Strategy Trading (In Four Parts)

SESSION 2

© 2012 Sunny J. Harris ALL RIGHTS RESERVED

Designing Your Strategy (or Evaluating Someone Else’s)

About Sunny Harris

• Trader for 30+ years

• BA, MS, PhD Mathematics

• Author of: – TradeStation Made Easy!

– Trading 101—How to Trade Like a Pro

– Trading 102—Getting Down to Business

– Electronic Day Trading 101

– Getting Started in Trading

• Working on Grading the Gurus

• See the Introduction in Session 1 for

more in-depth info

Designing Your Strategy

• or Evaluating Someone Else’s

• The BackTesting Engine

• What Is Possible?

• Can I Really Make That Much?

• Buying & Selling

• The Strategy Performance Report

Evaluating Someone Else’s

• Performance Statistics

• Testing by Thirds

• Optimizing

• Comfort Zones

• Log (or Lab) Book

• CPC Index

• Compare to Ideal PHW Indicator dots

Evaluating

• Doesn’t matter if it is Yours or

Someone Else’s

• The process is the same

Performance Summary Report

Solar_1 SP M7-15 min 04/16/97 - 05/14/97

Performance Summary: All Trades

Total net profit $ 22,200.00 Open position P/L $ 0.00

Gross profit $ 35,600.00 Gross loss $-13,400.00

Total # of trade 12 Percent profitable 50%

Number winning trades 6 Number losing trades 6

Largest winning trade $ 13750.00 Largest losing trade $ -3400.00

Average winning trade $ 5933.33 Average losing trade $ -2233.33

Ratio avg win/avg loss 2.66 Avg trade(win & loss) $ 1850.00

Max consec. winners 3 Max consec. losers 2

Avg # bars in winners 57 Avg # bars in losers 9

Max intraday drawdown $ -5700.00

Profit factor 2.66 Max # contracts held 1

Account size required $ 5700.00 Return on account 389%

Sunny’s CPC Index

• CPC Index =

Profit Factor *

Percent Profitable *

Ratio

• A “safe” system would have a CPC

Index >= 1.2

• Example from above SPR:

– CPC = 2.66 * 50% * 2.66 = 2.66

Measures of Risk

• Largest Winning Trade

• Largest Losing Trade

• Maximum Drawdown

• Time to Recovery

Drawdown

• High Water Marks

The BackTesting Engine

• BackTesting Assumptions

• LIBB: Look Inside Bar Backtesting

BackTesting Engine

BackTesting Engine

• Setting up an Optimization

Setting Up an Optimization

Setting Up an Optimization

Setting Up an Optimization

Setting Up an Optimization

Setting Up an Optimization

Setting Up an Optimization

• Set Final Value before Starting Value

Setting Up an Optimization

Setting Up an Optimization

Save the Optimization

• So it won’t disappear

• For use with Spreadsheet

• To find Comfort Zones

• Alligators and Islands

• As input to your LogBook

Thoroughness

• Can’t just try one dataset and one gigantic

optimization and that’s done

• No personal computer is large enough or

powerful enough to conduct millions of tests

• Doesn’t guarantee it will work in the future if

you have curve-fit the experiment

Testing By Thirds

• Conduct all tests on the middle third

• If it’s more data (farther back) still divide it

into thirds.

Testing by Thirds

• Once you find a RANGE of acceptable

results…

• Then, and only then, test the FIRST

third with those ranges of parameters,

• Then, apply those same ranges to the

LAST third of the data

• It seems tedious, but it is ESSENTIAL

• Applying your parameters to the LAST

third of the data is called FORWARD

testing

• Another way to forward test is…

Testing by Thirds

• Trade the system in real-time

• Or paper-trade (keep records) of how

the system works in real-time

• Wait 6 months and then test that

period with the identical parameters

Judicious Choice of Experiments

• Let’s say you have a system with

these input parameters, below

• (In fact, if you read

, by me, you will see this system

in the appendix)

• INPUTS: DATE1(960101),DATE2(1111231),Length1(3),Length

2(13), Leng(9), RSIleng(9),ADXswt(0), RSIswt(0),

jRSIOB(75), jRSIOS(25), xHR(180), yHR(60),

Dollars(100), LossL(100), LossS(100);

• There are 15 parameters in the input

list

Judicious Choice of Experiments

• To run an exhaustive test of these inputs,

using only 15 choices for each variable…

• We would have to run 15 quadrillion tests

• 15*15*15*15 … *15*15

• Is 1515

So what do we do?

• Take the most important input parameters

first

• Run an exhaustive test on those to find

acceptable ranges first

• Then try the next most important

parameters with only the range you found in

the first experiment

• And so on

• Or…

Genetic Testing

• Let MultiCharts make the decision of

what to test by checking the Genetic

Testing box

The first inputs

• Look at the inputs again • INPUTS:

DATE1(960101),DATE2(1111231),Length1(3),Length

2(13), Leng(9), RSIleng(9),ADXswt(0), RSIswt(0),

jRSIOB(75), jRSIOS(25), xHR(180), yHR(60),

Dollars(100), LossL(100), LossS(100);

• Date1 and Date2 are important

• They are for dividing tests into thirds

• It’s easier than changing the date

range of the symbol again and again

Tricks of the Trade

• In writing my next book ( ) I

recently bought a guru’s $500 system

• It was advertised to make something like

$10,000 in the last 4 months trading the

emini.

• Sounds great! Right?

• Wrong

• Here’s why…

Tricks of the Trade

• Here is the equity chart for the last 4

months:

• Looks pretty good!

Tricks of the Trade

• Here is the equity chart for the past 6

months:

Tricks of the Trade

• Here is the equity chart for the past

1 year:

Tricks of the Trade

• Here is the equity chart for the past 5

years:

Psychology Comes In

• Would you be able to trade a system

that made no money for 2 ½ years on end?

How About This Instead?

With This Kind of Equity Curve

Psychology

• A smooth equity curve makes the

psychology much easier to take

• Lee Gettes says, “If you have a losing

system, no amount of psychology will

help.” But when you have a winning

system, psychology becomes 100% of

the game.” (paraphrased).

Here’s Another Trick

• Many systems designers tout 80-90%

correct systems

• That is, systems where 80-90% of the

trades are winners.

• Designs like that are usually achieved

with very few trades, like 3-10, or with

systems that have very small wins

– For instance, see next slide

Here’s Another Trick

Looks Great! $500,000 profit.

Here’s Another Trick

Here’s Another Trick

How Much Is Enough?

• How Do You Know Whether Your Test

Generates Enough Profit?

• What is Possible?

• Should your chart generate $50,000 or

$100,000 or $500,000?

How Much Is Enough?

• That problem always perplexed me

• Until

• I invented an indicator to tell me

• On any chart, any time frame, any

symbol

• I call it PHW (for Potential Hourly

Wage)

• Here’s how it looks:

PHW Indicator at 0.01

How Much Is Enough?

• This is one of the most important

indicators in all of my work

• For 2 reasons

1. How Much Is Enough?

2. Does My System Match the Dots?

PHW Indicator at 0.02

Avoiding Curve-Fitting

• According to Ralph Vince

• “Optimizing is not the problem, over-

optimizing is.”

• When testing, as I said before

– Test only on the middle third of the data

– THEN, save the Optimization Report to

a spreadsheet

Saving the Optimization Report

Save Strategy

Optimization Report

Saving the Optimization Report

3-D Optimization Chart

• 3-D Optimization Chart

Opening the Saved Data

• From MS Excel

– File g Open

– Locate saved Report

– Open

– Accept delimited data

Sorting the Optimized Data

• Sort by Highest Net Profit

Sort the Optimized Data

• Sort the spreadsheet by Net Profit

Highlight Best 10% or so

Sorting the Optimization

• Then RE-SORT by the parameters

• i.e. Length1, Length2, Length3

• Look for thick yellow zones

• Should look like this:

Thick Yellow Zones

I call this:

• Looking for Islands

• And

• Alligators

• Let’s go back one slide and look again

Thick Yellow Zones

• Now highlight the center of each thick

zone with orange.

• You will want to keep your trading

parameters within the orange zone.

• That way, even if you’re a bit wrong

with your parameters, you’ll still be in

a zone of profit.

Orange Zone of Comfort

Marking Comfort Zones

• This is the Short Version

• Go to www.moneymentor.com, click

on Instructional Materials, click on

“Haps and Hazards of BackTesting” to

view a comprehensive slide show.

• This should be a 3-4 hour lesson

• I’m happy to teach you

How Much Is Enough?

• How Do You Know Whether Your Test

Generates Enough Profit?

• What is Possible?

• Should your chart generate $500,

$5,000, $50,000 or $100,000 or

$500,000?

• You better know this before you begin

• Don’t just trade something because

you “feel like it”

What Is Possible?

• IF You Don’t Have a Goal, You Won’t

Get There

• Turning Points

• ZigZag

• PHW Indicator

• CPC Index

Marking Turning Points

Highs and Lows

Fibonacci Retracements

Pivot Points

ZigZags

PHW

Can I Really Make That Much?

• Slippage

• Commission

• Whipsaw

– What is it?

– Ways to Avoid Whipsaw

• Linear Regression Lines

– Slope

– Angle

Strategy Properties

Commission & Slippage

Ways to Avoid Whipsaw

• Impose Filters

• Don’t take the system’s trade unless

Filter is True

• For instance:

– ADX Rising

– RSI not overbought or oversold

– RSI overbought or oversold

– Linear Regression Line NOT Flat

Looks like this, in Pseudo Code

• IF MACD > XAverage

• AND

• ADX rising

• THEN take trade

• Of course this means that if ADX is

not rising, you will NOT take the trade

Or it could look like this:

• IF MACD > XAverage

• AND

• AbsValue(LinRegLine) > 2.0

• THEN take trade

Buying & Selling

• Buy and Sell Statements

• Exit at End of Day

– “BuyMonday” by Joe Krutsinger

– Exit at 1258 instead of End of Day

• Trading at the Market

Buying & Selling

• Buy("Support") 5 contracts next bar at

Low Limit;

• Buy to Cover ("Profit") 10 contracts

next bar at MidPrice stop;

• Sell Short("BreakOut") 500 Shares

next bar MidPrice or Lower;

• Sell ("Profit") 10 contracts next bar at

MidPrice stop;

Joe Krutsinger BuyMonday

• //Joe Krutsinger BuyMonday

• inputs:Da(5) , Amount(500) ;

• If DayOfWeek(Date)=Da then Buy

Next Bar At Market;

• SetExitOnClose;

• SetStopLoss( Amount ) ;

Better, Safer Exit

• Instead of SetExitOnClose

• Use the time of your market less a few

minutes

• For instance:

IF Time > 1257 THEN BEGIN

IF MarketPosition = 1 THEN Sell ;

IF MarketPosition = -1 THEN Buy to

Cover;

END;

Strategy Performance Report

• Important Statistics

• Essential Statistics

• Key Tabs Under the Report

• Charts in the Performance Report

• Saving the Report to a Spreadsheet

Strategy Performance Report

Performance Report Stats

These Numbers Calculate CPC

• Remember that

• CPC Index =

• Profit Factor * Percentage * Ratio

• Must be > 1.2 to feel safe

Perf Report: Equity Curve Detailed

Perf Report:

Perf report: VAMI

Your LabBook

• Keep it Diligently

Your Trades Log

Upcoming

• Session Three will be more about

Testing and Optimizing Your Strategy,

or one you invent, buy, beg, borrow or

read about

Prices Are Rising

• Price Increase Effective 3/1/2012

• If you mention that you attended this

Webinar, you can have 50% off all my

products (except books)

Keep In Touch

• Sunny J. Harris

• 1547 Mission Meadows Dr.,

Oceanside, CA 92057

• www.moneymentor.com

• sunnyharris@moneymentor.com

• (760) 908-3070

• Skype: (760) 444-4174

• Fax: (760) 859-3057