Greg's Journal

New to Journal. GBP/USD has retraced from 1.7230 low back to recent high around 7270 on 3/10. Entered a sell market at 7268, based upon this "double-top" and oversold 15min chart slow stoch (20.4.20). Price is currently 7642, looking for 7323 or lower. Risk is oversold daily slow stoch indicator, but feel there is still room to roam lower. Have adjusted sl at break-even 7268, will revisit a buy or sell at 7400. Comments welcome.

All is quiet on GBP front. Strategy: I've held a sell/GBP order for many long hours, only to watch price trade in tight range of 7270/7238. Two expectations: price would retrace to 7230 or below by now; or continue on it's merry way up by now. What I could have done in the meanwhile were several near scalps, i.e. picking up 20 to 30 points at resistance/support areas (less spread) several times since order execution. Coulda, woulda. Shoulda? Depends one's style of trading, in and out, or to hold on for the larger anticipated move. My inclination is to hold 'em as per my risk/reward definition. That said, sometimes enough is enough. Got out at 7238, for about +25pips. Will wait until evidence is strong up or down. Trend is king, Price is queen.

Hi Greg,

For me, Price is King, trend is only a friend (or girlfriend).

Good Luck and Take Care
Habeeb

Yes, indeed, you are right my friend. I was dazzled by the rhymning.

Actually, I believe that the trader himself is king, price is queen and trend is just a pawn....


Thanks,

Nader

Followup to comments on GBP/USD yesterday. Latest move up early morn was definitely King and Queen. After nibbly stepping aside after a 25pip profit during tight trading range period (actually I was too tired to go on and went to bed), my alerts set at predetermined price areas just above and below range, went off to the upside at 5:30PDT. I crawled/jumped out of bed and into the office, still debating trading psychology with a trader in the dream I'd been having. By the time I reached the screen, GBP/USD was at a new high over last many hours of range, and then higher as another alert went off. Checked my platform. Currency prices were light-bulbing all over the place, signaling the end of hours of unnatural calm. What to do? Question didn't cross my mind: GPB/USD had already moved up over a 100 pips, and it still intended to go up. Why not? Obvious now. How far? Didn't know, didn't care, maybe another 100. Executed a buy w/30pip sl, sat there as GPB/USD soon took off, reaching 7465. Cashed out. GPB/USD has been ranging tight since. Have set alerts around the new range again. My guess is (unless fundamentals tell otherwise later on) GBP/USD will continue to 7600 more or less. I'd take 7550. I'd take anything. I don't know one way or the other for sure. Happy trading (else why do it?)

Came out well on GBP/USD last couple days, as per strategy in recent posts. Could have done better but satisfied, (1) preserved capital, (2) bagged some good pips as price/trend continued up. Over the last few hours caught a couple moves in the range, then price took a drop through support. At this hour waiting to buy another dip around 7432 intraday, and if that's not revisited, buy around 7485, just above recent high. Target will be 7600 more or less. Alerts are on. Price is king, Trend is queen. We got that settled once and for all...

Strategy: Trade the range, quick in and outs. Look for a trend w/30-100pip+ potential. 15min, hrly, daily charts. Draw trend lines, don't forget the big picture (daily/weekly). Draw support and resistance areas for range bound trades. Be calm, be scared, be calm. Look for oversold/overbought indications (is it really overbought/oversold?). Kiss: Keep charts clean visually. Don't anticipate. Get some sleep. Set alerts. React.

Have decided to BUY GBP/USD this hour though hasn't completed revisiting dip of 7422. Thus tight stop. In @ 7437, sl 7417, may be adjusted downward depending. Started with minimal lot, will add to as/if price moves up.

Have raised sl to breakeven (entry). GBP/USD @ 7495.

It appears my trade has run out of steam. I certainly have. Closed position for an okay profit @ 7489 (entry @ 7437). "Yawn." Will catch this puppy again anon.

same

Enterprise Log: "Beam me up, Scotty." GBP/USD has been in an uptrend mood for a few days. Got on board again @ 7440 (see other posts for thread of events), took the ride until it stalled. Re-entered @ 7490 around 08:40 (EST) this morn. +30pips riding the leg up, reset sl at entry point for breakeven in event of reversal. Went to bed, alerts popping as GBP/USD climbed, last alert @ 7580, near my target area of 7600+(previous posts). Price seemed to stall (always wary, just another area where I'm wary), closed position. GBP/USD has tapered off since, currently @ 7540. Alerts reset, strategy is to buy the dip. But I don't pull the trigger on anticipation (no limit orders). Just the facts, ma'am, which could change.

Questions to myself: Why would anyone regularly trade anything but the four majors?

Question: Markets are dynamic not static. Has there ever been a mechnical signal "system" that works!! (90% win rate = Holy Grail)?

Question: Why would a successful trader use someone else's system to execute trades (unless above)?

Question : Why are you starting a new thread with every comment or update, would it not be easier for you and for anyone who wants to check your trade progress if you just had one thread ?

LOL! ROTFLMBO!

Good question! Answer: Because another pair might have a better data structure at the time. Or, because it might have better Magnitude stability. Most majors don't fit this bill, only a handful are stable enough for some traders to trade inside their systems. Not all systems are the same and therefore, not all market behavior will be detected and measured in the same way by all systems.

Good question! Answer: Mine is currently runing at 100% accuracy over the past 47 trades (this weeks trades have been posted on this forum) and 94.82% accuracy over the past 280 trades with the currnent Day Trade in tow. It really all depends on the level and quality of your analytical research and the degree of creativity one brings to the process of system design, architecture and component integration. If done correctly, one can produce a very accurate Grail form which to profit from consistently over many years with the right degree of balanced tweaking to meet new market demands. In addition, if the system was "designed" from the outset to measure a "dynamic" market, then by definition its output will reflect that and be inline with a dynamic market.

If the system was designed to measure "static" markets (which I know of no system that meets that qualification), then said system will reflect such market conditions. It really all comes down to reasearch and correctly applying concepts discovered. Lastly, some systems are based on conventional 30 year old TA, while others are completely new approaches that use no traditional TA - in fact, some systems re-write the rules when it comes to TA development, so unless one has been exposed to "all" systems, then it might prove rather difficult to lump them into the same "Grail" classification.


Very good question! No one single trader knows it all. Thus, any one single trader is capable or learning something new from any other trader. There might be an instance when trader "A" is just one indicator away from raising the level of his system's overall accuracy to a point that seperates himself from the rest of the crowd, or at least places his trading ability into a new class of success. That one single idea can come from anywhere, and be sparked form anything.

Example: I was once on a flight (and I have many stories over the years just like this one) from Toronto to SFO coming back from a business trip after a three week stay in Markham, at Corporate HQ. While on board the A-340 somewhere over mid America, I looked out of window and picked-up the horizon - not a cloud in the sky that day. As I'm looking at the horizon thinking to myself what a wonderful day it was to be coming back home after three long week, it hit me like a bolt of lightening.

I was seeing in the horizon and contemplating in my minds-eye, the curvature of the earth and I envisioned that curvature increasing with altitude and then decreasing with a lost of altitude. Well, Bingo! That was it! That one single thought lead to the development of an entirely new system module that I now call the EventHorizon. I had to go all the way to Canada, wait three weeks, order a Bourbon 7 on the rocks and gaze out the window to get it – but it was worth every single minute of the wait. It later became (with much tweaking over the years) one of the most stable and most accurate trading signals in my entire arsenal. Proof that one never knows where the “next” big idea will come from. It can come from anywhere, including another traders system or subcomponents of said system – whether in whole, or in part.

Now, having said that, I would also say that all traders should learn how to trade effectively on their own and develop their own “system” for trading whatever that system might be. Some people are gifted at being able to play the news on the Fundamental side of the business while others are gifted with working on raw numbers and raw data. There is no one single way to become a successful trader, but using someone else’s work product to trade is not necessarily a negative – if that person is pushing the old system to new heights of achievement. Otherwise, I’m in the camp that says, Technical Traders should know their system inside and out before trading it.

00:10am (EST). Placed very short-term buy @ 7530 (5min/15min Chart); price popped to 7550, closed position. May do this a couple more times (choosing not to do a reverse trade back down however; at some point GBP/USD is going to continue down, or up, the latter my % estimate/anticipation of continuing trend toward 7600+.

...I rarely if ever see dialog regarding a day trade as it's insitituted, ongoing, or closed. Seems to me that an exercise like this validates the trader's system like none other, much more than before or after the fact input/stats. It means I have to put up or shut up, so to speak, "you've talked the talk, now walk the walk." (Price shot back below 7530 just now, placed buy, price back at 7550, exited position.)

By the way, I place a fairly good-size (for me) piece of change on my short trades (above). So I know I don't have l-i-n-g-e-r when trading the range, i.e. I can pop in and out, make $1000.00 and I'm a happy camper. History: Of course it wasn't always so. I had a decent stake in the beginning years, lost it, added more, lost it, until I was reduced to starting all over with chump change. THAT'S when I learned discipline and so much more about the science and art of trading (did I say art?)-- and bit by bit, grew another sizable stake. Worht mentioning that I wasn't at all comfortable executing in and out range trades on a tiny stake--but I learned how to make those short trades--and nibbly, such that I'm infinitely more comfortable now.

Really appreciate the comments re:the questions to myself, which I've read once and will read again more carefully, perhaps add my view which may be shaded slightly different. What I appreciate most about the answers is the obvious intelligence and thoughtfulness. Kudos.

I have a Santa Barbara friend who has made millions watching the Bloomberg tape run by at the bottom of his TV screen. His system? Frank gets a "feeling" about what he sees, then makes a phone call to his stock broker. He spends about ten minutes a day at it. If I hadn't seen with my own eyes several times, I wouldn't believe it, that it could be done. My friend knows nothing about technical analysis, cares little for fundamentals (except for a dream just before the stock market crash in '87, when he closed all his positions, then jumped back in when prices bottomed out.) This is a true story. I've read of other rare gifted souls, e.g. the book The New Market Wizards.

So when you're lucky, you're lucky. "You're gifted", I told Frank. Personally, I've never seen a system that has a 100% win rate. Frank comes close. I'd like to, I'd like to know the ins and outs of it (Frank is way beyond figuring out). I've poured through many systems that advertise 80% or more signal wins, however I have my doubts over time -- at point those mechanical systems will fail, leaving the subscriber (or $$$buyer) of the system carrying the empty bag that used to hold his dubloons.

I say there is a difference between mechanical trading systems and the dynamic analysis of dynamic markets. Tweaking a system doesn't make it mechanical in the pure sense, it has become dynamic. Mechanical systems are predictive. But certainly not 100%. The big interbanks and big-time traders (The New Market Wizards) that move prices have stuplifying computers that perform grunt work, but they are fluid in their final analysis, so I've read, and not strictly mechanical. There's a lot of hands-on human analysis involved.

Well, anyway. I've adjusted my trading over the years. I'm done with the "black box" approach, done with the mechanical systems of others. I'm pretty hands-on a this point, aggressive when need be, cautious otherwise, and doing okay. May I and all ever be as fluid and flexible as the blips on the screen.

No doubt about it, inspiration comes from anywhere and everywhere.

Quotable:

"There's plenty of money to be made when your trading systems are in sync with the markets."
FuturesTech pty Ltd. 2006

As a followup to my recent posts (and comments from other traders), I came across this perceptive article. Right on the mark.

Day Trading: The Hardest Game in Town
by: Edward Allen Toppel

Advice from a random-walker: Going with the flow and a clear exit strategy equal day-trading success.

So many traders can't (or won't) walk the talk. Why? Day trading is simple, but it isn't easy. Seems contradictory, right? Simple may equal easy everywhere else, but in the trading and investing arenas these concepts are hardly synonymous. Why do traders hold on to losers and take quick profits? Cut your losers and let your winners ride--that is the well-known, overused, and yet still-important market adage. Yet many traders do just the opposite. Has it ever been your problem, and is it still haunting you? I ask this question in my seminars, and inevitably almost everyone--at least the honest ones--admits that this is their biggest failing as a trader. What keeps us from walking the talk? What's your answer?

Looking for Answers in All the Wrong Places
Trading may be simple to understand, but it is difficult to execute. That's because we are looking for answers in all the wrong places. The solution isn't outside of you--in charts, fundamental analysis, research resports and other blind alleys--but squarely between your ears.

Traders often use the word discipline. Who are they disciplining? Their dog? Their children? No, themselves. More specifically, their egos. We are hard-wired backward for success in the markets. We want to avoid pain and only seek pleasure. Taking losses is painful, and taking profits is pleasurable. So it is only natural that we would take quick profits and delay taking losses. We are naturally wired that way, and that is why trading is simple but not easy. Overcoming one's wiring is tough and takes a lot of training.

Another major problem is waiting for the right setup or entry criteria to appear. Most traders spend a great deal of time deciding when and where to enter the market with little thought of where to get out when they are wrong. I posit that it really doesn't matter how and when you make your entry trade. What really counts is how you manage the trade. Nothing else really matters.

Exit Strategies Are Key

There are many different methods that traders use to enter the markets, running the gamut from A to Z. This includes everything from astrology to zodiac signs, with may other variations in between such as charts, Fibonacci numbers, Gann lines, fundamentals, numerology, etc. You get the picture. The mention of far-out approaches like tea-leaf reading or flipping a coin may elicit some chuckles. But everyone has their favorite method and is sure that theirs is the only way.

When I tell my students that I think flipping a coin or reading an astrological chart is just as valid as the more traditional methods, a bizarre look appears on their faces. After all, it is a known fact that monkeys throwing darts at The Wall Street Journal's stock pages often have outperformed highly paid money managers many, many times. There may be many other equally valid (or invalid) decision models. The bottom line is that I really do not think it matters at all. Exit strategy rules. Nothing else counts!

I am a random walker. Markets just bop up and own in a manner that is both hard to predict and erratic. The statistical correlation between any of the many methods over a great enough sample is .5, which is chance. So why waste the time? Sure, it is fun, but does the time spent really produce a greater result commensurate with the time invested? I say no. However, a trader needs to use his analytical mind or else he feels like he is cheating. Our brains just can't figure out some things, and the market's direction is one of them.

Random walk theory is the postulate of Princeton University Prof. Burton Malkiel, who wrote the book, A Random Walk Down Wall Street. It remains a best seller even today, though it was written nearly 32 years ago. His theory stated that stock price changes have the same distribution and are independent of each other, so the past movement or trend of a stock or market cannot be used to predict its future movement.

In short, this is the idea that markets take a random and unpredictable path. A follower of the random walk believes it's impossible to outperform the market without assuming additional risk. Tenets of the theory, however, recognize that markets maintain an upward trend over time.

The Wall Street Journal used to publish the results of monkeys throwing darts at its stock page and compare those results with those of active managers. Guess what? The monkeys won more times than they lost.

Most traders blow out because they hold on to losers. The winning trades take care of themselves. Focus on a game plan to exit when you are wrong, and make sure it is in place when you make your initial trade. You will get your share of winning trades no matter what method you use to enter the market, but one or two big losing trades will ruin you chances of being around when the big, winning trade comes your way. And like it or not, losing trades are part of the game, and how you manage them is everything!

My own stop loss/exit point depends on the volatility of the market I am trading. For instance, the E-mini S&Ps have contracted their volatility. I have dropped my loss point to about $200 per contract before I reverse direction. I am willing to take the chop (market stays in a narrow range) knowing--actually hoping--that every now and then a super-volatile day will come along and that I will be able to ride the wave to the max. My whole approach is based on this assumption, and actually, so are most day traders' approaches. Volatility plus ability to ride winners equals profits. This is true of any market. A surfer needs to ride the surf. No surf, no ride.

Don't Try to Be a Hero
Picking tops or bottoms is the single biggest cause of day-trader failure. Here's another big mistake of day traders: doubling up on a bad position. Though we all know adding to a failing position is a high crime of trading, we are still tempted--and often cave in. Why? No one wants to take losses. We are in this game to make money. So our temptation is to fight the tape, bury our heads and do something stupid. It is easier to delay the day of reckoning than to admit a mistake. The thinking goes like this: "If I just double the position, it will only have to recover half the adverse price movement in order to make me whole." Problem is--and this is the "Zen sin"--you are going against the flow.

As I discuss in my book, Zen in the Markets, picking tops or bottoms is the single biggest cause of trader failure. The moment you shovel more money into your position, you are saying, "I know it is going to turn here." Yeah right! If you knew that defining moment in the first place, you wouldn't have made the initial bad entry. Good luck? Not possible!

So, how can you avoid this temptation? Repeat a mantra that sounds a little like, "I will only add to winning positions and exit losing trades according to my predetermined stop loss." That can help you cure the impulse. But the best strategy is to put in place an exit point when you make the initial trade and stick to it.

Stick to the Plan
GTC, for too many traders, does not stand for "good 'til cancelled," the acronym's true meaning. It means "good 'til close" for those who start to adjust the stop and make stupid excuses. Stick to your game plan. You don't stand a chance if you don't. The temptation to pick tops or bottoms has ruined countless day traders with more ego than common sense.

Many traders experience a strong temptation to predict whether a stock, commodity or currency will climb higher or fall lower. Our egos are masters at attempting to call a turn--masters at attempting but miserable failures when it comes to consistently hitting the mark. Yet many of us still find bizarre pleasure in stepping before the freight train. The problem is, when we get lucky and actually call the turn, our egos balloon up and make us feel important.

A woman attending one of my recent trading seminars told the class she was able to call the turns nine out of ten times. The experienced traders in the room started to laugh. We all knew that this was the way to ruin. Why? In order to call a top or bottom, you must break one of the most fundamental rules of trading, and that rule is "got with the flow." Markets can go in one direction for a very long time. The bull market of the 1980s lasted nearly 18 years without one single year of a ten-percent decline in the averages. Every month, some famous talking head would pronounce the end of the bull market. This went on for years and years, and most of these so-called investment gurus lost their clients' money trying to pick the top.

My suggestion: Just don't do it. And if you find yourself tempted to call the end of a move, go to a movie or take a vacation. Your ego is taking over your trading. Picking tops or bottoms has been the end of many a trader or fund manager. Just try to remember how many stocks, housing markets and interest-rate moves you have already casually predicted to peak or bottom out by now--and you soon will return to earth and begin to preserve your equity. Just say no.

Check Your Ego at the Door
"Forgetaboutit" is just as applicable in the trading world as it is in organized crime. This is a phrase I used long before I ever heard about Tony Soprano. This is the word that I tell myself whenever I get that "big" idea as to where the market is heading. Down deep I really know I don't know, and I feel comfortable in knowing that no one else knows either.

However, this doesn't keep my ego (and yours, too) from trying to sneak into your trading decision-making process. That little voice in you will tell you that because this or that chart, balance sheet, industry forecast, etc., you have been able to crunch those numbers and come up with a clear call as to where the market will move. In the history of the markets, no one has been able to do this with any consistency and accuracy over a given period of time. What makes you think that you can? I call it "egoitis," and whenever I hear those sounds in my mind, I simply say to my ego, "Forgetaboutit." Don't even try.

The smartest minds in the business try to keep it as simple as possible. Bernard Baruch is famous for his statement, "Markets fluctuate." Alan "Ace" Greenberg's retort after a reporter asked him why the market crashed in Octorber of 1987 was, "Markets fluctuate. Next question." Random walkers also agree. It defies analysis. Yet they are out there trying to find the next Holy Grail, investment formula, etc. Forgetaboutit. Don't waste your time.

Risk Management Rules
Okay then, what are you supposed to do? Flip a coin? Read tea leaves? In my not-so-humble opinion, these methods are as valid as any other.

What really counts is how you behave once you are in the trade, not how you made the decision to get into it. It's all about risk management, not stock, option, futures or currency entry signals.

Ted Aronson, of Philadelphia-based asset manager Aronson+Johnson+Oritz, has an enviable 30-year track record. He once said, "It could all have been luck." I also suspect that though he was humble, he was also a very good risk-control manager so that when his analysis didn't work out, he was quick to get out. Once things didn't work out, he simply bailed with the words, "Forgetaboutit." You don't need to predict the direction of whatever you are trading. You simply have to accept the direction that the market is heading and go with it. Traders should try to simply accept what the market is doing and just go with flow.

Hey, isn't it time you said to yourself, "Forgetaboutit!" You will be a better day trader if you do.

SFO Magazine (October 2005)

Refer to my GPB/USD thread(s) on this forum, especially the article on page 2, posted yesterday, Day Trading: The Hardest Game in Town. I'll use this new thread from now to post some of my trades as they're executed, along with my thought process at the time; also to pose questions, and always to invite thoughtful feedback.

Below is another excellent article. As far as I know, this and the article above define the challenges every trader has to be successful. They are honest and true. Thanks for viewing. Greg

Developing My First Trading System: A Cautionary Tale of Hubris, Humility and Hope
by: David Silverman

This year I celebrate my 25th anniversary as a trader.

I am no superstar, but I make a living, which distinguishes me from the vast majority of individuals who, during this period, have tried to make it as professional traders. There is a certain amount of pride I take in having outlasted many of my competitors, but it hasn't been easy. Like all veteran traders I've had my share of ups, downs and sideways (often more frustrating than the downs), and even after all these years I struggle each day to understand the vicissitudes of the markets and overcome my fears and inhibitions.

If I have developed any insight after a quarter-century, it is that trading is an evolutionary process. The trader begins life as a weak, defenseless organism. With a puny brain incapable of processing information efficiently, he acts self-destructively, fading the market, adding to losing positions, promising God to never make the same mistake again, if He will just intervene this one time. Predators lurk and entice the novice into their traps. If, somehow, the trader survives, he may earn a place on the food chain, but he cannot rely on past successes to keep him there. With every tick and pip of the markets, other traders are on the prowl. So much for intelligent design. Such is the process of natural selection in the marketplace.

Playing by the Rules
In that context, I have given a great deal of thought to the question, what do successful traders have in common? While there are a number of answers to this question, above all, successful traders know how to follow the rules. By rules, I mean a set of fundamental beliefs so deeply held that it becomes inconceivable to think of deviating from them. It almost doesn't matter what those rules are, only that the trader believes they work and implements them in all instances. As for me, a single rule governs every trade I make. I will never, under any circumstances, put myself in a position where an individual trade or a series of trades will wipe me out. The way I accomplish this is to limit my losses to a maximum of two percent of the equity I am trading. So, for example, if I am trading a $1,000,000 account, I can lose up to $20,000 on a trade and still be in compliance with my rule. More importantly, I would have to make 50 consecutive losing trades of two percent in order to lose all of my money. This is almost inconceivable.

In practice, my losses are almost always less than two percent. While I sometimes experience a number of consecutive losing trades--I don't think it's ever been more than a dozen or so--my winning trades tend to be much larger than my losers. I suppose the two-percent loss threshold is somewhat arbitrary. But in order to justify doing this, I'd have to believe that I could make at least two-and-a-half times as much. Because I'm not sure this is a reasonable expectation and because the additional risk scares me, my two-percent rule remains the underlying principle upon which all my strategies are based.

The two-percent rule also creates a structure for my trading decisions. For example, assuming a $1 million account value, if I want to buy Google (GOOG) and my stop loss is $5 lower than my entry price, I know that I cannot buy more than 4,000 shares (this is actually an oversimplification because I rarely execute my entire position at one price, but for the purposes of the example, using round numbers illustrates the principle easily). In other words, if I want to establish a bigger position, I need to choose a stop price closer to my entry price or wait until GOOG trades lower. Moreover, if I am long five different stocks from the same industry, this must be considered a single position with a single two-percent maximum loss. (As opposed to five separate positions with a maximum loss of ten percent). This goes for pairs trading as well. If, for example, I am spread long GOOG versus short Yahoo! Inc. (YHOO), this is a single position with a single two percent maximum loss. It's not very elegant but, as I say, I make a living.

Developing a Trading Model
With these rules in mind, I decided last year to conduct an experiment, in which I would take a single trading idea and develop it into a formal trading model. This, of course, is done all the time by sophisticated trading firms using custom-built technology and by retail traders working with comparatively simple platforms such as TradeStation, MetaStock, Fidelity's Wealth Lab Pro and other off-the-shelf software from brokers or independent vendors. Everyone seems to be searching for the perfect trading system, the elusive Holy Grail of systems.

Not me. I feel fortunate when I can find my keys in the morning, so I have no delusions of grandeur. My more modest goal was simply to discover whether my cherished rules held up when subjected to the model developer's standard techniques of backtesting and optimization. In a way, the prospect intimidated me. For one thing, I was concerned with the potential cost. I know of traders and firms who have spent hundreds of thousands or even millions of dollars developing systems. Because such amounts are far more than two percent of my trading equity, I vowed to enter this project with a stop loss, no different that if I were trading GOOG. Additionally, a part of me feared the outcome for an entirely different reason. What if Burton Malkiel was right when he said, in his classic text A Random Walk Down Wall Street, "a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by the experts." Simply put, what if I found that the principles upon which I have based my career were without substance? It's not like the "Random Walk police" were going to come to my house and lead me away in handcuffs in the middle of the night, but how would I deal with the blow to my psyche? What would this mean for my trading strategies? Could I come to work on the day after and pretend nothing had changed?

Calling the Geek Squad
This would not be my first attempt at system development. About 15 years ago, I tried to learn how to write code to develop trading models, first using relatively primitive software from a company called Logical Information Machines and then, when that didn't turn out well, using TradeStation. The promotional literature from both companies implied that the software was so simple to use that anyone, except perhaps a village idiot, could be programming in a few short hours. After a hundred hours of unsuccessful attempts, imagine my humiliation. Well, not this time. This time I knew what I needed: I needed a geek. I turned, reflexively, to the University of Chicago, my alma mater. They allowed me to place an ad on their website, and within days, I had thirty-five resumes. I eventually interviewed fourteen impossibly young, impossibly bright graduate students. One of the candidates had a bachelor's degree in mathematics, a master's degree in computer science, and solved a Rubik's Cube in front of me in less than a minute, blindfolded. While this demonstration was as sad as it was impressive--imagine how many Saturday nights the poor boy spent alone playing with his Rubik's Cube--I was awed by his impressive display of right-brain thinking. I had found my geek.

I began spending money immediately. While I believed my new employee--let's call him Rube--had the technical skills I was looking for, I was concerned that teaching him the basics of the market, as well as my particular approach, was going to consume a great deal of my time. I was right about that. It cost me approximately 40 hours of one-on-one tutelage, but I viewed this as a necessary tradeoff. Time spent with Rube at the outset would surely produce a dividend when the programming process commenced. There were additional upfront expenses. Two PCs and four monitors cost about $3500. Two broadband connections added $100 per month. Various pieces of software, books and training manuals added a few hundred dollars more to the tab. His salary cost me $1,200 per week. He also drank a lot of Red Bull and a can of that stuff costs more than a gallon of unleaded gas.

Finding the Right Software
Once we got past the initial learning stage, I instructed Rube to investigate obtaining system-writing software and quote data, to determine the best way for us to conduct our research. While there are many software packages available containing preprogrammed functions and actual black-box systems, I did not believe they met my needs. First, it is very difficult and time consuming to ascertain that the definitions and assumptions the vendor made in creating the software are acceptable. Second, these packages tend to be expensive. Some require that you open a brokerage account. Others are sold for a monthly fee.

So instead, I decided to use a program called Wealth Lab Pro (WLP), available to me through Fidelity's Active Trader Pro (ATP), the front-end trading system I use to execute my transactions. Fidelity provides the software for "free" to its active traders, although, of course, nothing in the financial services world is really free, and were I not paying commissions on ATP, Fidelity would certainly charge a monthly fee for the model-building software. Rube informed me that in WLP he could write programs in C++ and easily export data to and import data from Microsoft Excel, where he could manipulate the database and do additional programming. I had no clue what he was talking about, but it seemed to make him happy, and when my geek is happy, so am I. One of the best features of WLP is that the quote fee from Fidelity comes directly from the exchanges and is fairly reliable. This is extremely important because when it comes to modeling, if the quote data is defective, so too will be the results of the research. In other words, garbage in, garbage out.

Another important consideration is that data, especially historical-intraday and real-time data, can cost thousands of dollars. Using WLP, which includes a huge amount of data at no extra charge, allowed me to keep my cost relatively low. Finally, Fidelity supports its products extremely well. The ATP/WLP help desk is open before, during and after trading hours. I have found the people who answer the phone to be knowledgeable and patient. Knowing there is someone available to curse at when you get frustrated is an important value-added service. None of this is to suggest that WLP is the only or best way to conduct this sort of research. But after I fully investigated the readily available software, it seemed lik WLP was the program that best met my specific needs. Nor am I suggesting that one needs to hire a computer programmer in order to successfully test trading ideas. Unless, of course, you are a village idiot. In that case, it is highly recommended.

The "Rubber Band" System
By this point, we were ready to begin programming. It would be impossible in this short space to describe everything that went into building my model because we performed thousands of tests using ten years of data for the 500 stocks in the S&P 500 and the 100 stocks in the NASDAQ 100. I will say that the concept is based on a type of trade I have been making for 25 years that somewhat simplistically can be characterized as my "rubber band" strategy. The idea behind it is that as the market moves, it stretches--like a rubber band--and when it can stretch no further, it will snap back. This approach requires one to fade the immediate trend. So, for example, one query we posed goes as follows:

1. Stock XYZ is up at least ten percent between the close of day one and close of day two.
2. Sell short 100 shares of XYZ on close of day two.
3. Buy back 100 shares of XYZ on close of day three.
4. Or, on day three, buy back 100 shares of XYZ if XYZ moves up more than five percent from close of day two.

There are three possible outcomes to this trade on day three: cover the short position with a profit on the close, cover on the close with a loss of less than five percent, cover before the close with a stop loss of five percent. And the verdict? The rubber band system is profitable. It generated more than 24,000 trades over ten years, an average of about 40 trades per stock, four trades/year/stock and overall, about ten trades every day from the universe of 600 stocks. The system made about $1 million, an average of slightly more than $50 per trade. Fifty-five percent of the trades were far more profitable, generating about $800,000. As I dissected the data, I found that certain stocks seemed to respond well to the system and others lost money every time the signals were present. Illiquid stocks (stocks with less than 100,000 shares per day traded) performed especially poorly. I could go on, but I just want to give you a sample of the information one finds in an analysis of this kind.

Don't Forget About Commissions (or Spreads)
So you ask, why not just make the daily ten trades in perpetuity and collect the winnings? Well, we haven't looked at the entire picture. Commissions on the completed transaction are $16, which brings the average per trade down to $34. Then, we must factor in slippage. Let's say that amounts to $25. We've now reduced the average to about $10. The margin of error is now so slim that what looked initially like an interesting system now appears to be a breakeven proposition.

But wait! We're just getting started. What if we cherry-pick, acting only on signals for stocks that make money with this system? Or what if we simply buy 200 shares of every stock that responds well and only 100 shares that don't? What if we only execute trades on the long side, which produced the best profits? What if we filter from the system stocks that trade less than 100,000 shares per day because they are a drain on profitability? What if we alter the original query variables? Buy XYZ after a 20-percent move? Get out on day ten? Sell stop of 15 percent?

I have no idea whether there is an individual change or series of changes we can impose that will salvage the rubber band system. The only way to know for sure is to test. This optimization--the attempt to find the variables that will produce the optimal results--can, theoretically, go on for infinity. At some point, however, one has to decide if the system is worth trading or if it is a dud?

Even after months of study, I remain unsure. While some of the work Rube and I have done looks promising, I do not believe we have tested our results rirgorously enough to justify committing my trading capital to them. But we are getting there. The next step is to take our findings to a professor in the Graduate School of Business at the U of C, an uber-geek, who will use all the mathematical tricks in his financial engineer's bag to break my model. If he cannot, I may be on to something after all. This exercise will cost big money, but I have discovered that model-building is like raising a child. Shoes, braces, college, weddings--you just keep writing checks and hope to God that one day they will support you in your old age. In the meantime, I continue to trade the old-fashioned way and continue to make a living.

Also, I have become surprisingly good at Rubik's Cube.

This article is published in SFO Magazine (March 2006)