Does your trading have an edge? Here's how to find out.

How do you know if your trading system has an edge or whether it's just random luck?

One way I learned was from Adam Grimes' book, "The Art and Science of Technical Analysis."  As I mentioned in the prior post, I consider his book a must have for traders.

In Chapter 12, there's a section called "Statistical Analysis of Trading Results" which discusses "deriving the p value, which is a significant test (one-tailed t-test) for the mean P&L being > 0."  The table on page 389 Adam used as an example looked similar to this (but without the t-value column):

The chapter didn't go into the calculation details, but with some helpful guidance that Adam emailed me, I was able to dust off  the cobwebs and think back to my college statistics class.  You can find out more about p value from here and here.

HOW DO YOU CALCULATE IT?

The steps are simple from within Excel.  Take each individual trade P&L and figure out: 1) the average P&L per trade, 2) the number of trades, and 3) the standard deviation.  If you use Tradervue, Greg will be rolling out the p value soon (if not already) within the reports section.

Then plug in the #'s above into a Excel spreadsheet with the formulas below.  This then calculates the t-value so that the p value can be derived.  It can all be in one formula, but I broke it apart to make it easier to read.

WHAT DOES IT MEAN?

A lower p value is better.  The lower the p value simply means that based on the series of trades analyzed, the results are less likely due to random chance or luck.  In general usage, a p value of < 0.05 is often considered to be statistically significant.

If you have a higher p value, that means your trading results, even if very profitable, could be likely due to random chance or luck vs. having some sort of edge.

For example, if your p value is 0.01, that means based on the data set analyzed, there's a 1% chance of seeing the analyzed results due to random chance or luck.  If your p value is 0.50, then there's a 50% chance your results are based on luck (i.e. not much of an edge).

CAVEATS

Like any calculation used to measure trading or investment performance, whether it's a straightforward % gain on portfolio, win/loss %, profit factor, average profit per trade, or more sophisticated calculations such as Sharpe, Sortino or Sterling ratios, there are pros and cons for each type of measure.

And if your risk based on account size varies per trade, analyzing the trading results based on an R-Multiple or %R should also be highly considered.  Adam Grimes discusses on page 392 that "standardizing for risk removes the position sizing effect" so that it could reveal that a system or trader via the p value could be "trading with a clear statistical edge, even though it was completely obscured by his position sizing decisions."

The p value has its fair share of criticisms, so it's just a reminder that one measure shouldn't be the ultimate judge.  It's best to look at trading results from multiple perspectives and take a holistic approach.  And of course, always use some common sense.

Using Tradervue for analysis of autotrading The Lincoln Million

Although it has been a while since my last in-depth reviews about Tradervue, Greg Reinacker has continued to build it into one of the premier trading journals.  It is elegantly designed and for all that it's capable of doing, it remains surprisingly user friendly.

Here are a few highlights of the improvements I've personally found valuable over the past year:

• Import trade data from more brokerages
• Calculate your performance statistics based on R-multiple and net of commissions
• Improved statistics (e.g. standard deviation, MFE and MAE calculations)
• Support for forex and options
• Ability to handle multiple accounts
• Even better tag based analysis and reporting
• Improved editing/admin tools...and lots more

For anyone who is serious in improving their trading performance, maintaining a trading journal is not an option, it's a must have.  And I believe Tradervue is one of the best out there.

USING TRADERVUE TO ANALYZE AUTOTRADING BY THE LINCOLN MILLION

Over the past several months, I've started to focus primarily on swing trading, which means collecting a meaningful population of trade data for analysis takes a lot longer (vs. daytrading).  And as I wrote in the prior post, I'm also focusing more on autotrading a large portion of my account.

Recently, I've gained enough data from autotrading The Lincoln Million (TLM) to perform an analysis.  TLM is a swing trading service where Doug has gained an impressive return on his own account, and one of a few services being autotraded in my account.

I've taken the The Lincoln List's Champ Camp trading course (worth it, recommended), and have seen Doug in action live within The Lincoln List and The Lincoln Million trading rooms (both daytrading and swing trading).  He has been very consistently profitable, but how would the autotrading results compare?

REPORTS AND CHARTS FROM TRADERVUE

Here are the actual results of The Lincoln Million's autotrades from January 1, 2013 through April 11, 2013 generated from Tradervue.  Although I've been autotrading the service since November, my $'s allocation per trade were not quite consistent and locked in until the beginning of this year, so I excluded that group of trades.

Positives:

High winning %  (82%)
Solid profit factor  (2.10)

Potential concerns:

Average winning trade smaller vs. losing trade ($89 vs. -$414)

Average hold time of losers much greater than winning trades (26 days vs. 5 days)

The report below displays a graphic summary of the Win/Loss ratio as well as the P&L and drawdown curve:

The report below represents another view of the how long winning trades are held vs. losing trades:

One interesting analysis method within Tradervue is the ability to analyze your stop locations.  I didn't expect the chart below to so clearly delineate a potentially more advantageous stop location:

INITIAL THOUGHTS ABOUT AUTOTRADING THE LINCOLN MILLION

The past 5 months represent my first experience into autotrading, so I really didn't know what to expect other than mostly hands off approach, like a mutual fund.  There are some other services I'm also autotrading which are based on writing options credit spreads and each service has their own pros/cons.  I'll likely write about those in the future once I have more data.

With regards to autotrading via The Lincoln Million, here are a few thoughts:

• There have been a decent number of trades that The Lincoln Million alerted and got filled on his own account, but were not filled via autotrading.  As expected, nearly all the missed trades were winners
• Primary reasons for no fills: short shares no longer available, signal to execution time lag (generally takes 3-10 minutes for autotrade order to arrive at my broker via Global Autotrading), and impact of orders on thinly traded micro and small cap stocks resulting in slippage
• Unlike trading the very liquid ZB or ES (T-bonds or S&P e-mini futures) products where you can put on large size per trade ($1 million/trade is nothing), trading microcap stocks often have a much greater issues with liquidity.
• Therefore, actual results from autotrading is likely <= 50% of posted results
• However, if you are following the chat room alerts in real time and manually trading, I believe it's possible to achieve performance 75+% of posted results
• Better yet, once you learn the setups, you can probably do very well trading your own stocks, which is what Doug ultimately wants you to accomplish

I admit, I've experienced frustrations watching unfilled trades become winners, getting bad slippage on fills, experiencing underwater trades that are held multiple times longer than winning trades, and simply seeing average winners be smaller than average losers.  My initial expectations on what the returns from autotrading TLM should be were extremely high, and they were not being met.

But when I started to review the trading results via Tradervue and started looking at the results from various perspectives (not simply total % gains), there was definitely a high level of consistency that needed to be respected, even when the autotrading execution was less than ideal.

STATISTICAL SIGNIFICANCE

The final sense of a-ha was when I ran the trading results through a significance test (one-tailed t-test where mean P&L > 0).  I learned the method of determining whether you have an edge from Adam Grimes' book "The Art and Science of Technical Analysis" within chapter 12 (highly recommended, it's a keeper).

Even with all the slippage and missed trades, the p-value was 0.07 for The Lincoln Million autotrades, which means there's a 7% chance the results are random.  Lower p-value indicate the results are more statistically significant (better) and p=0.05 is a commonly used guideline for a significance level. 

This is an indication that even with all the challenges from autotrading, this system still has a solid edge based on the current data set.  

Assuming future improvement of missed trades and/or reduced slippage, or perhaps greater success from manually executing the trades, the statistical significance can potentially drop well below the p=0.05 significance level, further reinforcing the notion that this method has an edge.

And what if I take his published results over the same period and perform the t-test?  The resulting p-value is less than 0.01, which means there's less than a 1% chance his results are random or due to luck based on the particular set of data analyzed.  Doug's trading method definitely has an edge.

ADVANTAGES FROM AUTOTRADING

Perhaps the The Lincoln Million autotrading doesn't align perfectly with my personality (but then again, would any system you did not create yourself?), which is why having it autotraded without my biases or intervention has worked relatively well to date.

That's one reason why I'm approaching autotrading as a way to diversify my overall trading portfolio by 1) utilizing historically profitable trading services that 2) I couldn't execute consistently on a long term basis.  In essence, it's like I'm selecting and hiring traders with various trading methodologies and styles, and having them each trade a portion of my account.  And if I don't like how they're performing or how their performance blends with the other traders (services), I can easily "fire" them.

 So far, here's one of the biggest benefits from autotrading The Lincoln Million -- I have continued to track and follow the trade alerts with a much greater level of focus and involvement since I have "skin in the game."  I believe that has enabled me to learn this method much faster vs. a passive approach, and to discover certain Lincoln Million setups that resonate very well with my personality.

NEXT STEPS

• Since I only have around 30 trades for observation, which is barely the minimum data set required for a statistically significant test, I will continue tracking the system to see how well it continues to perform
• Continue to monitor the number of missed trades/slippage to determine how much of an impact it has on overall results
• At a certain point, I might consider manually executing the trading signals instead of autotrading to see whether I can obtain better execution, but having the time to trade is currently a constraint
• Keep track of what happens if a trade is closed out when it's at a loss > $400 (based on current trade allocation level) vs. letting it ride hoping for a recovery.  This will be easy to track within Tradervue using the tag feature and the MAE metric
• And finally, this exercise has reminded me of how I need to step up my trade journaling.  I know the more I leverage the power of Tradervue, the faster my trading will improve

My 2013 New Year's Trading Resolutions

Wow, time flies, has it really been that long since I last posted?  Well, now that it's March, most people have long forgotten about their New Year's Resolutions.  So it's time for me to zig while most zag -- better late than never.


TRADING RESOLUTIONS FOR 2013

1. Stop overtrading/revenge trading/daytrading
2. Lower expectations of returns and trade small to help build solid trading habits
3. Explore and implement other trading methods, products, and time horizons
4. Start thinking of returns based on % risk (R), not $'s

GOALS

• Overtrading/revenge trading to account for < 5% of total trades
• Too much intraday trading can emotionally charge my trading in a very negative way
• Even reducing my historical revenge/rouge trades (30% during my worst periods) by half would have a huge positive impact on my P&L
• Target consistent 2-8% returns a month
• Focus on limiting risk (not maximize returns) while building up good trading habits
• Initiate equity swing program, options writing, and further explore forex strategies
• Swing trading via newsletters/chat rooms/autotrading (target 50%+/year)
• Options writing via newsletters/autotrading (target 25%+/year)
• Forex strategies via alternative trading methods (target 100%+/year)
• Evaluate performance based on R multiples.  Reports and analysis are based primarily on %'s

TACTICS

• Stop daytrading
• Suspended my futures accounts
• Reduced equity/options accounts to significantly below < $25k to put PDT into play
• However, allow forex account for "penny slots" daytrading -- minimal absolute dollar risk
• Reduce % risk of portfolio per trade
• Average risk per trade <= 1% of portfolio
• Lotto plays <= .5%   (weekly options plays)
• Stronger conviction (rare) <= 2%
• Capture stop size as a metric to calculate returns based on R. Reports and analysis should focus on %, not $'s
• Implement autotrading initiative to explore other trading opportunities
• Research and initiate autotrading of equity swing trading newsletter(s)
• Research and initiate autotrading of credit spread options newsletters(s)
• Analyze and explore other forex trading strategies in increase # of trades and returns

RESULTS TO DATE

More details later, but based on implementing a large portion of the tactics above, I have been NET PROFITABLE both in my equities and forex accounts the past 3 months.

One of the biggest factors has been to SLOW DOWN.  Daytrading was fine when I started with profitable trades, but a few losing trades in a row often had the tendency to quickly snowball into revenge trading.  I'll eventually daytrade again, but not now.

Based on the past several months, I'm cautiously optimistic and looking to focus on even greater consistency with my overall trading process as I complete 2 years of full time trading.

A break from radio silence

Has it really been about 2 months since my last post?  A lot sure has happened since then.  Hurricane Sandy certainly disrupted life for a while, and when I returned to trading sometime in November, it's pretty clear I wasn't ready.  I was back from my hurricane hiatus, swinging for the fences, looking to make it big.  Probably as a way of lashing out at life's challenges. 

I was having upwards of 20-30 point daily P&L swings (both profit and losses) trading ES with only 1 contract.  I even had some overnight sessions with the flighty and volatile soybeans, trading late into the night resulting in 20 or more point P&L swings on a single contract. 

The only problem is that for every 20+ point day, there were more days where I lost 20+ points on 10 point range day.  Big recipe for disaster.

Yeah, I wasn't watching my risk...at all.  And I paid the price...big time.

Although my forex account has quietly gained well over 150% for the year, I ended down in my futures accounts over 70%.  Luckily, in absolute dollars, I had started with a minimal sized account just to trade, so there's hardly any impact to my overall financial condition. 

But from the psychological capital perspective, I was hit hard. 

I usually think primarily in percentages of portfolio, and when I took the hit in November, I wasn't even thinking in terms of percentage of portfolio risked (only thought how much $'s I could/should make).  In hindsight, this is simply not acceptable.  This is not what a professional trader does.  This was pure gambling.  In order to prevent myself from truly blowing up all my accounts, I took preemptive action and transferred money out.  Time out.

I've learned through experience that it's so easy to destroy your money with reckless trading, but so much more difficult to accumulate profits.  All it takes is one bad day of senseless trading to wipe out days/weeks/months of hard work.  It's a similar concept trusting someone -- what takes years to build trust with someone, can be forever broken in just moments.  I need to respect this concept.

During the darkest hours, I admit, I had thoughts of quitting. 

This doesn't happen often, but I needed to think of an alternative life to trading, and strangely enough, this usually brings me back to trading.  Trading is something I've been planning on doing full time for the past couple decades, and I've realized after careful consideration that there's no better time than now to continue charging ahead.

By the 2nd quarter of 2013, I will have been trading full time for 2 years.  It sure does seem like I've been at it a lot longer.  I remember hearing many others say it takes on average 3-5 years in order to become a consistently profitable trader (for those who even make it that far), and I always thought I could accomplish it in a year...or less.  Sure hasn't been the case.

Where has this trading journey taken me so far? 

I started it all in early 2011 with stocks, and after about half a year, I lost about half my account, literally all the losses were commissions.  I was breakeven on a gross basis, even with all my revenge/rogue/impulse trades.  I discovered that there were certain defined setups that worked very well for me, but just couldn't be patient enough to avoid the revenge and rogue trades.

As an escape, I decided to switch to futures which had more leverage and no pattern daytrading rules to worry about, and ended up losing over 70% in about a year.  A little less than half of my losses were due to commissions.  Unlike stocks, I definitely had a gross loss trading the ES and nearly all of my losses came on a handful of weeks where I went on tilt and got sucked down a death spiral of revenge trading. 

In hindsight, the leverage/tick size/contract size of the ES emini in relation to my account size really put me at a disadvantage.  I couldn't size down below 1 contract and reduce risk/scale out of positions as I easily could with stocks.  My thought was that if I couldn't be consistently profitable with 1 contract, why even bother sizing up?  I was stubborn to try and make it with an all-in all-out trading style using 1 contract. 

What and how I'm doing now

And due in part to this last experience of pain, I've recently escaped again.  However, instead of focusing more on forex (which has continued to work relatively well since I started trading full time) I've decided to explore stocks once again and for whatever reason, utilizing options heavily. 

I'm currently trading with a very small equities account and don't want to get triggered as a pattern day trader, so I only swing trade.  This restriction has reigned in the revenge and rogue trading significantly, since I can only execute a few trades a day and thus have the time to think them out.

During December to date, I've only had about 18 trades, of which over 70% are winners with a profit factor greater than 3.00.  In comparison, a bad revenge filled day from the past would produce more than 20 trades with an accuracy of < 30%, so this is significant change. 

I am hopeful and optimistic that maybe, just maybe, I'm starting to make the turn.  But then again, I've had this feeling before...which then lead to me to overconfidence, which then led me to falling off the discipline wagon in spectacular fashion. 

So I am determined more than ever to stay the course of maintaining a consistent and disciplined trading process, rather than focusing on P&L.  I also have to credit the stock trading room I've recently joined, which has making a big difference in the way I think and trade.  More about that in the future.

2013, here we come!

Since I'll be traveling over the holidays next week, this year is essentially over for me and I'll be shutting down.  So this will likely be my last post of the year. 

I'm really looking forward to seeing my old friends and family back in San Francisco.  Hard to believe it has been about 2 1/2 years since we moved from the beautiful Bay Area, so there will be a lot of wonderful catching up to do.

I look forward to 2013 with renewed optimism and confidence.

Happy Holidays to all, and best wishes for a great 2013!

Recap: Week ending 10/19 - Tough week but good finish

The week ending 10/19 was another tough week as I continued my long journey to find my way.  It ended on a good note, but it was full of difficult moments.

STARTED THE WEEK OFF WRONG
I started the week focused on maximizing P&L -- not on my goals to limit the number of daily trades to 3 and to limit my profit targets to +2.00 ES points.  I wanted to CRUSH the markets.  That should have been a big warning sign.  Sure, it felt OK that I ended up making a decent profit to start the week, but in the back of my mind, I knew I fell off the program.  I know was cheating myself.

CRACKS FORMED ON TUESDAY
Whether it was from guilt or who knows what, the cracks started to form on Tuesday.  Just prior to lunch, I called it a day barely exceeding my # of trades goal and although it shouldn't matter, I had a slight profit.  Nice job, I'm getting back on track.  But...in the final hour, I went on tilt.  I took what I thought was solid setup to end the day on a really good note, only to realize I totally read it wrong.  Yes, got greedy, got stopped out, revenge traded, and ended down a few points.  Ugh.

MONKEYS RAN AMOK
So when Wednesday came around, the monkeys ran amok.  Shortly after the NY open, I already had 3 losses in a row and it was all downhill from there.  My initial thought was, "We just opened!  How could I stop trading so early in the day?"  My will was weakened, I took one more trade, realized I did something I shouldn't have, which then snowballed into "what the heck, I blew it", and my behavior for the rest of the day ended up being yet another big ding to my psychological capital.

RADICAL SHIFT / DO SOMETHING DIFFERENT / DO WHAT WORKS
Just around that time, I realized that the S&P was in overbought conditions based on the interpretation of the daily charts that I have used for many years, primarily on the forex charts.  The high probability setups only happen once or so a month, and I just don't have the patience to simply wait only for those signals. 

$ES_F - daily chart - 10/19/2012

But I needed to do something different to change my ways and make new habits after a rough start to the week.  Swing trading has worked well for me in forex products, so why not try something similar to that in the ES?  And when I am swing trading, the setups are very infrequent, so it's much more difficult to get into the rhythm of impulse trading -- another plus.

THE PLAN
So Wednesday night, a plan was made to establish a swing short in the ES, very similar to what I do with the forex trades.  A couple indicators I use on the daily timeframe showed a nice clean overbought condition, so it was time to find a good short entry.  My target was 1425-35 area.  I entered the short Wednesday evening and by Thursday morning, I was up over +5 at one point.  But then came the big Thursday morning grind up where I got stopped out just 1 point before the erroneous Google earnings release that spooked the market around lunchtime.  It was tough to get stopped out so close to the highs, but I followed my trading plan and felt good about that.

I ended up taking a few solid day trade setups to end the day with a slight profit.  And after the market close, the daily charts looked just as bearish, or even more so than ever.  So Thursday night, I reentered the short, utilizing some good resistance areas from earlier in the day.  That short ended up being 1 tick below the high of the night and following day.

PATIENCE IS TOUGH BUT WORTH IT
At the Friday NY open, something strange happened.  The market gap opened below yesterdays close and ended up having an "opening drive" lower.  That means it sold off strongly after the open with very little rotation/swings higher.  This was very unexpected based on pre-market action as well as other factors. 

A very key point to remember is that when there is an opening drive, there's about a 50% chance for a trend day.  Since trend days generally happen < 20% of the time, those are pretty compelling stats.  As the ES tanked and continued to fall with minimal rotations higher, I knew there was a good chance it's going to be a trend day, and that trend days generally end at the extremes of the day -- in this case, the lows of the day. 

$ES_F 30m  10/19/2012

I couldn't be near the charts for very long, since the temptation to exit would become stronger, so I took frequent breaks.  Having patience to just sit on your hands on trend day is tough. 

But I ended up exiting once the market started to consolidate a couple hours before the close, weary of a reversal bottom that would rip higher into the close.  And most importantly, it was right in the middle of the 1425-35 range that I had targeted for profits.  I followed my plan, although it happened 1-2 days quicker than I expected.

As it happens more often than not for trend days, the market did end up closing at the lows.  I left about +6 ES points on the table, but I'll consider myself fortunate that I was able to book almost +24 points.

RANDOM QUESTIONS AND THOUGHTS
The week ended on a good note, but I still have many questions and issues floating in my mind that I will need to evaluate and address.  This last trade hardly resolves my many challenges.  So although both my financial and psychological capital have been somewhat replenished, there are still a lot more obstacles to overcome.

• Over the past couple years, I've been successful at simply swing trading, so why do I keep trying to trade more like a scalper that goes for big wins?
• Oh, but what would I do during most days just waiting for a swing setup?  One part of me likes the "action" of daytrading!  [** Flashing lights and "Danger Will Robinson!" alerts going off **]  Trading should not be something you do to help pass time.
• Ending the week on a strong note is nice.  But this only means I need to be extra careful not to be overconfident on Monday.  And how will I feel if the market tanks another 20 ES points...without me on board?
• Am I getting closer to the point where I will stop chasing success?  The pieces of this trading puzzle seem like they're starting to come together, but I've said/thought that many times before.
• Cough medicine and the recent correlation to trading performance, so strange.  But correlation is not causation!  Or maybe not?  If so, what does this really mean?
• Why is limiting myself to 3 trades a day so tough?  Sounds so easy, doesn't it?  What if I had originally set the daily trade goal to 6, would that have made any difference?
• Although I have my fair share of really tough days that have hit my psychological capital hard, I still believe from my core that my dreams of trading success will become true.  It's only a matter of time.