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ate- to long-term trend systems. The problem with day-trading is that the maximum profit is limited by the day time frame, and the riskthe amount that must be allowed for a stopis quite large in relation to the realizable profit. This means that the Kelly ratio I discussed above is relatively low. Let me illustrate: T-bonds have an average daily range of about 28 ticks. Suppose you find through testing that if T-bonds rise 12 or more ticks from the open and then come back through the open within three hours, they have a tendency to close below the open. On average, you can expect, at most, 16 ticks potential profit by placing a sell stop at the open (28-tick range minus 12-tick advance over open). In reality, your potential profit will be 10 to 12 ticks unless you can pick the exact bottom for the day. To gain this much, you must risk the random intraday movement of the bond market, which I estimate at 6 to 8 ticks. On every trade, you have to pay the bid-asked spread of 1 tick on entry and exit, plus brokerage commissions of half a tick. The profit potential is reduced by 2 1/2 ticks to 7 1/2 to 9 1/2 ticks, while the loss is increased to 8 1/2 to 10 1/2 ticks. The average-win-to-average-loss ratio is likely to be less than 1. Referring again to Kelly, you're going to have to have a very high percentage of winners to overcome the average win/loss handicap. Using the Test-48 Kelly of 0.2 as a benchmark, you would need 60% winners with a win/loss ratio of 1 to match it. With a win/loss ratio of 0.8, you need 65% winners to get a 0.2 Kelly. If you can develop winning percentages this high, your rewards will be far greater in intermediate- to long-term trend trading. |
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Neal: What happens if markets stay in a trading range? You might not be able to trade trends. Do you have a backup plan for nontrending markets? |
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C.V.: I initially selected the markets I trade by looking at historical weekly charts. Most of the markets I trade have at least one, and often two tradable trends each year. They have continued to exhibit these characteristics during the period I have traded. While the possibility exists that one or more of the markets will |
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