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Mechanical trading systems - Weissman R.L.

Weissman R.L. Mechanical trading systems - Wiley publishing , 2005 . - 240 p.
ISBN 0-471-65435-3
Download (direct link): mechanicaltradingsystems2005.pdf
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and commissions. ©2004 CQG, Inc. All rights reserved worldwide.
66
MECHANICAL TRADING SYSTEMS
FIGURE 3.4 Spot U.S. dollar/yen 20-day channel breakout with 3% stop loss. Includes data from December 31, 1992, to December 31, 2002.
Note: All trade summaries include $100 round-turn trade deductions for slippage and commissions. ©2004 CQG, Inc. All rights reserved worldwide.
profit to maximum drawdown (P:MD) for the system with the stop loss is larger and the time percentage required to achieve this same P:MD is smaller. Therefore, the addition of the stop loss yielded a greater return vis-à-vis risk while tying up less investor capital over time.
Cutting Profits
Many system developers advocate closing out trend-following trades once the profits accumulated on any particular trade have deviated significantly beyond the historical average per-trade profit. If we could train ourselves to act as machines, devoid of destructive emotional reactions to fluctuations in account equity or missed opportunities, then I might agree with concept of cutting profits at historically optimal levels. Unfortunately, we do react to such events.
As a result, I strongly advise newcomers to mechanical trend trading against this practice despite its occasional generation of superior “theoretical” backtested results. To fully illuminate both sides of the argument, let us compare our original MACD (Table 3.6) to MACD with the addition of a profit exit set to $2,500, as shown in Table 3.12.
Trend-Following Systems
TABLE 3.12 MACD with profit exit of $2,500.
67
Asset Profit # Trades # Days Max Draw MDD MCL P:MD P:L Ratio %W Time %
ES 19829 41 46 -21720 912 2 0.91 1.44 68.29 72.84
TY 29812 40 46 -10747 750 3 2.77 1.90 65.00 72.61
ED 7722 19 125 -6812 1853 8 1.13 2.36 42.11 93.87
SF 40462 42 45 -20225 956 3 2.00 2.05 76.19 73.28
JY 13200 46 27 -29412 1480 2 0.45 1.16 80.43 48.07
CL 40590 38 46 -14370 520 3 2.82 2.48 73.68 68.05
GC -1270 29 79 -13810 975 6 -0.09 0.95 41.38 90.85
S -23937 33 63 -31425 2325 5 -0.76 0.59 45.45 81.84
LH 10460 32 52 -11170 823 3 0.94 1.29 62.50 64.61
CT 36095 35 47 -13845 359 2 2.61 2.33 77.14 65.02
Total 172963 355 52.6 -40477 570 6 4.27 1.64 65.63 71.07
Note: All trade summaries include $100 round-turn trade deductions for slippage and commissions. Data source: CQG, Inc.
Notice that despite its inferior profit to maximum drawdown (P:MD), the addition the $2,500 profit exit did improve many aspects of our original MACD system: a superior win/loss ratio, reduction of maximum drawdown duration, and average trade duration along with a lower percentage of time that our capital was employed in the markets.
Some system developers might contend that this comparison is unrealistic because it only cuts off profitable outliers, whereas most traders would cut off both the profit and the loss tails of the distribution. Table 3.13 shows the performance results of the MACD system with the addition of both a profit exit and a stop loss set to $2,500.
Clearly this version of the system is inferior to the others. The equalization of profits and losses in a trending environment would produce superior results only if markets trended more often than they reverted to the mean.
Even if our comparisons had shown the achievement of superior performance through the cutting of profits, I would still have strongly advised against the practice. My contention is that the main purpose in adopting mechanical trading systems is reinforcement of positive trader psychology and elimination of destructive behavioral habits. Furthermore, although the theory of generating a smoother distribution of returns by elimination of outliers may sound appealing to statisticians and system developers, the reality of taking what appears to be an optimal profit off the table only to witness its doubling or tripling is absolutely devastating to trader morale and discipline.
With the exception of huge losses, nothing leads to the psychological derailment of inexperienced trend traders’ discipline than watching the
68
MECHANICAL TRADING SYSTEMS
TABLE 3.13 MACD with profit and stop exit of $2,500.
Asset Profit # Trades # Days Max Draw MDD MCL P:MD P:L Ratio %W Time %
ES -5753 48 29 -21530 1356 4 -0.27 0.90 47.92 53.95
TY 15262 43 37 -11728 975 5 1.30 1.37 53.49 61.39
ED 7697 19 125 -6812 1853 8 1.13 2.36 42.11 93.87
SF 12400 52 19 -9925 987 3 1.25 1.21 55.77 36.89
JY 19512 53 12 -14512 1374 5 1.34 1.33 58.49 23.01
CL 28810 40 33 -15320 564 6 1.88 1.90 62.50 51.44
GC -9230 33 63 -19750 1239 6 -0.47 0.72 36.36 81.17
S -13537 38 38 -16800 2324 6 -0.81 0.72 39.47 55.92
LH 3220 32 41 -8230 754 3 0.39 1.09 53.12 50.77
CT 31995 38 29 -7725 373 3 4.14 2.13 68.42 42.48
Total 90376 396 36 - 30000 1064 8 3.01 1.32 52.78 52.44
Note: All trade summaries include $100 round-turn trade deductions for slippage and commissions. Data source: CQG, Inc.
massive accumulation of would-be profits from the sidelines as they are forced to settle for safely banked, so-called optimal rates of return. Although elimination of historical outliers sounds like the prudent, scientific path, in practice it is emotionally crippling. Traders who advocate elimination of the outliers usually are unwilling to let profits run and have an irrational desire to control the markets, particularly to control the level of their per-trade profits.
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