One Successful Trader’s Way

I was talking to a successful options trader yesterday. He has been in the markets for 17 years in addition to doing his regular job. It has taken him some time, but he has found a trade methodology that he believes in and is comfortable with. Look at his blog:    http://stockoftheday.blogspot.com

Don’t Over Fit

Part of his comfort with the methodology, I believe,  comes from his testing. He has tested his trade back over many years and sees how it performs.  There is a danger to creating trading strategies by backtesting.   There is a need to” improve” the parameters of the trading method so that the trading results improve.  This is a trap.  If the method works, it should work over a range of parameters.  If the parameters need to be fine tuned, that is a sign that they have been over-fitted.  They may have worked in the past, but probably will not work in the future.

One way to be sure to avoid this bias is to create your trading method over  say the past five years, but take out six months of three of the years.   Then once you have a method that you like, test it on the three six month periods that you did not look at.  That way if you have over fitted the parameters, the trades in the test periods won’t do well.

Juan has kept his trade parameters very simple and consistent.  That is a good sign.

How Does The Trade Behave?

He also has a very clear idea of why his trade does what it does. In other words, what are the hidden factors in the trade. Does it have an underlying bullish bias? Does it need volatility to increase to be profitable? What does time decay do to the trade? Does it profit from sharp moves or suffer?

Another piece of the puzzle is the time frame of the trade.  Are you most comfortable closing out all your trades every day?  Or every Friday?  Or do you want your trades to work over a month or two?  How are you most comfortable?

These are all important elements in creating a successful trader.