Thursday, August 21, 2008

Occam's Razor

Over the course of the past few weeks as the Basket of Systems components have been introduced I've received a number of emails from skeptics claiming that the systems can have little practical value as they are so simple in concept and coding.
I beg to differ.
There's an ancient approach to reasoning called Occam's Razor, which suggests that, all things being equal, the simplest approach to solving a problem . . . typically the one requiring the fewest steps . . . is the best one. Having run the gamut of trading very complex to very simple systems over the past 20 years, I'm definitely in the camp of the later.
If you've got some time on your hands, watching 2 minute bars and waiting for the daily RSI to reach oversold levels, you might want to amuse yourself at the following link:
http://en.wikipedia.org/wiki/Occam%27s_razor
About 10 years ago INTC was the poster child for technical signal alignment, and every TradeStation system you could think of using INTC made money. 2 higher high daily closes on increasing volume = BUY. Hold till you got a 2 bar reversal, then exit. It was like printing money. But those easy money days are gone. Order flow masking, algorithmic program trading, backdoor order flow conduits like Pipeline, Executioner and a slew of other "smart execution" programs have all made trading a lot riskier.
Last night I spent a few hours with Don Bright and some of his traders just talking about trading and looking at some of the ways they trade. Now I've known Don for about 8 years, have visited their Las Vegas office and have the highest regard for their integrity and savvy. They've been traders for 40 years and have run Bright Trading as a prop shop since 92. They currently have about 500 traders, local and remote, and that's a lot. On a average day Open, they're queued with between 30 and 50 million shares of orders. WOW. . .that's a lot. Their approach is focused on NYSE stocks, simple, basically threefold and they like to be flat at the end of the day:
1. Mean reversion to projected fair value from envelop variations at the open (set a high and low limit and trade against it with Opening Only orders).
2. MOC (market on close imbalances), using orders which trade with the imbalance momentum.
3. Pairs trades of various types
Of course, they've got very sophisticated software that executes all three type of trades on an auto trade basis, but many of their traders still opt for manual execution of pairs trades.
Now, this is not an endorsement or solicitation for Bright, I'm just sharing a conversation that you didn't get to hear, and I think there's more than a few nuggets of wisdom there.
Don's number one caution for traders. . ."Don't overcomplicate".
In the comments a few days ago Muhammad suggested using a 1/3ATR(10) stop for intraday trades. I don't know if he picked that up from Bright, but it's one of their favorites and you might want to test it with your own fantasy trading.
One interesting vignette (to me) was a report from a trader who typically trades pairs, 2000 share lots, with average 7 trades/day. He has a buddy, trading the same pairs, 200 share lots, with an average of 15 trades/day. The buddy's account equity is slightly higher.
Although their performance records only extend back 4 months, the argument favoring smaller trade size to manage risk/reward certainly looks promising. Bright Traders pull nickels, dimes and occasionally, quarters, out of the market on each trade: just a little reality check for those who think that a successful trade has to be measured in 50 cent increments.
For any potential prop shop traders, the link to Bright is noted above. They've got a 3 day "get to know Bright Trading" program and a 2 week boot camp if you want to get serious. Fees are VERY reasonable. Since their traders have professional status, there are tax implications and you need to get a series 7 license (think about 100 hours of prep), which they will facilitate, as much as possible.

4 comments:

sysin3 said...

ah so, Occam's razor.

you are wise beyond your years, Grasshopper.

on pulling quarters out of the market:

1) if I can get, on average, 1/8 three times per day, I'm a happy camper. (on 10000 shr that's what ? ;-)

2) if I can make 1 percent per day on average, that's 7.3x my money in a 200 day year. Einstein said that the compound interest formula was the most powerful force in the universe.

money (account balance) is a trader's "inventory". more inventory turns (at a profit) lead to greater returns. see Wal-Mart or Costco.

I have no desire to be "Tiffany's"

YMMV

Quentin said...

BZB-
Wow.....what a nice post. I agree with you BZB, simple is better.

Once I started trading simple opening ranges, things got better. Trading is still a battle, but i bet in the long run the simple traders last the longest.

Sysin3- good to see ya scalping for 1/8ths.


Good blog, BZB.

Quentin

Will said...

Bob - I've been actively following the markets for almost 20 years (pre-public internet, downloaded historical info from GEnie with a Turbo XT - 8mHz!! - and "analyzed" it with Lotus 123), and have been actively trading for the better part of 15 years.

I spent well over 10 years in the phase of "If I just analyze for another thousand hours or two, I'll find that magical and oh- so- esoteric combination". Most people are less rockheaded than me, and get through that phase sooner (if they don't quit trading first). I suspect much of the flaming you may get is from folks who are still in it. They're very smart, of course, and are able to come up with more complicated ways to win near-term and lose long-term than I ever could have, so more power to them.

After these years, I've explored only a few ways to consistently make money, all of which are simple. Like, cocktail napkin simple.

And I've settled into a mindset where I'm immediately skeptical of any strategy which requires too many mental pretzels to achieve its returns. (Or maybe I'm just gettin' old).

Thanks for the great post, and again for sharing your ideas and code, straightforward enough for rockheads and old guys to enjoy.

LP said...

Bob,

Will and another friend of mine got me out of the create "complex bs strategies" that will never work phase.

I agree with this post that simple is significantly better. The simpler they are, the easier it will be to implement and stick with it.

Also, I've found that the best day trading strategies are (drum roll please) mean reversion. I've noticed that both you and Will trade R/S 2 and 3s. What a simple way to may consistent money. That is once you learn the tricks behind pivot trading.

As for me, I've stopped day trading (time and country constraints) and I am focusing on simple swing trade strategies with stuff like the CCI and RSI2/4. These are such simple systems that can work in almost any environment. Why try to complicate it? Simpler is better.