On money creation and random walks...

Discussion in 'Trading' started by tom_p, Jul 1, 2001.

  1. tom_p


    From the now-closed "Financial Freedom through Electronic Daytrading" thread, tradeRX said :
    "Turn it upside down ...don't go long but SHORT every trade! According to the expectancy of your system, 2 out of 3 times you will be in the money. Ride the 2 "losers" down (now winners to you) for four points, sell the one long "winner" quickly, and make a fortune!

    Trade your system backwards and make big bucks. Now you have.....

    8 winning shorts = 8 wins @ 4 dollars X 1000 shares = $32,000.

    4 losing longs = 4 losers @ 1 dollar X 1000 shares = $4,000.

    Total profit = *$28,000* (- commissions)

    That's $20,000 more profit just by turning your system on its head. :cool: "

    Not quite. You're incorrectly assuming that the 2 losing trades that were stopped out at -1 would have gone to -4. Ignoring commissions this is a zero-sum game so "by turning your system on its head" you should get a corresponding loss, not "$20,000 more profit". Having said that, I agree with you about trade (or money) management alone not being enough. Anyone who says they can make money without any advantage (eg. tossing of a fair coin paying even money) using only money management is not only a wizard but a magician.
  2. tom =)

    you sir are correct.. with 2 trades of 3 having a profit of 1 dollar and 1 trade of 3 having a loss of 4 dollars it is obvious that the system has a negative expectancy if you try to "fade" it..

    i was going to post a response last night when i returned from the book store but the thread was closed..

    "And will you succeed? Yes indeed. Yes indeed! Ninety-eight and three-quarters percent guaranteed." -Dr. Seuss


  3. Babak


    not really a zero sum game

    actually when you consider slippage, spreads, and commissions it is clearly a negative sum game!


    money management basically allows you to reduce drastically the chances of blowing up. It allows you to stay in the game until your edge has a chance to play itself out and/or until you learn and increase the effectiveness of your edge.

    but by itself it will not shovel $$ into your pockets
  4. Cesko


    You are absolutely wrong. It has been proven that totally random system will make you money(with proper money management). In order to understand it you have to understand the reason why it is actually possible to take the money out of the markets. The closest explanation is in "Against The Gods" by Peter Bernstein, p.306, starting "On occasion, the other side...". As long as you are spending time to figure out the proper entry techniques you simply have no clue!!!
  5. tradeRX


    tom_p. I didn't assume anything more than what you assumed ...ie. your 4 winning longs would go 4+.

    I believe you missed the main thrust of my argument. That is, if you truly knew that 2 out of your 3 trades will lose value, then you are actually picking winners 66% of the time. You go short, not long, and score big.

    HOWEVER, the subtle point to all this is you do NOT really know what's going to happen. You don't know how many winners or losers you will get from implementing your system (or you would short every trade), therefore, your system is in reality not picking winners with any degree of confidence beyond random chance, so all you are doing in essence is employing a very simple trade strategy of buying and stopping out until you find yourself in the money, then you hold on for a hopeful 4 points.

    You see what I'm saying? Your results can be explained away on the basis of a simple trade management strategy. There is no need to invoke a "remarkable winning system" theory to explain your infrequent wins. In all probability, you do not have a system of picking winners, you have only a system of managing a winner once you get it. It's a subtle distinction but an important one. And, I might add, one that many many traders here don't see and are undoubtedly laboring under this misapprehension.

    "Plurality should not be posited without necessity"
    Occam's Razor


  6. Cesko


    Very well said!
  7. tradeRX


    Cesko. To make money form a random market, wouldn't the market need some kind of a trending undercurrent to it? Otherwise, your lucky winners would not move further into the money before retracing. Right?

    PS I will get the book you recommend.
  8. tom_p


    In one of my earlier posts I said that you and the others were talking about different things. Point by point, I have no desire to get into quibbling. As for the larger picture, I don't disagree with you.

    You say "You are absolutely wrong. It has been proven that totally random system will make you money(with proper money management). In order to understand it you have to understand the reason why it is actually possible to take the money out of the markets. The closest explanation is in "Against The Gods" by Peter Bernstein, p.306, starting "On occasion, the other side...". "

    I haven't read "Against the Gods" and I'm not saying you can't make money in the markets. If, however, you can make money, then I wouldn't call this a "totally random system". We're probably talking about definitions here. Going back to the coin toss example, Cesko, do you think you can make money using proper money management? If so, let p be your supposed advantage when you're getting even money. Now what I propose is that I'm willing to give you and Peter Bernstein slightly less than even money so that you'd be making p/2 only, but that should be enough. I'm pretty sure there are enough willing contributors in the academic and gaming community to raise millions of dollars for an exercise of this nature. So, am I "absolutely wrong"?
  9. Babak


    I don't see how Bernstein's writing on page 306 sheds any light on this issue (?) But judge for yourself:

    To set the context, he is talking about farmers being helpless in the face of volatile commodity markets in a chapter devoted to derivatives.

    "On occasion, the other side of the deal is a speculator -- someone who is willing to take over the uncertainty from others out of a conviction about how matters will turn out. In theory at least, speculators in commodities will make money over the long run because there are so many people whose financial survival is vulnerable to the risks of volatility. As a result volatility tends to be underpriced, especially in the commodity markets, and the producers's loss aversion gives the speculator a build-in advantage. This phenomenon goes under the strange name of 'backwardation'."

    Not only do I not see the connection with the above and the discussion on this thread, but I disagree with several points Bernstein makes:

    1] How in the world does he conclude that since many farmer's financial survival depend on commodity markets, this means that speculators make money over the long run?
    Commodity markets are zero sum games (unless hedging) and some would argue negative sum (including commissions/spreads/slippage)

    2] The 'phenomenon' that he describes as backwardation is actually just a market condition where spot rates exceed forward rates. Contango is the opposite condition where forward rates exceed spot rates.

    This phenomenon has nothing to do with "the producer's loss aversion" or volatility but it is based on what players in the market believe will happen in the future in terms of supply and demand

    3] Both players in the commodity markets are loss averse, not as Bernstein states, the producers. Or am I missing something? Haven't yet met a speculator who just loves to bleed his account. The speculator does not have any advantage just as the farmer has none. The producer is simply transfering risk to the speculator.

    Is it just me or is Bernstein out to lunch on this simple example?
  10. I would think you are right the market needs to eventually have a trend. This was the case except for the S&P's. When random entry was being test with coin flips on the futures markets the only underlying was the S&P's that wouldn't work. The Currencies though had some of the best success rates which are some of the best trending markets around. This was quite a few years ago and might have changed now the S&P's have finally stopped their Long trend.

    The stops much be far enough away to not be affected by normal market noise and commissions had to be reasonable. (which is pretty much the case with the internet now) compared to $5000 a roundturn.

    I'm not sure how Berstein's script is true or not. One reason I got out of futures was the producers were no longer hedging but trading instead. They have some of the best inside market knowledge and finally started to use it to their advantage.

    #10     Jul 1, 2001