that is backtested to work 99% of the time. All I can say is, to each his own. For me, the keyword of a trading system lies not with trading, but with system. Remember, it is a system. First of all, it is a system for trading. Not a system to trade. What do I mean by that? Consider this saying, "traders don't go broke by missing opportunities, they go broke by taking too many." A trading system needs to be selective. It needs prudent risk management. Secondly, you need to generate your own market view to trade. Rather it be technical, fundamental, sentimental, or just following some joe, you trade based on your view. Trading is a test of your market hypothesis using money. If you think the market will rise, you buy. If you think the market will fall, you short. Lastly, a trading system needs to execute trades. Otherwise you'd be an anlayst. It needs to time entries and exits. Again, this could be as simple as on a whim or as complicated as some n-th order algorithm. Thus we have the three pillars of a trading system.

  1. Risk Management
  2. Market Analysis
  3. Trade Execution

What's more, if we combine some of these pillars we get some well known concepts. For example, market analysis + trade execution = trading signals, wherein you derive signals based on market conditions to execute trades. Or risk management + trade execution = position management, wherein you manage your holdings by manipulating your trades based on your risk profile. All these relationships and composition of a trading system can be summarized with a Venn diagram. So, this is my view of a trading system:

[caption id="" align="aligncenter" width="414" caption="Trading system Venn diagram"][/caption]

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