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.Proof of this concept is available by the mere consideration of a shortlist of some of the household names of the greatest discretionary traders.This short list of the greatest would include the likes of legendary billion-aires such as Warren Buffett (I know he is not a trader per se, but he is thesecond richest man in the world and he got there solely through investing),George Soros, Paul Tudor Jones, Bruce Kovner, and T.Boone Pickens.The list of the who s who of trading and their multibillionaire statusshould be sufficient proof positive that discretionary trading and investingcan and does work.RAISING THE BARJust because there has not been a systematic trader of record the equalof these great traders, however, does not mean that it is not yet to come.c02 JWPR070-Pardo December 14, 2007 13:18 Char Count=20 THE EVALUATION AND OPTIMIZATION OF TRADING STRATEGIESAs I detailed in the preface to this book, systematic trading has not keptpace with the technological advances that have occurred to date.A greaterindictment and there is a causal relationship here to a certain extent isthat commercially available trading strategy development software haswoefully lagged behind on all fronts.The most significant difference between the performance of the highlyskilled discretionary trader and that of the systematic trading strategy ismerely one of degree and not one of kind.The discretionary trader has a vast knowledge base of different tradingmethods and strategies.This knowledge base also holds a store of knowl-edge about, for example, the strengths and weaknesses of these differentstrategies as well as their interactions with one another and under differentmarket conditions.Such traders also have the benefit of finely honed re-flexes and observational skills that can, sometimes nearly instantaneously,detect a complex pattern in one flash of insight that tells him that the mar-ket just made a top.If he is heavily long, he then gets out of all positions asquickly as possible.Of course, this is highly simplified, but the significant point is that thesuccessful and experienced discretionary trader brings a vast knowledgeof different methods of analysis, trading strategies, market knowledge, andpattern recognition to what he does.All this knowledge is then sifted, fil-tered, and parsed by the human brain through a process of synthesis andexperience to arrive at a proper and timely buy-or-sell decision.In contrast, consider a relatively simple but widely used systematictrading strategy made famous by Richard Dennis and the group of tradingstudents, the famous Turtles, whom he trained in its use.Let us consider ahighly simplified version of this strategy.The Turtle Trading Strategy (TTS)is a range breakout method originally derived from a strategy developed byRichard Donchian, an early pioneer of systematic trading.TTS goes long when an x-day high has been penetrated and goes shortwhen an x-day low has been broken.It exits positions on opposite signalsfrom a shorter y-day high or low.There are other variations, but in theend, it really doesn t add that much complexity, so these wrinkles will beignored for the sake of this illustration.This information is all that the TTS trading strategy knows. Go longat new x-day highs and go short at new x-day lows.Exit long and shortpositions on opposite signals at y-day highs or lows.In its original form,it factored in no other knowledge or information.Anyone with any imagi-nation can certainly think of a long list of other indications that might beadded to this strategy for its enhancement.The point to be noted here,however, is not the relative simplicity of the strategy, although that too issignificant, but rather the absence of any other information factored intothis decision to go long or short.c02 JWPR070-Pardo December 14, 2007 13:18 Char Count=The Systematic Trading Edge 21This is why I say that the difference, at least at this point in the game,between the skilled discretionary trader and a systematic strategy is oneof degree.There is no reason to believe that a systematic trading strategycannot be made that rivals the knowledge base of the discretionary trader.Just because it has not been done yet, at least to my knowledge, does notmean that it cannot or will not be done.When computer scientists first began the development of computerprograms to play chess, it was said that a computer would never beat achess master.That barrier was broken in 1997 when IBM s Deep Blue beatGarry Kasparov.Evidence is mounting that the front-runners in systematic trading arefinding ways to develop, test, and trade increasingly sophisticated andhighly profitable systematic trading strategies.Recall from the preface thespectacular performance of the trading world s rocket scientists who aremaking fortunes trading like D.E.Shaw & Company, Renaissance Tech-nologies, and the Prediction Company.I personally believe that we, as thesaying goes, ain t seen nothin yet.In support of this seemingly bold statement, consider the implicationsof the concept of Perfect Profit.I created this concept for use as an im-portant measure of performance for our implementation of Walk-ForwardAnalysis.I presented this in the first edition of this book on page 125 undera discussion of Model Efficiency.An expanded version of this discussioncan be found in Chapter 12 of this book: The Evaluation of Performance.The definition of perfect profit found in Chapter 12 is Perfect Profitis the sum total of all of the potential profit that could be realized by buyingevery bottom and selling every top.Of course, this is an idealized and unobtainable goal.Consider, how-ever, the potential (Perfect Profit) profit obtainable for five markets in fiveyears on daily bars.Table 2.1 lists these values for five markets.TABLE 2.1 Perfect Profit for Five Markets for Five Years of Daily DataPerfect Profit Daily DataJanuary 2002 toDecember 2006 Average YearCrude Oil $887,440 $177,488Eurodollars $56,887 $11,377Yen $601,000 $120,200Soybeans $783,450 $156,690S&P $2,368,000 $473,600Total $4,696,777 $939,355c02 JWPR070-Pardo December 14, 2007 13:18 Char Count=22 THE EVALUATION AND OPTIMIZATION OF TRADING STRATEGIESConsider that a sustained annualized rate of return of 25 percent ormore places a hedge fund or a commodity trading adviser (CTA) in theupper stratosphere of performance.According to the Barclay TradingGroup, as of June 2007, only 16 CTAs (out of a universe of 375) produceda five-year annualized compound rate of return of 25 percent or better.Now consider that the potential profit for one average year ($473,600 =$2,368,000/5) in the S&P futures market measured trading, one contract ina $100,000 account in the daily degree is 474 percent.The total for oneaverage year of Perfect Profit for the five markets in our table is $939,355.That is a return on our account of 939 percent!Now let us consider that there are more than 11,000 listed stocks, 7,000listed mutual funds, and over 200 different futures markets, and the poten-tial becomes absolutely staggering
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