How to evaluate the merits of an entry

Discussion in 'Strategy Development' started by OverTheEdge, Oct 9, 2010.

  1. What are the best ways to test the merits of an entry / setup / etc?

    Obviously the (non)trivial answer is to see if it provides an edge and makes you money on a consistent basis. But this assumes that the entry is already paired with the appropriate exit strategy or strategies, money management, market selection etc.

    However, I'm wondering if people use any analysis to test the potential of a particular entry signal before creating a complete 'system' around it.

    For example, could the following be of any use:
    - probability of a positive/negative close for various time windows after the entry is trigger?
    - MAE/MFE in give time windows
    - mean price evolution and standard deviation etc?

    Any thoughts would be greatly appreciated.

  2. I developed 2 strategies (my first two, so grain of salt here) and I thought about entries in a more conceptual way than what you've stated. My entry had to be the ideal point at which I could initiate a test of a hypothesis about future market price behavior, which in itself implied a complete "system", so that the entry, trade management and exit strategies are all geared toward testing that hypothesis and extracting maximum profit if it turns out to be correct and minimizing losses if it is incorrect.

    Also, while I did caveat that I've only developed 2 strategies, I have found that in the results it was actually the complete "system", especially stop movement, which worked together to make money, not just the entry signal. I ended up "making" more "profit" from my stop movement strategy than I made on winning trades, i.e. if I didn't have my stop movement strategy, the overall strategy would not have been profitable. Which is kind of a kick in the nuts because I actually did think through the logic of where I entered, but it didn't have as much of an impact on my results as simply managing the trade post-entry. Not having spoken with a ton of strategy developers, I have no idea if this is "normal", but it is my experience.

    Of course, if you're thinking of developing a strategy without stops, that will be irrelevant, but I would still say that thinking about entries as "hypothesis tests" is a good discipline because it forces you to think about the rationale for the trade and at least gets you to think about how your entry may or may not imply the other components of a "system".
  3. You can do it the old fashion way. Plot your entry signals and look at them. How many bottoms you catch for going long and how many tops you short? I like to see about 30% of the signals to be that accurate in their timing. If they are, finding a exit startegy is not difficult.

    Timing...test for timing...

  4. intradaybill,

    thanks... when you talk about tops/bottoms, how do define those? (ie. intermediate tops and bottoms may not be longer term tops/bottoms).


  5. I suggest you read the old LeBeau Bulletins at

    Here's a portion of No. 17 that might be helpfull.

    Those of you who have read our book and followed our work over the years will quickly recognize that we have long been outspoken advocates of the importance of good exits. In our opinion exits are much more important than entries yet the majority of new traders spend most of their time seeking the ideal entry strategy as if this would solve all of their problems.

    In the System Building workshops that I teach with Dr. Tharp, we play an exit game where everyone enters a series of trades at the same point and then implements their own exit strategy as prices are reported to the group. After about ten quick trials of this game the results typically range from one extreme to the other. A few traders make a lot of money, a few lose a lot of money and most fall somewhere in between. It would be rare for any two players to have the same results. The point of this simple exercise is to illustrate the effect of exits on our trading results. Everyone has identical entries yet the outcome of the simulated trading always ranges from big losses to big profits.

    The same is true in actual trading. Exits determine the outcome of our trading and have more impact on the results than any other factor. Yes, exits are even more important than money management (position sizing). Not even the best money management strategy can make a losing system into a winner but a minor change in the exit strategy can work miracles. We quickly discovered this years ago when attempting our first tests of indicators. We found that even a slight variation of the exit strategy used in the testing would affect the number of trades, the size of the winners and losers, the percentage of winners, the drawdown and the total profitability. We set out to test entries but quickly learned that in most cases we were testing exits because the entries had little if anything to do with the results.

    We eventually began isolating, as best we could, our testing of entries and exits. We now test entries based solely on the percentage of winning trades, exiting after a specified number of bars. This method of testing entries is based on our conclusion that the only purpose of entry timing is to get the trade started in the right direction as accurately as possible. Everything that happens after that has nothing to do with the entry because the outcome of the trade is now in the hands of our exit strategies. We want our entries to accomplish only one purpose and that is to get our trades started in the right direction as quickly as possible and this function is easy to measure. The higher the winning percentage after a few bars the better the entry. But how do we measure the efficiency of our exits? How can we tell if one exit is better than another? What is a good exit? What is a bad exit? Which is better: exit A or exit B?

    To try and quantify the relative merit of various exits we created the Exit Efficiency Ratio and contributed an article on this topic to Futures Magazine several years ago. (I'm trying to get this Bulletin out today and I am sorry that I don't have the specific reference for the article in front of me. I'll find it and post it on the FORUM page.)

  6. You define them in relation to the timeframe of your trading system. For example, in 1-day intraday timeframe, the top is the High of the day and the bottom is the Low of the day, and so on.

  7. Thanks Robert. Actually this is one of the key metrics I am currently using as well (% of profitable trades or probability of winning after x bars).

    Also read through some of the other posts at the link. a good refresher. Thanks for link.