Trading: Art or Science

[TRex]

There is one flaw in the trade like a casino theory.

Casinos have a build in mathetical edge--a pure irrefutable, statistical advantage over the player on EVERY decision. (I'm not taliking about blackjack card counters who might eeek out a small advantage, ie. a lot less than 1.0%.) There is no such thing as a professional craps, roulette, baccarat, pai gow player. Those games are negative expectancy and cannot be beat in the long run by the player (that's not to say the player can't get lucky and have a short term win, but over time that player will lose).

The very best professional traders can profit on 80% of their trades, but those trades or setups if you will, can fail at any time and cease to perform as they did in the past due to an adjustement in market behavior. just witness the increase in volitity in August. The market annihilated the pivot and S/R traders as no levels were respected by the market. Regardless if one is a quant or discretionary trader, the "science" failed. Why, because it really wasn't science in the first place. It may have been high probability trading, but it is not and never will be an edge like a casino.

So, the casinos don't have this issue. Their "market conditions" never change and the odds on their games remain constant on EVERY single roll of the dice, spin of the wheel, or turn of the cards Think of a casino as a giant toll both that extracts a small but constant piece of the players bankroll.

[Dogpile]

I think we have to distinguish between quant strategies you are reading about in the news and writing quant strategies in Tradestation (or a similar software platform).

the quant style to trading (scientific) as a general rule (that is in the news today) is playing off mispriced relationships between securities - not directional movement. I am sure they have 'biases' on directional movement but having read many of the books on LTCM and hedge funds and from talking to those who quantitatively trade options for a business (my brother in-law) -- most of these strategies are simply 'relative value' trades with no directional exposure --- put on in huge size. ie, you buy options that are trading with 28.6 implied vol when the entire options chain on the same security is trading at a 31 implied vol. you instantly hedge it by shorting the underlying. you are letting the market tell you how it is pricing the options (the volatility expectation) and you are buying options at a discount to this and locking in the 'edge'.

essentially, you are arbitraging securities whose spreads are wider than the underlying characteristics logically suggest. ie, selling October calls and buying November calls on the same security. I am not saying this strategy is guaranteed to work as it requires 'dynamic hedging' (essentially re-balancing your weightings as changing price can exponentially change the characteristics of a derivatives instrument)-- I am just saying that this is logically sound strategy that is 'expected' to work and exposure to 'shocks' can be neutralized to some degree.

LTCM did many monster trades on buying the treasury bond expiring in 29.5 years and funding the purchase by shorting the security expiring in 30 years. hard to logically argue that these securities are much different.

let's be clear, good arbitrage strategies work. the problems arise when everyone has the same quant strategy on and everyone is using heavy leverage and are therefore forced to liquidate mispriced securities. this is when things go haywire --- and what happened in 1987, 1998 and last month.

now, writing quant strategies in Tradestation or similar programs is generally not about arbitrage -- its about finding small biases regarding location and future direction. this is necessary to understand biases to exploit and make a living off the 'big moneys' crumbs.

we have been in the 'information age' for a long time now -- I agree with some recent authors that hypothesize that we are entering the 'conceptual age' --- where computing power is becoming commoditized. in my opinion, trading strategies are optimally executed by augmenting statistical strategies in conjunction with using the right side of the brain too (pattern recognition, synthesizing timeframes, and 'intuition').

but good quant strategies will continue to work -- and 'me-too' quant strategies joining the party late on what 'was' a good quant strategy will clearly have to fail big-time as the best quant strategy-writers will figure out a way to fade their own strategy when its gets too popular. we will be hearing about these guys probably over the next year.

[Dogpile]

"The market annihilated the pivot and S/R traders as no levels were respected by the market. Regardless if one is a quant or discretionary trader, the "science" failed."

what? many of the hybrid quant/discretionary traders I know had their best month of the year in August.

I don't think you can ever say, the 'science' failed. stratgies fail, science does not. for every strategy that fails, there was a strategy that faded the failed strategy. the strategy that worked was based on good assumptions (the science), the strategy that didn't work was based on only a perception of science (bad assumptions). a strategy built on the last X trading years of data might be valid in the future or it might not. traders who had failed strategies simply didn't adjust to the new volatility after an unusually long period of low volatility --- a 'bubble' I would say. if you built your strategy based on the assumption that a bubble wouldn't pop -- and the bubble does pop, I would just call that a bad strategy -- not a failure of science.

this is obviously a bigger point but strategies that rely on 'normally distributed returns' and/or 'linear movement' -- and don't properly factor in periods of intense non-linear movement -- will eventually fail. financial markets have been shown over and over again to exhibit 'fat tails'. extreme moves happen more often than one would expect. but this hardly predicts that quant strategies necessarily have to fail -- quant strategies have done extremely well. there is just a point where their own success eventually increases the risk of their own failure as the strategies that are working become widely adopted.

[Dogpile]

by the way, there is a hedge fund (Citadel) who apparently has taken the strategy of waiting for inevitible carnage in the hedge fund industry and buying the entire portfolios of blown-up funds at a discount. they are essentially arbitraging the concept that THEY won't be forced to unload mispriced securities since they are well-capitalized... while the hedge fund that is too heavily levered is forced by their loans to sell their mispriced (underpriced) securities (to Citadel).

[weiwei]

Just to add to what I said earlier to make it more complete.

The shorter the time frame, the harder it is to back test it, in other word harder to get a good quantitative result.(profit) Simply because of there are more noises in price action.

Price action is the combination result of many different factors, Fundamental, technical, sentiment, order flows for shorter term trading and others.

thus your focus on the cause of the price action will set your brain to If trading is an Art or science, thus determine your approach to the market.

After all at end it is the end result that count. Artistic trading style or scientific trading style as long as it works for you.

[mea]

Quote by Dogpile

I don't think you can ever say, the 'science' failed. strategies fail, science does not. for every strategy that fails, there was a strategy that faded the failed strategy. the strategy that worked was based on good assumptions (the science), the strategy that didn't work was based on only a perception of science (bad assumptions).

Exactly, Thank you.

[mea]

Please refer to answers section.

QUOTE=TRex;18596]There is one flaw in the trade like a casino theory.

Casinos have a build in mathetical edge--a pure irrefutable, statistical advantage over the player on EVERY decision.

Answer: Correct, and so can trading.

The very best professional traders can profit on 80% of their trades, but those trades or setups if you will, can fail at any time and cease to perform as they did in the past due to an adjustement in market behavior.

Answer: Correct, and the "edge" or advantage a trader can have is knowing a particular strategy will not be correct in the changing "market behavior" which was proved by science and capitalize on it by utilizing a correct strategy for the market conditions at hand.

just witness the increase in volitity in August.

Answer: Which means, different market conditions require various strategies which have to be matched to the market conditions.

The market annihilated the pivot and S/R traders as no levels were respected by the market.

Answer: Which is a sign of changing market conditions and you better have a successful strategy for it or stay on the side lines.


Regardless if one is a quant or discretionary trader, the "science" failed.

Answer: No, the science was applied incorrectly. Meaning, the person who analyzed the market conditions correctly and applied a correct strategy for said market conditions wins, and the person who failed to analyze correctly lost.

Why, because it really wasn't science in the first place. It may have been high probability trading, but it is not and never will be an edge like a casino.

Answer: Science has proven it can be exactly like a casino analogy, if the science is applied correctly. Just as casinos pay out a small portion of there winnings to the public. So can a trader, hedge fund, investment bank, mutual fund etc. win most of the time and give back very little to the market. Again, if the science is applied correctly.

So, the casinos don't have this issue. Their "market conditions" never change and the odds on their games remain constant on EVERY single roll of the dice, spin of the wheel, or turn of the cards

Answer: Correct. And, the secret to trading by science is the ability to recognize the changing market conditions and apply the correct strategy for it

My posting to you is not to argue or offend you. Rather, quite the opposite. Meaning, to have you as well as all others reading this think "outside the box" and possibly add to your trading arsenal.

Also, I have reviewed your site and was able to determine some of your methods, which are valid and I wish you the best in your endeavor.


Mark

[TRex]

mea, with all due respect to say "the secret to trading by science is the ability to recognize the changing market conditions and apply the correct strategy for it" is a contradiction in terms. I realize we're having an academic discussion, so no harm done.

The trading you're referring to would be better called theory, rather than fact, of science. Casinos operate on the mathametical laws which don't change regardless what the player is doing. Their environment doesn't have changing market conditions; and even if it did, any change in the games would still have a built in edge for the casino. The player would be hopeless to win unless by a stroke of luck.

Trading will never be a science as long as the market conditions change and traders have to continually adjust to find an edge. What works today can fail tomorrow and so on and so forth.

P.s. Thanks for the kind words about The TradingZoo Website.

[feb2865]

"the secret to trading by science is the ability to recognize the changing market conditions and apply the correct strategy for it"

It sounds discretionary to me

Listen folks, this topic is very much like the never-ending story about scaling out, stop-loss, indicators, etc. It becomes a soap opera after a while. Lucky for us, this forum is a well-organized one and traders do respect each to the max.

First you need to have a clear definition of what is science - and what is art trading wise. When I started I was sure I had this defined real good. As I mentioned in my earliest post, market proved me wrong.

If you have a system/strategy that works and adapts to this ever-changing environment, congratulations. If is an art or is a science - who cares??

does it makes you money consistently?

I learned that trading becomes very much like a fingerprint for every trader. I have a friend who utilizes MACD and price and it works pretty good for him. I tried once and got screwed up.

Everything lies in the eyes of the beholder.

I have an open mind about everything. You have a bot that spits dollar bills everytime the market opens, I am willing to try (paper trade of course) I have never make any indicator work in live trading. But that's me, doesn't mean traders outhere are not making money off indicators.

Whatever system you use, mechanical, science, art, etc. Please bear in mind that all of them has it's limitations. Learn when your system is telling the truth and when is giving you a wrong signal.

In all markets, at all time frames, there will be periods of accumulation and distribution. On whatever your use art/science/astrology/tea leaves etc. would be nice to train your system to spot these periods so you can act accordingly when the market distributes. At least this is how I trade.

Systems/strategies...art or science...are just road maps. You still need to drive the car.

[Dogpile]

<<"the secret to trading by science is the ability to recognize the changing market conditions and apply the correct strategy for it" is a contradiction in terms. >>

no, I don't think it is a contradiction -- it is just differences in timeframe.

Art Collins book goes into this. I am not a great programmer by any means but I can easily write a 'switch' into my program that turns on if one environment exists and turns off if another environment exists. the example Art gives is a switch that turns on in anticipation of a momentum move. his system recognizes this to be occuring if you close near the closing high of a 20-day range and the last 5-day high to low range is twice the size of the previous 20-day range. then use a buy-stop at the opening price + X # of pts.

just an example of how a mechanical trader can recognize changing conditions in market behavior.