Time to Evaluate

The real test of any theory is how it holds up under scrutiny of analysis through the scientific method. In that spirit, starting from Nov 1 I will be keeping a close track record of my trades and performance to evaluate the validity of risk management and to prove to myself it is the best method in the long run. I will do this also to keep track of monthly returns. My goal is to have positive monthly returns each month.

Why start now? Partly because I believe a majority of the volatility is behind us so it will be easier to set stops and not get completely whipped around with wild swings. In the spirit of my CFA studies and good science I want to find out what my expectancy is, and how well I can do following my strict rule set. I also want to see if there is a difference in daytrading expectancy vs. intermediate term expectancy. In the long run there should be no difference however maybe my psychology is set up better to day trade, or maybe it is better to trend or swing trade or maybe not trade at all.

Expectancy = (Probability of Win * Average Win) - (Probability of Loss * Average Loss)

Let's say I only take trades with a 1:3 risk/reward ratio. If my risk is R and I plan to lose 1R to every 3R gain and I expect to be correct or take trades that help me be correct 30% of the time.

(.30*3R)-(.70*R)=.9-.7=.2

This appears to be a good trading plan because it has a positive expectancy, which means over the long term I should make money. Limiting my loss to R will likely require that I set hard stops so it is never violated. So far I have been good at using my own discipline to cut a loss during a day trade. So far on 6 futures day trades I have made $95 dollars, with 2 of those being successful. This basically supports my trading plan because I was risking less money and making less. However, it is frustrating because my first trade of the day today was a success, then the second one was not because I cut the loss. Had I held a little longer it would have been successful in hitting my profit target(same with other times). However, the amount of loss I hold through did not warrant the return. Not to mention later in the day we sold off significantly, and if that had unfolded right after I bought a future and didn't cut my loss I would have had a very large loss.

The other side of the challenge is setting a target and being patient enough to let it reach it. I bought puts on the DIA yesterday at the close because I felt the rally favored a sell the news type scenario once the president was elected. This proved to be correct, however I took my gain too early in the day and had I held till the close my gain would have been 3x larger. I did attempt to be smart, I locked in most of my current profit then let the remaining contracts go, the downtrend it was following broke so I took the remaining profit assuming a reversal. The reversal was short lived and eventually we had a large sell off into the close.

Speaking to the large picture I think we had some good profit taking due to there really being no actual resolution and no one knows what Obama will do and who he will appoint yet. Cisco reported and met expectations but had a bad outlook which will weigh on tech tomorrow(futures are down 2%), which is unfortunate because I am long Dec calls on the Q's and I suspect I'll have to sell. A further sell off though should set up some nice buying opportunities in some good names I have been wanting to get into such as VMW, AAPL, CHK.

The Jobs report could be another negative catalyst however if we are truly bull confirmed people should start dip buying on these pull backs. We should see support around the 9,000 level.

So, the name of the game now is evaluation. Is this a worthwhile cause? I will compare my results to the averages and see if my rules and timing ability is a pointless affair as most money managers claim.