Scott Raybin

More – Fred Smilek Vision of the Power of Technology in the Securites Market

  • May 12, 2008

The goal of building long-term wealth through investing can be best achieved by consistently employing a disciplined investment process having a demonstrable statistical “edge” at a level of risk that ensures capital is never eroded to such an extent that the investor loses faith in the process.

We believe that a well designed trading system which has been developed to suit the investor’s psychology is a necessary component of a successful investment process.

A trading system represents a set of rules for making entry, exit and position sizing decisions.

We have incorporated a number of beliefs in the development or our trading system. These are summarized below:

A trading system must have a worthwhile mathematical expectation of profit if it is to be successful.
Proper position sizing is essential to achieving success. If you risk too little, you will not meet your longer-term performance objectives. On the other hand, risking too much may result in your being “terminated from the game” during those inevitable periods when you suffer an extended drawdown in performance. At least as much time in system development should be spent on developing good position sizing algorithms as is spend on developing good entry and exit rules.

Most investors place entirely too much emphasis on being right. It’s not whether you’re right or wrong that is important, but how much money you make when you’re right versus how much you lose when you’re wrong.

Most managers place entirely too much emphasis on entries, partly because of a psychological need to be right and partly because they feel they have more control during the entry process. The key to outperforming, however, is in how you exit the market, now how you enter. Cutting losses short and letting profits run is all about exits, not entries.

You must be willing to lose in order to win. A trading system can be profitable even if it generates winning trades less than 50% of the time. In fact, many profitable trading systems generate winning trades only 30-40% of the time.

Successful investing is 40% risk control and 60% self control. As such, the investor’s psychological profile may be the most important factor in contributing to investment results. Therefore, it is reasonable to conclude that an automatic trading philosophy becomes a paramount element in the trading system to reduce subjectivity and increase objectivity in the ever changing market conditions.

Risk orientation and conservatism are often considered opposing personality traits. Both are essential to achieve good performance. Our objective is to take the risk-oriented part of our personality and put it where it belongs: taking the trading signals. The conservative part of our personality also must be put where it belongs: proper position sizing.

Through diversification, we can smooth the equity curve and increase opportunity. Diversification can be achieved in two ways: (1) using multiple trading systems on the same market, each designed to capture a different market characteristic and/or different time frames; and (2) trading multiple markets with the same system.

The easier a system is to trade, the less robust that system is likely to be over the long term, However, a well designed system that is compatible with the investor’s psychology and trading beliefs, and which has been thoroughly tested and is well understood, will likely be more easily implemented than one which has not met this criteria.
We believe the research and development of trading systems is a never ending process. Even if a better system has not been developed, the effort is not in vain as it will usually lead to incremental knowledge which will be helpful at a future date. On the other hand, the R&D process may lead to small refinements that enhance system performance such as increasing mathematical expectation, reducing the length and severity of draw downs, or if they otherwise improve the reward to risk characteristics of the trading system.

A successful investment process consists of more than just a good trading system. We believe that a healthy attitude resulting from a through understanding of the investor’s psychology is crucial both in the development of the trading system and its ongoing implementation. The weak link in the process requires a well through out investment plan covering all aspects of the process from the minimum capital required to make the process work through to a disaster recovery plan.

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