Home > General Topics > Trading > What constitutes edge / why is my system working?

What constitutes edge / why is my system working?

  1. Some background: I am no quant PhD, and certainly no hedge fund guy. I am just an engineer with decent programming skill.

    I have spent a small part of the last 2 years developing and building a pretty simple intra-day trend-following system (fully automated) focussed on currencies. No fancy indicators, just signals based of when price exceeds a simple moving average. After a bunch of backtesting and paper trading, I'm seeing that it actually makes good return and I just started live trading with it.

    BT results: Sharpe > 1.7, with tight stop losses.

    While I was happy, I was also quite suspicious to see this working as well. Can someone help me intuit how such systems work?
    • What are the market forces making this system work?
    • Is this effectively taking money from less sophisticated traders? Or, am I riding the wave with smart money who just don't mind taking smaller losses which are actually quite meaningful for retail traders?
    • Why haven't hedge funds/smarter people arbitraged or sucked the alpha out of my system?
    • I've read Ernest Chan's books and it seems that this might be related to 'capacity' but I am still not sure why it is actually working.
    Thanks in advance.
  2. reminds, me a question someone posted on one Russian forum: How to proof to myself that my wife is not a whore? :)
  3. Why not go on Chan's blog and ask them?
  4. So, what's the bottom line ...throw some return percentages out there -- alot of people talk a big game, but they only generate matching market returns at best in a good year... when it's all said and done from their big scientific smart-sounding presentation.

    My fart has more depth and complexity and rewards than some people.
  5. Sharpe 1.7 - returning 100% a year for the last 2 years when trending (it is a trend follower, after all). Around 30% prior to that when the assets I was trading was not trending.

    RE: asking on the blog, I would, but was hoping some of the intraday/retail traders here (clearly there are many successful ones) who would offer some perspective.
  6. How much time have you been live trading?
    How many live trades have you done so far?
    Backtesting results is a good start but finding a profitable system is a long journey that can be painful.
  7. I started with FX about 5 years ago, mostly hand trading, breaking even and going nowhere.

    With this system, I paper traded for the last year on a demo account, and started live trading recently when my paper trading results were pretty darn close to my backtest outcomes.
  8. Ok.
    Backtesting is one thing.
    Paper trading is another thing.
    Real money trading is the real deal.
    The first 2 don't guarantee that you'll make money with real trading.
    After a year or so of real trading, you might re-ask yourself your original questions, if you still make consistent money. For now IMO, I think it's too soon to conclude on your system capacity to make money.
    For now, enjoy (while it lasts!) and hoping for you that in 1 year you'll still be as glad as today.
    Best of luck!
  9. Alright fair. Thanks and looking forward to the next year!

    In case it works, I'll still have the same questions, i.e where is the money coming from amidst other things :)

  10. Taxonomy of Trader Types via Harris is a well-defined universe of traders.


    This chart is missing the updated classification of ‘Futule Traders’ which is most likely who’s trades you are deriving your profits from.
  11. what do you call "works"?- generates profits so far? so what?..

    tomorrow it may stop.. that is your concern? :)

    what works - works always ...and anywhere... but not necessarily for anyone, since skills are required too, and balls, and money.. and luck...

    you intuitively understand that... you want confirmation that it will be working.. :) like that guy with the wife :)

    market forces do not make system to work or not to work,

    it's ideas (or coincidence) that it based on make it work (again what is definition of working)

    it depends

    if u trade Forex it means you take money from your brokers pocket (unless you hold overnight and he is hedging his total overnight exposure )

    if we talking stocks on exchange then you buy from one guy and sell to another -

    you are not taking money from one particular person when you win, you take it form the market)

    there are no smart money, all of them are stupid

    and who cares whose money you taking

    i guess your question is more : how they allow me to take it...? :)

    well if it the broker - soon he will finish your happines

    if its the stock market then it depends of how long your luck (and we both know that this is mostly just luck) will run

    nobody cares about you or your system, they even do not know you exist

    we ( retail traders) are just like worms underground.. elephants do not even know we are there..

    fuck Ernest Chan
  12. whoa
  13. Can you elaborate on this?
  14. well in forex most brokers give you quotes, playing the the role of the marketmaker,

    since there is no exchange similar to stock where brokers will rout your order (we are not talking about interbank) the broker is maintaining the market for the trader

    when you win you win from the broker , when you loose you loose to him
  15. Is that true? They are a market maker for a reason: the spread.
  16. %%
    Dont know; but some markets trend well, may or may not apply to you. As far as why markets trend... books have been written on that+some birds fly north in spring; south in winter. Some do not:caution:
  17. The spread is motivation but not a reason :), there reason is that there is just not anything else they can do with orders just to feel them ( or not:) )

    Overall spread is pinuts, most money are made on public's inability to successfully trade therefore client's money go into brokers pocket....
  18. Not knowing anything about your system or how you developed it, I can only issue the blanket warning that it's really easy to curve fit given enough parameters. The more trades your system produces, the greater the chance that the results will hold.

  19. Noooooooooo, noooooooo
    ... this really isn't quite right. Occasionally true, arguably (some might say "very arguably"), but certainly not at all representative of the counterparty market-making world of "spot forex brokerages": characteristically, representatively, they're in business to fleece their typically undercapitalized, typically relatively ill-informed, typically naive, typically gullible victims ... excuse me - of course I meant to say "customers" ... who typically have wildly unrealistic expectations of what they can achieve and within what kind of timeframe, combined with (you guessed it: "typically") a somewhat distorted perspective of what a "broker" is.
  20. Interesting. You guys are so negative about brokers. So what makes you think they do this? Ideally, they want clients who don't lose all their money.

  21. The guys may be - I'm not.

    I'm negative about counterparty market-makers who pretend to be brokers, many of whose clients really don't understand that when they "trade" against them, they're not dealing with someone who acts on their behalf in a market to which they don't, themselves, have access, but simply having a side-bet against a counterparty who holds their deposited funds, makes up their own prices for their own "products", and also makes up and interprets all the rules governing the transactions.

    Many are expert marketers, not expert brokers. They know exactly how to attract the type of customer they want.

    I'm not denying that there are some good, ethical, honest, well-regulated ones, too ... but those are actually comparatively few and far-between and the picture I'm describing is in reality far more characteristic of the industry in general.

    My knowledge and experience of the industry over the last decade or so, and a bunch of colleagues and friends who have considerably more knowledge and experience than I've had, directly, myself.
  22. I can see that for sure and so should be accounted for in your trading plans. OK, so who is reputable in the Forex market from your perspective?

  23. Interactive Brokers, for sure (but they're a genuine broker, not a counterparty market-maker, and these days they're not effectively available to all, either).

    As far as counterparty "brokers" go, everyone has their own opinion, based sometimes on their own experiences, and sometimes on what they've heard from others they trust and believe, and sometimes from other third-party participants in the industry.

    My own opinion is that it's really pretty difficult, overall, to do better than Oanda: it's true that their spreads aren't quite the best in the world (though they're certainly not terrible, either) and that those spreads perhaps aren't always quite as competitive now as they were 5 years ago, but Oanda seem ethical and honest, efficient and reliable, and they're about as well regulated as you can get. For myself, if going back to a spot forex counterparty market-maker brokerage, I'd probably look no further. Just my perspective.
  24. Sweet, those are my two top choices as well! I use IB though.

  25. I don't actually trade spot forex (or trade "retail") any more, but I used to use IB. None of what I'm describing as "pretty typical of the industry" applies to them at all. My only minor, intermittent problem with them was that I found their customer service very variable (that wasn't why I left them.)

    Before that, I happily used Oanda.
  26. Can one get access to institutional aggregator venues via guys like IB?
  27. Chan the man. How dare you besmirch his good name? Just kidding :)

    On a serious note though, when you say works always, I’m hoping you don’t mean “in the black” everyday. What is your definition of always?
  28. Curious, what was the size of your account at Oanda if you don't mind sharing? Overall, agree with your Oanda assessment.

    Arguably I haven't traded any meaningful account size for them to trade against me, but I've been impressed with what I've seen over the last 5 years or so - I've been able to double/triple my micro-lot account with some hand trading. With this new set of systems, I might actually scale in further with Oanda.
  29. Most big fx players are high-net worth individuals, governments, big insurance and financial institutions, sovereign wealth funds, hedge funds and global international companies like Samsung, Apple or Nike. They all use prime fx brokers e.g. Nomura, UBS, Goldman Sachs to hedge currency risks and speculate on forex movements. If you are big enough and have an account with these brokers, they don't really trade against you. They make money on volume spreads. They have an inner bank system connecting to each others and other deep liquid providers and banks. When you trade on their system, they simply wire your orders to match with other players in their system.

    If you are a small retailed trader with a retailed fx broker, most likely your brokers will trade against you. Trading in any form has risk. No one like risk. Even the small retailed brokers. They would rather make money on volume than trading against you. But they don't have choices. There is no enough money to be made on small volume with small retailed traders. If you trade several million dollars a day, even these small brokers most likely send your orders directly to their liquid providers to be filled. They would rather make money on commissions than trading against you.
  30. Beware these days simple systems simply do do not produce profits over a large number of trades.
  31. Sell dear and buy cheap. If such an edge exist, all algo traders are millionaires.
    It so hard to know the market.
  32. That's what I would expect as well, again, knowing nothing about the OP's system. My reasoning is that if it's something that can be simply coded up in NinjaTrader or some other common retail platform in a few hundred lines of code, then someone has probably already found the edge. So if you're a software engineer, I'd start by looking at strategies that are very difficult if not impossible to implement in common retail platforms. For example, I don't know of a single "money flow" or net exposure indicator that exists for a retail platform that merges option market data with underlying data.
  33. Inter trader brokers have a great ad about making your trades in the real market and only making money if the client makes money.
    Haven't tried it yet but it sounds promising.

  34. I originally started off there with a $3,000 account, after spending a very long time on a demo account first (their "FxTrade Practice" one). And gradually grew my account over the years until it was worth my while switching to IB and paying commissions instead of spreads.

    No reason you shouldn't, I'm sure. My own reading of Oanda is that they're super-efficient and automated at laying off their own net liabilities in the underlying market, however they do that, so they don't really care which clients win and lose.

    There's also some independently published research (of audited broker accounts) showing that they hold a higher proportion of profitable customers' accounts than other brokerages.

    Good luck!
  35. Why are there casinos,slot machines,cam girls etc etc etc.Gamblers/basic human needs/foolishness are always there.They farm the weak and there will always be replacements for those exhausted of their funds.
  36. I think this is fair, but I'd doubt that that is actually the primary intent of the brokers, i.e Oanda - to make money of the weak.

    Simple calculation: If there are 100 traders in world. Let's say 90% of them are unprofitable and have $10k accounts. And 10% of them are very profitable, making 50% y/y on average.

    Revenue from unprofitable traders with $10k account sizes: Assume they win atleast 50% of their original money into Oanda's pockets in a year: 90*0.5*10k = $450k per year.

    Spread Revenue from profitable traders making 200 trades a year on $100k account sizes (assume the profitable traders will stick with the platform for atleast 5 years, average spread revenue of 1.5 pips per trade):

    $100,000 * 0.015 pips * 200 trades/year * 5 years * 10 accounts = $15m dollars over 5 years, or $3m dollars per year.

    Sure, this is a broken calculation with lots of assumptions. But if I were Oanda, I'd be stupid to be betting my business on primarily trading against unsophisticated accounts.
  37. Yep, I would say it is in the broker's best interests to actually make sure that their customers are all profitable if possible. Is that even mathematically possible? I doubt it.
  38. Yes, there will always be more losers than winners. And by nature of hedging their market risk, any good broker will pocket the money from the losers. This makes people pissed off.
  39. You ask more than one questions, the questions are harder than the answers. What makes you car move and then move faster? "Power" or more gasoline to engine or as simple as pressing gas pedal. Markets move on volume or Chan's "capacity. Most hedge funds and HFTs actually trade with the trend, there trend definitions might be different than the masses. Couple hundred contracts might seem like much to retail but really small water drop at exchanges. You can only control entry and most of the time exits, unless you been playing the game a decade, stay with the trend, learn to breakdown completions of swing movement to get better idea when swing is coming to an end then stop taking signals deep into trend, Learn to spot ends of trend so you take profit at these spots and less intraday drawdowns.

    You might be getting in just before volume coming in. Only way to tighten risk is buying lower and selling higher, or going for less profits.

    I prefer to trade currency futures, but use Onada as backup, more important for me to be able to call desk than be on hold 20 minutes with IB
  40. The choice of broker is obviously a matter of great importance.

    Your having mentioned IB as an ok non-counterparty broker in a number of your posts should be valuable information to a number of ET members.
  41. You mention that it's automated and that the wins are super small or something. Maybe it's because it's the discipline (that the automated system forces upon you) of taking a small profit and then staying out until the next "good" entry appears from the system? Perhaps if you were to cast a wider net and increase the profit-taking point, it might not work? Just guessing around here... I don't think anyone can really give you a "for sure" answer.
  42. What is the P&L per trade value? I think in a lot of cases, people make unrealistic assumptions about their transaction costs (slippage, adverse fills, commissions) and that really eats into the results.

    PS. In this business, when something is too good to be true, it usually is. So before asking "why does this work?" first question should be "what could I be doing wrong?". Most of the time if you think about it, you will discover that either an assumption you made is incorrect or you have a problem in your backtest and/or paper-trading. Sometimes, you discover that it works in real life but you have chunky drawdowns (i.e. you were selling risk asymmetry in one or another form). Sometimes you discover that the strategy does not scale at all (it's nice to make a grand a month, but is it worth the hassle?). Then, finally, there is a chance that you have stumbled onto something that works.
  43. Question: What questions should OP ask if going live continues to get great results but OP still does not know why it works?
  44. ironchef...dude...*sighs*

  45. Nonsense, there are repeatable patterns/occurences all over markets.
  46. Well, it could be just an artifact of the bull market since 2009?o_O

    Maybe you and sle can give us some guidances on how to separate luck from skills. One can easily be delusional.

  47. You are an engineer, so you should understand this:

    As a small non professional retail trader, my opinion is for a normally distributed function (approximation of stock price change) noise is a function of the square root of time whereas mean can be any function of time (or an exponential function of time in a bubble) so your sharpe ration of 1.7 may not be that impressive. SPY Sharpe in 2017 is 3.5 and since 2013 is 1.6, if your BT is for 5 year, you just mimic the market on a risk adjusted basis, sorry, not that impressive.

  48. It's less about delusion and more about things like statistical significance (primarily) and then frictions, asymmetry, excess free parameters (secondarily) etc. Since I know nothing about the strategy, it's hard for me to say what to do exactly. For starters, try to understand if you have a strong directional bias - e.g. if you always been trading long. If so, adding a simple dual population test will answer your question, or, as an alternative (if you are trading something other than index), you can re-test your strategy as market neutral. That would be a start.

    PS. We, as humans, are not built to perceive statistical significance, that would be an evolutionary drawback. So bad it is that our Commander in Chief is readily confusing a single day observation with a long term trend.
  49. It was just a funny on the way you typed that line. Reminded me of that movie scene.
  50. Yes, so in the short term it seems that SPY can beat this system, especially given recent year's gains. But the 10yr SPY Sharpe is 0.38 and mine is around 1 which seems to suggest it might be profitable in the long term. The 2 yr rolling Sharpe for my BT varies between 0.9 and 1.7. There is one particularly nasty drawdown of 35% in the 10 year backtest. But hey, no risk no reward? Attached equity curve over 10 years.
  51. LMAO! I'm a "parasitic trader"!!!
  52. I think your 35% drawdown is the key. It's one thing on a backtest where you see the P&L curve come back up a few weeks/months later. It's one thing on a 10k gambling money account. Now imagine you have all your life savings there. Can you wear 35% and not stop your system / change its parameters? My guess is most of us will panic and get out at the low point.

    So my advice would be - think about how much you are comfortable losing, divide that number by 2 and solve for your system max historical drawdown before trading - because trust me, your actual max drawdown will be closer to 2x the historical one!

    On a brighter note - these drawdowns are the reason no institutional money can follow these strategies, and why they're viable for retail investors / not arbitraged away. Good luck!
  53. Great advice. At this point, I'm starting small. Very small. $100 on my live trading account, primarily to make sure that the trade structure/entries/exits/winrates and other metrics stack up close to the backtest. I don't expect them to match 100%, but I'm looking for atleast a 95% confirmation which would give me the confidence to add to the account. Above that, good point on the emotional side of that loss - losing 35% of x is different for different people, and I'll need to figure out where I put that x.

    Here's to a brilliant 2018 of learning, and maybe profit!
  54. Very impressive returns. The 10 yr SPY had a worst drawdown than yours. You may have discovered an excellent system.

    Good luck.
  55. Hello qxr1011,

    Can you please elaborate why you say F Ernest Chan? Is he not well respected teacher in the automated trading arena?