Mathematical Edge in Trading?

Guys - you have to on average make more per trade than you lose. If someone is professing to be in the "know", or have the 4 magic indicators (free in any charting program by the way), but doesn't give you any performance numbers or information on actual trades made - shouldn't that raise a red flag(s)? Google that statement.

But if there is such a thing as a holy grail - then I think this is what the formula would look like: PEO = (PW*AWD)-(PL*ALD).

Whereas, if probability of a win is 90% and you make $1000 and probability of a loss is 10% and you lose $10,000, then

PEO = (0.9*1,000)-(0.1*10,000)

= -($100) = Guaranteed long term failure

Being Right is Not Important !!!!! This is why trading options is really hard to win at. It's why buying when you have SLI drives up the premium due to the volatility portion of the options value (the gamma), and even though it goes your way - you LOSE $$. If anything, look at what happens when you fade the volatility premium.

So the question remains - can we quantify an edge and put some math behind it? A real mathematical edge.

Also, watch folks - just watch. The moderator will delete this post!



Edited 1 time(s). Last edit at 09/08/2015 02:33PM by rttforumadmin.

We did not delete your post - we only delete posts with Spam or posts with personal attacks against other posters. I did move your post to a new thread (and changed the Subject), since it's a different topic and relevant for discussion.

-- RTT Admin



Edited 1 time(s). Last edit at 09/08/2015 02:37PM by rttforumadmin.

I agree with the statement that “being right is not important”. In my own experience I have had stretches where I was right 78%-80% of the time and still lost money. I had another 6 month stint where I was only right 48% of the time but increased my account 20% during that same time period by letting winners run and taking losses quickly. I got better at identifying when things were not working, let go of hope and smoke, and simply took the loss to live another day. At that point I realized the only thing I could personally do to get better is continue managing the winners and losers and focus on getting better at the entry decision. GW always said this was 10% how (the technical) / 90% Art (chart reading) / 100% discipline. Roughly 95% of this forum is a testament that folks are still focused on the 10% (red and green boxes or other signals that tell them when to do something taking away personal responsibility of making that decision for themselves). Before anyone comments, yes, I do really like TradeStation and have a few alarms and signals I coded that point me toward stocks – but that’s it! Once there the signal that told me to look is ignored. I accept the charts as they are and make the final decision based on whether or not I consider the position to be a trade which brings me to my next point.

Since you asked about a quantitative edge I will offer this up for those interested. I spent quite a bit of time between mid-2009 to mid-2010 back testing FP/HRFP using a charting system that allowed me to run back tests, add in slippage assumptions, commissions, etc. I also added in a bit of “is this a trade” logic to ensure the stock had room to go in my direction (e.g., stock in the lower 20% of the Weekly BBs, just above/very near/ right on top of a major MA, or the opposite set up to go down, etc.). Entry and exit were simple. I program to buy when I had FP/HRFP on Daily/233 and my other criteria were met on the Weekly. I sold when I was up a buck in my position or down a buck – that’s it. My basket for the tests was the entire S&P 500 – all FPs and HRFPs for whatever interval I defined. Simply buying and selling the stock. I ran this test back four years, then select 3 month, 6 month, and 12 month intervals. Not calendar years or quarters – random starting and stopping points. Keep in mind this was programmed to buy and sell without human intervention. The results were the same. I always ended with my account balance increasing and a win ratio of 70% to 75%. There was nothing I could do to increase that percentage from a technical perspective. This also did not take into account that options perform differently than stock. I just wanted to test the entry signal. I believe GW always said FP/HRFP by itself was 70% to 80%. I spent a year back testing and all I did was validate that statement. Eventually over time I believe he started quoting higher percentages of 90% to 100% but that was not directly tied to FP/HRFP or SLI. That was following the rules, doing as instructed, and doing the work to understand what a trade actually looks like which brings me to my next point.

A lot of folks still get caught up in the SLI or old FP/HRFP thought process. Since I am outside of my NDA when this was first taught and had to learn this on my own I will let you in on a secret. No holy grail – just words of wisdom. HRFP/FP or SLI is not a final signal to tell you when to get in. They never were. Old 1-5 students had two other criteria that had to be met. Old RTP students had at least three criteria that had to be met in addition to the signal. New RTP students know there are four criteria that have to be met before entering any trade (there are actually five but the 5th is handled in Sept, March, and May). It starts with a signal but does not end there. It’s all about being able to read the chart which cannot be quantified. It’s the ART. If I apply the four filters to my losers above then the vast majority of those trades would never have been made. I also suggest to former 1-5 students that are still struggling to consider taking Survival I to get you on the right track. There are things taught in that class that should have been taught in the old 1-5 instead of the “Mr. Miyagi” approach. New Survival students that have taken II and III need more time doing the nightly exercises to gain experience. It is 100% about being able to read the chart. Even then you will never have 100% wins. The 100% includes breakeven and gains. Breakeven is also subjective but will not go into that here. Finally, GW has said for years that all successful students will experience 100% loss in their trading careers. You must be prepared mentally and financially to accept 100% loss and move on which brings me to my last point.

The example provided regarding profit and loss is misleading for anyone that is following appropriate money management. Survival and former RTP students have an edge here but GW said in 1-5 that the most successful would never put 50% of their trading capital in one trade. The ability to lose $10K in a trade suggests that you have to be able to put at least $10K in a trade (100% loss). The most aggressive students that are following the rules as taught today will have a trading basket of $60K to $70K in order to do that. Those that are a little more conservative will have more. When we apply the rest of the profit and loss equation of being right 90% making $1k on each trade and then losing $10K on the one loser your net loss is $1K. If you do this 2 to 3 months in a row you should have an internal circuit breaker in place that stops from trading to figure out what you are doing wrong. If you have multiple $10K losses that are significantly more than your gains you should also have internal circuit breakers built in to stop you from trading. When you resume trading your trade size should be less if you are following appropriate money management. You will also still have a basket size in excess of $40K to 50K to live another day. All of this also assumes that you were able to build your account from the suggested starting point to $60-$70K or more. If so then you have the ability and it’s about fixing what you are doing wrong. I do not recall anywhere we are instructed to start with $60K or even $20K (assuming 50% trade size). A person starting out with the suggested basket size, after practicing for a year, and following money management would be able to survive 8 to 10 months in your before reaching a point of not having enough capital to place a trade. Remember the first year of trading following a year of practice is about keeping your capital. Breaking even is the goal. Losses are a part of the education which is why we are taught to start small. My old 1-5 notes also indicated that the most successful wiped out their baskets 3 or 4 times before reaching a point of increasing their baskets, holding gains, and moving in the right direction.

Finally, if GW’s process is so bad then why not post your own methods? I really mean this with all sincerity. You profess to be a professional trader for 38 years which implies success. I congratulate you! You are doing your own thing and obviously successful. Why not start your own thread in this forum and teach what you know or offer tidbits of wisdom? I went back and re-read every post you made. All negative, “can’t do”, “show your results”, “I challenge you…”, “GW doesn’t work”, etc. My intent is not to be confrontational. I might have missed something but did not see one positive post. If you have a better way then why not share it? Why is everything about bashing someone else? If you have family members and/or co-workers that lost money trading GW’s way why not motivate them in the right direction and offer guidance? You spend quite a bit of energy bashing others when you could focus that energy on helping others or making more money in the market. After 38 years you should have a lot to offer. Just something to think about. Wish you continued success!

NCT

NC - I mean all the respect in the world with this reply. So please understand that I am only interested in things that lead to a healthy debate - not name calling. I do trade full time, have for a number of years, and have had quite a bit of success. But it's not my obligation to prove that something doesn't work nor is it my obligation to teach or offer guidance. If someone was jumping off a bridge with a set of fake wings, I would have the opinion that that isn't going to end very well. It's not, however, my obligation to point out why and what you should do to correct things. It's just an observation.

So it's my opinion and observation, take it or leave it, that this is bunk. The one thing FACT I continue to fall back on is the numbers. Performance. FACTS. Show it.. To not do so is the first ingredient of fraud (I AM NOT SAYING GW IS A FRAUD!). I will tell you though, that if GW lived up to even 1/2 his claims of performance, he would be on the front cover of every major financial publication on the world. Look at the greatest traders in the world. The best of the best among them average around 20-25% avg geometric return. And those are the top 1%. FACT.

Maybe in the future I will post some of my approaches to trading.....



Edited 1 time(s). Last edit at 09/10/2015 12:18PM by GWNO.

I humbly respect your reply and look forward to any approach you decide to share in the future as I do not limit myself to one thought process. My last observation is this and I hope it is taken in the positive spirit it is intended. I am an analyst by trade and always strive to see both sides of any debate. You certainly do not owe me or anyone else the satisfaction of seeing your results. You are absolutely right that you do not have anything to prove nor is it your obligation to prove that GW's system does not work. I agree 100%. That said, when I read all of the posts over the past year I see several open challenges for others to share their results. In your response above we are back to GW owing us his performance results. If you are not willing to do the same then you cannot expect others to do so. It comes across to the rest of us as someone that wants to complain and create noise. That just a fact! I never intended for you to share your results nor do you owe us but was simply pointing out a double standard. I am truly looking forward to any positive things you wish to share about your approach to the market. I also believe you and GW have more in common than you think. In the early days I wrote down the following within the first hour of class 1: "This is not get rich quick. If that is what you think I will refund your money right now and you can leave". Later in another class I wrote down: "90% quit as they are not willing to do the work to get good. They expected this to be easy or get rich quick. Roughly 8% or so become average to ok, mediocre. They do not take it serious enough, treat it like a hobby, and never have the consistency or confidence to retire even if they reach that level. The remaining 1% or 2% actually get good at it". The last comment about the 1% to 2% was circa early 2006. I cannot comment on what was said or taught prior to or after that time but from mid-2005 to early 2006 those were the expectations I wrote down in my notes on more than one occasion: 90% failure rate (defined as quitting) with 8% to 9% becoming mediocre at best but not having the consistency or confidence to get good. Maybe I attended the only classes that had full disclosure but those were the expectations so I walked into this with eyes wide open.

Finally in your defense I personally felt like the original "Mr. Miyagi" format did not work for me and could have been better. It worked for some as one of my best friends retired to do this full time around 2008. He has a wife and 3 kids, all attending private school, and walked away from a $150K+ salary to do so. I know his wife well and she would not allow him to trade full time for 7 years if he was not able to consistently replace his salary (no, he is not going to post his results). His trading style was more like Darcy but he still worked his W/O every month with a small target of 3% to 5% but using slightly more money. He does not sell the calls - just buy and sells the stock. Some months he makes two W/O trades if the opportunity presents itself and other times he does nothing. All that said the 1-5 format simply did not work for me even with his help. My buddy/mentor and I have two entirely different trading styles so he was very little help. The Survival series is the only thing that put me on the right path. It worked for me. Only 10% or so of the information was entirely new. The remaining 90% was basically the same info in a format that was easier for me to digest or it validated a discovery I had made on my own. I just didn't have the support network to validate my findings or the confidence to know I was on the right track before. Does someone need to take the new class? Not really. The entire concept of a supported trade using W --> 233 I started doing on my own circa 2007. It came to me after 3 weeks of intense study looking at every good move across multiple charts going back several years. I spent hours on the weekend and each night studying every move. What was the one thing they all had in common? I couldn't quite put the appropriate rules around it and make it work for me as I wanted it to work 100% of the time. When it didn't I moved on and tried something else. My buddy that retired took the same info I gave him and developed his trading system around that supported trade concept. No, I do not think I should have been forced to retake a new class format but I am a glass half full kind of guy. I also felt like an idiot when I first learned about supported SLI and all the time wasted trying new things. I was grateful for the opportunity and know I would still be seriously off track without it. My expectations are still 90% / 8% to 9% / 1% to 2%.

So there's my story and absolute last comment on this subject. I truly wish you the best and look forward to whatever you may decide to share.

NCT

GWNO,

Would you mind giving some more details regarding your statement that "It's why buying when you have SLI drives up the premium due to the volatility portion of the options value (the gamma), and even though it goes your way - you LOSE $$. If anything, look at what happens when you fade the volatility premium."? I know that when one sees a SLI ( or FP/HRFP as previously taught) everyone else also sees it and this means the option premium has already likely been inflated, but if there's enough run on the underlying price, and it happens fast enough, you will still make a profit on your call or put purchase.

I understand gamma as being the change in delta for a given change in the underlying. I look at volatility (implied volatility) as the "plug factor" in valuing options. If you have a given option cost, then everything else but the implied volatility is known and you can solve for implied volatility. This lets you know how the current implied volatility relates to the historical option implied volatility and the historical price volatility of the underlying. I use this analysis to give me an indication of whether the option is over or under valued relative to historical norms. I'm not sure I follow how the gamma is related to the volatility portion of the option value.

BTW, I am enjoying the discussion between you and NC Trader. You both have very valid points to make. I have not taken the new format classes so I can only comment on the previous 1-5, Advanced, RTP, and DE classes. For me, 1-5 and RTP were the most useful. As I continue to study I find quite a few places where I go "so that's why Gary recommended to do it this way." I do actually differ with Gary on a few things. I would never sell options naked - I always hedge, and I consider a cash secured sale of puts as hedged. On high priced stocks I will do call or put option purchases with debit spreads to lower my cost of entry. I also do glance at the delta and gamma, and my charts include historical volatility and implied volatility.

I'm still a bit below the 8-9% mediocre group that NC Trader mentions, but I think Gary does not overemphasize how much work and effort trading takes. It's one of the hardest things I have done; but it's also one of the most fascinating. Since you obviously have a large amount of trading experience, I hope you will drop a "nugget" or two about your trading approaches in this forums from time to time. This forum has been a great source of information for me. Other than Gary's classes, I would say that 95+% of what is out there is complete garbage. I have yet to find another educator that I would spend money with, although I have been tempted to pay for some of what John Carter offers with his simpler options program, and I like the Tom Sosnoff Tastytrade approach, although I don't want to trade at the frequency he recommends.

Keep the posts coming. It's always helpful to see what other folks find useful and evaluate it against what one is already doing.

NCTrader Wrote:
-------------------------------------------------------
>His trading style was more like Darcy
> but he still worked his W/O every month with a
> small target of 3% to 5% but using slightly more
> money. He does not sell the calls - just buy and
> sells the stock. Some months he makes two W/O
> trades if the opportunity presents itself and
> other times he does nothing.


NCT,

Assuming I can pull you back into this discussion, do you know why your friend chose not to sell the calls against his stock purchases when doing W/O? That is the one trade where I have been able to find success.

The underlying point that I found in your post was that some things work for some people but not for others in the stock market for whatever reason. That rings true to me, and actually is heartening to someone like me who finds value in multiple techniques - like Sosnoff, but minus the high frequency combined with the general GW style and thought process.

I agree with Dan, by the way, and found this interchange to be interesting.

Certainly, although the answer will not provide any great insight. My friend didn't sell the calls because of his personality. His thought process was "I got my 5%" or whatever and moved on. He was about taking shortcuts, doing his thing, getting the minimum and moving on, inflexible of changing once things started working out. Imagine doing a W/O as instructed, you are up 3% or 5% and decide to get out because "you got yours". That's what my friend would do. Now imagine that you look over and see Monthly chart low on the BBs, indicators, coming together, price moving sideways along an MA, you look down at Weekly and see SLI or FP/HRFP up. You also realize it is late Sept / early Oct. Why would you get out just because you reached your target? It's about seeing the entire picture. Even though he had the ability to become great he was about doing the minimum. If you do this as instructed it is about given you the most opportunities - not about trying to make the absolute most money per trade or even stopping at the minimum. It's about leaning to be smart and make the best decisions over time.

I'm learning much from these posts, thanks to all. NCT's above critique of the "I got my 5%" mentality strikes home, as I'm a compounder and when I hit my daily target I leave the table. Of course, that's not the same as a "per trade" target. Still, makes me think. Anyway, here's my two cents on the original question, "So the question remains - can we quantify an edge and put some math behind it? A real mathematical edge." I think the answer is both material and spiritual. Yes, we can quantify an edge. But our ability to do so is limited. If I look outside and see very dark clouds, I'll almost always be right in predicting rain, yes? But if I look outside and from what I see I predict rain for a date years in the future, this is less reliable, yes? So our ability to forecast is limited. But we must and do try to make forecasts of all sorts of things, or we could not have survived as a species.

All of the universe is orderly. There is no true chaos- only uncertainty for us. Every "apparently" chaotic system can be shown to have within it at least one point of order, and from that we can often derive other information. We are far better at predicting "change" than we are at predicting "direction" of change; in this sense, "direction" becomes almost a metaphysical question, kind of like Schrodinger and his cat. The universe and all in it would suffer greatly without an underlying order. If everything were random chaos, solid objects would only briefly exist then disappear; air in the room would aggregate in one corner of the room one moment and disperse the next.

I left options trading in 2009 when I saw that both long calls and long puts were being made to lose; so even though (like NCT) I was right about direction 87% of the time, I lost money due to flat beta combined with theta. Nothing against that market, might go back to it one day, now that I've got better tools. So I consider that a mathematical edge can be had in options trading. I've watched Tastytrade many times but I like Oscar Carboni much better. I think a major key to finding the edge, obviously, is learning to forecast beta. If I ever go back, that'll be my focus.

sounds like a bunch of engineers on here....

Personally, I have no problem with long calls/long puts. The math takes care of itself:

Analysis Data For 12/10/2015 - 12/11/2015
Trade Date Action Symbol/Desc. Qty Price Comm. Net Amount Gain/Loss for symbol
NETFLIX
12/10/2015 O STC NFLX Mar16 130 Put 10 $17.20 $15.00 $17,184.44
12/07/2015 O BTO NFLX Mar16 130 Put 10 $13.40 $15.00 ($13,415.24) 3,769.20
Total Realized Gain/Loss for NFLX $3,769.20
Total Realized Gain/Loss $3,769.20

Quote
Awesomeness
sounds like a bunch of engineers on here....

Awesomeness, my apologies. I'm not an engineer- just sometimes I pretend to be one.
RaleighTrader, I looked at your post and I swore I wouldn't get drawn deeper into this because the whole subject makes me look like a conspiracy nut. I have no doubt that your math works today, but I gotta ask you, did it work in 2009? As a loser in Q1 and Q2 of 2009, I was in good company, with many major hedge funds buying puts. Everybody's quant and tech algos said DOWN. Everybody, that is, except the banks'. And until June of 2009, we didn't realize just how much cap the banks were getting under the table to force the market up. So in early June we all threw in the towel--- and THEN the market dipped, only to resume that odious and obscene climb all over again. Remember the conditions at the time, the fundamentals? Banks were crushed and trying to hide the fact, so they devised the above scheme and put the brakes on beta to kill long puts/calls. In effect, they made themselves whole again with money from retailers like myself and from incautious hedge funds. Wish I still had the charts to show but was a long time ago. By the way, I admire your skill, truly.

I was going to print charts so support my comment but have too many other things to do. Those that are interested can go look it up. I remember 2009 well. To this day I can tell you that the market turned around 3/9/2009. I just disproved that thought because the actual day was 3/10/2009. What I learned during that time, toward the end / after the fact, was to turn off the TV and radio. Listening to the news put me in a mindset like the one posted above which was in direct contradiction to what GW teaches and the evidence on the charts. It doesn't matter what big money thought or how much money hedge funds were losing. It doesn't matter what CNBC or Fast Money thought. All that matters is your ability to read the charts. If you have a chart platform that allows, scroll the Monthly, Weekly, and Daily back to the end of February 2009. I am not providing specifics for those that have not taken GW's classes but will give you general thoughts. Using $SPX as the general market for my commentary.

EOM Feb 2009

Monthly - 3 pieces of evidence that a bounce could be coming. This is a monthly chart so it might be this month, next month, or a few months from now but things are setting up for a bounce.

Weekly - 4 pieces of evidence that a bounce could be coming. Again, maybe not bounce this week or next but nice rise setting up - especially given the recent severe decline.

Daily - 5 reasons to think a rise is getting ready to materialize. Again, coming but can't call timing. Waiting for signal.


Week 3/2

Everything still basically in place. Weekly now "weakly" crossing down so if you get too hung up on one chart it looks about ready to drop but the other evidence is still there suggesting a possible bounce in conjunction with Monthly and Daily

Week 3/9

Monthly - still has possible bounce evidence
Weekly - still has same bounce evidence as before but we also have a very good chart pattern that completed. One GW loves. RTP students now know market should rise given this info and everything else we have been seeing for the past few weeks.
Daily - now rising

** Note - for those that were paying attention to the news the Fed stepped up to the plate during this time. Doesn't matter, charts are the evidence. We trade what the charts tell us to trade. ***

Week 3/16

status quo - still rising

Week 3/23

By the end of the week the Weekly gave a signal up that several here should understand. We are now looking for a rising market for the next several weeks. Maybe not in a straight line but rising.

By the end of March we should have warm and fuzzy about a nice little bounce coming to fruition on the Monthly. Not signaled yet but it's coming.

By the end of April Monthly signaled up. Again, may not last forever but everything we started seeing by the end of Feb has now come to past.

My point is that by the time June rolled around the hedge funds and whomever were just deciding to throw in the towel were late. The charts already started telling those that learn to read the story that a good bounce was coming and under way. That picture started showing up late Feb / early Mar. A pullback in June should not be a surprise based on the calendar we all use but a continuation up is still likely based on the Monthly. I still have a ways to go on improving my chart reading but even I saw that.

I made money during this time but not what I should have because I was hawking the news like everyone else. Constantly fighting a battle in my head between what I saw on the charts & felt would happen vs listening to the news. Later that year I finally turned off CNBC during the day and eventually turned it off all together. I occasionally watch weekend documentaries on CNBC - that's about it. Also cancelled my subscription to WSJ. That's the time I finally learned that the financial news really is noise.



Edited 1 time(s). Last edit at 12/10/2015 09:46PM by NCTrader.