Golden rule of a Simple Trading System

A Simple trading system is first and most important founding stone for survival in any-ones trading career. Its opposite a Complex trading system leads to loss of focus – which is a sure shot way to lose everything. Value of a simple system can never be overemphasized, unfortunately this is overlooked and quickly forgotten. A graduating trader would be learning new skills and tempted to follow more complex system utilized by so called “gurus”, not understanding those rules are for that guru, here its worth mentioning countless traders have destroyed their life by blindly following techniques from gurus.

By the term “Simple trading system” here I don’t mean something stupid or discovered by a newbie. A Simple trading system is one which is based on strong principles, time tested, evolved from your experience but most importantly free from any complexities, things that leads to too much pressure buildup on the mind, clogs the perception, things that lead to luck factor play, require intuition or form a gray areas in decision making.

It’s necessary to understand that damage done by any trading system that are more Complex in nature are numerous, first – you tend to forget them, and because mind is tired always trying to keep them in front, you also forget other more important items like news, crucial dates, chart events etc, you become unable to perform simple chart observation, cannot judge simple trends, because a loaded mind is not powerful and agile enough. You may regularly find yourself in situations not able to decide what to do and end up in frustration.

Depending on how many rules you can remember and apply without failing in live markets is your – Simple trading system. A veteran or someone with superb memory, one who lives in present state of mind can incorporate 20 variables to watch and adjust his thought process quickly, but think before copying anything like that, is going to help you?

A simple trading system can be mixture of 3-4 items, as an example below.

  1. Take entry only when indicators or algorithm gives signal
  2. What times in trading session you take those signal or ignore
  3. What does trading data from exchange portal say ?

So like that based on above simple rules you can quickly reject or take a trade without having to regret or frustrate. Once you have successfully developed your simple trading system, stick to that and don’t change them frequently.

How adding more indicators does not increase profits

To answer this in a deterministic manner and not to confuse you further, I would first ask you to throw another important question – whether the indicators you have posses any real edge in market? By edge I mean winning tendency over and above 50%, so if your indicator have winning tendency of 56% then it has edge of 56-50 = 6%, notice that 50 is discarded, and does not become the part of our overall edge calculation. To be clear, I should mention that win rates are calculated using strategy back-testing over a sufficient time series data.

Why, we eliminated 50 part of winrate is because all kinds of financial market provides you a default edge of 50%, without doing anything on your part, basically it just means that, in an efficient markets at any points of time the tendency to go up or go down are always the same, no matter what strategy we deploy. We know that markets are not 100% efficient but for most mathematical model based strategies this still holds a solid ground. Therefore 50% is not an edge in reality, when we combine anything of 50-50 probability it will not enhance our win rate anyway, this is what our probability theory also tells us.

Lets run through a very simple example for our understanding, lets say we have three indicators A, B and C of win rates 50% each, in a mathematical language, when an indicator A is true state we have 50% probability of winning, and same goes for B and C. Now we are asking when A, B or A, B, C have simultaneously true states that time whats the winning edge ? is it more than 50 or less !!

As you figured out, they all have 0 (50-50) edge, therefor when system is stacked by A+B+C,additional stacking do not change existing edge any further.

To put it in simple words, only if an indicator have over and above 50% edge, then combined with another indicator could results in further improvements of overall winning probabilities, and we know that most of our indicators have 50% or less (most are in range of ~35%) win rates, they become less than 50% because of brokerage and late entries, so by now it should be clear, that such combination stacked up together cannot lead you to a more profitable trading system.

Why is options selling difficult ?

Options have evolved in ways that they works in favor of sellers, but wait its not for every seller, you have to have mastery in smelling market sentiments and then only you can use options to make trading robust. We will discuss more on options behavior without which one cannot become an option champion.

Options are hedging instrument, but in standalone trading, why are sometimes options preferred over stocks ? this is because options give you more time, as opposed to stocks where a losing position, necessarily create a emergency situation where one has to decide and act hast-fully, which means run stop loss before it becomes too large.

This emergency situation is eliminated from options trading which is a huge advantage, temporarily your position may come under loss but you are not really a loser unless the underlying price crosses the option strike on expiry day.

options selling
Options are used by variety of traders for different reasons

Day trading is chewing iron bullets – the style which option value change with underlying price, creates a very poor risk-to-reward ratio for sellers, this is due to the fact that when underlying price drops, corresponding option drops by logarithmic function and during rise its exponential rise, this makes them difficult to use for day trading, as when you lose its manifold than what you get in winning trades. Look at the diagram below which shows how option price adjust.

options price with underlying

Historically Oom ( out of the money) options selling wins 90% of the times, so its only 10% trades are loser, now the tricky thing to understand in losses in an option trade are never small, it cannot be small, why?

This is because when selling you earn only small option premium, but when lose you always shell out the difference between underlying price and strike price which is completely in a different scale. Therefore those 10% trades have enough capacity to eat up all profits generated from 90% winners, sounds ironical…isn’t it !!

Another thing is options price do not drop during days when an important news is about to be released, so even if you get the direction right don’t expect options to generate profit for you.

A frustrating thing about options are, they do not carry one-to-one correlation with underlying value, and anyone who trades options by watching spot price will have disappointments, this is because underlying and options are abide by only strike and expiry date. in between options can behave like an independent instrument.

Three breakthrough for a profitable trading

A lot has been said about, “what makes a winning traders traits”, in this post I am going reiterate what are those and try to make it more clear. Although the points remains abstract in nature.

A profitable trading career a rare thing to see,, as it demands combination of multiple skill-sets in a single person. A successful trader usually have to pass through three phases, and on mastering 1 or 2 of these itself is not enough to believe you are done! Some peoples may have built-in traits to handle situations better, hence little time is needed for them and they can move to next phase.

Three phases are, discipline, knowledge and intuition  and if they are learned the the same order, earlier you reach goal, if you ended up in jumbled order, you will need to again go back to earlier and learn missing ones. Needless to say these three fields are from three different worlds, and usually a person strong in one area is likely to struggle in other.

trading traits

Discipline comes the first, most trader in their start of trading career believe that knowing, how the markets work will put them profitable position and so first priority to learn that, this is not true! The fact is knowledge part requires some mentor-ship and with time only you will learn them, whereas a trading discipline is in your hands ( although most difficult )

Knowledge, is your IQ, it is made of the part of our physical world, an intelligent person may find it easy to grasp existing financial markets know-how. he/she maybe able to understand technicality and math side of market very well Technical analysis, and Fundamental analysis you learn in this stage.

Part of this knowledge is learned onset of this phase and then its a lifetime learning. Sadly knowledge alone is never been substantial for making a profitable trading, but it cannot be ignored also, as without basic knowledge a trader will fail badly no matter how lucky he/she is.

Finally,most important, intuition part, but no one talks about it, if you are doing everything right and still failing, this is where its lag is. ask yourself, world is full of intelligent analysts who share very good tips, but their own trading suffers, else why would they choose to be an analyst. intuition is your subconscious minds power. it guides you all the time without you knowing.

Lets go in this deeper, suppose your trading system has edge of 60% means 6 out of 10 trades are found to be winner in backtest. if you ended up trading only losers and missing winners, so despite a winning trading system, it fails you in trading, on the contrary an not so sophisticated trader whose, who relies on simple moving average cross but mostly ends up taking winning signals, now who tells you a certain trade to take ?its the subconscious mind.

Many successful traders may not realize about helps coming from subconscious mind, and not even bother. Some peoples call it luck, again persistent luck or bad-luck is something to look. Mediation is a proven technique to fix-up the vibrations in your subconscious mind and make it work in your favor.

Finally to conclude, all these phases unless you have not mastered don’t quite trading, as without that its not even imaginable.

 

 

Myth of options time decay

One of the much touted jargon of trading industry is, that option value decays over the time,  hence with selling options – easy and consistent premium can be earned on a regular basis, everyone wants to believe that, specially new option sellers fall into prey for that, In this post we will discuss risks involved in options selling.

First of all let say that, I am not debunking option selling or instead suggesting to buy options, For nimble traders in fact it does work with right risk management in place. But just ask yourself, if selling were so easy everyone would have done the same? and no one has to lose money in stock market!

options price change

Big money fund managers sell options but they do it for hedging purposes this is, so called option experts won’t tell you. And to profit in selling a naked option you must have a robust prediction mechanism in place, there is no excuse for that along with that you need a stop loss too.

We hear all the time, that options decays its value over the time, and there are popular pricing models (Black scholes) for that like, can it be simple as plain vanilla ? Well not denying that there is drops at discrete times, but its not like they lose value every hours or so, certainly in a longer expiry like months or more you will see options price losing its value on some days.

Wait, but peoples want to apply that on day trading or where holding period is few days. Let me tell you as long as there is a hope in traders who bought those options, it will not drop 1 penny, real options work like that, get this clear.

First thing to keep in mind is in options risk-reward don’t work in favor of a seller , an option seller may get 10-10 points in 3 trades and can lose 50 in 2 trades later. that’s how options price moves, to put it in simple words option price don’t change similar on either sides of falling and rising market.Without bringing in complexity of option pricing models, let us see little bit of math of this then it will be clear.

We can roughly say, at any point of time option moves by certain percentage of its own price, this is in either direction, in technical terms we call this delta, so a 100 rs option may be changing +/- 5% every 5min (5 rs either side), when the options are rising the further change also becomes large, for example that 100 rs option becomes 150, next change will be 7.5rs and thus options rise at exponential rate, on the opposite side if market is falling further drop is curtailed on every next drop. hope this is clear.

Reality of option selling trading do not rely on prediction or trend following rather a guess of market limits, so you may be having an opinion that market will remain range bound around +200 and -200 during this expiry so you can take a position

 

Windicator – algorithms for financial markets

Windicator is our algorithmic trading solution for capital market around the globe. Main idea is to bridge gap between computer driven and discretionary trading. Windicator can quickly implement an emotion free rule based system for a consistent profit.

End to end algorithmic trading solution

Ask a question – what infrastructure you need for automated or supervised trading business?

Data feed… ! No

Trade API… ! No

Intelligent Algorithms… ! No

The answer is You need Data feed, Trade API and Intelligent Algorithms to do that, Yes that’s right you need all three. And here we provide end to end solution so you don’t have to do a monkey business of stitching these components from different vendors.

 

How it works

Algorithm is a form of software-as-a-service (SaaS). This means little or no hardware requirements from your side, having a smartphone is more than enough!

Windicator engine that runs on the server has modules for data connection, algorithm execution, order management and interface for sending signal outputs to any external client software that connects to it using websocket protocol.

Traders can receive real-time buy/sell signals on his PC / Smartphone to act upon them. Optionally a trader can directly place exchange orders, this requires your broker has a API for data feed and order management.

Web interface shown in demo is just one form of using the service, in reality any websocket driven client can connect with API keys. NOTE that algorithms offered here are not HFT type.

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windicator signal buy/sell amibroker