@Habakkuk, I don't understand what you mean by 'short life span'. Do you mean the optimal exit (in terms of profitability) is usually <3-5 days?
Also could you please this sentence in more detail? I don't follow.
"The exit will determine the return distribution only - it's not producing excess profits".
'short life span' means that the signal strength 'wears off', e.g. an entry signal is good as soon as it is triggered, because by tomorrow or the next day it will typically have lost most of its validity - if it had any in the first place. The trade will (should) have moved in the right direction by then and some of the profit potential is gone. I hope that makes sense.
This might be controversial, especially for Fundamental Analysts who forecast stock performance several years ahead. But for the OP who wants to design a mechanical trading system it's sensible.
It doesn't mean that there is an 'optimal' trade duration. That depends on several variables, just off the top of my head:
- system type, trend following obviously as long as it's your friend, momentum a bit shorter, mean reversion only a few days
- are there entry signals available for the trading capital?, if not you might consider letting it run for another day
- brokerage and spread; if you exit on the same day or the next, it can be expensive
I spent some time last year importing the 260 trades from peter2's thread into Amibroker, looking for a single mechanical logic exit that would perform as well as his discretionary ones, all 7 of them ... He was considering switching between 2* and 3*ATR trailing stops at that time.
From memory his average edge from entry until the next day's close was 1.5%. That's something I can only dream about. It then drops off very rapidly and is (on average) down to just a few basis points per day after 2 weeks or so. Some trades trended much longer than that, of course.
The trade exit determines the shape of the return distribution. Take the standard trend-following exit of "cut your losses short and let your profits run". You get a typical Win percentage of maybe 40% with av. profit/loss ratio 2:1 or better. The distribution has a long right tail, some very big winners, hopefully.
Let's do the exact opposite, "grab any profit when it's there and let your losses run". You won't find that in any trading book. The way it works is to look at the end of each day: if it was an 'UP' day, close the trade, regardless of whether it is in profit. If it was a 'DOWN' day, keep it open.
You will probably think that's sheer lunacy, but what you get is a win rate of typically > 60% and almost 1:1 profit/loss. The annoying thing is the long left tail, the occasional big loss.
In Amibroker it looks like this:
Sell = Close > Ref(Close, -1);
SellPrice = Close;
There are many other possibilities like > Open or > MA(something)
The important thing is to realise that the obvious, sensible, approved trend following exit has no edge - it is neutral. Therefore, logically, doing the opposite is also neutral. Most people would say "you're going to lose ALL YOUR MONEY".
I believe that mechanical exits don't/can't have an edge because they are
forced to make a prediction every day. There is no such requirement for the entry logic. Entry can wait until the right condition arrives.
See if you can prove me wrong using random entry and a logic exit.