Boss,
When ever I saw you post i feel safe and questioned by some one who really understanding the issue.
A reply/observation/doubts to your earlier post ( post # 999) is half way and will post ASAP.
Stock72,
I guess your strategy is to do with option trading as your earlier posts suggest. I dont have any option trading experience, except for one test trade to see how options expire and find out total brokerage+taxes on option trading. However I learned from my trading guru Gary Smith, that same position scaling strategy that is done with equity can also be done with options and he suggests one to take huge risks when the capital is low and scale down risk appetite as capital grows. Thats the way he actually traded for his life.
But when I looked at option prices on Oct 1, I was shocked to see exorbitant premiums. On 1st Oct, Nifty was close to 5700 so it was easy to see how much was the premium on strike price close to market price. Premium itself was about 105 on the first day of the month for Oct series. Now how am I going to trade options for profit? As it expires to 0 on expiry day, it means that the daily decay rate is about 3.5 per day, which is very huge. That means everyday I will be losing 3.5% and to just compensate that Nifty has to move by 3.5 points on average per day in my favor. If we dont look at daily average, it means that Nifty has to move 105 points on average every month just so I dont have loss. This certainly is too much of a stretch on Nifty. Because it means average trading range for Nifty per month should be 210 points just so I dont make losses. To make profits Nifty has to move more than that.
Given that the premium we pay is like stop loss in equities, (our loss being limited to premium paid plus of course brokerage), and assuming just once in a 3 time chance of market making a significant consistent move in our favorable direction, it should move atleast 300 points, just so we are breakeven. Even this is a too much of a stretch. There are two ways out of this problem: one is trading options of individual stocks instead of an average (Nifty) as there is a filtering advantage for stocks that isnt there for averages and the other is to apply position scaling strategy.
While I can reduce losses further with a position scaling strategy so that a rare 300 point move gives great amount of profits, I still havent grasped how well it works with options. In stocks, I will just keep on buying more every time a stock gains 5 or 10%. In options they keep on decaying, even if Nifty rises 35 points in ten days, the option price is same as first purchase price, I dont know how to scale here. So for now, I cant give any precise ideas on option trading. But on important note, buying on dips that too, buying options on dips, well, that is completely outside my trading philosophy. If your strategy incorporates that your capital is ultimately doomed.
So you have indeed tested your trading strategy on past 10 years of data. On the outset the results you mentioned are looking good. Because it has variations instead of tightly fitting the data. However the lower cap and upper cap are not sounding good.
Options give you leverage (that premium we are paying is essentially an interest rate we are paying for giving us that leverage for a set period of time). Hence it should give much more profits on the upside say 2500% instead of just 500%. On the downside, in a given year how it should be simply it should be as small as possible. If you are presenting me a positive lower limit, then I would tend to think it mustve fit closely on the past data. Reggie has posted the downside of back tested strategies. I too read that. I completed reading that book (only first round). Like the discussion in the other thread about that topic went, the strategy that you have could be just a closely fit one. For any given random series of data, one can find lot of equations closely fitting them, for an optimization goal. Yours can be just one of them.
However in the stock market, there is no need to blindly believe in the complex equations that give us some solution. Not just in stock market, in other systems too. We should be able to simplify it and tell precisely what are the prime factors (inputs) for which the given equation gives some special results like an eqn.=0 gives roots of the equation. Here we should be able to tell what kind of movement is the strategy going to give profit and what others will give losses?
No movement certainly gives losses, plain and simple. I do not what exactly it is considering as a favored movement. For option sellers, no movement or range bound movement is good. For position traders, trends are favorable. For straddlers, breakouts are good, regardless of the direction. Each of them have different ways of losing, with some commonality as well.
Trend traders, will lose most of the time. Straddlers too lose, may be big amounts when they do, though they are increasing the odds of a move in either direction by consolidating two events, the value of gains (outcomes) too must be large to compensate for the double price they pay. Just increasing odds isnt good, so it should be worser than trend trading strategy. Sellers are susceptible to rare events (black swan events). They keep making money all the time, but when they lose, they are gone out of the game and may be in debt as well. I will talk more about the trend trader shortly.
Looking at all this, one thing is for sure. Its the broker and the exchange who makes the money consistently. So options are really created for the benefit of brokers and exchanges (and govt. though their share is small). Thats why whenever I think options, I think that it is a sucking game.
Now here is one point that Taleb talks about. What do you choose when presented with these options? Make consistent money say $1 a day for 99 days and lose $1000 on one day or lose $1 a day for 99 days and gain $1000 on one day. Simply put, first one is for option sellers and the second for option buyers. As reality is not so simple, some amount of that money goes as constant money to brokers + exchange regardless of the gain or loss. Let us take that out of equation, they have their own problems like getting more clients, scaling operations, marketing, etc. etc.
When you had fitted your strategy why did you look for minimum gain? Did you see if the max. gain goes to 2500% if minimum is made to be ~0 or little negative say -10%. You sure have the capital replenishing power due to SIP (stable income source, in other words a job). So even a -30% per year is fine, isnt it? Vary this parameter depending on your risk and replenishment strategy and see how far you can push the upside.
Despite doing all this, we are looking at only a truncated part of reality because the reality holds much more possibilities than what the ten last golden years had. (Golden as of now). Look at Sensex from 1970. You will find its lackluster movement for such a long time. Though there were no options then. Think about the times of defamed Harshad Mehta, the big bull, and the bull run of that time. That was all past. Now that we have derivatives and online trading which make things move faster, the crashes or rallies happening much faster in the future, does your system account for that?
And I dont know minute details like how the strategy decides stop losses (I know stop loss on options is silly), how it scales up a position and how it decides entry point etc. Without these things I cannot confirm that you are having a good strategy, as I believe these simple things can have a drastic impact on the overall gain, even if your strategy has a max. gain of 2500% on a random year. No matter what I suggest, these doubts will keep making me suspicious about the long term survival of your system.
If I put those doubts aside, we can look at the interesting part. Now why on NSE do you want to have minimum gain per year? It certainly sounds like you want to make a continuous source of income from the market. You already have one, your job and a very good one at that. That we locals here feel jealous, though we too have such opportunity to try for that once in a while. I too have a steady source of income. Many traders who already have a steady source of income, keep asking for a constant rate of gain from the stock market?
We are all fed with the steady growth rates that we used to see with post office savings, FDs etc. and look at stock market as just another avenue to beat that. Why dont we think like entrepreneurs? I mean some successful ones. I too was mired with this kind of thinking, for too long man. I regret past six years. Right from the start I started calculating that too using my scientific calculator that I used in Engg. studies.
That simple bug trapped me all these years. I kept on looking for a steady source of income, now not just in the stock market, when I stopped trading in 2008 I began searching for other avenues for constant income source and a passive one at that. Even if small - enough to let me survive while I give fulltime to trading. Bloody hell kept on happening since then. I said to myself hey mario enough is enough. All the while I wasnt looking at my primary source of income but kept on chasing elusive dreams. After-all these years, now I see it isnt so hard to job and also invest/trade passively.
I thought I was good trader back then. This is such a subtle idea but it trapped me, blindfolded me and made me lose 3.5 precious years and also a predictable (which I already predicted) nice bull market within that time. You see how powerfully our own mind can trap us. Never mind. I got out of it now.
Now we will look at the stock market like an entrepreneur. We, jobbers, have capital replenishment power, unless we take massive liabilities like housing loan, etc. With this, we can change our goals. Instead of looking for minimum gains or constant gains, we keep trying for one such period of time for the stock market during which our profits will explode exponentially. All other times we will keep losing little by little, which will anyway get replenished regularly owing to SIP power. But when that particular time period passes, our lives would change once and forever like a successful entrepreneur.
So I stopped looking at the rates of gains, per quarter gains (though I write about them for the sake of blogging and entertaining audience, it doesnt affect my perspective), relative gains (comparing with FD returns, etc.). Because trading has non-linearities unlike savings in FD or bonds. If I get lucky, I may gain huge early. Or I may be rich after sometime. If not that atleast I wont be a big loser and will have a great story to tell despite any possible outcome, for the rest of my life. I am sure not everybody will hate a well-crafted story just because it didnt have a happy ending. I know, I remember Gharshana but its source was Kaakha Kaakha.
When you are maximizing your max. gains while keep drawdowns to minimal levels, tell me to what kind of market movements does it correlate to? Did you apply this system in January when market moved consistently?
I think of it like this. The market has all the possibilities. Range bound movements, trends, breakouts etc. I must make my gains, very big ones at that during certain phases of the market and not lose much or gain little during the other phases. If all phases of the market have equal chances, I will be good enough. I will be poor only due to bad luck when all other phases of the market keep repeating all the time. But I will keep on waiting, because the longer it takes the probability of the missed outcomes increases. When it happens the wait will all be worth it, just like any entrepreneur says.
I still wonder why your system didnt give you profit in the last 3 months while NIFTY moved in a trend from 4800 to 5700. Tweak your system. If it is too complicated with equation, make it simple like manual decisions based on manual thinking and assessment of the state of the market at any time. I gave up on systems, because they are too rigid. If you could build a system, we can be replaced fulltime by robots. I strongly believe, you can never make a robot that makes big money from the market. All robots eventually get screwed in the stock market. The market moves them out.
