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The Rationality of Logic
By Darren Merwitz | July 24, 2007
It makes sense that things should make sense. I am the first to admit that there is a lot I don’t know. But there is a lot I’m ok with not knowing, mainly because I don’t need to. I don’t need to know why I’m kept alive by breathing air, why toast burns, or how swiping my access card gets our office security door to open.
But here is what I do need to know:
- When and why my strategy will make money.
- When and why my strategy will lose money.
Here is a typical situation. You code one of your strategies into a charting package that you have been using. It doesn’t do quite as well as you had hoped. So you tweak. It does a little better, but still not as well as you’d like. So you tweak again.
Eventually, you end up with a vastly different coded strategy to the one you started out with - usually a lot bigger and a lot more complex. You don’t fully understand why, but it does a lot better than the original, so you figure it’s better and use it. A month later you’re wondering why your account is so far down, and can’t understand where you went wrong.
Don’t get me wrong, tweaking isn’t bad. Neither is optimization. But here is the golden nugget:
“You MUST understand your strategy”
Having a strategy that makes money isn’t enough. You need to know why it makes money. You need to know why it loses money. And the environments for each.
Logic is your biggest ally in strategy development. If a strategy does well when the input is 4, but poorly when the input is 5, does that really make sense? It may, but you need to be able to reason out why.
A ranging strategy that trades during Asia hours may do better than one that trades during European hours. This may sounds strange, but markets are generally quieter during Asia hours, and break-outs are less likely, and thus are more amenable environments to ranging strategies. It makes sense and can be reasoned out.
This sort of logic needs to be applied to every espect of your trading strategy. From the time of trading, to the entries, exits and money management. I’m obviously excluding signal services and money managers, in which case you should be using due diligence to make your decisions. But, if you don’t understand what your strategy is doing, you may as well give your money to a monkey with darts to manage. Now that doesn’t make a lot of sense, does it?
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Topics: Systems Trading Blog |