Greetings --
Just a few comments to points made in the last few days.
1. I think the folks who suggest that we traders need to work on the psychology of trading so that we can accept the behavior of our systems have it backwards. By designing our own objective function, we encapsulate our preferences and our comfort zone into the trading systems right from the start.
If we prefer short holding periods, we should ask for short holding periods -- that is, we should put a term in our objective function that rewards short holding periods -- then trading systems that score well will already be biased toward short holding periods and we will not have to adapt ourselves to systems that have long holding periods. Substitute any characteristic that is important to you for holding period -- RAR, equity curve slope, equity curve smoothness, Sharpe ratio, commissions paid, and so forth.
2. I have no complaint about trend-following systems. If they work, use them. My caution is that the 1982 to 2007 period has been an exceptionally strong bull market in equities. Any trading system that takes long-only positions should have some way of identifying that the market conditions are not right for it, and it should exit open trades and inhibit new trades.
Some skeptical friends of mine think that we will need to wait until after the next ice age to see a bull market like this again.
Whether that turns out to be true or not, prices of equities have risen far above their mean. When prices revert to the mean, they always pass through the mean and are extended to the other extreme by about the same amount. If that happens to equity prices, the excursion could take broad market averages down by 80% or more from here. If there is a market drop, and if trend-following systems work to profit from it, those systems will not be long-only.
3. Stops hurt systems. That does not mean do not use stops. It is just an observation that there are many ways to exit from a trade, and the worst of those ways is a maximum-loss stop.
Exits can be triggered:
1. By the action of an indicator or recognition of a pattern, similar to what caused the entry.
a. The parameters can be the same as those that caused the entry, but in the other direction.
b. The parameters can be different for exit than for entry.
c. Some other indicator can be used.
2. By the price reaching a profit target.
3. By the time in the trade reaching a maximum holding period.
4. By the price falling back to the level of a trailing stop.
5. By the price falling back to the level of a maximum-loss stop.
In my experience and research, exits caused by 1, 2, or 3 are preferable. Exits caused by 5 are worst.
Thanks for listening,
Howard
www.quantitativetradingsystems.com