The Two Fundamental Questions of Trading, 08/14/05
The Two Fundamental Questions of Trading are:
1) What methodology do I trade?
2) When do I stop trading it?
The answer to the Second Question is to use a series of control charts to help determine stable and tradable. The control charts I use are a modified Chi^2, a ratio of actual wins to expected wins over the last x trades, and a rolling P&L.
The modified Chi^2 is a test of stability, fewer spikes and lower peaks are better. The ratio of actual wins to expected wins is a measure of current performance of the win/loss ratio and the rolling P&L is a measure of current profitability vs historical profitability.
An example from last Wednesday, 8/10/05, is here:
Wednesday_Control_Chart.pdf
[09/14/07 - paper lost, hac] A first look at Wednesday's pattern was positive and tradable but the control charts said the pattern had moved too far from its historical norms in both win/loss and P&L to be stable.
Being able to answer the question, "When do I stop trading my system?" has finally allowed me to begin automating; now I teach my systems how and when to turn themselves off.
Which is a good thing.