after extensive testing using Monte Carlo mathematically correct for Drawdown analysis I see only bad news.
Using random selection with replacement to create 200 trades long series of cumulative return (More than 10 000 of them) and from this extracting the distribution for drawdowns it is very hard to come below very big drawdown with any system!!
As we know from Howard Bandy, Drawdown increase over time. This increase follow a diffusion equation. Square root over period.
This is really bad news because any test over longer periods will have DD of over 50% for ANY system. The only way to feel good and get it lower is to test shorter periods. (Much like peeing if its cold, keeps you warm a minute but then...)
The law of large numbers is a strong force!
Is there anyone who have seriously looked into this big problem for any and all system and can recommend solution, literature or other sources of information?
You are tracking random numbers with Monte Carlo. Your found result is true when you play lotto
or other games with random data (as well as fix cost on every turn which deletes your account in
Systems for trading are different:
1) they should be optimized for letting winners run
2) should be optimized from market view to restrict losers to a minimum.
Therefore optimizing is the clue to prevent your account from dripping to zero.
This is a number crunching task.
To make it short: Trading does not show a random outcome like lotto et al.
Now: All my books on Monte Carlo from studies at University are not useful to predict trading results.
The following 3 users say Thank You to GFIs1 for this post:
I am not tracking random numbers but draw from a given set of trades. This is best practice and accordance with, for example, the method used by Bandy in "Modeling Trading System Performance" or Tharp in his "definite guide to position sizing.." as well as many more.
The trades that are drawn are "optimized" for letting winners run. (Not in the sense of curve over fitting though..)
ATR trailing stop, percentage stop loss and more is used in all systems. Always.
I am afraid this might be a sad reality of trading systems.
And you might find those University books on Monte Carlo more useful than you wished for... There is no way to do a correct analysis of system performance and robustness without them!!
I was rather hoping someone have direct experience with this problem and have thoughts around it!!
The following user says Thank You to Loop for this post:
Ok lets drill in a bit then:
To design and backtest a system that survives in the market(s) is not trivial. Many traders want to see the automated,
semi-automated or manual (upon upcoming signal) system work in ANY market at ANY time.
This is the crucial point - as one fellow poster here said "Know Thy Market" you need to specify a system on the specialty
of exactly this one.
Now coming to the time BEING in the market and the time STAYING at the sideline:
To avoid any big draw down you need to exactly define for a system WHEN to NOT enter.
Sounds easy? It isn't!
The most errors are made by entering the market under circumstances to do not so.
When you can define to squeeze points out of the market when several conditions in your model are true then you can
get results and note them for the Monte Carlo test. You may see that your tests still bring negative results. If I understand
your words right then you see still a dripping account to limes zero...
Even knowing your entries and exits you need to define your hard stop. To prevent losses or large losses in your account
or even wiping this out. That step seems to be the most important:
You need to filter out NOISE and to stay in the game at the "edge" of normal movements to get your positive points out
of the market.
That means backtesting and even more test under normal market conditions.
You may find the optimized hard stop for a given trade - even with some exceptions for special situations. I am speaking
from patterns that occur.
Once found that optimum one can trigger the system and see the outcome under market conditions in the bay of sharks.
To sum it up:
A trading system needs to be stable with positive results in the long run. This means to find the moments when NOT to
trade to avoid in shaky markets some draw down which could be eventually foreseen.
Once the system presses some points out when conditions are "good" then it survives.
Finally it does NOT matter the quantity of trades but the QUALITY. Think about!
Hope this helps
who recommends to read the "realtime" (system) journals on FIO that show trading results that are consistent.
PS: one last word on the economics of any given market from an economy point view:
If there are losers there must be winners - to balance it all...
The following 4 users say Thank You to GFIs1 for this post:
You note perfectly the zone of position sizing:
I voted in my upper post for position ZERO when uncertain area is in sight or upcoming.
My trigger is the Ichimoku cloud - of which you can easily read many things about - even in my journals.
SO - given the obvious - we CAN get out of a high risk momentum and let pass the ugly head of draw down
with just omitting the risks by taking a trade right there and then.
But that needs a certain preparation for the system at work.
Getting back to my second to last post: SOMEONE is always making the gain in the market...
THUS - we need to get into row ONE.
The following 3 users say Thank You to GFIs1 for this post:
There is something I realized when running Monte Carlos...
For example, I'll put in my 100 trades that took place over a month's time, and let it run over 10,000 simulations. That's, effectively, 1,000,000 trades. *clucks*
Can a Monte Carlo simulate my bias on mechanical trading? Can the Monte Carlo simulate fear that makes us break our rules? Can a Monte Carlo follow our rules? It cannot do any of these things, and cannot do many other things we would need it to do to give us an accurate emulation of what may happen if we kept doing what we did, based upon our previous trades.
I like the Monte Carlo, but only so far. It is simply not a realistic view of what WE would do in the long run, over 1,000,000 trades.
The following 2 users say Thank You to HoopyTrading for this post: