Book of the Week: Systematic Trading

09 Jul 2016

This week I read Systematic Trading by Robert Carver after being introduced to his blog about Investment Idiocy. He also has a public journal on elitetrader detailing his 84.9% profit since April 2014 trading futures. The book is a little dense and you should be ready to get the spreadsheets out.

I run a highly diversified futures trading system with around 45 instruments, eight trading rules drawn from four different styles, and 30 trading rule variations. In a 35 year back-test, conservatively fitted with out of sample bootstrapping, it has a Sharpe ratio (SR) of around 1.0 after costs, but the highest volatility target I’d advocate using for it is 37%, rather than the 100% suggested by the Kelly criterion and the back-tested SR. Why such a conservative number – am I a wimp?

Types of Traders Carver groups traders into 3 groups. Asset allocating investor - assume you can’t forecast prices and allocates funds amongst and within different asset classes. Semi-automatic trader - makes bets within a system with leverage usually from derivatives Staunch systems trader - use trading rules to find alpha through back testing Any of these groups can benefit from systematic methods that help avoid cognitive biases that stem from the illusion of control, risk aversion and the desire for regret minimization. Trading rules derived from ideas or data provide a systematic way of predicting price movement. One of the big takeaways from the book is that I need to define the daily cash volatility that I am comfortable win. To get large gains, I must be willing to have my portfolio be down 50% at any point in time. The swings go both ways. Some people use the Kelly criterion to decide how big their bets will be. Carver suggests 50% of the Kelly criterion. Another thing I found interesting was putting trading costs as fractions of the Sharpe ratio. Depending on how expensive tractions are, it only makes sense to trade them at a frequency that has an upper bound. Holding period | Typical turnover | Maximum cost SR | Likely instruments
—|—|—|—
1 day | 256 | 0.00031 | None
3 days | 85 | 0.001 | Cheapest futures, e.g. NASDAQ
1 month | 12 | 0.0067 | Nearly all futures except short maturity bonds, STIR
6.5 weeks | 8 | 0.01 | Index spread bets, e.g. FTSE
3 months | 4 | 0.02 | Individual equity spread bets
6 months | 2 | 0.04 | Cheapest ETFS, e.g. equity indices
one year | 1 | 0.08 | Benchmark inflation linked bond ETF
2.5 years | 0.4 | 0.2 | Most individual equities
You can do everything right and lose money. Purchase Systematic Trading on Amazon.com or check it out from your local library.