June 21, 2006

Search for the Holy Grail

Filed under: Uncategorized — by TraderMade @ 2:12 pm
Tags: ,

This is from the pmking’s blog entry:

Some things in trading just aren’t possible. Maybe a car analogy will help. Imagine for a moment you are designing a car and it has to have the following characteristics:

  • 0-60 miles per hour in 6 seconds
  • Top speed of 180 miles per hour

So it’s a fast sports car at the high end of performance. Now you have a couple more required characteristics:

  • Carry 7 passengers in comfort
  • Do 40 miles on a gallon of gas

If you know anything about physics and conservation of energy you will quickly realize that these 4 characteristics would be virtually impossible to embody into one vehicle (with current technology). You have 2 main choices – compromise on some of the requirements, or design 3 cars (a sports car, an SUV, and a compact).

What has this got to do with trading? Well a lot of the time people are trying to design the ‘Holy Grail’ system that has the following characteristics:

  • High win%
  • High average winner size to loser size
  • High frequency
  • High return
  • Low drawdown
  • Low slippage
  • Low implementation costs

Just like the car design where some of the characteristics have an inverse relationship (e.g. top speed to fuel economy) trading systems exhibit similar behavior. High win%, for example, is usually inversely proportional to both trade frequency and average size of winners compared to losers.

When you are attempting to design a trading system it is important that you make sure you don’t have an ‘impossible specification’ for what you want to achieve because you don’t clearly understand the relationships between the various system components and characteristics. Otherwise the only thing you’ll achieve is frustration.


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