Whilst doing a data review recently I happened to chance upon a domestic data supplier who promised to give me “next days data” for only $15 per month. My immediate thought was I would give you 15k per month for tomorrows data. As a flight of fantasy consider the value of such information. At the time of writing the current daily range of the Share Price Index (SPI) is 55 points with each point being worth $25.
So in the course of a trading week there are 275 points up for grabs. If you managed to capture 90% of these you would take home 247 points per contract. In dollar terms this is $6,187.50 per week, per contract. So if I had ten contracts I would take home $61,8750 per week or $247,500 per month – so you can see why I would be willing to pay $15,000 per month for next days data. Hell, I might even be convinced that day trading actually works.
It may seem that I am being overly critical of a simple error but this form of lazy language is a perennial problem for traders and as those who have done the Mentor Program can attest to I am somewhat militant about the language used to describe the components of a trading system. The problem of loose language raises its head in both system testing and in the construction of a trading plan.
Within the context of system design this problem is known as postdictive error which is simply including information that would not have been available in making a decision. For example when you designing your trading system for testing you inadvertently include data that is not available at the time the trading design is made. A simple example of this form of mistake is to use today’s closing price (or today’s high or today’s low) in calculations that ultimately affect the way you trade today – in effect the system cheats.
This will result in your trading software producing a beautiful looking equity and you entertaining dreams of retiring to Monaco. What is more likely is that you trade the system and end up moving to Launceston, which trust me is nothing like Monaco. These errors are quite easy to fall prey to. For an example of how even very bright people can be fooled by there errors have a read of The Predictors by Thomas Bass where a group of physicists looking to generate predictive trading models fell into the same trap during one of their data runs.
Within the context of trading plans lazy language can either provide too many choices for the trader or simply not provide firm enough direction. Last year I attended a trading conference where I was due to speak on the simplicity of trading systems. On before me was a fairly well known US trader who during the course of his presentation stated that when ABC happens they then look at one of their eight exit strategies. I happened to be standing up the back when I heard this and the resultant flow of hot tea out of my nose did wonders for my blocked nose. If a position has gone bad then it has gone bad there is no point in having a multitude of possible exits. The trap this trader had fallen into was the belief that somehow the imperfect nature of stops could be engineered out of a system by having a multitude of overlapping stops. In reality what such an approach does is merely overload the trader with decisions at a time when their decision making abilities is very poor.
The other potential problem that poor language generates is a lack of true direction. For example most traders can recite the mantra of riding trends, keeping risk small and cutting losses but when questioned as to the specifics of how this is done they are more than a little vague. Take for instance the tendency of traders to rotate through various indicators looking for something that is akin to prediction when in fact trend following is reactive. This occurs because within their initial trading plan they have said that they will be trend following but they have not defined what they perceive as a trend.
Is it –
- A change in the long term trend as defined as price moving above a given moving average.
- Is this moving average plotted a on a weekly or a daily chart?
- Is a change in trend defined as a stock making a new 52-week high?
- Is it a combination of the above features?
Each step of a trading plan needs to be carefully elucidated and all points of possible emotional and intellectual debate spelled out in fine detail so that when the time comes to enact the plan the room for internal debate is narrowed. The less room your psyche has to maneuver the more chance you have of following your plan, the more you follow your plan the more chance you have of surviving, the more chance you have of surviving the more chance you have of being profitable.
