Drawdown is a Reality of Every Trader

Being able to deal with and understand drawdowns are among the most important concepts in trading and in the life of a futures trader. Misinterpreting drawdowns lead to wrong assumptions and decisions that not only may result in larger drawdowns, but can even mean the “end” of a trading account.

Conventional drawdown parameters and risk metrics such as the Sharpe and Sortino ratio may add value when it comes to understanding one’s own performance. However, we think that on their own, they are not sufficient to understand drawdowns and you may require the understanding of additional concepts to fully appreciate the positive and the negative of your own style, and/or the analysis of an automated system or a managed account run by a commodity trading adviser.

A good starting point is the so-called ‘peak to valley’ drawdown metrics where a trader analyses the largest drawdown periods that the account spends below a high watermark. However, instead of just focusing on the largest absolute drawdown, it is recommended to also check for annual, semi-annual and quarterly ‘peak to valley’ drawdowns so that you get a feeling as to what to expect during shorter and longer time periods. The purpose here is to know your performance, so that the next time you enter a drawdown period, you are better prepared and you know roughly what to expect and what is “normal” when it comes to your own method.

Next, you should look at the drawdown duration and how long your typical drawdown lasts on average. The time component is an important metric because financial markets go through the same cycles over and over again and, thus, trading systems will naturally have better and more challenging periods.

Charts courtesy of iSystems

In the context of drawdown-duration, it can useful to knowing under which market conditions your trading method performs best. Thus, a trader who knows the current market environment can better understand his drawdowns; all trading systems undergo those cycles and you just have to push through the more challenging times to make it to the next market cycle that may favors you system and method.

At the same time, a trader who understands how long his average drawdowns last from a time perspective, can easily see when markets shift back into his favor and then also adjust his risk management accordingly – we will cover that later.

Finally, a trader who knows his average drawdown duration in trade numbers can adjust his position sizing in a way that allows him to minimize performance drawdowns. Here, it is especially important to know the average and the maximum number of consecutive losing trades your system produces.

Whereas most trading literature suggests keeping risk constant during drawdowns (sometimes you will even see recommendations to increase the size) because it will, theoretically, allow you to get out of the drawdown faster, this is almost never what a trader should be doing.

Manage your drawdowns like a Professional Trader

The main problem a trader faces during a drawdown is almost never the loss of monetary capital, but the loss of emotional capital. A drawdown can weigh heavily on the psychology of a trader and when frustration, lack motivation and helplessness set in, traders often abandon their trading rules and become undisciplined which then leads, of course, to even worse drawdowns.

A trader who experiences emotional problems during a drawdown also has little use for the previously discussed statistical based drawdown metrics since his greatest challenge is usually to pick himself up. Knowing that a drawdown will end is good but once a trader hast lost his emotional capital, rational thinking is hard to follow.

In summery:

Drawdown is simply the pain period you must endure while your systems does not have positive expectancy.  You measure drawdowns between your highest performance peak and the lowest equity. However, if you recover from the drawdown, and reach new equity highs, you can measure your previous equity high to your new equity high.  s mentioned above, this will give you a perspective how long it took market conditions to change to match your trading method.

Time is also a measure of drawdown.  Traders and investor could periodically be in more pain over the length of drawdown than the actual financial loss occurring.

10 tips to potentially help you survive the next drawdown.

In order for you to survive and make it out of a drawdown, here are our top 10 tips:

• Start collecting your drawdown statistics and keep accurate records
• “Peak to valley” and drawdown-duration are more important than conventional Sortino and Sharpe ratios
• Get your drawdown statistics for annual, semi-annual, quarterly and monthly periods to get a feeling for what is ‘normal’ and expected
• Start tracking the market conditions and understand during which market conditions you perform better and when drawdowns are likely to occur
• Always make sure that drawdowns are caused by actual market impacts and that they are not caused by you and bad trading behavior
• Review your trades every week to understand your trading performance and behavior
• Reduce your risk during a drawdown and focus on capital protection as your main priority
• Don’t try to force a quick end to your drawdown. Only focus on maintaining a healthy mindset
• Once you realize that a loss in emotional capital, take a few days off and regain focus.

There is a substantial risk of loss in futures trading. Past performance is not indicative of future results. 

Automating trading systems is a very popular approach because people generally believe that it can help them make decisions free of emotions and be more consistent in their trading. Although the intention behind automating trading systems are usually good, the execution is often not. In this article, we will show you why you should consider optimizing certain aspects of your trading and which parts should stay manual.

The idea behind automating a trading system

FOMO (the fear of missing out) is a very strong driver of emotionally driven trading decisions. Just think about how often you have seen a potential setup but it wasn’t giving you all the confirmation, but you still jumped. Such scenarios can be very tempting and FOMO makes you enter such trades too early and then often lose – you have your trading rules for a reason.

Inconsistent trading leads to inconsistent results and a trading strategy that is too discretionary will often lead to a lot of impulsive trading decisions. Just look at screenshots of your last 10 or 20 trades; if they look very differently from each other, you are probably not being disciplined enough. Automated trading can potentially help you make more consistent decisions and maybe get rid of some of the account volatility.

Challenges of automating trading

Unfortunately, automating a trading system won’t suddenly turn a losing into a profitable trader overnight and there are a few things a trader needs to be aware of when automating his system. Financial markets are very dynamic and momentum, volatility, risk environment and correlations constantly change. We have probably all seen those automated systems that perform very well some of the time and then lose all profits in just a few trades. Automated strategies don’t adapt to changing market environments, hence the name automated, and some discretionary is required to manage the downside.

We will now show you which parts of a trading method can be automated, which can’t and what to be aware of when doing it.

Elements that can be automated

1. Entries

Entries are ideal for automation, and they are often the primary source of errors for many traders. We highly encourage traders to write out a checklist with all entry criteria of their trading strategy. A checklist is an efficient tool to help you stay disciplined and to eliminate many trading mistakes.

Ideally, you’d write down all your criteria, place the checklist next to you during your trading and then go through the checklist every time you want to enter a trade. It will immediately tell you if you should take a trade or not.

Automating entries can often make a huge difference already.

2. Position size

An inconsistent position sizing approach can lead to increased account volatility and additional risk. You should create rules for how much of your account balance you are willing to risk on your trades. To take this a step further, you can create a dynamic position sizing approach where you grade your trades by quality and then come up with a tiered risk approach where you risk more on the best trades and reduce your risk on other trades.

Aspects that should be semi-automatic

1. Stop loss setting

A stop loss should always be set at reasonable price levels that make sense in the market context. A common problem when automating a system is that traders don’t adjust their stop for volatility or market context and always use the same stop size.

You can automate your stop based on general rules, but then add a flexible component such as the ATR or other volatility based factors.

Disclaimer: The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.

2. Take profit placement

The same holds true for take profit placement. Targets can be automated as well, but need to be adjusted based on market context. When volatility is low, you should not aim for an overly optimistic target because price won’t probably reach it as easy. Also, be aware of natural support and resistance levels when setting targets.

Full discretionary is advised

The following three points describe the greatest problems of fully-automated trading strategies.

1.Market selection and building a watchlist

So even though you can automate entries, you should pre-select the markets and instruments you trade first. If you are a trend following trader, eliminate ranging and low momentum markets from your watchlist. If you trade reversals, you don’t need to keep high momentum markets on your watchlist as well.

2. Trade management

Trade management mainly refers to stop trailing. Often, automated trading strategies come with an automated approach to trailing stops as well. However, trailing stops automatically has to be avoided because it can’t factor in some of the most important trading principles. Price moves in waves and volatility and momentum constantly change. Whereas a tight stop trailing approach can be right some of the time, when price tends to swing more, you need to give your trade more room to breathe.

3. Exit taking

Price won’t always go straight to your take profit order, and you’ll often be able to spot early warning signals that could indicate that price is about the change direction. Discretionary profit taking and exiting your trades manually can often help you secure gains in a more efficient way.

However, if you notice that you tend to make impulsive and emotionally driven exit taking decisions, you should think about adding some rules to your profit taking approach and move this point to the semi-automatic components of your trading system.

There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.

Losing streaks happen to every futures trader. However, Variance drives trading performance and influences the way traders think and act. Variance means account volatility, and it describes how the outcome of your trades impact your account development.

In trading, results can’t be forecasted, and you will never know when you enter a winning or losing streak, or how long it will last once you are in it. Therefore, understanding variance and how wrong assumptions can lead to significant underperformance is of great importance to traders.

Gambler’s fallacy

The gambler’s fallacy describes a phenomenon when people misjudge the likelihood of events. If something happened more frequently than you’d expect it to happen under normal circumstances, people then mistakenly believe it’s going to happen less often in the near future.

For example, if you play roulette and red come up four times in a row, you probably believe that seeing black has a higher chance on the next spin since it is “overdue.” Or, if you flip a coin and it comes up heads three times in a row, is it more likely to see tails on the next flip? Of course not.

It is important to understand that each event is independent of the outcome of the previous one; the previous roulette spin does not influence the next one, and the last coin flip does not change the 50-50 chance for the next flip. Each event is unique and has to be seen as such.

Now let’s see what this means for traders.

Losing streaks – how traders enter the downward losing spiral

There are two problems when traders enter losing streaks:

Being too fearful and not fully capitalizing on the next trading opportunity
Being overly aggressive and expecting the streak to end

Both problems have their root in a wrong understanding of variance and independence. A trader who assumes that after five losses in a row, a winning trade is “overdue” will be too optimistic and thus risk too much on his next trade. On the other hand, a trader who believes that his losing streak will continue will miss profitable trading opportunities and worsen his drawdown.

In trading, consistency is key. Although it’s often easier said than done, you have to keep executing trades as you see them. The trader who misses a profitable trade in the middle of a losing streak will end up being even more frustrated and then enter prematurely on the next signal. This leads to the emotional downward spiral many traders are so familiar with.

Winning streaks – how long will they go on?

Winning streaks feel great, but making wrong assumptions about winning streaks can easily throw you back, and you end up giving back all profits. The main problem traders usually face during winning streaks is overconfidence. Once you start believing that you “can feel” or have a “gut feel” for the next market move, your discipline level drops and a trading disaster is inevitable. The next loss will come sooner or later – typically sooner for the overconfident trader.

Again, consistency is what will keep you from making mistakes. You should create a set of rules for your risk management and be clear how much you risk per individual trade. Along with your regular checklist, you can avoid a lot of impulsive mistakes and unforced errors.

 Making better trading decisions

Deeply understanding how variance, independence, and the gambler’s fallacy works are the key to a stable account development. Missing out profitable trades during losing streaks often leads to worsening circumstances and an extended losing streak. Each trade is unique, and the previous outcome should never influence your future decisions.

Rules are the easiest way to avoid account volatility and impulsive trading decisions. Working with a checklist can eliminate a lot of subjectivity from your trading. A checklist can help traders develop confidence during losing streaks and avoid sloppy trading during winning streaks. Along with fixed position sizing and rigid money management rules, traders can potentially avoid many of the common problems that lead to costly mistakes.

There is a risk of loss in futures trading. Past performance is not indicative of future results. 

The Fibonacci tool is a very commonly used tool among traders, but one of the greatest functions of the Fibonacci tool is often neglected. Whereas most traders use the Fibonacci retracements to determine entries – which can be tricky because it is always unclear which Fibonacci level price will adhere to – the Fibonacci extensions are much less subjective. With the help of the Fibonacci extensions, identifying potential profit targets becomes very simple and it takes out a lot of guesswork.

What are Fibonacci extensions?

Whereas most traders only know about the regular Fibonacci retracement levels (0.382, 0.618 and 0.764), the Fibonacci extensions are levels that extend beyond current price. When it comes to Fibonacci extensions, there are mainly two levels traders need to be aware of: 1.382 and 1.618.

Once you have identified a trend-leg with a retracement (an A-B-C move), you can use the Fibonacci tool and the extensions project the 1.382 and the 1.618 levels onto your charts. Those two levels are then potential D price target levels.

All graphs are used for illustration only and not meant to imply any profit or loss. 

The difference between 1.382 and 1.618

So which of the two price levels do you choose as potential take profit orders for your trades? There are three things a trader has to take into consideration when picking take profit orders:

First, the strength of the ongoing trend can help you make a decision between the two levels; in a market environment with less trend-strength, the 1.382 level often makes for safer take profits target as wide trend swings cannot be expected.

Second, your risk appetite determines the choice of your take profit level. A more conservative trader might choose 1.382 more often than a more aggressive trader who chooses the 1.618 level. Another option would be to use two different take profit orders and scale out over the two Fibonacci levels.

And finally, the depth of the Fibonacci retracement can provide information about the likelihood of price reaching the Fibonacci retracements. A very deep retracement often means that the trend lacks strength and momentum, and choosing the closer 1.382 can be the safer option. A C-retracement which is short and price reverses back into its original direction fast can mean that the trend is strong and the 1.618 is likely to happen.

How to use Fibonacci to time your trades 

Traders often make the mistake of jumping the gun and immediately enter a trade after they can spot an A-B-C sequence. The problem with that is that at such a point, it is unclear if price will even break the C-point and make another run.

The safer option is usually to wait for a confirmed break of the B-point. However, in an established trend, more aggressive traders often choose to enter as soon as they can spot the A-B-C pattern which then provides a much larger (potential) reward to risk ratio. On the other hand, such premature entries usually lead to more false signals as well.

Another way to go about this is to look for Fibonacci sequences on the higher time-frames and then follow your regular trading system on the lower time-frames; the Fibonacci extensions then only serve as potential take profit areas and are not used as trade entry signals.

All graphs are used for illustration only and not meant to imply any profit or loss.

Conclusion: The Fibonacci tool helps you find better take profit targets

As we have shown you, there are many different ways how the Fibonacci extensions can help you find better ways to identify take profit areas. Especially if you are currently unsure about how to pick reasonable take-profit levels and are more or less just randomly choosing your trade exits, the Fibonacci extensions can help you eliminate the subjectivity in your trading approach.  The following point sum up what we have discovered in this article:

• Wait for an A-B-C move to apply the Fibonacci extensions
• Wait for a confirmed break of B
• Entering before B has been broken can provide a better reward to risk ratio, but also leads to more false signals
• The 1.382 is the more conservative target and the 1.618 should be chosen in a strong trending environment
• The depth of the C-retracement can provide information about trend strength
• Fibonacci extensions on higher time-frames can be used as profit targets on lower time-frames

There is a risk of loss in futures and forex trading. Past performance is not indicative of future results. 

Programming with a professional programming language

Several trading platforms use an existing, well-established programming language that’s designed for professional programmers. Examples of these platforms are MultiCharts .NET [https://optimusfutures.com/Platforms/MultiChartsNET.php] (which allows coding in either C# or Visual Basic) and Sierra Chart [https://optimusfutures.com/Platforms/SierraChart.php] that adopted C++.

Advantages of a professional programming language

Professional programming languages have a few advantages. First, they have so much features and capabilities that they allow for programming practically anything. With C#, for instance, we can create professional websites, complete Windows applications, and even Windows and XBox games. What this means for trading is that we’re not limited by the features of the trading platform, and we could use a professional programming language to store trades in an external database, create custom pop-up messages, send customised emails, save charts as an image and upload them, and much more.

Another advantage is that these programming languages can be written in a professional code editor, like Microsoft Visual Studio (which also has a free edition, Community, for individual developers and small professional teams). These editors offer a lot of advanced features that make programming and debugging scripts much easier and efficient.

Professional programming languages also offer object-oriented programming techniques. With this feature complex ideas become easier to program since it allows code to model the problem we’re trying to solve. This not only makes complex code easier to understand (since it mimics real-world behaviour), it’s also easier to write and manage. That, in turn, reduces errors and programming time when coding very complex trading strategies.

Disadvantage of a professional programming language

The most important disadvantage of professional programming languages is their steep learning curve. Not only are these complex languages, there’s also a lot to learn even if you only want to do basic things. And while anyone can learn a professional programming language, it does require a significant time investment. Furthermore, because these programming languages have their own terminology for abstract operations, the available help online can be hard to comprehend.

Programming in a scripting language

Other trading platforms, like MultiCharts [https://optimusfutures.com/Platforms/MultiCharts.php] and TradeStation [https://optimusfutures.com/TradeStation.php], created their own proprietary programming language that’s developed with the needs of traders in mind. These languages are often not that advanced (and therefore more aptly called scripting languages) but offer some important benefits.

Benefits of a scripting language

The most important benefit of scripting languages is that they are (relatively) easy: they need less code to perform certain actions and the code that’s needed is also less complex. This not only reduces the time needed to learn a scripting language, it also makes implementing ideas in them that much quicker.

And because it doesn’t take that much time to learn a scripting language, it’s also easier to switch trading platforms: if you already have some programming experience from a trading platform, you can know how to program in another platform within a week.

Drawbacks of a scripting language

An important disadvantage of scripting languages is that their capabilities are limited. Several things that are standard in a professional programming language are missing from scripting languages. While scripting languages often can use DLLs (a small file that contains code written in a professional programming language), that does require know how to write DLLs in languages like C# and C++.

Another drawback of scripting languages is that you’re limited to the code editor that comes with the trading platform, which typically doesn’t have much features that makes programming more productive (think WordPad versus Microsoft Word) or lacks debugging features.

Which programming language should you choose?

While choosing a programming language is also a matter of personal preference, some general pointers for choosing a language are given below.

Choose a professional language like C# when one or several of these statements apply to you:

?      You love programming and would rather spend more time on it.

?      You already have some experience with an object-oriented programming language and prefer not to go back to a more basic language.

?      If you don’t have much programming experience, you’re willing to spend a decent amount of time in the next half year to learn programming.

?      You love to learn complex topics and don’t mind learning programming from a 700-page book.

?      You like to think logical and abstract about the things you’re going to code.

?      You want to go beyond the features that the trading platform holds and want to be able to program your own applications.

?      You plan to code complex quantitative trading strategies.

Here are several reasons why a scripting language might be a good choice for you:

?      You’re new to programming and are more comfortable learning programming with an easy-to-understand programming language.

?      You think programming your own scripts is a necessity but not something that you’d do for fun.

?      You view programming as a minor part of your trading activities, and would rather not spend too much time and energy on learning programming and coding scripts.

?      You only need to occasionally program an indicator or trading strategy or make small changes to an existing script.

?      You don’t like the idea of working with an abstract programming language and just want to code your idea so you can go back to your other activities.

?      You’re yet not sure that you’ll use the trading platform in the long term so you’d rather not spend a lot of time learning its programming language now.

There is a Substantial Risk of Loss in Futures Trading. Past Performance is Not Indicative of Future Results.

At Optimus Futures we offer a range of trading platforms [https://optimusfutures.com/Futures-Trading-Platforms.php] for traders with different needs and goals. If you need help choosing a trading platform, reach out [https://optimusfutures.com/Support.php] and we’ll assist you in getting started.

Matt: Hello Jonathan. Thank you for taking the time to do this interview with Optimus Futures.  You have built one of the fastest ways to execute trades via the futures market, so we wanted to pick your brains on a number of things. What changes have you seen in market data in the last few years?  Is there more data coming out of the exchanges? And if so, why is this happening?

[JJW] Since I began working with real-time market data in 1988, the amount of market data sent by the exchanges during the trading day has been increasing and the rate of the increase itself has been increasing. During the New York market open in the late 1980’s through the early 1990’s, the rate at which market data was published from all US equity and options exchanges generally did not exceed 300 messages per second.  By 2000 the rate had begun to exceed 100,000 messages per second.  By 2010 the rate exceeded 1,000,000 messages per second.    This year we found that the rate for Eurodollars futures alone sometimes effectively exceeded 500,000 messages per second.

There are many factors that underlie the increase in market data. The obvious ones are greater trading activity, availability and greater transparency of order books by the exchanges, more traders, improvements in technology and the ease of access to stable and inexpensive computers and networks and trading screens. However, in my opinion, the most significant factors are the increase in sponsorship by so many businesses of 401K plans and the increase in disposable income realized by home owners starting in the late 1980’s. Again, in my opinion, the excess cash realized by home owners was the direct result of the policy begun in the Bush (senior) administration (I think it was then) of funding the US government with short term debt. This caused interest rates in general to reduce, especially in the shorter term notes. Housing re-fi’s took off and homeowners found themselves with lower payments which meant two things: more taxes were paid to the government (without political wrangling) and more cash was available to the home owners. The home owners in turn often put their excess cash in stocks and in mutual funds – more trading and more market data.

Matt: Do you foresee any additional changes in terms of data in the years to come? Is there a certain technological trend that is associated with market data?   

[JJW] More programmatic trading.  I think that now it is relatively easy to program trading screens to place orders based upon market data.  For example, our trading screen, R | Trader Pro, has made it very easy to configure Microsoft Office Excel to place orders into our system based upon market data obtained from our system.  As more traders use programs to spot trading opportunities I think there will be more orders submitted and therefore more market data published.

Matt: How do you view speed as a factor of profitability?  How can an average trader see the differences in terms of profitability, slippage and overall execution? 

[JJW] For certain trading, given a large margin account, speed is all that matters.  For programmatic (automated) trading, slippage can be reduced by locating the trading program relatively close to the exchange.  For example, a trading program located in London that places orders on the CME may find that its P&L improves by a tick or two just by relocating to Chicago.  The time it takes for market data to get to London and orders to return to Aurora (where the CME’s matching engine is located) can be as much as 65 milliseconds.  The price of a future can move many ticks in 65 milliseconds so running the trading program in Chicago can reduce the 65 millisecond time to less than 1 millisecond.  I would expect slippage to reduce significantly with such a move.

Matt: We noticed that your API is very flexible and adaptable to most 3rd party softwares? How you were able to achieve this?

[JJW] I agree that our api’s (R | API, R | API+ and R | Diamond API) are often thought of as flexible.  I think of them as robust as the api’s they use (not available to the public) are even more flexible.  When we developed R | API, R | API+ and R | Diamond API, we took into account feedback and suggestions and requests from customers and users.  Our api’s are not everything that everybody wants, but they go a long way to providing what most of the programmatic trading community seeks.    

Matt: Let’s discuss the CME data centers. Your trades are routed directly to the new CME center in Aurora while many other data vendors still route to Cermak, claiming most traders will not feel the difference. What is your opinion? 

[JJW] I think that traders that place orders manually are not likely to experience a difference in order execution or P&L if the system from which they get their market data and to which they send their orders is located in Aurora or in Cermak.  But programs that trade automatically will get about a 1 millisecond advantage by being located in Aurora, instead of Cermak, connected directly to the system from which they get their market data and to which they place their orders.  That 1 millisecond can sometimes make a big difference.

Matt: Let’s discuss your API, the R | API+.  What are its main features? What type of feedback have you received from the traders that have used it?

[JJW] As it reads on our website R | API+ is R | API but with access to the premium features of our market data and trading infrastructure.  This means that a program written with R | API+ can place bracket orders, OCO orders, orders with trailing stops and can perform dynamic symbol lookups.  It can also get market data history in the form of time bars, tick bars, volume bars and price range bars.  Some FCMs charge more for use of third party programs that incorporate R | API+ but that has not stopped the increase in use of such programs.  I guess that users find these features to be worth the extra cost, if any.

Matt: We at Optimus Futures were able to hook up Sierra Chart, Multicharts, and other platforms to Rithmic and they all worked flawlessly. Which brings me to my next question. What does a good software need to have in order to connect to Rithmic?

[JJW] I think the ease of use of these programs with our market data and trading infrastructure is a testament to their developers.  With good developers and good software, just about anything can be done.

Matt: Let’s talk about your own trading screens, R| Trader and R | Trader Pro.  There are a number of features that we really like, such as the ability to release trades in a specific time, the ability to open multiple DOMS, and Server Side OCO’s.  Do you conduct ongoing research with your existing users to determine which features to add?

[JJW] We do not have any formal research in place.  Most of the new features in these programs are the result of users coming to us and asking us to put in mechanisms that would help their own trading.  Though we cannot promise that we will incorporate every feature in every request, we do incorporate many and we do encourage users to contact us with their requests.  Of course, users should never disclose to us anything that they feel is proprietary or secret as all changes and enhancements to our software, even if suggested by others, remains our property and may become available to be used by others.

Jonathan, thank you again for taking the time to sit with us. We look forward to continuing our efforts and hope to grow with you and your company.

Optimus Futures, LLC offer Rithmic platforms via three clearing firms.  

CLICK HERE if you would like to Experience Optimus Futures with a Free R Trader Pro Demo Account. Our Demo trading account allows you to paper trade the futures market using the Rithmic data without risking any of your funds. Use our Free 30 Day Trials to test your strategy, familiarize yourself with the R-Trader Plus and experience our customer service.

CLICK HERE if you are an Algo and/or short term frequency trader and would like to hook your machine to the R-Trader API to achieve fast execution, a stable environment and superior automation.

There is a substantial risk of loss in futures trading. Past performance is not indicative of future results. 

Computers are a natural evolution

First, it is important to understand that computers and HFT is a natural evolution of how market participants interact. Back in the days, there were no real-time charts and people had to trade based on the outdated information they got from the newspaper. The people who had access to real-time market information had a huge advantage over the normal traders. Then, with the invention of the telephone, people who had access to a phone were able to get price information and place trades much faster again. Eventually, when a few people had the possibility to use a computer to watch markets in real time and place trades by a mouse-click, everything changed and their advantage over the average trader was huge once more.

Throughout history, trading profitably wasn’t only something for the privileged ones who had access to the newest technology. Even if some traders seemed to have a significant disadvantage, it didn’t mean that there were no profit opportunities and we will show you why.

The complexity of trading

The fact that a computer program beat a human chess player does not translate to the world of trading and financial markets, although it’s a comparison people often draw. First, in chess you only have one opponent and the goal is to beat this one opponent only. Second, chess is a rule-based game with a limited amount of choices and possible events. These characteristics allow computer programs to accurately calculate the best possible move at any given time; and computers are much better equipped to calculate the potential moves 10, 20 or even 30 moves in advance. In chess, your opponent is limited to a few moves and there is nothing he can do to surprise you by doing something unexpected; the complexity of trading does not compare to this.

At any given time, anything could happen in the world of financial markets and the influencing factors are limitless. Governments, central banks, political and geo-political events, individual economies around the world, and, maybe most important of all, the unpredictable human component is what contributes to the complexity of trading and financial markets.

There may be computer programs which are continuously making incredible amounts of money, but, by no means, are they able to accurately predict the future of price moves. It is more likely that they are just more efficient at executing trades, making use of speed advantages and play the odds in a way which humans often can’t because of their emotional nature.

Algo trading is a niche

As we have just said, the main advantage of computer and HFT lies in their ability to avoid emotions and to execute trades within milliseconds based on a set of rules which they will never break. And, without a doubt, if humans were trying to beat HFT by engaging in the same field, there were hopelessly lost. The existence of algorithmic-based trading models might have changed the way short-term price movements manifest on your charts and HFT may even be the reason why short-term trading and scalping is ‘harder’ (better say different), these days.

But, as mentioned earlier, HFT is just the next step in the evolution of trading and trading technology. Thus, traders have to acknowledge that the nature of the financial markets and how they have to interact in the markets has to evolve with it. Stubbornness and ignorance are fatal in trading. If HFT is changing the landscape of trading, it is a trader’s responsibility to change with it. Instead of trying to compete with HFT programs on the tick-based or very low time-frame charts and trying to scalp of a few ticks here and there ,maybe it’s time to move to the higher time-frames where the impacts of HFT is less significant, if you see your competitive trading edge diminishing.

Adaptation and excuses

Ed Seykota has probably said it best:

“The markets are the same now as they were five or ten years ago because they keep changing-just like they did then.”

After all what we have said, it is time to perform an honest self-evaluation; self-awareness is an essential character trait of every successful trader. Should you really blame the existence of HFT and Algo-trading, or is it more likely that your trading approach and mindset are not as professional and serious as they should be? Are you putting in enough work and are you continuously working on your skills as a trader to develop and improve your competitive edge? Looking for excuses for trading failure is the reason why so many traders are struggling on a day to day basis. You can’t change the markets, but it is not necessary either. Work on yourself first; you are your greatest enemy as a trader.

Futures Trading involves a substantial risk of loss. Past performance is not indicative of futures results.

The general belief is that discretionary / self-directed trading, where the trader makes all trading decisions, can outperform algorithmic/automated trading, where the decision making is based on coding a trading concept into a program. Regardless of whether there exists a “super trader” who can overcome today’s ultra-fast computations of quantitative trading systems, charting and price analysis and is able to execute just as rapidly and accurately, here are three elements from automated trading that you  should incorporate into your own trading strategy:

1. Automated trading incorporates position sizing by computing capital and margin to equity ratios quickly and automatically. Discretionary traders may let human emotion determine how many contracts to trade. For example, if the trader is losing money, he or she may trade larger sizes in an attempt to make the money back. This may lead to further losses. On the other hand, if a trader is doing well, he or she may get over confident and trade larger sizes only to give lose any gains as a result of over trading.

2. Automated Trading generally incorporates stop orders into the trading program to manage risk. These stops do not get cancelled or changed until the program determines they should. Some traders neglect to place stop orders in the hope that the market will eventually turn back in their favor. Some traders will move stops, or cancel stops based on these hopes and/or fears. Discretionary traders need to maintain a strong discipline to implement their methodology as part of risk management and make adjustments only in extreme market conditions.

Be advised that stop loss orders may not protect profits or limit losses to the amount intended. Certain market conditions may make it difficult or impossible to execute such orders.

3. Automated trading triggers orders only when the logic or methodology dictates as it analyzes and looks for specific setups and coded parameters.Traders at times reflect on “missed opportunities” and conform to the old adage, “never leave money on the table”. This kind of attitude inevitably leads down the wrong path for traders who must at all times remain objective and rational. There is also a growing group of traders who also take it upon themselves to learn a programming language and develop an automated trading strategy only to override it at the first negative turn of events. This may have been due to their account size not being appropriate for the level of risk they undertook or possibly because their emotions overtook their objectivity. Regardless of the reason, if you decide to take this route and develop your own automated strategy, then you owe it to yourself to allow the methodology to execute orders as intended and not as your emotional make-up tells you to.

The idea here is that traders should not focus on “what might have been” or “what could be” but instead exercise discipline, consistency, objectivity and emotional fortitude when reviewing and reacting to their trading methodology. Developing a solid trading plan takes time, and if you strive to combine the elements outlined above while continuously fine-tuning your strategy by drowning out all the emotional noise and focusing on the trading, you may be one of the few discretionary traders whose methodology can potentially outperform automated trading systems.

Suggestion: If you are unable to develop your own system, consider following an automated trading solution through Striker Automated Futures Trading Services.  You can view real time performance and choose a system based on the markets you wish to follow.

TRADING FUTURES AND OPTIONS INVOLVES SUBSTANTIAL RISK OF LOSS AND IS NOT SUITABLE FOR ALL INVESTORS. THE USE OF STOP LOSS OR CONTINGENT ORDERS MAY NOT PROTECT PROFITS OR LIMIT LOSSES TO THE AMOUNT INTENTED. CERTAIN MARKET CONDITIONS MAY MAKE IT DIFFICULT OR IMPOSSIBLE TO EXECUTE SUCH ORDERS. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

VFM 29641

There is no one size fits all when it comes to trading

Everyone approaches trading education from an angle that he feels is most comfortable for him/her and that also matches his character traits and personality. Some approach it from the traditional, purely technical analysis standpoint, some follow a more statistical and math based approach, and others prefer to create and code automated trading strategies and apply a more quantitative approach.

In our opinion, and from years of experience, those who succeed, are the traders who also understand the nature of financial markets and price behavior beyond just the technical side and who are also able to interpret it in a better manner. Whether there is trading from a huge hedge fund or some sophisticated algorithmic solution, there is a logic and flow in the markets.

The combination of observing charts, measuring and analyzing volume flow and seeing the consequences afterwards will allow you to make your own conclusion as to market behavior. Financial markets are living organisms, moved by human beings, and a trader who understands the connection between volume analysis and the subsequent price movements can often make better assumptions and draw better conclusions about what is happening, and what is likely to happen next.

 Look beyond – trading is not all black and white

Over time, good traders adapt to the markets they are trading and they learn what a likely extension of price is, interpret an overreaction and/or when to just stay away because the market has not yet decided what to do; keep in mind, not trading when you are not sure about the scenario is a valid option and preservation of capital is a key component in trading.

When successful traders say “The market can’t hold”, it could be a pure reaction to the observation of their chart, indicator or the price action of volume. However, once traders can ‘see’ beyond the price manifestation on their charts and understand the underlying dynamics, they can interpret the context much more efficiently and react to what the market is telling them. This occurs when they have learned to respect the anticipated market behavior that could be completely contrary to what their indicators show them.

What is your reference system? Be flexible and open-minded

Look at it this way: A doctor attended a medical school where he learned a reference system for the human body. He has also learned what tests to conduct in order to confirm his suspicions about the truth of the patient’s case. …”let me send it to the lab”. However, when there is a strong disagreement between actual findings and his feelings, he would at times consult with another expert for an opinion or perform a different test. Namely, he does not only rely on his findings, but also understands that the human mechanism could respond and behave in many manners depending on a large array of factors.

A good doctor does not follow his reference system blindly, but with discretion and knows from experience when it is time to deviate from the traditional path in order to help his patience best.

A good trader that has a good reference system will most likely behave in the same manner. His reference system is his trading rules and the confidence and the trust that he has built from his past performance, but he also knows when to ignore it once he recognizes that the method is not in sync with the markets.

THERE IS A SUBSTANTIAL RISK OF LOSS IN FUTURES TRADING. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES.

Suggestion: Try Our Demo trading account allows you to paper trade the futures market without risking any of your funds. Use our Free 30 Day Trials to test your strategy, familiarize yourself with the platform and experience our customer service. CQG Q Trader provides powerful trading tools and technical analysis features to trade and monitor the markets. It combines advanced analytics, charts, and multiple trade execution interfaces in one comprehensive solution for professional traders.

Volatility is a very commonly used concept among traders when it comes to describing risk and the risk and profitability of a trading strategy. But volatility is not always the best suited metric to choose when it comes to evaluating the performance of a trading strategy, and it may even lead to wrong and dangerous assumptions and implications.

What is the volatility of a trading strategy?

When talking about the volatility of a trading strategy, it describes the relative size of losses and gains, compared to the average gain or loss. A low volatility trading strategy would, therefore, be a steadily performing system without major outliers – but it doesn’t say anything about whether it is a potentially winning or losing trading strategy. On the other hand, a trading strategy with a high volatility has significant swings in the development of the account equity, both positive and negative.

Volatility vs. Risk – two completely different things

As indicated, volatility does not describe the risk and the profitability of a trading system because it only refers to the relative size of losses and gains, not about the actual performance.

In an earlier article, we have discussed the limitations of evaluating trading systems based on the percentage performance. Volatility is also of only limited use and misinterpreting this metric may lead to wrong assumptions about a trading strategy and the potential outlook, with potentially disastrous consequences.

Where does your strategy fit in? The 4 potential scenarios

Whether it is choosing an automated trading strategy that you want to follow or building your own trading methodology, understanding and defining the risk parameters and finding a methodology that fits your personal level of risk-tolerance is of great importance for long-lasting success. When it comes to describing trading methodologies in terms of volatility and risk, there are 4 potential scenarios.

Disclaimer: Regardless of any assumptions, There is a substantial risk of loss in futures trading. Past performance is not indicative of future results. Futures trading involves significant leverage and may lead to large gains or large losses beyond the principle invested.

#1 Low volatility and high risk

This combination is particularly dangerous because it usually describes trading systems that have performed well in the past and have not been exposed to adverse and changing market conditions. For example, in a long-lasting bull market a trader buys every dip and even when the trade goes against him, he adds to a losing position to bring down the average price. This strategy may work well in a strong trending bull market, but once market conditions change and a shift from a bull to a bear market happens, a trader may continue to add to a losing position until he wipes out all of his trading account with one trade.

Another example of a low volatility, high risk trading strategy would be selling out of the money options. Such a system may have long periods of small winners by collecting the fees from the option buyer, but one trade that goes against him may threaten his whole trading account because of the unlimited loss potential when being the seller of options.

#2 Low volatility and low risk

Such a trading strategy is defined by a strict and disciplined risk and position sizing approach. For example, a trader always chooses to risk 1% of his total account on any given trade and his potential profit is 1.5%. Furthermore, we assume that he does not violate risk management principles such as widening stop loss orders or taking off stops completely. The outcome of all his trades may look very similar and low volatility and low risk may indeed exist in such an environment.

Risk describes the occurrence, or the possibility, of encountering relatively large losses which may impose significant threats to a trading account. A low risk trading methodology, therefore, is less likely to experience such losses and account development is rather steady.

#3 High volatility and high risk

This combination is often how trading strategies of inexperienced traders and traders who are looking for “a quick buck” are characterized.

The high risk aspect comes from potential large losses which are mainly caused by mismanaging risk and giving in to impulsive trading decisions. As mentioned earlier, not trading with a stop loss, widening stop loss orders, adding to a losing position, revenge-trading or over-trading are all things which expose a trader to great risk and potentially large losses.

The high volatility of such trading is described by the large account swings such traders are likely to experience. When taking positions that are relatively large, compared to the overall account size, and undisciplined and impulsive trading come together, the account development may experience large swings and great ups and downs.

# 4 High volatility and low risk

A trading methodology with such risk and volatility parameters is the opposite of the first one and we can describe this scenario by explaining the position of the trader that takes the opposite side of the trade of trader #1.

A trader who cuts his losses very fast and operates with tight stops may be stopped out frequently and may also have periods of relatively long, but consistent, losing streaks. However, his goal is to capitalize on the few big winning trades and ride them for as long as possible.

The buyer of out of the money options has a similar risk profile. He pays the premium for the options and most of the times he will not be able to exercise the option and has to take a loss. But, due to the unlimited profit potential as an option buyer, only a few winning trades may offset past losses rather quickly.

Conclusion: Due your due diligence and find what suits your personality

Before following a trading strategy, it is indispensable to thoroughly evaluate the risk parameters to reveal potential deficiencies of a trading strategy. Even a seemingly well performing trading strategy could expose the trader to significant risks.

Furthermore, even a trading strategy with low risk and high volatility may not be suited for all traders because of the emotional challenges that come with enduring long losing streaks and still being able to perform at a high level. It is therefore important to audit yourself and see which type of risk is suited based on your personality.

Trading futures and options involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results. The risk of loss in trading commodity interests can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.