Random Entry & Perception

[DionysusToast]

I thought this was worthy of it's own thread.

The following is a passage from Van Tharps' trade your way to financial freedom. Read it with an open mind before proceeding....

He promptly returned to his office and tested his own system of exits and position sizing with a “coin flip”-type entry. In other words, his system simulated trading four different markets and he was always in the market, either long or short, based upon a random signal. As soon as he got an exit signal, he’d reenter the market again based upon the random signal. Tom’s results showed that he made money consistently, even using $100 per contract for slippage and commissions.

We subsequently duplicated those results with more markets.

I published them in one of my newsletters and gave several talks on them. Our system was very simple. We determined the volatility of the market by a 10-day exponential moving average of the average true range. Our initial stop was three times that volatility reading. Once entry occurred by a coin flip, the same three-times-volatility stop was trailed from the close. However, the stop could only move in our favor. Thus, the stop moved closer whenever the markets moved in our favor or whenever volatility shrank. We also used a 1 percent risk model for our position-sizing system, as described in Chapter 12.

That’s it! That’s all there was to the system- a random entry, plus a trailing stop that was three times the volatility, plus a 1 percent risk algorithm to size positions. We ran it on 10 markets. And it was always in each market, either long or short, depending upon a coin flip. It’s a good illustration of how simplicity works in system development. Whenever you run a random entry system, you get different results. This system made money on 80 percent of the runs when it only traded one contract per futures market. It made money 100 percent of the time when a simple 1 percent risk money management system was added. That’s pretty impressive. The system had a reliability level of 38 percent, which is about average for a trend following system.

Before we dig in to this - would any brave soul like to say what it is they get from this passage ?

For instance :
Did you learn anything ?
Is there anything you now believe that you did not believe before ?
Has this re-affirmed any opinions/beliefs you previously held ?

I am interested to hear the different perspectives people have based on this passage, if you decide to join in, then I think there are lessons to be learnt. Of course, many people will see this as a 'trap' and not want to join in for the fear of being ridiculed.

Rest assured, this is not the intent. I do believe that there is a very important lesson for traders in there, which will be clear, especially if we have some diversity in the opinion.

 

[montmorencyt2w]

I am finding it a bit hard to reconcile his percentages.

For example, what does:

"The system had a reliability level of 38 percent, which is about average for a trend following system. "

mean?

 

[PualoP]

I am finding it a bit hard to reconcile his percentages.

For example, what does:

"The system had a reliability level of 38 percent, which is about average for a trend following system. "

mean?

38% percent of his trades were winners

 

[montmorencyt2w]

So 38% was the overall success rate, and 80% and 100% were the success rates when those particular limitations were applied?

 

[nkingy2003]

Is this actually a system that he recommends people to try or is it just an example so show people how simple winning systems can be?

 

[DionysusToast]

Nkingy...

The following came before the above passage, so will help to put it into context :

Tom was explaining that.the most important part of his system was his exits and his position-sizing algorithms. As a result, one member of the audience remarked, “From what you are saying it sounds like you could make money consistently with a random entry as long as you have good exits and size your positions intelligently.”
Tom responded that he probably could.

So - we have a paragraph where a claim is made that a random entry could be used as long as trade management/position size was handled properly. This is followed by the paragraph in the OP that explains how it was tested.

They are not selling this system. It is just part of a trading book.

 

[nkingy2003]

Yea I am familiar with Van Tharp's book however I haven't read it. Its said a lot that the most important thing in trading is money/trade management.

It would be interesting to see what the results would be like following a totally random entry system like this.

 

[robster970]

When I was participating in the futures skype room with Gladys, a chap called Hunter and I tried this. I would toss a coin, make a call long or short and he would enter and take a well timed exit with either a scratched trade or a small profit.

We concluded that the direction was irrelevant but what was important was the timing of the entry and exit as essentially under short timescales, price movement was mainly noise and largely behaving as stochastic process and likely to be reverting to a mean.

Conclusion I drew was the following which ironically took me a little longer to incorporate into my longer term trading methods:

1) Directional calls are only important if you are looking at mkt as a weighing machine rather than voting machine.

2) Entry timing is only important to mitigate risk at entry.

3) MM and Exit ultimately determines whether you are profitable or not.

Entry = risk. Exit/MM = profit/loss.

 

[Splitlink]

I do not dispute these claims. Whether ordinary traders can, or would be willing to, dedicate the time to it, let alone the money, is doubtful. How much would a trader be prepared to set aside for such an experiment, anyway?

Would a coin tossing experiment work in a full-blown trend? My argument for entry being random is based on not being sure where to enter, but my direction would be clear to me ie. I would go with the trend.

 

[MrGecko]

Happy to be ridiculed so here goes:

* I take from this the fact that in the short term dt, trends exist (i.e. non-zero drift rate).

* However, in the limit dt → ∞ I expect this series to sum to nil **

* I do not see any causation between coin toss result and trade profitability

** NB: lognormal distribution exception and transaction costs excluded

The auther may be trying to make "holistic" points about trading strategies (for example KISS) but I do not believe they are pertinent to this discussion.

 

[Black Swan]

Why the "fear of ridicule" statement? Takes ten mintues to teach any monkey an entry that'll *work* (be in profit temporarily/quickly) 7/8 trades out of ten...MM and the discipline to stick to an edge, day after day, month after month in order to build an income is the hard bit...The random entry debate has been done to death and proven time after time...

 

[MrGecko]

We concluded that the direction was irrelevant but what was important was the timing of the entry and exit

This is an interesting point. A coin-tossing strategy could work if is was deployed in times where there was likely to be a significant "trend/drift rate"... this is the basis of breakout trades.

 

[Black Swan]

Chuck LeBeau, 57, and David Lucas, 50 tested every technical indicator under the sun during their seven-year partnership and came to a disturbing conclusion: Most are no better than flipping a coin.

"We tested how effective the market entry is to exit after n-days and see what percentage of the time we were on the correct side," Lucas says. "Its amazing how few technical studies, pattern recognition or whatever you want to use are actually better than random. If you can get over 55% after five days, 50% after 10 days, youre doing remarkably well."

Lucas got a bachelors degree from Central Connecticut State University in New Britain, Conn., and studied biological statistics at the State University of New York at Binghamton, N.Y. After safeguarding missile silos in North Dakota for the U.S. Air Force from 1966 to 1970, he started as a computer programmer at Signa Insurance in Hartford, Conn.

"After a while, unless youre a real computer junkie, it gets old," says Lucas, who joined E.F. Hutton in Long Beach in 1984. "I wanted to do something that was a little more vibrant."

LeBeau got hooked on futures earlier. At California State University, he took an investment class taught by Charles Harlow, a second-generation commodities trader. Upon graduation in 1963, LeBeau was drafted in the U.S. Army. He worked his way up to captain, as commanding officer of the armed forces courier station at the U.S. embassy in Paris. After "tough duty in the trenches of Paris," LeBeau extended his tour to bring his wife over. He started with E.F. Hutton as a broker in 1967.


http://www.streetstories.com/lb_futures96.html

 

[Hilarymannah]

The coin tossing strategy is of course quite the good strategy for those who are unable to read the market,....For those of you who can see the picture through the dots, you're well aware of how silly the random walk "theory" is,...

 

[bevok]

Its helpful in illustrating that entry is only one part of a successful trading system, and indeed that low 'reliability' can still be profitable. That said Van Tharp is an educator rather than trader and tends to go to an extreme. Entry IS still important - finding techniques which will give good risk /reward trades and positive expectancy.

Incidentally the markets have changed since the early 90s - trying that experiment as described results in a losing system now.

 

[DionysusToast]

Why the "fear of ridicule" statement? Takes ten mintues to teach any monkey an entry that'll *work* (be in profit temporarily/quickly) 7/8 trades out of ten...MM and the discipline to stick to an edge, day after day, month after month in order to build an income is the hard bit...The random entry debate has been done to death and proven time after time...

Well - I shall tell you why.

It seems we have a tendency to believe the written word. If I'd read this book and not merely been pointed towards this pattern, then I'd have probably spent a few minutes reading this passage and then moved on. I'd have more than likely believed what it said and then, taken it for gospel and maybe even repeated it as fact.

The problem is, it is flawed.

First - let's consider what this study ISN'T... It is not a Blind Experiment...

A blind or blinded experiment is a scientific experiment where some of the persons involved are prevented from knowing certain information that might lead to conscious or unconscious bias on their part, invalidating the results.

For example, when asking consumers to compare the tastes of different brands of a product, the identities of the latter should be concealed — otherwise consumers will generally tend to prefer the brand they are familiar with. Similarly, when evaluating the effectiveness of a medical drug, both the patients and the doctors who administer the drug may be kept in the dark about the dosage being applied in each case — to forestall any chance of a placebo effect, observer bias, or conscious deception.

Blinding can be imposed on researchers, technicians, subjects, funders, or any combination of them. The opposite of a blind trial is an open trial. Blind experiments are an important tool of the scientific method, in many fields of research — from medicine, forensics, psychology and the social sciences, to basic sciences such as physics and biology and to market research. In some disciplines, such as drug testing, blind experiments are considered essential.

The bottom line is that an expectation of a particular result leads to bias in testing.

Interestingly, another psychological oddity is the fact that I could not write the first post in this thread without alerting you to the fact that something was wrong. It would be impossible for me to bring this passage to your attention without also bringing to your attention the fact that something was amiss (or I wouldn't be asking the question).

As it is, there are 2 major flaws in this study :

1 - The approach taken to the study is flawed
2 - The test itself is NOT proof of random entry, rather they admit to curve fitting as well as omitting key data

Given the text - does anyone else see why the approach is flawed and why the entry is in no way evidential of randomness + MM = profit ?

Also given the text - does anyone have an opinion on whether the authors intended to deceive or whether they deceived themselves in the process. The flaws we can prove, this we can't but I would be interested to hear your thoughts.

 

[arabianights]

ur toast, dionysus

 

[DionysusToast]

When I was participating in the futures skype room with Gladys, a chap called Hunter and I tried this. I would toss a coin, make a call long or short and he would enter and take a well timed exit with either a scratched trade or a small profit.

We concluded that the direction was irrelevant but what was important was the timing of the entry and exit as essentially under short timescales, price movement was mainly noise and largely behaving as stochastic process and likely to be reverting to a mean.

Conclusion I drew was the following which ironically took me a little longer to incorporate into my longer term trading methods:

1) Directional calls are only important if you are looking at mkt as a weighing machine rather than voting machine.

2) Entry timing is only important to mitigate risk at entry.

3) MM and Exit ultimately determines whether you are profitable or not.

Entry = risk. Exit/MM = profit/loss.

As you have done this, can you see what the difference is between your version of random entry and the one in the passage ?

As for your results, and understand that this is not an insult but I do not believe that you have proved that a random entry can be profitable.In my opinion, there are some immutable laws of mathematics (and some would say physics) that you have to overcome to make it work. More than likely you have seen positive results over a relatively short number of trades and suffered from confirmation bias to take the results to mean that random entry + mm = profit.

Unless you will pull out the "my methods are secret" card, I would like to see the details so we can see if certain natural bias may have affected your work.

There is one way random entry will work. You flip a coin, enter the market and then exit any trade you would not have taken yourself. For instance, you may be in an obvious uptrend, get a short trade, enter and exit. This is not money management, this is discretionary trading, by exiting after entry you are effectively not taking the trade. In a nutshell, it's cheating.

 

[DionysusToast]

ur toast, dionysus

Well - if you are what you eat, then I am indeed, toast.

Specifically - toasted blueberry bagels with peanut butter on them - still currently digesting.

 

[arabianights]

i'd love to spread butter on you and suck it as it melts off

yum