The Mark of an Educated Mind

 It is the mark of an educated mind to entertain a thought without accepting it. – ARISTOTLE

When using a mechanical trading approach we must learn how to entertain a good set of probabilities without accepting them as fact.

What is potentially more dangerous than the information which makes up the numbers is how we feel about the accuracy of the numbers. Arrogance about potential accuracy can lead us to overestimate what we think we know and underestimate future randomness. This is how you blow up. As Aristotle said we should entertain a good set of probabilities without accepting them as fact.

Let’s assume we decide not to kid ourselves so we work on a system that is grounded in our market intuitions, with simple non curve fit rules. Then we build a large (60-70 markets) portfolio to make sure it is robust across many liquid markets for many years. We then build in more commission and larger slippage numbers than the standard $75.00. Now we run the systems to generate a large sample of trades.

Usually, if we are honest about this, it will destroy most systems. It is also the reason why most systems out there fail in the real world. If it does not destroy the system then we most likely have a one-eyed king. A system that can see, but does not see everything we would like it to see. The good news is that we are aware of this fact, which forces us to be more proactive in managing the system.

One of the more intelligent ways to manage a reliable set of statistics is to set up independent risk controls that are monitored each day. The system will trigger trades and any filters that are built into the system will filter risk per trade and manage correlation issues.

However once those trades hit the account they need to be managed for changes in risk and correlation.

It is a fact that the computer can do things better than humans, such as tracking multiple trading systems over multiple markets. It is also a fact that systems have limitations that the computer can not see, but humans can. To ignore these messages from reality is a mistake.

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