Admit it - your profits are based on luck

Haha - I certainly could be wrong. As I have said in other posts, it is important to understand your edge before designing a system to exploit it. But lets say there is no edge, or that my system fails to exploit it with statistical reliability. Fine - but again, with drawdown expectations that are small enough you can realize that without an impact on your account that you aren't prepared to see (since such levels are ultimately determined by you).

As you said, it really comes down to your school of thought. And again, at this point, the ability to reliably exploit my edge doesn't agitate me. If it fails, it fails; if it never worked, it never worked - but at least I can pull the plug early, and have at least a reasonable basis for doing so. Really, it is just another part of the trading plan that many fail to plan for. And if it were to happen, at this point, I would still be significantly in the green, so it doesn't keep me up at night. Perhaps I have been 'lucky' over the thousands of trades that I have made, but luckily you don't have to be lucky for that long in order to not have to worry as much about luck anymore.

Hanover,
I think we are getting closer to agreement. 1) Yes, I agree that casinos make fortunes on very small edges. The difference is that the casinos edge is fixed (except for blackjack) and never varies. They never have to expend any effort or thought, they know their edge is always their (except for catching card counters!). Traders have no such luxury. Our edge (when we may have it for a short time) in incalcuable and we never know when it will turn negative. Even if I knew I had an advantage, that does not mean that I will not lose 15 trades in a row. An edge does not guarantee a win on any particular trade or series of trade. I have played semi-pro blackjack for 10 years and I can attest that horrific, logic defying losing streaks can occur even when you have the advantage. That is the essecence of variance.
2) Yes, to have a high degree of confidence in not going bust you need a very large bankroll. I could manage 2million usd in an account with a 1-3 $ pip size and probably go on for many years.....but if I had 2 million usd, why risk it in forex? There are a lot safer ways to get a 4-6% return on your money and live quiet well!

In the end, almost all of us small retail guys are trying to turn a relativley small amount of start up money into a large sum. I do not believe there is any way to do that without huge risk. We will need some luck on our side. All the best to you in your endeavors...I always enjoy our discussions!

Cheap 2 cents CAD.
TD, no doubt you are a Math Wiz. You've shown that before. does this Thread stem from the possibility that you have been unable to Solve The Market by mathematics of prediction? If so, relax, just let It tell you instead of trying to tell It.

Also, If you believe yourself, why are you {assumably} still Trading?

FX-Petra, I like the way that Topherhk88 (back in post #571) has made the clear distinction between "(1) a functioning edge but detrimental losing streak" and "(2) no edge/diminishing edge". As I see it, the first is an MM issue, akin to a Blackjack pro unwittingly overbetting his bankroll; while the second is about negative expectancy, akin to trying to beat Blackjack without a (card-counting) edge.

I can totally relate to what you're saying about casino-based expectancy being precisely calculable, while with trading, the probabilities are vague at best, and also potentially subject to constant change. A robust trading system should be less vulnerable to any such change, and I think that it's here that the traders who understand fundamental drivers and bank agendas have an advantage over those who trade indicator based ("buy when the red line crosses the blue line"), or automated, systems. I'm aware that there are traders out there who've been winning with a fair amount of consistency for several years, hence I assume that their methodological edge is of the more 'robust' variety. I don't believe that the task of finding a workable edge is an insurmountable one, especially given the fact that we can be as selective as we wish with our entries, finding pockets of 'less than random' price behavior.

Agreed, the only sure-fire answer to a 'black swan' losing sequence is infinite capital, but I suspect it's possible (assuming a robust methodology) to keep position size at a level where the returns make the exercise worthwhile, but the risk of 'catastrophic' drawdown is acceptably low (depending on what one is willing to endure, a personal choice). Otherwise, as you point out, there is no point in pursuing a career as a trader.

The major variables as I see them are:

1. System expectancy (or edge, or profit factor = $$ won / $$ lost): higher expectancy justifies more aggressive position sizing, since risk of loss, and therefore a 'black swan' loss, is less. (All this is assuming that we have an adequate level of statistical confidence, and that we make the assumption that the edge is robust enough to remain effective for a good while). Expectancy is the product of entry and exit, i.e. how frequently/heavily one is net long while prices are rising, and/or net short when prices are falling.

2. MM, or position size: the priority must be to preserve capital, minimizing the impact of a black swan. Both return and drawdown increase/decrease in direct proportion to position size (although, if position size is increased N times, risk of ruin increases significantly more than N times). Hence the object is to somehow find a compromise offering a worthwhile return, with minimal risk of catastrophic drawdown.

3. Transaction volume: for any given profit factor, the more transactions executed in a given period of time, the faster the rate of return. The casino's massive volume allows it to make decent annual returns, despite having only a small edge, and tiny position sizes (max bet relative to capital backing).

I don't think capitalization is necessarily a factor, if one thinks in terms of percent returns. A 5% p.a. return is still 5%, regardless of whether one's account size is $10k or $10m. Sure, one can more easily live off the latter's $500k return than the former's $500 (LOL), but my point is that, if I had $10m (as opposed to $10k), I'd be expecting 1,000x the return, no matter how I 'invested' it. Like you say, to justify any added risk in trading forex, one would want to see significantly higher % returns to those offered by 'conventional' investments.

Incidentally, it amazes me that there are folk who apparently believe that the answers to all of this somehow lie in the area of psychology/mindset/self-mastery. The way I see it, discipline must be a 'given' from the outset, and any lapse is inexcusable. Can you imagine a Blackjack pro, having spent countless hours practising an advanced point count until it's second nature, then suddenly deciding that he knows better than the textbook math, merely because there's money on the table? And just because trading probabilities are vague, does this give a trader the mandate to trade his plan any less accurately than a Blackjack pro? I would argue that the increased difficulty demands even greater discipline.

For me the answer is to set aside an amount I can afford to lose (say $10k), and trade it with a system that I've perfected in demo, giving it my best shot, come what may. If I happen to have an edge that lasts for a while, and the the account grows to the point where forex eventually becomes my primary source of income, then I'd say the gamble was definitely worthwhile. As the old saying goes: nothing ventured, nothing gained.

I too have enjoyed this discussion.

All the best,
David

My point was that if the Random Walk Theory were true, it would be a miracle if someone was able to continue to profit for over 50 years. As a result, I don't believe in the Random Walk Theory of prices.

Chart patterns occur in various TFs. You may find a head and shoulders pattern formed over several hours during a day, or over several months.

Patterns are formed by SR levels and by trendlines. We concentrate on the patterns formed by support and resistance levels as these tend to have a sounder conceptual base.

A criticism of patterns is that they are also evident in random data, charts generated using random numbers. If the patterns appear in data where there is no trend then what is their significance?

You may observe head and shoulders and similar patterns in random data, but you will not observe support and resistance levels. Studies of foreign exchange markets have shown that limit orders are not scattered randomly in the market, but are clustered around support and resistance at round numbers:

Empirical tests carried out on various point and figure chart formations, were profitable between 70 and 90 per cent of the time in bull markets and between 80 and 90 per cent in bear markets. Average gains (on profitable trades) were 2 to 3 times as large as average losses (on unprofitable trades).

nevermind

I've thought about trying to create a program that used a random number generator and depending on that number the program moved price up or down for 5minutes (and assuming it returned a long candle, still move up and down in that 5m, just it would close long).... Then in this program I would have a trade station and charts and maybe allow 20 traders to trade from this fake program as a test. The code would then also take the direction of the majority of the 20 traders and price would go against this direction. I know I know, but what can I say, I am a conspiracy theorist.

Sometimes I think there is a way out, but sometimes I think it is pure luck.

I would like to know, however, since tdion believes it is all luck, what system he is using that gives him belief enough to trade it? Is luck on your side now?

To bad we can't have level II info in the Forex as they do in stocks....... What is LevelII

I think MBT has a version of it but I don't care much for that broker, with their commission and spreads that just aren't that competitive.

All of the brokers have this info they just don't show it to us, and of course it is relative to their own book due to the lack of centralization of the currency markets. (Or perhaps there is more centralization than we think. Have to look into that.)

For example Oanda has this Open Orders Summary
That graph gives a snapshot of the trigger points for the open orders on OANDA's books (including limit orders, and Stop/Loss or Take/Profit orders on trades). The graph could be used as an indicator of client price expectations contributing to natural resistance and support levels. There's a graph for each major currency pair (click on a pair's button to go to its graph).

Also there is this Open Position Summary
That graph plots the open positions on OANDA's books according to:
The prices at which traders entered into the positions (along the horizontal axis).
The volume of Long vs. Short positions (plotted vertically at each price interval, up for Long and down for Short positions). The plotted values are percentages—all values plotted on the chart (both long and short), along with any outlier values falling off either end of the chart, would add up to 100%.
The graph is divided into quadrants based on Long vs. Short positions and on whether entry price points are below or above the current price (this is the most recently sampled price, and could be up to an hour out of date).

And there is this new chart .. Historical Position Ratios
May be some useful info obtained there as well.

So what is all this for? Perhaps to make your trades a bit more informed instead of just lucky.........

Hey Bemac! Let me weigh in my thoughts on trading. I believe that a set of trading rules will profit in one type of market, and fail in another.

The key is to be able to withstand gigantic losing streaks when the "bad" markets appear. Then, compound aggressively during a "hot streak."

Unfortunately, if your bankroll is wiped out, you are toast. So trading very small lot sizes is key when you have no house money. Once you are up a little, bet aggressively and hope for the best.

That's the best I think a small fry trader can do.

In the Book A Non - Random Walk Down Wall Street, (Copyright 1999) the authors Andrew W Lo and Craig MaCKinlay, completely disprove the Random Walk Hypothesis.

Andrew Lo is a Harris & Harris Group Professor of Finance at the Sloan School Of Management at MIT.

A Craig MaCKinlay is Joseph P Wargrove Professor of Finance at the Wharton School, University of Pennsylvania. With assistance given by John Y Campbell of The Econometrics of Finacial Markets, Princeton University.

In their book through complex statsitcal and empirical and mathamtical approaches they have given solid proof that markets are not Random.

To this date no rebutal has been made to this book and the matamatical models have been duplicated by other researchers with the same results.

So.... can they see the future? what is tomorrows bar going to be? I have respect for math but I also don't trust statistics or statisticians because it is soooo easy to manipulate the numbers.
Just look at the Gov. reports and figure..... if you knew the truth you'd be crappin down both legs.....

Facinating, thatwasme.

So stepping away from PHD theory, how can these findings be applied to real world trading?

I bet their models include volume and level 2 data not accessible in forex.

And what about companies exchanging huge payroll checks back and forth? Forex is not really a speculative market..... it is a money pit of business transactions.


Still, I would be interested in hearing more about your (their) findings.

Well tdion, I have read the book it is on my shelf. You on the other hand are only guessing as to it's content, so I would have to say your research seem a bit weak.

Again No one has been able to rebut the outcomes. And no they are not academic trifles, they are actual outcomes that are used everyday in the world of finance. Just because you do not know of them does not demean them. It is your lack of knowledge that is in question. I am only stating a fact and not a personal attack, of course.

Here is a copy of some the reviews. The book is available at amazon, pretty cheap.

Review
What Andrew W. Lo and A. Craig MacKinlay impressively do ... [is look] for hard statistical evidence of predictable patterns in stock prices... Here they marshal the most sophisticated techniques of financial theory to show that the market is not completely random after all. -- Jim Holt Wall Street Journal With all its equations, this book is going to turn out to be a classic text in the theory of finance. But it is also one for practitioners. -- Diane Coyle The Independent Where are today's exploitable anomalies? Lo and MacKinlay argue that fast computers, chewing on newly available, tick-by-tick feeds of market-transaction data, can detect regularities in stock prices that would have been invisible as recently as five years ago. One example: 'clientele bias,' in which certain stocks are popular with investors who have certain trading styles. A case in point that doesn't take a supercomputer to detect, is day traders' current enthusiasm for Internet stocks. Lo says that day traders tend to overreact to news--whether that news is positive or negative--so it should be possible to profit by taking the opposite side of their trades. -- Peter Coy Business Week

Where are today's exploitable anomalies? Lo and MacKinlay argue that fast computers, chewing on newly available, tick-by-tick feeds of market-transaction data, can detect regularities in stock prices that would have been invisible as recently as five years ago. One example: 'clientele bias,' in which certain stocks are popular with investors who have certain trading styles. A case in point that doesn't take a supercomputer to detect, is day traders' current enthusiasm for Internet stocks. Lo says that day traders tend to overreact to news--whether that news is positive or negative--so it should be possible to profit by taking the opposite side of their trades. -- Review

Review
What Andrew W. Lo and A. Craig MacKinlay impressively do . . . [is look] for hard statistical evidence of predictable patterns in stock prices. . . . Here they marshal the most sophisticated techniques of financial theory to show that the market is not completely random after all.
(Jim Holt Wall Street Journal )

With all its equations, this book is going to turn out to be a classic text in the theory of finance. But it is also one for practitioners.
(Diane Coyle The Independent )

Where are today's exploitable anomalies? Lo and MacKinlay argue that fast computers, chewing on newly available, tick-by-tick feeds of market-transaction data, can detect regularities in stock prices that would have been invisible as recently as five years ago. One example: 'clientele bias,' in which certain stocks are popular with investors who have certain trading styles. A case in point that doesn't take a supercomputer to detect, is day traders' current enthusiasm for Internet stocks. Lo says that day traders tend to overreact to news--whether that news is positive or negative--so it should be possible to profit by taking the opposite side of their trades.
(Peter Coy Business Week )

I reread my last post and detected a bit of cynacism.

That was not the intent of my wording. Sorry.

I have no idea where to begin respond to such an uninformed and unresearched statement and a complete generalization. It would be pointless.

Did you mean the very last post? Or the last 500?

Never mind.... just a sarcasm..... I use TA in my trading and as such I obviously do not subscribe to a totally random walk theory, more of a higher probability theory.

You've been waiting to use that one for awhile.