Quantifying Setup/Entry Quality

Discussion in 'Strategy Building' started by Talas, Jan 6, 2006.

  1. Talas


    Although I've been investing longer, I've only been working towards trading for a few months. I've read everything I could get my hands on.

    I'm now to the hard point of putting a system together. I'm working on quantifying the quality of the setup/entry that I've indentified and delaying, for the time being, the work on various exits. To this end, I'm using a fixed % stop loss from the entry point along with a fixed exit at close after X days (no position sizing or rather fixed $ position size).

    I'm curious what method more experienced, successful traders prefer to use to evaluate the quality of their setup/entry ?

    Any input is appreciated.

    - Talas
  2. Of all the various kinds of stops, percentage stops make the least sense to me. I prefer to target s/r or trail a stop if it looks like a strong trend. I guess these are a bit harder to codify, tho.
  3. torel


    quick and dirty idea: apply the best possible exit point for each entry point and take the sharpe ratio of the trades as a quality metric for the entry strategy.

    If you define a constant timeout for the exit, then the best exit point is the highest price after the entry point and before the timeout. So for this test, you have to peak in the future.

    However, this method doesn't necessarily yield to the optimal entry strategy, but it can be used as a first level entry startegy selector.
  4. Did you create your strategy using one set of data and then 'walk forward' test it on another set? This is the method used by many to test systematized entry ideas. If you did so, what was the win/loss ratio and average win/loss?

    You have said you want to 'quantify the quality' of you entry setup. I intepret this to mean that you want to know if your entry strategy is any good, as opposed to meaning that you want to figure out what kind of trades this systems is getting you into, i.e. what is the 'price movement profile' of the instrument for which a trade is triggered at the moment the signal is given. 'Quantify the quality' might mean that you want to measure (quantify) the 'trendiness or rangebound-ness' of the stock, or perhaps the recent volatility, or some other parameter (quality).

    If you could give us a little more information, you will probably get some help.
  5. torel is correct, you can use the Sharpe ratio to give you an indication of the tradeability of the system. A higher Share ratio means that the system will provide returns with smaller swings up and down in your account. Lower Sharpe ratio systems can be traded if you have the stomach and the bankroll necessary for it.

  6. Talas


    Thanks guys. I'm grateful for any input.

    Allow me to clarify, how do you decide if your setup/entry criteria is 'good enough' to warrant further development or whether it needs futher refinement or even discarding ?

    Correct. I'm backtesting on stocks. I guess the system would fall under a volitility breakout system (long side only currently). I picked my development data set to cover 1H02 since I wanted something that would perform acceptably under mediocre market conditions. I've then tested it on 'out of sample' data sets, as you mentioned, to see how it performed in other market condions.

    Time |  W%/L%   | AvgW$/AvgL$
    1H02 |  40/60   |     1.7
    2H02 |  33/66   |     2.0
    1H03 |  50/50   |     1.8
    2H03 |  45/55   |     1.8
    I don't recall exactly but the W%/L% was slightly higher without the 10% stop loss, as would be expected. I had added it as a money management stop since I knew I couldn't handle losing more than 10% of a position using % allocation, but perhaps I need to leave the stop loss off until after I do position sizing using % risk?

    Being that this is my first foray into trading and my first system, I'm struggling with whether to work on the setup more or to start focusing on exits and position sizing... which is why I'm curious as to how those who are successful make the decision.

    - Talas
  7. sharpe ratio is not very useful.
    search for earlier posts on this.