Trading Black Swans in Forex
Your system is not catching the black swans. It is just a plain old vanilla trend-catcher by first letting yourself bleed to death by the whipsaws while waiting for a big trend to come, hopefully and eventually.
Chinese torturers has a name for it. Death By A Thousand Cuts. You definitely need a very very deep pocket and finally a therapist to get you out of depression. Nick leeson of Baring bank in Singapore eventually broke the bank by following this system. He lost only a couple of billion quids trading Nikkei and ended up 5 years in jail.
The dead sure way to make a million bucks out of the market by this system is to start with a couple of millions.
The entire premise of a black swan event is that they are the infrequent >6-sigma events...why would anyone wait out the 5-7 years it takes for a single black swan event to occur just to monopolize on that once in a decade rare opportunity?
You want to build in safeguards (circuit breakers, just as the establishment uses) to minimize the damage black swans can cause, but to create a strategy that attempts to truly wait out the markets in hopes of catching the next one in the coming decade just seems like a fool's errand to me.
And Eurotrader is right, this system appears no different than a trend-trader that tries to catch the big moves while bleeding during the periods of sideways trading. You don't need to call them black swans.
Posting here like this it's gonna get allot of negative comments. [...]
Yup. It's common-or-garden trend following with a layer of Nassim Taleb icing to make it look more appetising and interesting. It's like the systems which throw around the terms "neural networks" and "artificial intelligence" just because they sound good and clever.
Let's pick on one of the more obscure statements: "Mr Taleb became famous after the 2007 financial crash". In fact, Taleb was more than moderately well-known long before 2007. For example, Malcolm Gladwell wrote at length about him in 2002: http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm (albeit Gladwell himself wasn't remotely as famous and followed then as he is now).
Is trend following technique History? One of my favorite stories is the one where the two Traders bet each other about whether or not someone could be taught to become a successful trader. The guy who won the bet was able to teach regular people how to follow trend following techniques and they became some well know traders.
Now-a-Days seems everyone is more concerned about Pricing Models for everything. I guess trading really is a Self-Fulfilling Prophecy...(IMHO). Hehe... this should get some people going :)
One of my favorite stories is the one where the two Traders bet each other about whether or not someone could be taught to become a successful trader.
Trend following is real and people make lots of money invoking trend following strategies. The reason why people still opt to pursue alternative trade strategies has to do with maximizing their rate of return (ROR) and/or minimizing their risk of loss (ROL).
Consider that if all any of us were interested in was simply making more money from our current equity then we'd just buy a government backed bank CD and sit back to drink margarita's all day.
What compels us to this industry is the desire to make even more money from our current equity.
Ideally all of us are busy at work devising cleverer and cleverer trading schemes to maximize our Risk Adjusted Return on Capital (RAROC).
Trying to catch the falling knife...i.e. constantly shorting an otherwise bullish trending market in the hopes of catching a once-in-a-decade fundamental market reversal (typically progenitored by the black swan event) does not strike me as a superior RAROC approach.
Thanks JJC,
I read New yorker regularly, but I missed that BLOWINGUP article. Thanks again.
Ideally all of us are busy at work devising cleverer and cleverer trading schemes to maximize our Risk Adjusted Return on Capital (RAROC).
Sticking somewhat to the original topic, Taleb has some interesting criticisms of VaR, which is a component of RAROC. (However, you have to get beyond the fact that he's got a twitchy finger on the rhetorical trigger. "I have always held that VAR is charlatanism" is a sample quote from his website at http://www.fooledbyrandomness.com/quant.html)
1005phillip:
constantly shorting an otherwise bullish trending market in the hopes of catching a once-in-a-decade fundamental market reversal (typically progenitored by the black swan event) does not strike me as a superior RAROC approach.
It certainly doesn't appear to make much sense if you try to do it with spot forex. You want something much more asymmetric - such as the baskets of options which Gladwell describes Taleb as trading.
Omg.. from Black Swans to Black Scholes (just when I was thinking about it). You'd think you're training to become a Kong-fu master. I'm betting you advanced guys know the formula off the top of you heads. What's the big deal with this Soros guy anyway? You'd think he invented trading. Break England's bank, big deal. Guy just got lucky he didn't go broke in the process. Yep, I said it. (Oh-boy they gonna kick me off the site for sure now.)
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What is a Black Swan :
A Black Swan is an unpredictable event that carries massive consequences.
In the market a Black Swan is a long term trend that can either bring you big profits (if you go with it) or put you out of trading (if you go against it).
I was first introduced to this concept when I came across a bestseller book called "The Black Swan: The Impact of the Highly Improbable" by a certain author called Nassim Nicholas Taleb.
Mr Taleb became famous after the 2007 financial crash (which was a Black Swan itself) and his book made it to the top of the bestsellers' list (the success of his book is a Black Swan also).
After reading a part of the book I started thinking about a practical way to benefit from Black Swans and reduce their disastrous effects in a trading environment. I came finally to make this system that can put the investors using it in the way of Black Swans to benefit from them when they happen.
What this system does
What it does basically is making small losses and small profits until it catches a long trend.
There are two certainties about this system :
- It makes losses
- It catches big trends
About losses : the risk percentage is set at 1%, in addition the system uses a Stop Loss limit to keep losses small and under control.
About big trends : the system does not use a Take Profit limit in order to stay open to large profits, when a big trend is caught you want to follow it until it's over.
What you can expect from this system is sustainable growth on the long term, I wouldn't be fooled by results of less than 7 years.
Read the next part what the system does not is more important than what it actually does.
What this system does not
This is the most important section about this trading system.
I will tell you a few things NOT TO EXPECT from this system :
This system will NOT make you rich in short notice, I don't exclude the possibility of doubling your investments in one year but it is very unlikely to happen.
This system will not fool you with short term results that will eventually blow up in massive losses.
It is very unlikely for this system to blow away all of your investments and gains : I mean if the risk percentage is set at 1%, this means you will lose everything only after 100 consecutive losses, while in backtesting the EURUSD (from 1999.10.01 to 2010.06.17) the system made only 29 trades of which 17 were profitable (58.62%).
This system does not use any sort of mathematical models or dogmas built over statistics.
How to predict a Black Swan
The first property of a Black Swan is that it is unpredictable.
The EA presented here does not try to predict Black Swans (since they are unpredictable), but to be ready for them when they happen.
"Bleed or Blowup"
In the book of Mr Nicolas Taleb I read a catchy title : "Bleed or Blowup".
For him there are two ways of loosing money (and I don't know a third way for that matter) :
Blowup : you can make small gains over time by taking big risks, and when a Black Swan happens you loose a lot, may be all of your initial investments. For you the Black Swan is over when your investments are totally consumed.
Bleed : you will be taking small losses over time and when a Black Swan occurs you benefit from it, as opposing to the Blowup part there are no limits to how much profits a Black Swan can make for you.
Blowup :
I am in the automatic trading for a few years now, I have came across many many EAs that would give you astonishing results (backtesting or live trading), but after a while they make BIG losses.
Let's take a look at one of those systems (Risk Percentage 57%) :
this is one year of backtesting,looks good huh ?
another year and it looks even better, some people might jump on this system that looks like a miracle !
few months later : Oops ! Just before doubling the initial investments the system blew up. The bottom line is : similar systems eventually blowup.
What you just saw is similar to what happened to many investment funds over history, entire banks went bankrupt for taking large risks and believing too much in statistics and mathematical models. This is the type of strategies that - on the long term - make investors wish they have just spent their money another way.
Now let's take a look at another approach to loosing and winning money.
Bleed :
This approach is about taking small risks and waiting for Black Swans to make big profits out of them.
System used : Black Swan FX Trader (Risk Percentage 5%)
Take a these two charts of BSFT :
EURUSD chart : Ten years backtesting
GBPUSD chart: Over Ten years backtesting
A matter of choice
I think the choice of a strategy of loosing is the most important aspect of trading, because after all you want to win, but also you want to keep your investments.
It is about the choice between one of two trading strategies :
- Taking small risks with no upper limit of profits, looking for long term results
- Taking considerable risks with an illusion of success that would fade into big losses.
You can visit my bog at http://black-swan-fx-trader.blogspot.com/ .
I attached statements of backtesting so that you can look at the Black Swans the system caught.
Best of wishes