I’m posting this message cause I have nothing better to do at the moment.
My opinion is that the keys to long term trading success are
1. Cut losses
2. Position Sizing
3. Let profits run
It is the third point, “3. Let profits run” that I wish to expand my opinion. Please note that the following is purely an opinion.
Most systems are optimized for certain market conditions and as soon as market conditions alter, these high performing systems suddenly take a dive and disappear. If these same systems had employed a let profits run strategy including keys 1 & 2, then would they still be profitable today?
Unfortunately the major disadvantage with a let profits run system is that the big winning trades are few and far between and every trade must be taken to avoid missing the few big winning trades. The fact that the big winning trades are few and far between, it is critical to employ 1.cut losses and 2. correct position sizing strategies to minimise the drawdown in between the big winning trades.
Another disadvantage with a let profits run system is that it is mentally draining on a trader to frequently see open profits evaporate and it takes alot of mental discipline and self belief to
follow to your original “let profits run” strategy and not succumb to taking profits too early.
Most traders can not mentally cope with a “let profits run” system for reasons outlined above and due to the natural tendancy for frequent steady profits and thus the attraction to systems that do NOT let profits run.
I believe that even 1.if a system is optimized for certain market conditions, employing a “let profits run” strategy goes a long way to ensuring long term profitability should/when market characteristics change and 2. theoritically a let profits run system (in addition to keys 1 & 2) can sustain a low win/loss ratio but still maintain profitability.
From a contrarian point of view, if most traders are attracted to systems that do not let profit run (ie due to the natural tendancy for frequent steady profits) and statistically most traders lose money, then inverse logic suggests that traders should choose systems that do exhibit a “let profits run” strategy but this is extremely difficult for reasons already stated?
I am replying because I have nothing better to do either… And I’m not a vendor, so all I say is just theory:
I am surprised that you do not mention
4. Predictive value
With this I mean the ability to predict the direction of moves of the traded assets in the near future. Without that it is not trading but gambling, even if you apply the points 1-3.
(I believe that some people attach a specific meaning to the word “predict”, but I mean no more than the ability to buy or sell the right thing at the right moment. If you think there is a better term for that, please let me know.)
To the extent that the predictions are right it will be less important to let your profits run. You can simply have a stop loss and a profit target at the same distance from the entry point provided that you are right 60% of the times.
Points 1 and 3 (cut you losses and let profits run) can easily be implemented with a trailing stop. So I don’t think that it is always discipline that makes them difficult. The problem is rather to know where to put the stop. Discipline plays a role only in discretionary outputs when you have no idea where the stop should be.
Cut your losses and let your profits run are vacuous advices if you don’t know at which level the stops should be placed. You can as well get a loosing system if your stops are wrong too often.
Another point is
5. Modest leverage.
This is not the same as position size (e.g. if I buy $1000 in options instead of the underlying stock, the position size is the same but the leverage is higher). The problem with a high leverage is that a stop that produces an acceptable loss at the leveraged instrument corresponds to a much tighter stop in the underlying asset, which increases the probability of a loss. So a hight leverage makes it difficult to cut your losses and still be profitable.
Hi Jules,
Good points, but I intentionally omitted predictive value since if
1. cut losses
2. position sizing (with accounted leverage…as you pointed out)
3. let profits run
are implemented “correctly”, then predictive value becomes less important.
The predictive value can never be measured with any degree of accuracy prior to entering a trade, hence systems should not be developed based on a pre defined predictive value. In contrary systems should be developed with a low predictive value.
No “static” system can accurately predict the market direction over a long period of time, simply due to changing market characteristics but a trading system can still be profitable if its able to correctly implement the three key ingredients.
If a system with a high predictive value did exist, the system would still need to correctly employ 1.cut losses and 2. position sizing strategies to be profitable over long period of time, but personally I do not believe a system can sustain high predictabilty over a long period of time without being modified to suit changing market characteristics.
The real question is…what market variables can systems control?
1. Cut losses - Yes
2. Postion Sizing - Yes
3. Let Profits Run - Yes
4. Market Direction - NO
The Market Direction is the gambling/chance component of all trading strategies and where most trading systems errorneously focus all of their energies. Naturally systems should endeavour to find the optimum direction/entry to give it an edge and increase its probability of success but it’s only a slight increase relative to the other 3 key points.
If market direction is an unknown quantity and can not be controlled , one must assume worst case conditions and design a system for a low predictability (ie low win/loss ratio).
How does any system maintain long term profitability with a low win/loss ratio?
By employing a “let profits run” strategy.
I think an important part of the “key to success” is the ability to identify market inefficiencies and manage risk.
A “let profits run” strategy can be attractive when returns are serially correlated (i.e. a positive return today is more likely to be followed by a positive return tomorrow than by a negative return).
I think a problem with a “let profits run” strategy (for both vendors and subscribers) is how to decide when to stop trading the system in case the next big profit doesn’t show up, while ongoing small losses slowly eat into the account equity.
Okay, I can see that with a positive serial correlation a "let profits run" strategy is actually utilizing some kind of prediction. But is the serial correlation always positive?
I agree that the more general key is to detect a market inefficiency, but unfortunately this tells you even less than "let profits run".
Oops…I meant positive serial correlation. I think detecting a market inefficiency is a more general characteristic of the "key to success" than "letting profits run". IOW, someone who is able to detect market inefficiencies without letting profits run can still be a profitable trader.
Oops…I meant positive serial correlation.
In my view you said it too.
“I am surprised that you do not mention
4. Predictive value”
"There are two kinds of forecasters: those who can’t and those who don’t know they can’t."
John Kenneth Galbraith
An interesting newer book on trend following is "Way of the Turtle" by Curtis Faith - who, as the title implies, was one of the original Turtles. About 1/4 of the book is Turtle anecdotes, the rest is trend following methodology in general.
Hans.
Good points, but I intentionally omitted predictive value since if
1. cut losses
2. position sizing (with accounted leverage…as you pointed out)
3. let profits run
are implemented “correctly”, then predictive value becomes less important.
I completely disagree. Jules is correct. I say predictive value is 80% of trading.
Some 90% new leveraged traders lose their money quickly. Although some can be attributed to money management, I would say that new people have almost no access to a system that truly outperforms (such as finding market inefficiencies, as Science Trader says).
They read a few books, and usually use trash such as Gann, Elliot Waves, Fibonacci, Astrology, Japanese Candlesticks, Technical Analysis, Psychology and other crapola. The fact that it almost universally fails under serious longterm statistical testing doesn’t sway the adherents of these mystical arts.
And when the newbies follow Ken Roberts and other Pied Pipers offering systems that maybe worked 12 years ago, they combine these random trade-generating machines with overleveraging, mistakes, and undercaptilization, and there you go. Welcome to Vegas…
As it is said: "I see dead people. And they don’t know they’re dead."
from The Sixth Sense
> From a contrarian point of view, if most traders are attracted to systems that do not let profit run (ie due to the natural tendancy for frequent steady profits) and statistically most traders lose money, then inverse logic suggests that traders should choose systems that do exhibit a “let profits run” strategy but this is extremely difficult for reasons already stated?
I guess you didn’t get the memo: “It’s simple, but it’s not easy”.
Seriously, it “is extremely difficult” to make money trading. It
is counter intuitive.
As an aside, even a day trading system can be a "let profits run"
system. I.e., as opposed to taking profits at a target a day trading
system can trail stops and hold into the close as often as possible.
The larger point is that “let profits run” methods can hold trades
as long as possible in the context of their time frame.
Another aside, check out some of the “cut profits short and let
losses run” systems that have blown up on C2 (where are you
Johnny Primetime?). These systems used huge or no stops
and tight profit targets and they all went broke. Do the opposite,
have a little edge, and see what happens.
