Diversified Trend Trading Approach

Asymmetry - Focus your attention on what you can directly control.



Under modern portfolio theory everyone is aware of the tendency for risk to increase with returns...however there is an assumption in this notion that relates to investors/traders being rational decision makers. The reality however is not so straightforward. For example there are many examples in the equity market where a move into less volatile assets can actually result in enhanced returns when compared to more volatile assets.



Just another reason why you need to test every assumption in this 'mantra filled' investment/trading world. The reality is that traders/investors are not necessarily rational, and human biases such as the 'lottery effect' and a host of other human biases can be responsible for shifting the conclusions away from modern portfolio theory towards markets being inefficient at least some of the time.

But no matter what conclusions you have in relation to the risk-reward relationship, there is no question that risk will be an inevitable bedside companion to reward until of course the day when we no longer have to take any losses......no I don't believe in pink unicorns. There was a touch of sarcasm in this comment.

So here is the question. Have you ever really thought about the aspect of trading that you can actually really control....namely risk management, or has your mind always been focussed on the sexier end of the relationship.....namely profits? For example, do you want to get as much return as you can get with a given amount of risk and try to make every trade a winner....or do you focus your attention on protecting your trade capital through strict risk management and simply letting the market decide how much profit it will deliver to you? The mindset that accompanies these different perspectives to trading is significant in shaping how you interact with the market.

You like potato and I like potahto
You like tomato and I like tomahto
Potato, potahto, Tomato, tomahto.
Let's call the whole thing off

The lure of profits is a hard aspect of trading to dispel from the mind....but it might be time to flip the mind and wonder what could be achieved if you simply focussed your efforts towards that aspect of trading you can actually control.

As all of us recognise, positive expectancy is our long term goal of trading....but to achieve this you need an asymmetrical strategy. A strategy whereby risk versus return is not symmetrical but rather where on a per trade basis, we have more profits and less losses. Now in an efficient market, this asymmetrical fundamental relationship is where fairies exist.....but in a market prone to inefficiencies at times, this is where asymmetrical opportunities exist that are the bread and butter for concepts such as "cut losses quickly and let the profits run".

There are two ways to create this asymmetry that represent different ends of the spectrum:
1. Step into the world of prediction whereby your ability to forecast with fidelity delivers you enhanced profits compared to your losses assigned through your exit mechanism; or
2. Step into the world of risk management whereby you focus your efforts on strictly limiting your downside risk exposure (keeping your drawdown within your expectations) and simply letting your system breathe when in profit.

Option 1 tends to mean that we need to become specialists in prediction..and that is actually where actual risk lies (namely the risks of uncertainty). With this mindset we find that we prefer to focus on one or a narrow range of markets whereby we invest our efforts in understanding these markets and their nuances in detail thereby hopefully improving our predictive abilities. We become market specialists.....but what happens when market conditions change? What we find is that we very quickly enter drawdowns well beyond our expectations and are more likely than not to throw away our current failing system and look for another predictive system that responds better to current market conditions. The game of an Option 1 trader is full of stops and starts....successes and failures and the classic whipsaw and volatile life of a retail trader.

Option 2 under a dedicated focus to risk management however allows you to trade any liquid market and even those markets that many Option 1 types would consider high risk. It also allows you to stay a generalist as opposed to a specialist and is far more forgiving if market conditions change as your active risk management protects your drawdown exposure or at least ensures that your rate of entering an unfavourable drawdown is far slower. The game of an Option 2 type trader in general is therefore more boring, less spectacular/volatile but far more enduring and sustainable. On the flip side regarding your profits, you don't really care about where the market takes you as you recognise that with your systems open-ended nature, that simple market uncertainty means that at times an ineffiocient market may occassionally deliver you a windfall.

Under Option 2, we are never certain about anything, are boring at dinner parties, drive volvos, dress funny and wear horn rimmed glasses .......but you can never get rid of us as we never ever die! There are less of us in the retail world but we are immortal. We are the Connor Macloud's of the Clan Macloud :-)

Trade well

C

Go with the Flow



"Okay, here goes Copernicus again......blarbing on about un-related things trying to force a notion of 'trend following' into everything he does. Why doesn't he just stick to knitting and show us his trading ideas and be done with it?"

Well my friends, I do beg to differ. What these posts are seeking to achieve is something far more powerful than a simple trading system or method. Something that can leverage your skill sets in any endeavour you seek to achieve. The idea is about forcing the mind away from focussing on the narrow 'things of life' (the noise ....or the interactions) and endeavouring to see and understand the underlying processes at play that give rise to those things.

The central 'big idea' is about accepting your lot as a participant of a great system and observing the principles of trend following in every endeavour you do. To go with the flow so to speak like an eddy in a river that utilises the flow of this magnificent universe to 'ratchet up' your life's experiences and capabilities and make a far grander melody than what be achieved by the discordant tune of a solitary battle against the elements.

It is not about smoking herbal remedies while levitating and chanting, as this defeats the purposes of attempting to understand how this universe or any complex system within it actually ticks, but it is about removing those distractions in your head and simply observing complex systems at work. As a trout fisherman I don't simply cast my fly into any patch of available water. I focus on a bee or any pollinating insect and where it hovers above a flowering plant at a particular time of year and then I surmise that my trout will be found under a fallen log in a creek next to a grassy paddock where I know these flowers tend to congregate. I then simulate the pollinating insect using a carefully crafted fly, placed at a specific location above that log mimicking the insects movement and...... 'Bobs your Uncle'. That's not predicting as contrived as it may sound....it is simply observing natural processes at work and understanding the flow of it all.

I have spent considerable time in my posts discussing 'systems' and for good reason. At the root of everything in this very rational universe lie the system processes that drive the principle of 'cause and effect' into the future. These principles arise in a universe where there is a uni-directional sequence of events (thanks to principles of entropy) that drive the causative structures which unfold as a consequence of the necessary inter-related natures of systems within systems.

Why do I say 'necessary' inter-related systems? The mere fact is that within this universe (defined as everything there is) you simply cannot find an isolated system. The only isolated system is the universe itself. We can have subsystems within that context that appear isolated.....for a time at least, that can utilise the mechanics of the system surrounding it to run-counter to universal processes....(eg. the eddies in the river)......but inevitably all these subsystems give way to the greater rules of the isolated system (eg. the river) within which they are contained.

What 'necessary' means in this context is an attribute of symmetry. It is not by chance that systems are related. It is a necessary outcome arising from conservation laws. No sub-system can be truly isolated from each other. For example, let's assume that you have the most symmetrical state that is possible in a system, ie. that of an isolated cloud of gas. It is homogenous and isotropic in that if you embed yourself in this system, no matter where you look there is total symmetry and nothing to distinguish one 'thing' from another.

There is 'NO-thing' and yet there is 'something'..... namely a state. Watch your world turn up-side down with your new definition of nothing. Some of those puzzles you may have queried such as 'how did the universe arise from nothing?'..... dissolve away in an instant when you have a something after all to play with. 'Nothing', as defined as the absence of something, is the misnomer. Nothing may actually be a something. While on the subject of nothing, have you ever seen an 'absence' in nature?.....which means no things and no volume or space....I dare say you haven't. Nature abhors a vacuum. You might however have seen a volume of space with apparrently no contents.....but as you dig a bit deeper you find that the apparrent void is teeming with processes such as excitation fields....anyway, stop wandering and get back to the meat of this story.

The state of a system relates to how many things you need to know to characterise or describe that system.

If we treat our universe as being defined as 'everything there is', then this applies a conservation law to the total contents of our universe (or system). There is no leakage of the stuff over time, be it what describes the stuff (namely energy) or at an even deeper level, the information required to define the attributes of that stuff. Now no matter how you subdivide this state of stuff by inserting boundary states that allow for nested systems, if you summate the stuff of all the composite sub-systems, those conservation laws persist.

Now let's cool the gas so it becomes a liquid. In this liquid state, it is 'nearly' the same everywhere you look, however there is one major difference between the liquid state and the gaseous state, it now has a surface bounding it and we have a reduced volume. If we summate both the energy/information dissipated through cooling plus the bound energy/information of the liquid state including the energy/information of the boundary, we restore the conservation laws of energy and information of the prior gaseous state. However by simply looking at the contents as opposed to the boundary, we find that the symmetry is not perfectly preserved. We now have what is referred to as a broken symmetry (or a portion of the total symmetry). We can restore the total symmetry however if we summate the boundary conditions and the volume of it's contents.

In breaking the symmetry we have given rise to a new structure and a new set of states is now available to us. We have increased system complexity and entropy (the number of ways you can characterise this state) through the emergence of this structure. We are not altering the total energy or information of the entire state but rather re-configuring how this information or energy is packaged.

We then cool the liquid further and it becomes a solid. We have once again broken the symmetry of the liquid (one more symmetry) but gained further complexity, structure and entropy in the ensuing solid state. The conservation laws are still there, however to find them we need to understand how all these broken symmetries can be restored to the original symmetry to calculate them.

Now have a look at this video and be blown away. Be patient as the kicker comes at the end when the flow is reversed. You will see complexity in action through evolving states arising from directional processes. There are very specific laws at play determining the plot of each dye molecule within the system throughout the entire process. The information is still there, but just re-configured. That's how to view the evolving state of our universe. Despite the unfathomable complexity, there are very specific and prescriptive laws at work to ensure that everything has a correct place. This is why we can use the principles of covariance and state transforms to make sense of it. Unfortunately we rarely see the bi-directional processes at work in our universe as displayed in the video due to it's over-riding uni-directional flow. It doesn't mean however that we can never see it, as local processes can temporarily go against the flow....but it is a rare event that humpty dumpty ever gets put back together again. But one of the aspects of our universe that we see every day that utilises the flow to create order from disorder is life itself.



With systems within systems, the laws of the greater system arising from broken symmetries penetrate throughout ensuring that their is co-ordinated action throughout the greater system. Each subsystem is interrelated with each other through these deeper symmetry relationships. As a result, cause and effect relationships are simply a consequence of these inter-related linkages. Einstein recognised this in his 'principle of general covariance' which was the cornerstone to building his theory of general relativity.

In applying the principles of 'going with the flow' we can perhaps now understand why trend following is very aligned with following the principles of cause and effect. It is not just a philosophy, it is a grand clue from nature in how to ensure our lives are full and aligned with the natural ways of the world.

On a deeper level it means seeking to understand the processes at work and most importantly their inter-relationships to make you a better strategist which allows you to anticipate how a current cause in the 'now' translates to a future effect. By going with the flow you can harness the flow of the system to magnify your participatory impact in this great universal symphony...just as life itself does. The principle is found in aikido, where you leverage your defensive capabilities by drawing on the 'flow' of your aggressor. It is a far more efficient method of dealing with conflict as it actually suppresses anger through dissipation as opposed to exacerbating conflict through addition.

Following the trend as a general principle, like the scientific method is one of continuous improvement where your trend following models adapt with the system processes and progressively allows you to better navigate undertainty using the past as a clue to the future. Your models, like the scientific principle, attempts to explain what we observe now and how we got to today. We then project what is known into the future as a forward looking risk management tactic. We are not astrologers however as the future is uncertain so we avoid predicting....but we do nevertheless project the past into the future as a roadmap to keep track of how the future benchmarks against the past. That way we continuously adapt our risk modelling.

It is about observing how this grand planet and all who occupy it got to where we are now after approximately 3.5B years of risk management and not focussing on where we are now and where we will be in 3.5B years from now. Is it possible that nature has a few clues of it's own on risk management? Are you prepared to trust nature and follow the trend....or are we just too clever for that?

Aveagreatweekend

C

This summer heat in Brisvegas is more than I can bear. :-)

Interesting Perspectives from a Long-Term Trend Trading Approach - Covenant Capital

Here is the track record of Covenant.



Enjoy

C

U can be my guest in 18 C Beirut spring .

Bring it on Bass. Anything to get out of this heat :-(



Nothing good ever came from the heat wave.

You really have nice pictures

December 2016 Update of Fully Automated Systematic Approach

Most of this thread is dedicated to a discretionary approach to trading trends, namely the DTT and it's variants .....well a semi-automated approach at least. Obviously I am a big fan of this technique and so far I have yet to find a superior outcome in the fully automated space.....but the following blended fully automated system is getting close.

My preference of course is to continue testing portfolio blends and working on specific system configurations in the fully automated space as to be perfectly honest....I hate sitting at the screen.....and I rarely trust that gooey matter in my skull.

Below are the performance metrics of a blended system applied across a universe of 46 investments across 6 asset classes comprising:

1. a 10% allocation weighting to 12 simple breakout techniques of varying timeframes with an applied weighting favouring the medium term breakout ranging between a 100 to 200 day lookback;
2. a 10% allocation weighting to the FUSEX ETF which mirrors the performance of the S&P500TR Index;
3. a 30% allocation weighting to a mean reversion strategy; and
4. a 50% weighting to a trend retracement strategy.

Results are as follows. Please note that the results are Net of Fees (NAV) assuming that this strategy is applied under a standard 2/20 fund structure. As retail traders, we avoid these costs and the gross returns are represented by the green equity curve in the chart below. While the Net Fee CAGR is 17.03% over the period, the gross CAGR outside a fund structure is approximately 25% PA. Not bad over a 14 year period.....however you would have had to endure a drawdown of 40.54% to enjoy these returns. You might say that such drawdowns are unacceptable...however drawdowns such as this over a long timeframe (eg. 16 years) are a necessary evil and quite common in the trend following space when seeking to maximise the risk-return relationship.

For example the chart below represents the comparative performance metrics of the Trend Following Index which reflects the performance of 47 of the world's top CTA's in the trend following space.



To achieve the levels of returns of a +20% CAGR over the 16 year period, some wicked drawdowns are simply a fact of life.....but remember that over this period of time, a simple buy and hold approach in an ETF mimicking the S&P500TR Index would have had two drawdowns of 30% and 50% over the same period, yet would have only delivered a paltry CAGR of 6.73%.



Cheers

C

Time to Boogie :-)

I don't know how u can be annoyed with this kind of heat, u should embrace it .

ROFL. You are mischievous....do you know that Bass? Now where is my wife lurking? *nervously turns around*

I dont know why u should *nervously turns around* i'm sure that the wife knows already at this stage of your life that !!! ...

A good article from Jez Liberty on the benefits of diversification - The More the Merrier

http://www.automated-trading-system....on-free-lunch/

A Walk Back In Time with Hed Kandi :-)

The Rant

All of us are searching for a system or approach that offers positive expectancy (or an edge). As I peruse the posts of this forum, almost every topic relates to a specific system or approach that seems to work given recent market and attracts interest from all around as .....just maybe, this is the system that is going to work for me? We all recognise that market conditions can and do change over the course of time, however what we tend to do is blame our system when it starts to fail in delivering a steady stream of profits. Some of you may even start blaming the markets as being a 'rigged game'.

Many of us, like gamblers, are simply eager to get to the roulette table and start the ball rolling and placing our money down, for the thrill of it all....without any heed to the reality of the game itself. It is a bit like being given a new car and you simply get in, start the engine and head off on your way....without spending the time to consider how it works, when it works, and the times when you need to be careful in how you drive it.

Few of us respect this complex market. The prime reason for this lack of respect is that we treat trading as a game or a gamble, risking a very small amount for the thrill of instant riches. I would suggest that if we decided to trade with our entire net worth, the game would take on a more serious and subdued tone. As opposed to risking a $5K or $10K trade capital, up the ante to a $300K trade capital account and see if you take the same risks as you are doing now. I would suggest that under a more severe risk challenge, you might approach this game a different way. There is nothing like imminent death to make you aware of your risk enviornment. A bruise just doesn't cut it. You need real skin in the game.

Unfortunately many traders have never taken the time to carefully examine why their system performs in particular market conditions and in what market
conditions your system fails to perform.

This can be directly attributed to either:
1. The nature of discretionary trading itself which prevents us from being able to benchmark system performance itself, as each trade has been taken based on the thoughts of the trader at the time. While a trade journal helps to a degree there is no easily accessible record of the conditions that triggered that trade which will enable a quantifiable and riguorous post mortem at a later date;
2. The lack of any back-testing history or result that is used to benchmark future performance. For example, a long term back-test allows you to identify when your system performs and when it doesn't. It allows you to determine:

- the maximum historic drawdown from an unfavourable sequence of trades;

- what is the maximum drawdown I am prepared to tolerate before calling it a day with this system or putting it in park?

- Is my system underperforming because of current market conditions. Have those conditions arisen in the past, how long did they persist for etc.

- the average volatility of returns that have been produced by your system over a broad historical range of market conditions;

- The long term average win rate and the long term average risk$ to Reward $;

- Whether your system has positive or negative skew which is crucial in your ability to determine system risk;

- etc. etc. etc.

What the above is saying is that you are victim to the market and your innate biases if you go down the discretionary path to trading. Accept that risk at your peril. If you want a sustainable plan for financial independence, you need to accept systematic trading, so be prepared to skill yourself up with automated systems and build your skill capabilities in this arena....Do the hard thing and learn the systematic way, or leave it to chance and your innate abilites as a trader....it is your choice....but the latter choice is far more subjective in nature.

Without an understanding of why your system performs during particular market conditions, you effectively are trying to steer a flimsy raft across the seven seas without a rudder. You have no ability to assess whether or not your system possesses an edge or not, how robust it is (eg. whether it will sink or not) and you are purely left in the hands of the market. The market will determine your fate....which when luck runs out, will result in a bitter end......with a few sharks to help you out along the way.

Now let's imagine that you are serious about wanting to 'trade for a living' as opposed to being fanciful and letting lady luck determine your chances of survival. What steps can you take to 'actually' achieve this outcome.

Step 1 - Don't be a fool. If you plan to make a living from trading then be prepared for a major capital investment and a major investment in upskilling your capabilities. You are a gambler and a dreamer if you think otherwise. This can be a lottery or a business. Once again it is your choice but think on it wisely. Yes people can win lots from a lottery, but with a correct mindset you can also run a successful business and this to a large part depends on you. Is there any investment opportunity that offers you a consistent return of >30% per annum for say 10 years without blowing up? Do some research and see what the best of the best in the investment world can achieve. Once you have done your research, then plot where do you as a retail trader sit in this spectrum without capital and a R&D department at your disposal.

Step 2 - Be Humble and realise you have an amazing amount to learn. Look at any complex system, be it the oceans, a big business, the cosmos, the weather....etc etc etc. Do you really think that you do not need to study it in detail and spend the time to learn about it before you commence interacting with it. Let's say you lied in your job application and were appointed as a highly paid manager to a large company such as Google. How long do you think you will survive without spending time attempting to understand how to implement your job description?

Step 3 - Recognise that it is experience and knowledge of the market that will be your keys to survival in a competetive hostile marketplace. Be prepared for a long journey before you can ever hope to become a successful trader. You will have lucky streaks and unlucky streaks. The key to surviving is being able to discern what luck versus actual skill is.

Step 4 - Learn how to use your brain and how to rely on your judgement - If you are after spoon feeding....then get back in the crib. If you want to have a degree of independence in this cut-throat world, then start using the great thing inside your skull called a brain. Remember that what you think is simply a composite of the experiences that reside in your brain. Those who think small need to top their brains up at the next available gas station. If you want to build your creative problem solving abilities start filling that brain up with knowledge and experiences to improve your thoughts. If your thoughts are the ultimate arbiter to you of identifying what is wrong and what is right, then the more you know, the better placed you will be with your thoughts and ultimate behaviour (which is the physical manifestation of those thoughts).

Step 5 - Learn how to test assumptions or ideas - If you do not know how to test an idea or assumption for it's validity, then wait until you do. Like monkeys we can all mimic and copy others, however understanding how a system works is the priority. How do you fix something if you do not understand how to test it? If you simply apply someone else's system, be prepared for a sting in the tail when for some reason it no longer works. You will be left listless and wanting and will not know which way to turn. We can all use a computer but few of us know how to fix it when it just doesn't want to work. Here is the rub.....so suck it in......as an independent trader, no one actually cares about you and without having money to pay someone else to fix it, you are quickly going to find that you will need to revert to the old ways. Being a successful independent trader means you need to be able to fix things for yourself. You need to build your skills of self-reliance.

Step 6 - Do not trust anyone and test everything. The only way you can discern between good advice and bad advice is to test it yourself. That is the only way that you will be able to overcome your inherent suspicion of bad advice. To be able to determine whether or not an idea is a good one or bad one therefore depends on your understanding about how to test the assumption or idea. Do not believe any trading mantra.........for gods sake test it before you accept it.

Ok....enough of the pearls of wisdom. You have probably had enough. What in essence this is saying is that in any profession, to succeed in it.....and I mean truly succeed (as opposed to simply relying on luck), you need to build your capabilities in this field and be prepared to invest your efforts towards learning and applying what you have been taught. So stop being so goddam lazy....remove any unjustified ego you may have.....stop thinking that you are entitled to something.....stop being a parasite and just grow up.

Before this rant ends I would just like to say that there are a few examples of successful traders who have an audited verified track record. The problem is however that it just falls on deaf ears time and time again. That is because in this very hard world of trading, most participants in the retail world are simply newbies (with wide fresh eyes waiting to beat this market) or as the more veteran amongst us say...... the next round of cannon fodder for the market. There are actually very few successful experienced traders participating in any current trading forum as survivorship bias always eliminates the weak from the strong and in this complex market....survivorship bias rules supreme.

So where are these successful traders with a verifiable track record? Well to be perfectly honest, they do not reside on the retail trading forums. They are actually busy managing other peoples money. Why? Because they are not stupid and are prepared to back themselves and their abilities to offer others a solid investment return. That way they can leverage their personal returns by trading their own capital and the capital of others.

Where are they then? Just have a look at the professional fund management space such as here . Do your own research and take the time to understand them.

Stop being so 'friggin lazy' and expecting that some nobody from nowehere on this forum is going to give you (another nobody from nowehere) the keys to instant success and gratification.

..........ok so rant over.

Aveagoodweekend

C

And that my Friend is the hard truth that no one on these forums seem to understand .

Great rant, a wake up call for those who are serious about this business.