Plato for Traders

I was born in the former Soviet Union and spent most of my life in New York city, so my sense of idealism is -- shall we say -- contained at best. But when it comes to trading I am actually the biggest idealist around.

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This year I have completely revamped my trading style from proprietary to systematic and as a result I’ve spent the last six months buried in algorithms -- devising them, having them coded and then testing them in live market environments.

Here is the rub though. Real life trading rarely works the way it is supposed to. That nice, smooth equity curve generated by your well thought-out spreadsheet becomes a custerf*** of botched executions, missed trades and unintended consequences. But even when you fix most of the egregious problems of your algo there is still the issue of drift.

Your backtested results created under the ideal conditions never take note of slippage, spread widening, size limitations and a million other factors that plague live trading. Yet instead of bemoaning that fact and dismissing your backtests as unrealistic we should welcome them with open arms.

Much like Plato’s table the ideal backtest result is something that us mere mortal traders can never achieve but should nevertheless seek to accomplish. Let me give one great reason for the value of the ideal.

All systems go into drawdown.When that happens most traders suffer a crisis of confidence and abandon what possibly could be their best money making idea. But if instead of quitting we stopped and looked at the “ideal” results of our system, our sense of confidence would return. The “ideal” system, much like the Platonic ideal of beauty is what grounds us as human beings and provides us the standard to strive for.

Without the “ideal’ , the real would never happen. We would all quit before reaching success. So here is a quick and dirty formula that I like to use in all of my systems.

  1. What is the “ideal” win ratio?
  2. What is the “breakeven” win ratio?
  3. What is the “real” win ratio?

If number 3 is anywhere between 1 and 2, relax you are on the right path.

Boris Schlossberg

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