I often ask about ways to test a system to know when to stick with it or abandon. Quality control/TCM is one of the ways people mention of knowing how far removed your model or process if from the expected. I thought of another semi related way borrowed from blackjack.

In blackjack counters use a system wherein certain cards are given a +1 value, others a -1, and then some receive 0. Idea behind this is low cards (2,3,4,etc.) benefit the dealer while high cards (10, j, q, k, etc) benefit the player. If a player sees a lot of low cards come out successively, the count goes up by +1 per low card and the odds go up. When the count gets high the players have a decided advantage.

I think an interesting way to apply this to markets, mainly via systematic models, would be to line up the overall stats/odds of a given model. Then one could paper trade it keeping a sort of count for high probability entry. So if paper trading and you see the model loses 6 straight trades and this has only happened <5% of the time over a large N and the historical info shows that the odds (in both frequency and magnitude terms) favor a win on trade 7, you go live. The "count" has given you a high probability entry within a high probability system.

An ultimate stop loss per model could be assigned. You could give the model maybe 10% total drawdown potential. Subdivide this into 4 parts of
2.5%. Enter when the odds or "count" go in your favor (as described above). If you start making money then great, let it ride. If however you lose 2.5% (even after entering at the high probability point) you stop trading, wait some predetermined amount of time, and try again with the approach above. If the model experiences a 10% drawdown after 4 attempts with the count approach then you shelf it.

The same could be applied to the winning side but I would be more inclined to just let it run if in the black. If playing with the house's money why not let it ride.

This logic could also be used to size trades, increasing size when the count gets high and decreasing when the count gets low.

Jim Sogi writes:

Since stops degrade performance, the alternative is to use trade size to prevent disaster. Yet smaller trade size decreases performance as well. Is there a study stop systems vs a trade size systems comparing the two with some sweet spot data on lower drawdowns, and ultimate returns? I think the long term historical optimum was 1.9 leverage. 2.1 leverage went bust long term in the big crashes.

Phil McDonnell writes: 

In my opinion trade size is the only reliable way to control risk. I am not sure why Mr. Sogi believes that reducing size reduces performance. If you have a stock picking method that gives you many stocks then the edge should be similar for each of them with no loss of edge. I suspect he is assuming something else.





Speak your mind

4 Comments so far

  1. steve leslie on June 14, 2012 7:49 pm

    I know alot about casino games having played them at high levels (pro level blackjack) and poker are my specialities. And this may or not be relevant.

    Whether or not I was ahead or behind was never a determinent factor in my play of games. I played in sessions 4-8 hours in black jack and rarely more than 8 hour sessions in poker. I just get tired. In blackjack the cards do not know you nor carry a bias. I played the same structure on my betting strategies whether or not I was winning or losing. After playing thousands of hours of blackjack, the cards really play themselves. I had a bank roll whether I was winning or not was meaning less for the session. I never varied from my structured play. If i was fortunate enough to get ahead that money was taken out of play and put in the safety box.

    Poker is different. Tournament poker is a far different beast than cash poker. No limit is worlds away from limit. So the type of game determined the play. But in structured cash games winning and losing was meaningless. My goal was to play every individual hand to my highest level of skill. At the end of the session I counted up my chips cashed in and walked away. The next session I take my same buy in and go from there. The stuff you see on TV and in legend is alot of bullshit. real professionals are grinders they do the same crap day in and day out It is a job. They play poker by the year not by the day or by the weekend.

    Tournament poker on the other hand is entirely different. Tournaments go through various stages The early stages are for survival and to build a stack. Think of your self as highlander. You get stronger as others around you die. The mid game is about more survival and to make it to the end game. You are always positioning yourself. Waiting and watching counting how many are dying around you. How the tables are shrinking How many souls are between you and the pot of gold. The first goal is to get paid then the next goal is to get to the final table. Mistakes here can mean the difference between winning and going home with warm and wet pockets. The end game is all about aggression. Pushing a position, intimidation, using every conceivable strategy devised and thought.

    You learn that in gaming, the game never ends it continues on for ever. There is always a game somewhere. The statistics ultimately work themselves through the system. Numbers are not rational nor irrational. The numbers don’t know you they don’t know the casino and they don’t know anything about wagering. They are just numbers.

    This may or may not equate to trading I will leave it up to the reader to decide.

  2. Harry Balzer on June 15, 2012 10:36 am

    I use such a count with equity / index trading and have found that options solve the stop problem. Instead of buying or shorting via futures or stocks, scale a long options position with expiration acting as your stop.

  3. Declan Patrick McManus on June 15, 2012 5:45 pm

    @Steve, what is pro-level blackjack? I have seen professional poker on TV, but never professional blackjack.

  4. steve leslie on June 16, 2012 10:36 pm

    I am not sure if the game can be beat today. Certainly not at a high level. For various reasons. 10-20 years ago things were alot different.

    Pro level Blackjack is a multi tiered play. First is a basic play strategy which has not changed much from when Dr. Thorp ran his computer models. In fact I still have a cheat sheet I extracted from somewhere It is 20 years old. This is for example splitting 8’s and Aces. Doubling down on an 11 hitting a soft 17 etc. Perfectly played you are at a slight disadvantage to the house. maybe 1/2 of a percent.

    The next level is using a card counting system. The simplest mentioned above is a simple plus minus. Then you can get more extreme using a multi count system. I suggest reading Million Dollar Blackjack by Ken Uston as a great book on the game of blackjack. Uston was probably the best blackjack player ever. The Stu Ungar, Chip Reese of Blackjack.

    Once the card counting system is established the betting strategy is incorporated into the count. The simplest is a 4 bet strategy. For example your average bet is $50 your small bet is $25 and a big bet is $100. When the numbers are in your favor, you put more money into play, when they are against you, naturally you pull back.

    Utilizing this system you end up with a slight statistical edge of 1-1.5%. Thus if you utilize the 3 tiers correctly you will make on average 1.5x your average bet. If your average bet is $50 you will make app $75 per hour.

    You can increase this by using team play described in the movie 21 about the famous MIT card counting team.

    Here is something the casino will not tell you. They determine your comps based on the amount of action you give them. If you are playing $50 per hand of Blackjack,after an 8 hour session you have earned app.$200 in comps. This can be applied for RFB and entertainment.

    So if all goes well and in a perfect world, after 8 hours you should make somewhere around $400-$600 in money and $200 in comps.


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