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Trading in the Twilight Zone
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Trading in the Twilight Zone

  #1 (permalink)
 Vendor: protradered.blogspot.com 
NY + NY/USA
 
Futures Experience: Advanced
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Trading in the Twilight Zone

Market Reality is created by your trade order.
When we trade in sim mode our order does not exist in the live market. We are ghostly shadows. Our orders successful completion is based solely on whether or not the inventory side we were on (followed) was the winning side long enough for us to get a profitable target. Since no order was placed, there need not be any opposing inventory to either complete or negate our order. There was no slippage, no real fill pressures, no one came for our stop, and there was no winner or loser. It simply means that we were on the dominate side of the inventory order flow. This is a good start. It means we were following the order flow well enough to recognize the dominate side and the commitment point of price.
However, one peculiar thing that happens with many systems, strategies, and methods after we plunk our money down and put a real order in the market is that the results seldom play out as consistently positive as they did in sim. Since we are now in the order flow, and not just following it with our theoretical strategy, that participation creates the reality we are in. Sounds metaphysical, and its a pretty strange phenomena... but it's true. I won't go into the cosmic forces of the emotional energy of expectation, fear, hope, creation, and belief; but if you spend some time thinking about it then your answers are probably as good as any I could come up with.
This is a common complaint I hear often from traders with some experience and large libraries of purchased systems. My question to them is always did you get some references from real cash users of the system, or was your purchase based on sim performance results. The worse results to base a purchase on is market replay results, and back testing results are not that much better. More reliable would be forwarded tested results using cash transactions in real time. Also, and pretty important, just how many of these systems are being traded actively in the market? The actual trader using the strategy has a lot to due with the results, as does the number of traders using the same trading patterns.
The reality that is created for us is a direct result of our physical participation in the market. There must be an order on the other side of ours. For every completed transaction there will be buyer and a seller, and you will be a winner or a loser.
When you consider systems, whether mechanical automated systems or discretionary, be sure to get some solid track record of that systems performance in the real market with cash over a period of time - at least a few months worth.
If this is not available then you are probably looking at system design where you will become one of the cash testers. It may work well, or it may not. You have a 50/50 shot at making it work by creating the reality of the systems performance using your money.
Alternatively, watch the system being used in real time by someone using their own cash account, if possible. Watch them over a period of time. See what kind of results are generated. Keep in mind that successful application of any system, automated or not, has a lot to do with who is using it, how they are using it, and with what they are using it.
To be honest, if I had a completely 100% reliable successful set and forget fully automated trading system I would not be telling it to anyone. Why? It is my belief that there are pattern sniffers in the market and if my pattern of auto trading was very successful, I would prefer it be a pattern of one.
But, it is not a perfect world, and controlled losses are part of the business. So you have to eventually pick something to run with.

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  #3 (permalink)
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An interesting post and observation. Chaos theory insists what you say is true. At least in theory. However, the practicality of this reality, I think, needs to be called to question.

My concern goes like this:

While my participation in markets must change the future in some way, as you suggest, the same holds true for anyone else's participation. Unfortunately, I can't possibly know what new traders are entering my market, or which old traders are leaving it on any particular day. The point being, of course, that if your participation in a market invalidates your backtesting results, so should any trader's participation with equal effect.

We can reduce this idea to a question: Can backtesting can be trusted? I say no. If backtesting works for you, or anyone else, fine. At minimum, I will insist that it is just not necessary. I do not backtest. I 'back check'. What this means is, I develop a methodology using deductive logic alone. I then glance at historical data to make certain my thinking is not grossly off the mark. If I find the 'back checking' validates my thinking across sufficient random sampling, then I move along. Testing further is no longer necessary.

I understand that this makes a lot of people very uncomfortable, but there are ideas that capture the very essence of what markets are. Specifically, there are methodologies that must work. No squiggly lines, indicators, or seashells necessary. It takes time to see this.

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