Fact-Based Trading

[mtardif]

Hello,

I have been wracking my brains trying to come up with fact-based strategies for trading. By "fact-based" I mean "mathematical probabilities" as opposed to relying on one or more signals that have in the past produced good results (historical-based trading). As well all know, just because it happened in the past doesn't mean it will happen in the future. My idea is that there are "absolute distribution of probabilities" that the market cannot escape.

Even with using "signals" (moving average crossovers, momentum oscillators, etc), probablilty is 50/50 - it will either work or it won't. There are only two choices. The market cannot escape that fact.

As an example of "fact-based" or "mathematical probabilities", consider this example.

- I put on two long positions.
- The first long position has a take profit of +100 and a stop loss of -50.
- The second long position has a take profit of +100 and a stop loss of -100.

Given this setup, and without me closing positions early, just letting the TP or SL targets get hit, there are only three possible outcomes. The market cannot escape giving me one of these outcomes.
(1) Position 1: +100, Position 2: +100 (BEST OUTCOME).
(2) Position 1: -50, Position 2: +100 (ACCEPTABLE OUTCOME).
(3) Position 1: -50, Position 2: -100 (WORST OUTCOME).

Now, in the long run, the market should deliever outcome (1) 33% of the time, outcome (2) 33% of the time, and outcome (3) 33% of the time. There might be times when distribution of one is more frequent than the other (like outcome (1) in a strong bull market), but in the long run, over time, to me it seems the market cannot escape returning each outcome 33% of the time, since it can only deliver one of those three outcomes. If any one outcome had a statistical probability of occurring more than 33% of the time, then that would be the proverbial "Holy Grail" and the search would be over. The market must act in such a way as to provide equal distribution of probabilities, otherwise everyone would be rich.

So for example, in 3000 trades, assuming even distribution of probabilities, outcome (1) would yield +200,000, outcome (2) would yield +50,000 and outcome (3) would yield -150,000, which would leave a Net Result of +100,000.

This is to show how I am thinking. Has anyone else out there thought this way before? Has anyone ever tried to do this? Is my reasoning flawed? Can anyone tell me why this would not work?

It would seem to me that the 5% of traders out there who are profitable are thinking comepletely different than the 95% unprofitable traders are. It would not surprise me that the 5% of the rich throw out "decoys" and "dead-end trails" for the 95% to follow (like historical-based technical trading systems), sending them down the proverbial "garden path", while the 5% laugh because they're keeping some esoteric secret from the rest of the masses. OK, I realize than sounds like a "conspiracy theory", but think about it, if you were rich, you wouldn't want everybody else to be rich because then, who would be left to work for you? (The purpose of the poor is to service the rich.)

My thinking is that making money in the markets is so simple but yet so hard to find. If we were willing to think in terms of different paradigms, willing to change our way of thinking, maybe then we could see things differently and get that "AHA!" moment that leads us to some blatantly obvious revelation but could only come to us if we thought about it in a way that let this revelation appear?

Any and all feedback is appreciated.

Thanks.

[mtardif]

As John Locke wrote in his essay "Some Considerations of the Consequences of the Lowering of Interest and the Raising the Value of Money" in 1691:

"This business of Money and Coinage is by some Men, and amongst them some very Ingenious Persons, thought a great Mystery, and very hard to be understood. Not that truly in it self it is so: But because interessed People that treat of it, wrap up the Secret they make advantage of in mystical, obscure, and unintelligible ways of Talking; Which Men, from a preconceiv'd opinion of the difficulty of the subject, taking for Sense, in a matter not easie to be penetrated, but by the Men of Art, let pass for Current without Examination. Whereas, would they look into those Discourses, enquire what meaning their Words have, they would find, for the most part, either their Positions to be false; their Deductions to be wrong; or (which often happens) their words to have no distinct meaning at all. Where none of these be, there their plain, true, honest Sense, would prove very easie and intelligible, if express'd in ordinary and direct Language."

The modern equivalent of that statement is: "Those who know how to make money will keep it a secret and confuse those who do not know how to make money with bull shit." Which is basically what I was getting at in my previous post.

[bossxero]

Hi MTardif

First of all... a warm welcome to this board... hope you will enjoy your stay here

As for your theory... well, you wrote it so beautifully and it indeed make me think a little more. Why not try this type of trading on a demo account and see how it does. Maybe its a good idea and maybe its not. But there are concerns though, such as, will you open long and short positions at same time or only trade in a single direction? Indeed your thinking differ from most of us and this is really wonderful... I would like to hear more from you.

All the best

[mtardif]

Originally Posted by bossxero

Hi MTardif

First of all... a warm welcome to this board... hope you will enjoy your stay here

As for your theory... well, you wrote it so beautifully and it indeed make me think a little more. Why not try this type of trading on a demo account and see how it does. Maybe its a good idea and maybe its not. But there are concerns though, such as, will you open long and short positions at same time or only trade in a single direction? Indeed your thinking differ from most of us and this is really wonderful... I would like to hear more from you.

All the best

Hi bossxero,

Thanks for the warm welcome!

I did whip up a quick MetaTrader 4 Expert Advisor to test this out (Double Long.mq4). All this EA does is open two long positions, set the SL and TP targets accordingly, and wait for those targets to be hit before opening two new long positions. No indicators are used.

I back-tested using the GBP/USD pair on M30 from March 2006 to present. Results are in the attached files. On a 10,000$ deposit, it yielded a profit of +2,435$. As you can see from the attached graph, the performance is jagged. The drawdowns are occurring when the market was in a prolonged bear market, where the -150 pips outcome was occurring more frequently. The gains are being made when the market was in bull mode, where the +200 pips outcome was occurring more frequently.

I suppose a way to improve this would be to set the EA to only open long positions if the trend of the weekly chart is up. That way we could possibly eliminate a lot of the losing long trades. I'll have to play around with it some more, but I don't want to get into too many indicators because then the probabilities will become diluted.

[hayseed]

hey mtardif..... good post.......

i've given that line of thinkin a tremendous amount of thought .... some of my conclusions differ slightly from yours ......

clearly understand your desire to keep it simple but complicating it just a tad might be worth the time..... it might be fun to recode things just to see how much more we could squezze out of it..... what ya think..... h

[billbss]

As an example of "fact-based" or "mathematical probabilities", consider this example.

- I put on two long positions.
- The first long position has a take profit of +100 and a stop loss of -50.
- The second long position has a take profit of +100 and a stop loss of -100.

Given this setup, and without me closing positions early, just letting the TP or SL targets get hit, there are only three possible outcomes. The market cannot escape giving me one of these outcomes.
(1) Position 1: +100, Position 2: +100 (BEST OUTCOME).
(2) Position 1: -50, Position 2: +100 (ACCEPTABLE OUTCOME).
(3) Position 1: -50, Position 2: -100 (WORST OUTCOME).

Now, in the long run, the market should deliever outcome (1) 33% of the time, outcome (2) 33% of the time, and outcome (3) 33% of the time.

It won't work. Your math is off.

These are the actual probabilities:

(1) Position 1: +100, Position 2: +100 / 27.28%
(2) Position 1: -50, Position 2: +100 / 36.36%
(3) Position 1: -50, Position 2: -100 / 36.36%

This does not factor in the spread. If it did it would look even worse.

The reason the three scenarios do not have an equal chance of occuring is because Position 1 does not have an equal chance of hitting profit vs hitting the SL.

Position 1 is twice as likely to get stopped out as it is to hit profit.

It is twice as easy for a pair to move 50 pips than it is to move 100 pips.

Position 1 will be -50, 66.7% of the time
It will be +100, 33.3% of the time

Position 2 will be -100, 50% of the time
It will be +100, 50% of the time

If you put on this trade 100 times, this is your probable results:

+200 pips 27.26 times = +5452 pips
+50 pips 36.36 times = +1818 pips
-200 pips 36.36 times = -7272 pips

Total = +2 which is caused by rounding errors
Real total = 0 pips

This doesn't factor in the spread.

The spread actually changes the probabilities a small amount.

A good approximation is to take 200 trades (100 @ 2 positions each), multiply by the spread and subtract from the 0 total.

If the spread is 3 pips then you will lose 600 pips every 100 trades.

[bossxero]

Originally Posted by hayseed

hey mtardif..... good post.......

i've given that line of thinkin a tremendous amount of thought .... some of my conclusions differ slightly from yours ......

clearly understand your desire to keep it simple but complicating it just a tad might be worth the time..... it might be fun to recode things just to see how much more we could squezze out of it..... what ya think..... h

Hi Hayseed,

You could start by adding some filters to it such as the 200 EMA etc and then we compare the results. Lets say, price below 200 EMA, short only and the inverse for long. I think this path might be worth exploring.

[mtardif]

Originally Posted by billbss

It won't work. Your math is off.

These are the actual probabilities:

(1) Position 1: +100, Position 2: +100 / 27.28%
(2) Position 1: -50, Position 2: +100 / 36.36%
(3) Position 1: -50, Position 2: -100 / 36.36%

This does not factor in the spread. If it did it would look even worse.

Thanks billbss, I figured there was something wrong with my math because there is no way the market will yield a "probability-based advantage". That is a fact we unfortunately cannot escape...

Which means we therefore would need to rely on signals that work out at least 50% of the time and make sure that our profit is at least twice the size of our losses.

Ah but, signals, signals, signals, a million ways to make a signal, where do you start? In my experience, signals coming from anything less than a weekly chart are not dependable.

I modified my Expert Advisor to fire off double positions based on the momentum of the weekly chart. Stochastic (13,3,3) is used to measure momentum. When the weekly momentum switches from negative to positive, open long positions. When the weekly momentum switches from positive to negative, open short positions. This is a start. I am sure there are many refinements that could be made.

In the test I did on the daily chart of GBP/USD from 2005 through to 2007, the EA yielded a profit of +6138.70$ (based on mini lots). This is the most consistent long-term performance I have been able to come up with so far.

As before, any feedback is appreciated.

[hayseed]

hey mtardif.... big improvement.... very big improvement.....

both the introduction of your trend reference and also letting the second order ride till trend reversal will make for a far far more balanced and realistic expert.......h

[bossxero]

we also have a 22% DD on this which is un realistic... and bad for equity.