SCOTT WELSH TRADING BLOG

The Robot Is Better Than You

The Robot Is Better Than You

Sept. 21, 2013

Make no mistake; it’s better than me, too.

It’s not your fault. You didn’t know The Robot was better. How could you? All you’ve ever been told is that you should never, ever trade with a dreaded “Black Box” and that High Frequency Trading Robots will kill us all.  You’ve been told that nothing can take the place of a human being making human decisions based on human intuitions using human greatness (nodding your head in agreement).

But let’s take a minute and examine exactly what the best trading humans in the world have to say.

As an example, let’s say that you’ve read about four hundred trading books and ninety-six trading magazines and you are definitely almost completely positive that you want to buy Stock XYZ. However, just as a little back-up, you would love to know if it’s really a good time to buy XYZ or not.  Here’s what Motley Fool Advisors David and Tom Gardner (some of the most respected stock pickers anywhere) said in today’s paper (September 8, 2013):

“Every investor or analyst has his or her opinion, and sometimes, inevitably, they’re wrong. They can have different focuses, too. Some might seek very undervalued stocks, while others will accept a smaller margin of safety in exchange for greater possible growth. Read the arguments, do your own research and decide for yourself.”

Understand? The Gardners are telling you that everyone could be right or everyone could be wrong, that it could go either way, and that you really need to just to decide for yourself. How do you feel about that? Still a little unsure how to turn that advice into a repeatable trading system that will allow you to quit your job?

How about this? We’ll ask Warren Buffett, arguably the greatest investor ever, about your stock. Excuse me, Mr. Buffett, my friend here was thinking of buying XYZ. If he does buy, how long do you think he should hold onto it?

“When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.” –Warren Buffett

Understand? He’s saying that you should never, ever sell your stock even after it may have declined as much as 75% during the meltdown of 2008. How do you feel about that? Do you have a repeatable system yet?

Okay, let’s try this. Let’s find out how a big-time fund manager picks his trades. In this month’s Futures Magazine (September, 2013), Ben Davies, founder and CEO of Hinde Capital, was asked that question:

Question: What’s your trading methodology?

Ben Davies:  We center everything around macro analysis, all in conjunction with understanding the market dynamics. It doesn’t matter what our macro conclusions are on a potential trajectory of an economy or marketplace, we have to wait for a signal generation of whether to deploy risk in that asset class. As you know, if the marketplace isn’t in a dynamic state to facilitate your view, you end up losing a huge amount of capital in terms of time premium, opportunity costs and mental capital associated with that. We always feel we need to know what phase the market is in — is it trend ready, exhausted or in homeostasis? 

Understand?  Wait, what the…?!?

So maybe those humans aren’t of much help. Big deal, you say. You don’t need their help. You say you’ve found some books that do give specific, workable information (those exist), and that you’ve found some webinars that give detailed explanations of excellent systems (those definitely exist). You’ve got all the necessary information now and you’re definitely ready. Guess what? You’re not ready.

I once thought like you. I once thought I had it all figured out. And then I had a conversation with The Robot.

SW: So, Robot, I think I’m ready to start trading for a living.

Robot: I apologize, sir, but I find that highly improbable.

SW:  What do you mean, Robot? I have a system! I have entries and exits and stop losses and targets. I have everything!

Robot: I see, sir. Then may I ask what the maximum drawdown is on your AAPL chart there?

SW: What do you mean “drawdown”?

Robot: Drawdown is the maximum amount of money your system has lost in a given period, sir.

SW: Well, I know that my system lost two trades last month. That was like, $450. What’s your drawdown?

Robot:  My maximum drawdown on AAPL from 1/1/2002 until 9/6/2013 was $8,490.72. In addition, from trade close to trade close, the maximum drawdown was only $8,211.04. Of course, you know that the higher number is more relevant to keeping your trading account.  Additionally, I traded 76 shares each time, sir.

SW: Well, I don’t want to trade stocks anyway. Not enough leverage. I’m going to trade currencies!

Robot: Very well, sir. May I ask you what the total profit was on one of your currencies?

SW: Sure! On the USDCAD last month, I had 9 winners and 5 losers. I made about 30 pips on my winning trades and lost about 45 pips on my losers.

Robot: “About” 30 pips, sir? How much is that? And what was your slippage amount?

SW: Tradestation said the pip spreads on USDCAD can be “as low as 2.1 pips” and… I don’t know what that means.

Robot: And what was your profit on the USDCAD for the past five years?

SW: I don’t know, Robot! It took me two hours just to test the past two months. What’s YOUR profit?!?

Robot: No need to shout, sir. Trading one full lot, my profit on the USDCAD from 9/7/2008 to 9/8/2013 was $12,740.43. My maximum drawdown was only $2,217.96. I traded 383 times and my average profit was $33.26 per trade. I had a winning percentage of 69.97%.  I also had a profit of $6,890.64 on my long trades while I had…

SW: Shut up, Robot. Just shut your freaking mouth.

Trading for a living is a business, and you can’t run a business without knowing the exact details. Trading a system because it looks good for the past several trades is like picking baseball players because they look good in a uniform. You’re not really solving the problem. Unless you know exactly what your system is capable of, you can’t even begin to plan the size of your trades or your potential profit per month. You can’t even begin to examine your monthly budget to see if trading will actually cover all your expenses. In short, the dream of trading for a living doesn’t even begin unless you know the numbers are, down to the last penny.

The reason that 90% of all traders fail is not because their system doesn’t work or that their winning percentage isn’t good enough. It’s because failing traders rely on guesses or the trading gods instead of relying on data and cold, hard facts. The traders who make it know how often they win and how often they lose, how much they’ll make and how much to bet. Data gives the confidence that allows successful systems to be repeatable, which means you can be successful.

Facts win. Data wins. A mathematical system with defined probability wins. And that’s why The Robot wins.

 

 

Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.