## Friday, July 29, 2005

### Part II: Scale Fish not Trades

In part I, I mentioned how scaling into trades ends up increasing the complexity of your system while reducing the edge and thus your profitability. Now, on to scaling out of trades.

Scaling out of trades is pure magic. Yes, magic. The more I think about scaling out of trades...the more I realize how powerful this technique is to your system. Think of it this way. Scaling out of your trades gives you the chance to create trading systems that are 100% profitable. How in the world can you beat that? :)

Let's get to work. Here's the 1st example we'll work with:
Full Deck Method
Starting Equity: $35,000.00 Symbol: XYZ Shares: 1,000 Entry Price:$35.00
Exit Price: $52.50 Gain/Loss%: 50.00% Gain/Loss$: $17,500.00 Results: New Adjusted Equity:$52,500.00
Net Profit%: 50.00%
Net Profit$:$17,500.00
Win Ratio: 100.00%
Number of Trades: 1

Not too shabby for an old dog like yourself, eh? Keeping your deck fully loaded throughout the trade thus capitalizing on the big 50% move.

Now, what happens when you attempt to scale out instead? Let's keep it simple, we'll break the scales into quarters and scale out at the 6%, 18%, 32% profit mark, and then let the remaining quarter ride. So, here's what the trade looks like:
Scale Out Method
Starting Equity: $35,000.00 Symbol: XYZ Shares: 250 Entry Price:$35.00
Exit Price: $37.10 Gain/Loss%: 6.00% Gain/Loss$: $525.00 Symbol: XYZ Shares: 250 Entry Price:$35.00
Exit Price: $41.30 Gain/Loss%: 18.00% Gain/Loss$: $1,575.00 Symbol: XYZ Shares: 250 Entry Price:$35.00
Exit Price: $46.20 Gain/Loss%: 32.00% Gain/Loss$: $2,800.00 Symbol: XYZ Shares: 250 Entry Price:$35.00
Exit Price: $52.50 Gain/Loss%: 50.00% Gain/Loss$: $4,375.00 Results: New Adjusted Equity:$44,275.00
Net Profit%: 26.50%
Net Profit$:$9,275.00
Win Ratio: 100.00%
Number of Trades: 4

Wow! That's rough. The Scaling Out Method cut our profits almost in half when compared to the Full Deck Method. What kind of magic dragon you've been puffing Taylor? But, there's another layer hidden behind these numbers. This hidden layer is a roller coaster filled with ups, downs, and a whole lotta nothins that earning 50% on your investment requires.

What if I told you that in order to achieve that 50% return you had to witness a run-up to $46.20 (32% profit) then a fall back down to$37.10 (6% profit)? That's a 20% drawdown in the trade or $9,100.00 in paper profits just wiped away. Now, you're probably thinking...no way! I have trail stops buddy! I'd never trail my stops 20% or more from the high/close/whatever. If that's true then you'd never achieve that 50% profit for this particular trade example. And since trail stops are a whole nutha beast let's move on. So, back to the example. If you scaled just like we discussed before...instead of$9,100.00 paper profits vanishing along with your hopes for the trade...only $2,275.00 is lost (4th scale still open) while$4900 (3 scales sold) in actual profits are locked-in. This Scaling Out Method works to lock in your profits but more importantly reduce the drawdown in the trade.

Let's keep testing. What if in the example above we had another trade after the XYZ stock. This new trade was in the ZZZ stock and believe it or not lighting does strike twice in the same portfolio because this trade worked just like the XYZ stock. Hit every mark...but instead of climbing back from that 20% drawdown from the peak of 32% profit...it never came back? And instead you were forced to close out with the paltry 6% profit. What kind of details would that give us...

Full Deck Method
Starting Equity: $35,000.00 Symbol: XYZ Shares: 1,000 Entry Price:$35.00
Exit Price: $52.50 Gain/Loss%: 50.00% Gain/Loss$: $17,500.00 New Adjusted Equity:$52,500.00
Symbol: ZZZ
Shares: 1,000
Entry Price: $35.00 Exit Price:$37.10
Gain/Loss%: 6.00%
Gain/Loss$:$2,100.00

Results:
New Adjusted Equity: $54,600.00 Net Profit%: 56.00% Net Profit$: $19,600.00 Win Ratio: 100.00% Number of Trades: 2 Max Equity Drawdown: -19.69% Scale Out Method Starting Equity:$35,000.00
Symbol: XYZ
Shares: 250
Entry Price: $35.00 Exit Price:$37.10
Gain/Loss%: 6.00%
Gain/Loss$:$525.00

Symbol: XYZ
Shares: 250
Entry Price: $35.00 Exit Price:$41.30
Gain/Loss%: 18.00%
Gain/Loss$:$1,575.00

Symbol: XYZ
Shares: 250
Entry Price: $35.00 Exit Price:$46.20
Gain/Loss%: 32.00%
Gain/Loss$:$2,800.00

Symbol: XYZ
Shares: 250
Entry Price: $35.00 Exit Price:$52.50
Gain/Loss%: 50.00%
Gain/Loss$:$4,375.00

New Adjusted Equity: $44,275.00 Symbol: ZZZ Shares: 250 Entry Price:$35.00
Exit Price: $37.10 Gain/Loss%: 6.00% Gain/Loss$: $525.00 Symbol: ZZZ Shares: 250 Entry Price:$35.00
Exit Price: $41.30 Gain/Loss%: 18.00% Gain/Loss$: $1,575.00 Symbol: ZZZ Shares: 250 Entry Price:$35.00
Exit Price: $46.20 Gain/Loss%: 32.00% Gain/Loss$: $2,800.00 Symbol: ZZZ Shares: 250 Entry Price:$35.00
Exit Price: $37.10 Gain/Loss%: 6.00% Gain/Loss$: $525.00 Results: New Adjusted Equity:$49,700.00
Net Profit%: 42.00%
Net Profit$:$14,700.00
Win Ratio: 100.00%
Number of Trades: 8
Max Equity Drawdown: -5.33%

Now where getting somewhere. The Full Deck had 2 winning trades, $19,600 profit, and a -19.69% system drawdown. Scaling Out had 8 wins,$14,700 profit, and -5.33% system drawdown. So, who's the winner?

Well, the Full Deck Method still earned almost 10% more in profits than the Scaling Out Method. But, with 300% more in system drawdown I think it's fair to say the Scaling Out Method provides the better return for the amount risked. Throw in just one more trade that is a loser to boot and the whole ball games changes. Currently, the win ratio on both systems are 100%. But, with a loser added to the mix the Full Deck Method would drop down to a 67% win ratio. While the Scaling Out method at a worst case scenario would still achieve an 89% win ratio. And could be better if just one of those scales were made before the trade turned into a loss.

What do you think? A way to lock in your profits, free up your money quicker, let some profits ride, reduce your system drawdown, and increase your win ratio to boot. Not too shabby, eh? But, what I like even better is again...where else do you get the chance to create new trading systems with guaranteed profits?

Now, please don't get picky on me. I'm not counting slippage and commission costs into the mix. Feel free to do that when analyzing your own trades. And the 6%, 18%, 32%, and let it ride scale is just an example. By all means, test out different combination of scales in your own trades. Should be enough to keep you busy for a good long while. :)

Rants:
I've been a programmer for 10+ years now. This has involved working with many other programmers both old and new. Know what the most common fault I have witnessed over these 10 years? The failure to test ideas. The failure to test programs. We think it should work, so it must. Ha!

Just what do we have against testing? Why do we feel the need to pontificate on things that can easily be tested? It's a really strange phenomenon that even I'm guilty of from time to time. And I know better!

I think the key is this: Avoid trying to prove an idea with logic and speculation. Use logic and speculation to create ideas and use testing to prove whether those ideas are indeed valid. Maybe logic is not the correct term here. But, I hope you get my meaning.

Side Note:
If you've had a good day, week, month, or year...do you reward yourself for trading well? I haven't really done this before but I'm beginning to think this is a good idea. If all you do is roll the profits back into the business then where's the reward for all your efforts? Usually, my reward or gratification comes from the creation of new systems or learning of new tools/ideas/methods. And of course, writing this blog helps to communicate my thoughts to an audience that can understand and appreciate what I do. That's a reward in itself. But, maybe Rod Tidwell is seeping into my brain and a little part of me is shouting...SHOW ME THE MONEY! Ha ha.

Anyway, upon this theme...I'm thinking about getting a Kodak Digital Camera (EasyShare DX7440 4MP with 4x Optical Zoom for a little reward. I'm a photo-taking newbie so if anyone has any comments on this camera or any other good digital cameras in the $200 -$300 range, please let me know.

## Thursday, July 21, 2005

### Scale Fish not Trades

I have from time to time worked on different scaling into methods for my trading systems. For those not familiar with scaling into trades it involves adding to an existing position based on some condition met. The condition could be a new equity high, a new break-through in the price of the security, or whatever you can imagine. But, aye, there's your first clue.

Condition? Entry? Why this sounds like a new trading system to me. And that's just exactly what this is. Anytime you add a position...you are initiating a brand new trade. With new conditions, rules, entries, exits, etc. Let's put this into system terms.

You are trading one system and enter a trade for 100 shares of stock XYZ. If you want to scale into XYZ again with another 100 shares...the first thing you should ask yourself is what condition will need to be met in order to buy another 100 shares? And with this means testing different entry methods. Seriously, what are you doing when you begin to explore entry methods? You got it...creating a new system. Sure, you may be using your original system as a filter for the trade. But, don't limit yourself to the same exit and position sizing rules as the original system. And don't limit your original system to the position sizing rules of this new one. If it's true you're finding success with scaling into a stock 2 or 3 times. Maybe, just maybe, you need to rethink your existing system's entry rules.

Think about it. If you're creating a trading system and you have thrown the kitchen sink at testing different entry methods to obtain the best possible entry point in the stock. Then why would you short-change yourself with your position sizing strategy by cutting it in half, thirds, or worse yet...quarters? If you honestly think you're served better by not loading the full deck at the first entry point and better waiting to get fully loaded at the 2nd, 3rd, or 4th entry point...then possibly you'd be better off just using those conditions as filters to your system and wait to pull the trigger until all those conditions are met. Understand?

Don't get your feathers ruffled by my comments. I have heard from countless traders that scaling into positions changed their lives and they found great success this way. And due to this I have tested and retested scaling into trades in all my systems. And on every system I have created...scaling into a trade produced mixed results. Not one garnered better results than the original non-scaling method. But, like I said, my original method was already tested for the optimal entry point. So, it's safe to assume that cutting my position size would only worsen the performance of the system. And add a 2nd, 3rd, or 4th level of complexity.

Let's get serious about this...look at the trades you scaled. Put the pencil to the paper and determine what scaling did to you and your money. Don't pick just one trade that was a winner. Pick several...at least 25 seperate trades. 50 trades would be even better.

Calculate what would have happened if you didn't scale at all and had your full position on from the first entry. If you did better then you're trading the best entry and why short-change? If you did worse then go a step further...calculate what would have happened if you didn't take the first entry at all...just used that as a filter for the 2nd entry and that's where you had you're full position on. Yes, this would mean some trades from that series wouldn't have been taken due to the filter. That's okay...that's just what a filter is. Screens your entries for the best possible point. Take this exercise as far as your scales go.

One last thing in regard to the exercise I gave you. You may well find that you have two or three valid systems on your hands rather than just the one after analyzing your past trades. If this is the case...spend some time seperating these systems, devising new exit rules & position strategies for each. And retest your past trades with the new rules applied.

If after all this, you still find that scaling into trades works better...then more power to you. JKD, dude.

Now, I will tell you where I have found success in scaling. Scaling out of trades. Aye, that's where the true magic lies. Stay tuned to Part II where I discuss how scaling out of trades can improve winning percentage, drawdown, net profit, and more.

Are you wondering where the Aye's are coming from? Well, I've read a book recently that is off the hook. Hawke by Ted Bell. One of those novels that grab you in the first few pages and don't let go! It's about a bad-ass British dude that is a descendent of Blackhawke, the pirate. There's boats, treasure, sharks, the Caribbean, nuclear submarines, Navy Seals, and even Castro himself. It'd make a great movie.

Another good summer read is a book I bought my wife a few weeks ago. The Summer I Dared by Barbara Delinsky. Again with the ocean stuff but this time covers Maine and the lobstermen, father and son, mother and daughter, and I'll admit some more sappy stuff. But, hey, it's good. I really enjoyed the description of the lobster business and the people who live up in Maine. My wife's favorite passage in the book is the following: "Real intelligence is like a river; the deeper it is, the less noise it makes."

My favorite passage was when father was speaking to son, "Barely a third of my high school class went to college, and none of those applied to the ones I did. That gave me an edge in the admissions process. Apply to different schools from those your friends choose. Pick ones you like. Don't be pressured by anyone else, not by me or your mother or the college counselor, and certainly not by your friends. Here's your chance to do what you want, for a change. Go for it." Yep, that's me...always looking for the independent view...even in a sappy novel. :)

And last but certainly not least. Get a load of this...the 2006 Dodge Charger! Talk about American marketing hard at work! And the worst part??? I want one!!! Ha ha.

Later Trades,

MT

## Wednesday, July 20, 2005

### Part II: Automated Trading Tools

Here's a follow-up to the first email I sent regarding automating trading tools...
Just another follow-up to the last email I sent you. I think I might have found the answer to my search for stock alerts. The software is from Trade-Ideas.com. Just an unbelievable product. They offer a web-based product and a stand-alone version. The Trade-Ideas product allows you to set server-side alerts on the US Equities market for unlimited symbols. You can use your own symbol lists or choose to select symbols based on the exchange traded.

The only downside I see is they don't have the capability built into the web-based or stand-alone product to email or page the alerts. But, do offer a way to write your own script to connect directly to their server and stream the alerts. Which you then could add code to email or page the alerts to you. If this could be done...something like the tradebullet software I discussed in my previous email could then be used to automate trading signals.
Just a few more comments before signing off.

One, what's the deal with CyberTrader? Their trading platform seems really interesting but their customer support is for the birds. I have placed two emails to support asking them general questions about the tools they offer. What response do I get? Just the standard "a real person will reply soon" email by their server and then nothing. I have yet to receive one reply from a real person over at CyberTrader. CyberTrader, what's the deal?

On the plus side is Interactive Brokers and MB Trading. Both of these brokers responded well within 24 hours to all my emails about their tools, order types, etc. I have test drove their platforms for a few days now and slowly but surely I'm beginning to drift towards one over the other. But, it's really close. Interactive Brokers no doubt offers a world of choices in trading and as a result their platform takes some time to get used to. MB Trading seems more streamlined in their offerings. Their trading platform feels a little more intuitive to me. I don't plan to get real creative in my systems trading. Plain and simple is what I stick to. So, MB Trading is getting the edge here. Plus, the ability to place trades over the phone for the same costs as the web. That's a big plus for me especially considering the reliability of my cable connection.

Another advantage of MB Trading is quotetracker is free for active clients (\$7/monthly savings). And apparently Trade-Ideas works with quotetracker by sending Trade-Ideas alerts to a portfolio of your choice on quotetracker that you can then monitor tick by tick. If I persue this option I'll let you know how this process works.

One last thing. Completely off topic...but with all the talk about products I thought I would share. I bought a new John Deere L111 riding mower today. To be totally honest, it's the first time in my life I bought something so outright American branded, marketed...ah you know what I mean. Something that elicits a feeling when you buy it solely from the marketing blitz hitting you year after year after year. I've always considered myself an off-grid type of guy when it comes to that type of stuff...but I'll be the first to admit...those marketing guys/girls are good!!! No doubt. Even though it's just a little riding mower I can't help but feel like my grandfather who was a farmer/rancher would be a little proud. I wasn't kidding when I said those marketing gurus were good...now was I?

Now, excuse me while I check out Harley Davidson's Deuce. Ha ha.

Later Trades,

MT

## Tuesday, July 19, 2005

### Automated Trading Tools

I got a question about trade triggers and such by a reader and turns out the reader was looking for a bit different information than the one I offered. I didn't want the information to go to waste. So, I'm sending it your way. Enjoy!

Yes, trade triggers have been an agonizing research experience for me the last few weeks. It's very difficult to find any of the brokers that offer such a thing. And the few that do offer 40 or fewer like Ameritrade.

I have not used trade triggers yet, mostly because I require more than the 40 triggers that Ameritrade offers. And I cannot find any other brokers that offer more. Though, you might check into Schwab's CyberTrader platform. From what I can tell they offer trade triggers but I have emailed their customer support and never received a response.

Interactive Brokers offer conditional orders that work similar to trade triggers. But, yet again, are restricted to around 40 or fewer. And they require for you to have their platform up and running otherwise you will lose your triggers. In other words, it's client-based...not server-based. At least from what I can tell.

MB Trading, from what I understand after speaking with support does not offer conditional orders/trade triggers.

So, from there I had to persue real-time quote monitors that alert you to a price change or level reached and then email/page/sound the alert. There you have another interesting scenario. Most real-time quote providers only allow you to monitor 20 to 50 symbols at a time in real-time. Probably the best source for real-time quote providers and their quote limits is the following site from quotetracker.com: http://www.quotetracker.com/qsources.shtml.

Now, there are a couple that will go beyond 100 symbols and that is Quote.com, Esignal (if you purchase additional symbols), and AIQ Systems (up to 700). I decided to go with AIQ systems because they also offer the alert triggers. I haven't received their software yet...but if interested I can email you what I think after I try it for a few weeks.

There's another step you can take if you decide to automate those triggers. Software like http://www.tradebolt.com/ and http://www.tradebullet.com/ can actually take the trades from your software package and place the trade for you. The tradebullet software looks especially interesting with their ability to handle just a plain text email of the order that can then connect with your broker. If this is the case, I should be able to program something from AIQ in the email alert and then tradebullet will place the trade. Thus, automating my trading. But, much testing will need to take place to see if this really works. Next week, I plan to talk more with tradebullet and really see what they can do for me.

Finally, I use the Wealth-Lab software product extensively and it has the capability to completely automate your trading systems. But, it requires a real-time provider and then you're forced with the maximum symbol limit. But, there are several traders I know that are utilizing IB and Wealth-Lab successfully. Here's a forum dedicated to this task: http://www.wealth-lab.com/cgi-bin/WealthLab.DLL/category?id=14. And another forum that caters to automated trading in general: http://www.elitetrader.com/vb/forumdisplay.php?s=&forumid=48.

On a side note, Wealth-Lab has been bought out in America by Fidelity, so there should be some automated trading capabilities built-in with that version.

One last option I could persue is that quotetracker can handle the real-time feed from AIQ...and wealth-lab can handle quotetracker's feed. This would get me past the max symbol limit and thus causing me to come back full-circle to wealth-lab in automating the trade triggers. Again, testing needs to be done to see if this would truly work.

I will add that from everything I have seen, Ameritrade's trade triggers look like the best package out there if you do not require a multitude of symbols to watch for. The best thing about the Ameritrade package is the trade triggers are server-based and thus you can go out on vacation, have your computer turned off, and Ameritrade will take care of trades and alerts. You can choose to have the trigger send you an email or actually make a trade for you. A trigger expiration date can also be setup. They will also give you the option to be notified a day or so ahead when your trigger is coming up for expiration. You can also base your trigger on an index and then submit an order for a particular stock based upon a condition the index met. Not too shabby. The current indexes offered are Nasdaq, S&P500, S&P100, DJIA, CBOE Volatility, Russell 2000, Amex Networking, Amex BioTech, Phlx Semiconductor, and Phlx Gold & Silver.
Look for Part II tomorrow where I detail a great find with a server-based alert provider. Also, if anyone has any experience in automating their trading with tools/brokers/quote providers such...do share! Leave comments, please.

Later Trades,

MT

## Tuesday, July 12, 2005

### Et tu, Time Stops?

I'm still here and busy as a bee. I'm currently knee-deep in research for one of my new trading systems. About all I can disclose is that it requires intraday real-time monitoring of symbols. Not a few symbols but a multitude. And that is where I have spent all of my time. Finding and evaluating the products that offer this type of service. Let me tell you...there aren't many.

Hopefully, in the next few weeks I can cover more on this topic.

One last thing I wanted to bring to everyone's attention. Do you use time stops in your systems? I do and if you don't, you should. Time stops get you out of a losing trade or more importantly get you out of a wash trade. You know, the type of trade that just sits there and wastes your capital? Anyway, how do you set your time stops? Do you use trading days or calendar days?

Recently, I had one of my preconceived notions challenged pretty good by one of the great resources over at the Wealth-Lab forums. My opinion has always been that I can control trading days not calendar days. In essence, I can sell the position on a trading day but cannot sell it on all calendar days such as holidays or weekends. So, my stance has always been that in setting up time stops one should count the number of trading days in the trade...not calendar days. Wrong!

The poster let it be known that holding over the weekend is putting my position at risk and thus those 2 days should be counted along with the trading days of the week. And he was so right. And it was one of those Aha! moments when you finally realize something that should have been so simple all along. Anyway, I went back to one of my short-term daily systems and readjusted the time stops to take into effect the weekend. Here's an example...

If my time stop was 6 days and I initiated the position on Monday. Then I should exit at the close of the next Monday if I was using trading days. But, if using calendar days, when should I exit the position? Next Monday? This coming Friday? Good question. And that's what I programmed and tested for. And it turned out that if the day was Friday and my time stop was going to close on Monday then I should close the position on Friday and avoid extending the risk on the position by 2 days.

Do you understand? This probably makes total sense to traders that do not system test their systems. But, for system traders, most system simulations use trading days in determining the number of days a position is held. So, it is natural, to follow that logic in testing your time stops. But, if it wasn't for the great AutoRun product that works with Wealth-Lab that uses calendar days to determine days held for a position...I never would have questioned this very simple piece of logic.

Some may say what difference does it make...just a few days shouldn't make that much difference to a system's performance. And you're right. There's not that much difference. The system I tested with only reduced the system's max drawdown by a few percentage points while increasing the average profit a few percentage points. Also the average days held in a position was reduced by a few days. A few percentage points here and there and it adds up. Kick in a reduced number of days a position is held and more time is given to trade the edge the system was created for in the first place. Trade the system for several years and those little differences begin to grow.

The devil is in the details...and if you're a system developer like me...you spend hours upon hours digging into those details. And wouldn't have it any other way.

Later Trades,

MT