accuracy Archives - Algorithmic and Mechanical Forex Strategies

Virtu Financial, the high frequency trading firm whose initial public offering of stock was caught in the unexpected firestorm that was the book “Flash Boys” by Michael Lewis, is reviving the IPO plan they shelved last year amid controversy, is seeking $100 million.

99.999 win percentage is an odd statistic

As a recent Securities and Exchange filing reveals, the company, operated by a litany of some of the exchange world’s top executives, boasts that out of 1,485 trading days it has only one losing day. This is the key statistics that left those familiar with algorithmic trading scratching their heads.

On the surface this 99.999 win percentage is a rather unworldly performance statistic in the world of algorithmic trading.

Virtu Financial is not a trend follower

The most popular managed futures strategy, trend following, has an average win percentage near 55 percent. Trend following might not be the best algorithmic strategy to compare to Virtu, however, as the firm claims in its S-1 that their trading “is designed to be non-directional, non-speculative and market neutral.” Micro-trend following and benefiting from market moves in one direction is a popular high frequency trading strategy, but based on their S-1 this is not the primary strategy.

This doesn’t explain the win percentage.

The highest win percentage of all managed futures strategies, near 75 percent, is short volatility, which is also the least popular strategy. While the strategy is known to win most of the time, the key statistic is to understand its small win size and large loss size. In managed futures the size of a trader’s wins can often be more important than how often they win. In the case of short volatility, while they win most of the time, when they lose they lose big – with an average loss size that is close to double that of a discretionary trading category, for example.

While risk in Virtu may exhibit strong downside volatility during crisis, much in the same way market crashes bankrupt many individual market makers in the golden days of the trading floor, comparing Virtu’s strategy to a short volatility strategy is inaccurate.

Perhaps the most applicable managed futures strategy to benchmark might be the relative value / spread arbitrage category. The spread-arb strategy has a high win percentage, near 60 percent, and it also has the best win size / loss size differential. The strategy works by buying one product and then selling a related product. The directional strategy works when a market environment of price relationship dislocation occurs.

While the fit isn’t perfect, nonetheless the most relevant managed futures strategy for which to compare Virtu is its direction-less, market neutral approach taken by certain spread-arb CTAs. The primary difference being Virtu doesn’t hold positions for directional profit. What they do, much like a short term trend follower, is take a position and then immediately lay off risk in a hedge. For instance, they may buy oil and then immediately hedge that position in another market and perhaps even using a derivatives product with different product specifications. In the olden days one could simply describe this as a “market making” strategy, but in the new school world of high frequency trading, separating two-sided liquidity providers from directional trend followers has oddly become more difficult.

99.999 percent daily win percentage overshadows 49 percent intra-day win percentage, highlighting the importance of win size

When comparing Virtu to known managed futures strategies, the 99.999 win percentage sticks out like a sore thumb – until you read the next punch line in the most recent S-1. That is when the firm reveals that its win percentage on an intra-day basis is 49 percent.

This puts the pieces of the puzzle together. The 99.999 percent win percentage needs to be considered in light of the 49 percent intra-day win percentage. This highlights the fact that Virtu, by logical default, is benefiting from size of win. Just like a trend follower, it isn’t always win percentage that matters most but size of win and controlling loss. This is likely the secret sauce inside Virtu’s success.

This article originally appeared on Virtual Walk and was authored by Mark Melin.

The percentage of successful forex traders is relatively small, yet they share certain similarities: A well-built trading system, plus the right combination of personality traits and learned behaviors.

Of course, the tools are important – Regardless of a trader’s personal characteristics, a successful trader always builds, uses or finds a good Expert Advisor (EA). Most people believe that if they just find the one magic bullet, then everything will be fall into place. As Shaun discusses in the forex robot secrets report, that’s almost never the case.

Characteristics of successful traders

Traders and EA developers who succeed are usually found at one of the two extremes of intelligence: Either they’re highly intelligent, or they’re extremely dim witted. There doesn’t seem to be much middle ground in which “average” developers succeed.

On the one hand, it seems easily explainable that sharp developers should be more successful than “average” ones. Yet, those at the other intellectual extreme are often also more successful than the typical developer.

Why?

One theory to explain the trading success stories of traders and EA developers who are outside-the-ordinary is illustrated by this anecdotal experiment: If a mouse is placed into a cage where cheese is found on a particular side of the cage 60% of the time, and 40% of the time on the opposite side, every mouse will eventually learn to choose the side of the cage where cheese is found 60% of the time.

In other words, mice are at least intelligent enough to stop guessing and simply choose the pathway which is more often successful. In contrast, humans generally try to improve their success by finding and improving on some sort of pattern in randomness, even when it’s not there.

This theory may explain why less-intelligent traders can be successful by sticking to a system based on simple rules that win more often than they lose. Of course, “home-run” systems that are over-optimized in an attempt to “win everything every time” usually fail.

From the perspective of the mice described in the above experiment, it’s not about getting all the cheese every time, it’s about getting enough cheese more often than not.

A trading success story is based on more than just brain power

An automated trading success story may begin with brainpower, but it doesn’t end there. Brainiacs tend to build trading systems based on deep technical analysis. Theories are developed and modified as testing reveals strengths and weaknesses in a given system.

If a mouse is placed into a cage where cheese is found on a particular side of the cage 60% of the time, and 40% of the time on the opposite side, every mouse will eventually learn to choose the side of the cage where cheese is found 60% of the time.

But, there are plenty of intelligent, well-educated traders, and many of them don’t thrive when they’re involved in day-to-day trading. Significantly, winning traders’ ideas tend to become simpler over time instead of more complex.

An EA can be too powerful

Being too smart is a handicap that can keep traders from winning, and the power of EAs can also work against them. EA-focused traders tend to drift off course instead of remaining focused on the simple pathway toward trading success.

Without consistency, it’s difficult make any progress, nor measure results effectively. Too many indicators and too many pathways to explore may tempt EA traders to go astray, and wander away from the simple, basic rules that win.

Trading is a process, not a destination

When the trader approaches system design as a process rather than as a fixed destination, the outlook becomes much better. Success is relative, and improvement is ultimately more important than perfection.

For example, when a trader focuses on a system’s accuracy, the trade-off usually comes in the form of accepting a less-profitable exit point from a given trade. So, a trader’s urge to win a slightly-higher percentage of trades often erodes the system’s performance.

In contrast, process-oriented system designs let traders assess how making slight changes in the trade-entry protocol affect the system’s efficiency. And, using expert money-management methods can help by reducing the emphasis on entry and exit protocols.

Emotion in trading can’t be denied, yet it can be channeled appropriately

Emotion is impossible to separate from trading. But, it shouldn’t be the reason for trying to develop a winning Expert Advisor.

Instead, rational reasons for building an EA include situations in which a trader has been trading a given system long-term and wants to automate a proven winner, or finding ways to automate one’s trading based on narrowly-targeted indicators that win more often than not, even without generating perfect signals.

The question isn’t how to to remove emotion – Instead, the question is how to channel it appropriately, especially when the trader or EA developer has made a huge investment in time spent developing a system.

The goal is to develop and implement a consistent system – not a perfect system. When traders swing back and forth between winning and losing, the lack of consistency makes them feel less confident in their systems.

When a trader is “married” to a supposedly perfect system, there isn’t likely to be any trading success story in his or her future.

Work with professional EA developers

Designing a winning trading system takes hundreds of hours of time, plus at least a decade of experience. As mentioned earlier, system development is a process instead of an endpoint. Still, there’s a way to expedite the process – work with a professional developer like OneStepRemoved.

Where are you in your trading journey? Share your ideas below for you how “find more cheese” in the markets.

How to be 99.999% accurate when your system is only 49% accurate