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trader and Excel based software developer of risk management software
My company:
Fulcrum Shift Trading
My blog:
Fulcrum SHift Trading
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  • Scaling or legging out of a winning trade - the empirical evidence using the NEW "Equity Curve" worksheet in the m3 modeler

    There is a great debate in the trading community as to whether one should close out an entire profitable position at a single pre-determined profit objective or, whether to close out part of your position at the same pre-determined point objective booking a portion of  the profits, then move your stop loss to break even thereby leaving you in the trade in the event that the move becomes a large or runaway winner. If you stop and think about the dynamics of these 2 options, the only way a trader can participate in a large move is to either consistently trade for large point objectives or, to apply the scaling or "legging" methodology on which the m3 - Money Management Modeler was built upon. For example, if you exclusively trade the SP500 E-mini contract and you use a single point objective when closing out your entire position, then how will you ever participate in a large runaway move? An argument can be made for the mechanical trader whose decisions as to when to buy and sell are generated by a computer algorithm, but if there is a pause in momentum of a particular trade, even the most "patient" system will eventually trigger a sell signal (or buy if you are short). Trading a "patient" system also has its serious drawbacks. Most systems that go for the large winning points have very poor win/loss ratios, meaning most signals to enter a trade result is losses but developers defend this by pointing to the size of the average win when they are correct. Think of a "home run" hitter in baseball - usually they have  poor on base percentages but when they connect - they connect. Other systems take the exact opposite approach where they have great win/loss ratios but the average win size is minimal. Brokerage firms love these types of traders because of the number of transactions that ultimately generate commissions fees. The scaling or "legging" approach is the best of both worlds and with sophisticated trading platforms that are readily available today to even the most novice of traders, there has never been a better time to employ this methodology. 

    In my original m3 platform on the "EquityCurve" worksheet, I allow the user to "check off" which equity curve he or she wishes to see

    m3 - Equity Curve Check Boxes
    m3 - Equity Curve Check Boxes (Click to enlarge)

    - you can have as many as 6 equity curves populated at one time - its completely flexible. If you are un- familiar with the tool, as I mentioned above, there are countless blog postings and web tutorials that I have archived for viewing at your convenience. I felt that the cumulative equity curve on legs 2 and 3 needed improving. If a trader has reached their profit target 1, then using this methodology, one would close out a portion of the position and then adjust their stop loss to break even. In my programming, if a trader reaches profit target 1 and then adjusts their stop to break even, the trader is then in a no lose or risk free trade. With a risk free trade, if the position did NOTreach the profit target 2 (and there is no guarantee that it would) then with the stop adjustment in place there is zero risk. When you look at the equity curve you were constantly seeing a 45 degree angle upwards given the way the programming was written. A win ,for example, would be recorded as lets say 3 points and a losing trade would be denoted with a "0" because of the no risk stop adjustment. While this is completely accurate, it is also misleading. given the equity curve was solely based on the wins with the "non-wins"  which shows no draw down because of the adjusted stop. It can still be used as long as the user acknowledges that this is a leg 2 ONLY equity curve where there is NOloss reflected in this equity curve. A loss can only be recognized within the 1st leg that is the only time risk is present. Once again - if you have reached your profit target 1 - you adjust your stop to break even removing all risk from the trade while leaving yourself still in the trade looking for additional profit.

    I have addressed this challenge with new programming. In the pic below you will see 2 equity curves.

    Random vs. Single Exit
    Random vs. Single Exit (Click to enlarge)

     The 1st seen in a burgundy/red colour is the "SingleExit" equity curve and the white is the "RandomEquity" curve. This new and improved Monte Carlo simulation is superior in every metric. The "SingleExit" equity curve is self explanatory. This is for traders who feel that exiting at a single, pre-defined profit objective is the superior way to go. The results speak for themselves. The "RandomEquity" curve now incorporates lossesin conjunctionwith wins and the wins can be any of the 3 possible outcomes - profit target 1, profit target 2 and profit target 3. Not only can the random outcome be any of the 3 winning profit objectives or losses but the winning outcomes have now been weighted to reflect the probability of reaching any of the winning profit targets. So, a loss is still denoted with a -1 but a win could be any of your 3 profit point objectives and most importantly when a win occurs the probability of which leg will  be reached reflects the user inputs. Given some of the complexities in this explanation I have attached a 5 minute web tutorial highlighting this new and very important dimension to the m3. This is the empirical evidence proving that to scale out of a winning position incrementally with stop loss adjustments is the superior way to go over a large enough sample size.

    One final feature that has been added to this latest platform is one you wont see but the capabilities of this new functionality can not be stressed enough. As before the tapping of the F9 on your keyboard engage the RAND or RANDbetween function which is basically a Monte Carlo simulation. Now, with the "DataTables" function added into the mix, a SINGLE tap of the F9 button automatically runs 1000 iterations of your settings. This saves you the user massive amounts of time knowing that result has been crunched repeatedly to produce the final results. You still have the ability to repeatedly use the F9 key but just remember that each result is as if you tapped the F9 1000 times. Here is the screen shot below where I have highlighted the formula.

    Data Tables
    Data Tables (Click to enlarge)

    Enjoy the web tutorial and hopefully this will change the way you approach your trading endeavours going forward. (Click to play)


    Fulcrum Shift Trading

    Nov 24 1:24 PM | Link | Comment!
  • $SPY - Probable forecast and and how to capitalize with double digit returns over the next 12 weeks with options
    Using the F-Shift Forecaster, I wanted to get an idea - a PROBABLE idea as to where we are headed in the overall market. I downloaded WEEKLY historical data courtesy of Yahoo Finance and populated the forecaster to produce an unbiased probable outcome 12 weeks from today. Its easy to say "higher" given the current rally we are in but I needed something more specific than that to hang my hat on. The results are are probably going to make you re-think any opinions you may have. I know I did although even though I did and still DO have an opinion on the market - I trade only what I see and NOT what I believe.
    F- Shift Forecaster - The Breakdown
    F- Shift Forecaster - The Breakdown
    Lets drill down into the "break down"  seen in the 2nd screen shot above.  As the pic. says, there is both the numeric value and the graphic representation for you to analyze. Personally I believe a picture tells the story a whole lot better so lets turn to the graphs.
    The 1st thing that jumps right out at me is the distribution of probable outcomes. There are 4 possible outcomes and they are as follows;
    1) Greater than (>) 10% from today's start value
    2) Between 0-10% from today's start value
    3) Between 0-(-10%) from today's start value
    4) Less than (<)-10%  from today's start value
     The 1st pair of columns - both black and grey - show us the probability of a value exceeding 10% from today's start value which by the way is 111.34 as of yesterdays close November 17,2009. There is a 34.5% weighted probability of that happening while under the non-weighted forecast there is only a 28.10% chance of occurrence. This is a difference of 22.78% between the weighted and non-weighted probability of occurrence - certainly noteworthy.
    The 2nd pair of columns reflect the probability of the SPY's finishing between 0-10%. Here discrepancy is much tighter with the NON - weighted outcome having the edge with 20.70% of occurrence relative to its weighted outcome counterpart which reads 18.20%. A difference of -12.08% from the weighted to the NON- weighted.
    The 3rd pair of columns reflect the probability of the SPY's finishing between 0-(-10%). The readings are 22.10% probability of occurrence for the NON - weighted relative to 17.80% for the weighted. Again a percentile difference of -19.46% from weighted to NON - weighted.
    Finally the 4th pair of columns reflect the probability of the SPY's finishing not only positively, but ending with a value less than (<) 10% from the start value ( 111.34). The weighted results at 29.50% are almost identical to the NON-weighted results which came in at 29.10%. The percentile difference between the two probable outcomes was only 1.37% from weighted to the NON- weighted readings.
    So what does all of this tell us? That the 12 week probable outcome is pretty evenly distributed with a bias to EITHER a large move  higher (greater than 10% from today's start value) or a rather large pullback of -10% or more from today's start value. Armed with this knowledge of the probable outcomes, how can we devise a trading strategy that will capitalize on this outlook? Its called trading a double diagonal options strategy which offers a WIDE range for profit potential from three (3) separate metrics;
    • 1) a rise in implied volatility levels from the current yearly lows
    • 2) Theta or time decay
    • 3) as mentioned above a WIDE price range allowing the UI (underlying Instrument - SPY's) to move up,down or stay neutral
    Look for part 2 of this 3 part series later today or tomorrow and I will walk you through a trade that may turn out to be the only once you would have to make in 2010 !
    Fulcrum Shift Trading
    Nov 18 2:24 PM | Link | Comment!
  • Using margin - a double edged sword

    Having the ability to trade on margin is a powerful leveraging mechanism if it used correctly - but one MUST also be aware of the potential dangers. The greater the margin that is afforded you through your brokerage, the greater the potential damage one can unknowingly do their capital. Lets take a look using the m3 - Money Management Modeler. The reason I chose this topic to blog about was due to a client of mine who had requested that I expand the margin levels from the standard 2x that I had built into the platform. He requested that I allow for 10x margin! I shook my head in disbelief but I made the changes changes as per his request - I'm just not so sure this particular client realizes how damaging that could be to his account balance should the trade move against him. Below is a screen shot of a hypothetical trading account with a start value of $50,000.

    m3 - Money Management Modeler - the risks of margin
    m3 - Money Management Modeler - the risks of margin (Click to enlarge)

    In the screen shot about one can clearly see the advantages of trading on margin. In this $50,000 account example, the 3:1 leverage provides a trader with $150,000 purchasing power. That's great if the trade goes in your favour - not so great if you have utilized that available margin and it is a losing trade. That's why margin is called a double edged sword - it cuts both ways. Brokerages are all too happy to provide you additional funds to trade with. The will obviously reap the benefits twofold - 1) they charge interest on those additional funds they are providing and 2) more importantly they collect additional commission fees because of the increased position size of the trade you are now able to make. This could be on one LARGE single trade using the margin, or over a basket of  smaller positions . Either way the additional trading capital which is made available when used, generates additional revenue for the brokerage and the best part from their (the brokerage) perspective is the fact that they can liquidate your holdings at any time if the positions that you entered on margin begin to move against you. This is known as a margin call and trust me - they are not fun. Risk management and position sizing trump any margin made available to today's trader EVERY TIME. With a tool like the m3- Money Management Modeler, over trading or taking on a single position that is too large relative to your risk just doesn't happen unless you consciously choose to ignore the results that the platform produces. Used correctly in the right hands and with the right tool, margin can be a POWERFUL leveraging mechanism to rally your account balance at an accelerated pace.

    Fulcrum Shift Trading

    Nov 16 9:20 AM | Link | Comment!
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