Things you might do, even though they HURT performance
Posted: Fri Feb 18, 2011 12:24 pm
System developers talk a lot about optimization: hunting for just the right parameter settings that maximize performance. They do things like (a) run gigantic numbers of parameter stepping backtests; (b) use genetic algorithms to adaptively search for the best parameter set; (c) argue endlessly about which measure-of-goodness is best at measuring which equity curve is best; and so forth.
On the other hand, you might intentionally decide to modify a trading system in a way that hurts performance -- if it improves something else. I think I've read that Jerry Parker (Chesapeake Capital) admits to doing this; I believe he said he takes profits prematurely -- partially scales out of profitable positions before the trade exit signal is received -- because this makes his customers happier. Even though he himself doesn't like the idea. However he has decided that happy customers are more important than happy Jerry Parker.
Another thing a system trader might do is, deliberately reduce the number of instruments in the portfolio (or the number of systems in the Suite), even though this reduces the benefits of diversification and hurts performance. You might do this because it lets you trade a smaller account, or because fewer markets/systems/orders means fewer opportunities for mistakes, or simply because it reduces the amount of time you spend sitting at a screen.
One more thing you might do is, sacrifice performance a little bit, if doing so greatly reduces your risk of "ruin". If you're trading OPM, "ruin" might mean "suffering a big nasty drawdown that scares all your investors away".
If you're truly scared of a big drawdown, you might decide to implement the Before and After idea below. Before is a garden variety mechanical system with standard fixed fractional position sizing (grey inset at upper left). After is the same system, but using more conservative / paranoid position sizing (grey inset).
The After system sizes positions based on the "Closed Equity" (which is equal to mark-to-market total account equity, MINUS the open trade equity of all currently open positions). In effect it says "I dare not pretend that Open Trade Equity is really mine; it could disappear in a heartbeat. Shoot, Open Trade Equity is just a euphemism for Paper Profits!")
The After system also uses the Dradwown Reduction idea from the book Way of the Turtle p.258. For each 5% of drawdown, the system reduces positionsizes by 20%. When in a drawdown, the system begins to place significantly smaller bets. And if the drawdown gets worse, the bets get smaller still. This hurts performance but protects against disaster.
As you can see, the After system has got lower CAGR, MAR, and Sharpe. Nevertheless, you may feel that the After system is SAFER for the long term health of your CTA business, than trading the no-safety-equipment Before system.
That's just one example. I'm curious to know, what tradeoffs have YOU made, what stunts / tricks / speed governors have you installed, that hurt your performance but you did it anyway?
On the other hand, you might intentionally decide to modify a trading system in a way that hurts performance -- if it improves something else. I think I've read that Jerry Parker (Chesapeake Capital) admits to doing this; I believe he said he takes profits prematurely -- partially scales out of profitable positions before the trade exit signal is received -- because this makes his customers happier. Even though he himself doesn't like the idea. However he has decided that happy customers are more important than happy Jerry Parker.
Another thing a system trader might do is, deliberately reduce the number of instruments in the portfolio (or the number of systems in the Suite), even though this reduces the benefits of diversification and hurts performance. You might do this because it lets you trade a smaller account, or because fewer markets/systems/orders means fewer opportunities for mistakes, or simply because it reduces the amount of time you spend sitting at a screen.
One more thing you might do is, sacrifice performance a little bit, if doing so greatly reduces your risk of "ruin". If you're trading OPM, "ruin" might mean "suffering a big nasty drawdown that scares all your investors away".
If you're truly scared of a big drawdown, you might decide to implement the Before and After idea below. Before is a garden variety mechanical system with standard fixed fractional position sizing (grey inset at upper left). After is the same system, but using more conservative / paranoid position sizing (grey inset).
The After system sizes positions based on the "Closed Equity" (which is equal to mark-to-market total account equity, MINUS the open trade equity of all currently open positions). In effect it says "I dare not pretend that Open Trade Equity is really mine; it could disappear in a heartbeat. Shoot, Open Trade Equity is just a euphemism for Paper Profits!")
The After system also uses the Dradwown Reduction idea from the book Way of the Turtle p.258. For each 5% of drawdown, the system reduces positionsizes by 20%. When in a drawdown, the system begins to place significantly smaller bets. And if the drawdown gets worse, the bets get smaller still. This hurts performance but protects against disaster.
As you can see, the After system has got lower CAGR, MAR, and Sharpe. Nevertheless, you may feel that the After system is SAFER for the long term health of your CTA business, than trading the no-safety-equipment Before system.
That's just one example. I'm curious to know, what tradeoffs have YOU made, what stunts / tricks / speed governors have you installed, that hurt your performance but you did it anyway?