for improving the self, in the hope that you will eventually join the ranks ofthose who are successful day traders.10 Introduction
No Exaggerated Claims
Furthermore, I do not make any exaggerated claims about what you canachieve as a day trader. Although “the sky’s the limit” in futures trad-ing, it is up to the individual trader to maximize what can be achieved.I am only a guide who can teach you techniques which I’ve found use-ful during my years as a trader. There are no unrealistic claims in thisbook. If you want those, you'll have to read some of the magazineswhich help perpetuate such rubbish...or you'll have to read some ofyour junk mail. If anything, I've attempted to tone down all claims sothat when you achieve success you'll be very pleasantly surprised. I'drather have you keep your expectations low so that you will be happywith what you achieve. For too many years too many unscrupulousoperators have preyed upon the public, asserting absurdly fantasticclaims, pandering to the weaknesses of human greed and hope. You’llfind none of that in this book.
Historical Results
Throughout the book you will find references to historical results or tostatistical summaries. Unless otherwise stated, these are as up-to-date aspossible to the time of this writing. I warn you that with time, these sta-tistics will change. They should therefore be updated either throughyour own research or by consulting with my office. Should you have aquestion regarding their current applicability, please don’t hesitate tocontact me.
Note also that my examples are taken primarily from current marketactivity. I could easily hunt and search for historical examples whichillustrate my points perfectly. These would, however, be textbook casesand, therefore, misleading. The reality of day trading, indeed, of alltrading is that nothing works as well in reality as it does on paper. Thisis a fact which I must emphasize early and often so that you will, aboveall, emerge from this book as a realist.
Do Your Own Research
I always encourage individual research by traders. There are so manyideas which can be applied to today’s futures markets that any one indi-vidual does not have a monopoly on research. In fact, every trader is sovery different in his or her perceptions of the markets that distinctly dif-ferent methodologies and applications will be visualized and developedIntroduction 11
by different traders. Some of the ideas presented in this book may sparkin your mind concepts and methods which could prove highly prof-itable. Don’t allow yourself to be restricted or encumbered by mywords, rather use my work as a starting point for your own goodresearch. Certainly if you find that my techniques are working for you,then continue to use them and adapt them to serve your own purposes.
I always look forward to hearing from my readers, particularly if theyhave feedback on the techniques I’ve taught and/or if they have devel-oped new methodologies which improve upon those suggested in mybooks. If you have developed your own trading methods and are willingto share them, then I most certainly invite you to get in touch with me.
Practice
Practice is extremely important. It is absolutely necessary if you are tofully implement the indicators, concepts, and topics discussed in thisbook. I urge you to practice in real time as soon and as often as you can.Learning to day trade from a book is very much like learning to ride abicycle from a book. None of what I am about to teach you will crystal-lize into profitable action until you get on the bicycle and begin to rideit. Hopefully you will not have to fall off the bicycle too many timesbefore you understand the actions which go along with my words.
Getting Started
Aside from the motivation and persistence which are required for suc-cess in any venture, you will not need any other tools in order to getstarted with this book. I will make a few suggestions however whichmay prove valuable.
1. Read slowly. Although you may feel that the subject matter is verystraightforward and simple, please read through it slowly, first forthe general idea, and then a second or third time for the specifics.
2. Apply your knowledge to the examples. Where I have provided exam-ples, I urge you to apply what you have learned in order to make cer-tain you understand it.
3. Take notes. I also urge you to take notes both in the margins of thistext and on a separate notepad. The material will be easier for you tocomprehend and retain if you take notes.
4. Take your learning to the markets. Once you have internalized the con-cepts, please observe them under real market conditions to determine12 Introduction
how well they work for you and if they are consistent with yourneeds as a trader.
Risk and Loss in Futures Trading
The regulatory agencies which oversee the futures markets, namely theCommodity Futures Trading Commission and the National FuturesAssociation, have imposed certain specific requirements on those whoare members of these organizations. Failure to comply with the regula-tions of these agencies can result in expulsion from membership, repri-mand, and/or monetary penalties. Although I am certain you are allalready aware of this fact, I am required, therefore, to warn you andremind you (in case you didn’t already know) that there is a risk of loss infutures trading.1am also required by law to give you the following disclaimer.
The CFTC requires we state that—notice: Hypothetical or simulatedperformance results have certain limitations. Unlike an actual per-formance record, simulated results do not represent actual trading.Also since the trades have not actually been executed, the resultsmay have under- or over-compensated for the impact, if any, of cer-tain market factors, such as lack of liquidity. Simulated trading pro-grams in general are also subject to the fact that they are designedwith the benefit of hindsight. No representation is being made thatany account will or is likely to achieve profits or losses similar tothose shown. The risk of loss in futures trading can be substantial.You should carefully consider whether such trading is suitable foryou in light of your financial condition. Past results are not indica-tive of future results. There is a risk of loss in futures trading
Furthermore, I am also required to mention repeatedly the potentialfor risk whenever the potential for profit is mentioned throughout thecourse of this book. I feel that all of you already know the risks, and Iresent having to repeat them. It is a waste of space and time, and it is aninsult to your intelligence and mine. Consequently, I will do so, not bychoice, but by the necessity of regulatory dictate.l
The Basics
Before digging too deeply into the technical aspects of day trading, we'llneed to examine some housekeeping details which pertain to our task.First among these is a brief but necessary definition of terms. Thefutures markets have their own language without which they could notfunction and without which you will be unable to trade. So let’s take alook at some important terminology which will be used throughout thetext. These terms are not presented in any order other than, perhaps, fre-quency of use.
Definition of Terms
Day Trading, Day Trader. In order to avoid confusion or misun-derstandings, I'll first define for you the terms day trading and day trader.Although you may think that this is an unnecessary waste of time andspace, I cannot tell you how surprised I am at the all-too-common lackof knowledge which most individuals have about day trading, what it isand what it is designed to achieve.
A day trade is a trade which is entered and exited on the same day. It doesnot mean that the trade will be held overnight, that it will be keptovernight if profitable, that it will always be entered on the opening andexited on the close, or that it will not entail risk. Day trades are alwaysover by the end of the trading day. By definition they are no longer daytrades if carried through to the next trading session. True day traderswill not hold positions to the next trading session regardless of howthey have fared during the day. Succinctly this means that a loss is aloss and a profit is a profit and that all scores are settled by the end ofthe trading session—win, lose, or draw. Day trades may be entered at
1314
Chapter One
any time during the day, but they must be closed out by the end of theday.
Position Trader, Position Trading. A day trader is one who daytrades. As soon as a day trader holds a position overnight, he or shecannot refer to the trade as a day trade or to him or herself as a daytrader. A position trader, however, holds trades for an extended period.The position trader in futures is like the investor in stocks, albeit with ashorter time perspective, which is not necessarily limited by the life ofthe futures contract.
There is no crime in being a position trader and certainly no crime orembarrassment in being a day trader. However, you must be carefulwhat you tell yourself, or you may begin to believe it. A day trader is anindividual who is committed to a certain specific course of action. Tosway from this course of action is to subvert the program. To stray fromthe program is to abandon its principles and to acquire a new set ofexpectations which may not be consistent with the original objective. 1urge you, therefore, to be committed to your course of action once youhave determined it.
If you wish to be a position trader, then do yourself a service and donot refer to yourself as a day trader, lest you confuse your objectives.Simply stated, what’s right for the position trader is not necessarilyright for the day trader and vice versa. Position traders may be willing,for example, to carry a losing position for quite some time in the expec-tation that it will eventually become profitable. To the day trader, this isa violation of the cardinal rule.
Is it not possible, you ask, for traders to wear different hats at differ-ent times or many hats at the same time? Absolutely! There is nothingwrong with trading in many different time frames at the same time, pro-vided you do so with specific structure and follow specific rules whichwill be explained to you later on in this book. But remember, this bookis primarily, in fact, exclusively, for the day trader.
Short-Term Trading, Short-Term Trader. A short-term trader asopposed to a day trader or a position trader is one who trades for rela-tively short-term market swings of 2 to 10 days’ duration. There is nofirm definition of the exact length of time short-term traders hold theirpositions. The distinction between a short-term trader and a positiontrader is not as precise as is the distinction between a day trader and allother types of traders. A day trader trades within the day time frame asa hard and fast rule, whereas position traders’ and short-term traders’time lengths are not as specifically defined. Many of the techniquesThe Basics 15
described in this book may be applied to short-term trading as well asday trading. For those interested in learning short-term trading systemsand methods, I recommend my book Short Term Trading in Futures(Probus Books, Chicago). It is available through my office.
Intermediate-Term Trading. An intermediate-term trade is oneusually held for several months. Such trades are preferred by manytraders, money managers, and investors. Intermediate-term traders seekto take advantage of larger price swings.
Long-Term Trading. In reality there are very few long-term futurestraders. A long-term trader may hold positions for several years, rollingcontracts forward as they approach expiration. What the day traderdoes is the complete antithesis of what the long-term trader does. Forthose interested in long-term trading I recommend my book, Long TermTrading in Futures, available from my office.
Slippage. Slippage is the tendency of a market to fall or rise veryquickly, picking buy and sell stop orders very quickly. Hence, when Irefer to a $100 deduction for slippage, I mean that I am deducting $100from every trade in a hypothetical back test in order to represent moreaccurately what might have happened. A market which tends to havetoo much slippage is, therefore, a market in which quick and suddenprice moves tend to result in price fills which are unexpectedly orunreasonably far away from your price orders.
Trading Systems. A trading system, as opposed to a tradingmethod, timing indicator, trading technique, market pattern, and so on,is an organized methodology containing specific market entry and exitindicators, as well as an operational set of procedures (called rules)including, but not limited to, various risk management (follow-up stop-loss procedures) methods and procedures. A trading system is imple-mented by following specific timing signals which dictate market entryand exit. I am defining this term specifically here in order to distinguisha trading system from other market techniques which are not as specificand/or which do not follow a predetermined set of procedures.
Trading systems must be necessarily rigid in their construction for thepurpose of delineating specific procedures which, theoretically, shouldlead to profitable trading, provided the system is functioning as intendedor tested. In practice, most traders do not follow a trading system. They deludethemselves into thinking that they are trading according to a system, however,they violate the rules of their own trading systems so frequently that one ought16
Chapter One
not term their actions systematic. This definition is designed to set the stagefor more extensive commentary on the subject in a later chapter.
In closing this brief definition I reiterate that a trading system must besystematic or it is not a trading system, regardless of what the individual whoprofesses to be trading a “system” may think. A few traders actually followtrading systems. The vast majority of traders begin with a system butalter it to suit their internal feelings about the markets to the extent thatthey are not following a system at all other than, perhaps, in their ownminds.
Timing Indicators, Timing Signals. A timing indicator is definedas any specific technique, whether fundamental or technical which objec-tively indicates market entry, exit, or the underlying condition (i-e., bull-ish, bearish, neutral) of a given market or markets. A timing indicatorcan also be called a timing signal. I will use the terms interchangeably.
The definition given above is intentionally general for the specificpurposes of this book. You will find, in later chapters, that literally thou-sands of timing indicators may be used in many different ways. Timingindicators must be objective, that is, not subject to interpretation. An indi-cator which is subject to interpretation is not an indicator, it is, rather, atechnique and, therefore, subject to different interpretations by differenttraders and even by the same trader in different situations. I will makeevery effort in this book to differentiate among timing indicators, trad-ing techniques, and trading methods.
Trading Technique. A trading technique as opposed to a timingindicator, timing signal, or trading system is a fairly loose collection ofprocedures which assists traders in making decisions about marketentry or exit. Frequently a trading technique consists of one or moretiming indicators combined with general entry and exit rules and/orrisk management procedures. A trading technique is, therefore, not atrading system but rather an approach to trading which is generallyobjective but not nearly as precise or rigid as is a trading system.
In practice, most traders follow techniques as opposed to systems. Much ofwhat you will learn in this book relates specifically to trading tech-niques; however, I have also included some of my favorite trading sys-tems. A trading system can be used as a trading technique if you wish.As I pointed out earlier, this is in fact what most day traders and mostposition traders actually do.
Market Entry and Exit. All traders should be familiar with theseterms. Do not bother reading this definition if you are already familiarThe Basics 17
with these terms. Market entry means simply to establish a new long,short, or spread position. Market exit means to close out an existing long,short, or spread position. There are many different types of orderswhich may be used for entering and exiting markets. These are dis-cussed later on.
Optimization, Curve Fitting. The act of fitting a trading system topast data is called optimizing. When a trading system developer opti-mizes a system, he or she does so in order to generate a set of systemrules which have performed well on historical data. Although the sys-tem appears to have worked well in the past, it is in fact “fitted” to thedata. Hence, the system will frequently not perform well in the future.To a given extent, most system testing involves some degree of opti-mization or curve fitting. Although opinions on curve fitting differsharply among market experts, I caution you to avoid such systems.
These, then, are some of the very general terms which I will usethroughout the course of this book. Terms not noted herein will bedefined as they are introduced. Please note that my intent in redefiningterms which you may already know is not to insult your intelligence butrather to make absolutely certain that we are communicating, since thisis of paramount importance when teaching specific trading systemstechniques and methods. Furthermore, many terms commonly usednowadays are not clearly understood by the individuals using them.What a Day Trader Is;What a Day Trader Does
Perhaps the single most important issue at the outset is to define exactlywhat I mean when I use the terms day trader and day trading. It will be inour best interest to define what the day trader does to make certain thatyou learn the skills you need to succeed in this highly demanding task.A day trader trades strictly within the day time frame. The day trader,therefore, establishes positions at some time within the day and alwaysexits these positions by the end of the trading session. Failure to exitpositions by the end of the trading session violates the single mostimportant rule of day trading. The day trader who does not exit posi-tions by the end of the trading session is not therefore a day trader. Iemphasize this point inasmuch as there are many individuals who wishto day trade but who, for lack of discipline, cannot do so effectively or
consistently.
To carry a trade beyond the close of trading on the day of entry is toviolate not only the cardinal rule of day trading but also to destroy the advan-tage that day trading offers over all other forms of trading. You may find myinsistence that a day trader only trade within the time frame of the daysomewhat annoying, but I must emphasize this point strongly. I will doso repeatedly in order to impress upon you the importance of staying
with your primary goal as a day trader.
For those who insist on violating the rules, I will provide some sensi-ble alternatives and procedures which should prove helpful. I do, how-ever, insist that positions entered as day trades be closed out as daytrades with very few exceptions to this rule. Since a day trader is onewho trades within the day time frame, day trading is the job of the day
trader.
18What a Day Trader Is; What a Day Trader Does 19
What Does a Day Trader Trade?
Although some would argue that only certain markets are amenable today trading, I disagree. At some time or another all markets are suitable forday trading, provided that certain conditions are met. | will teach how to rec-ognize which markets to day trade and when to day trade them.Regardless of which markets are traded, the day trader will adherestrictly to the policy of entering and exiting positions within the daytime frame.
Some markets lend themselves more readily to certain trading sys-tems, methods, and techniques. I will identify these for you. Some daytraders will avoid certain markets, feeling, perhaps, that the potentialfor profit is not large enough or that risk is too high. This is not neces-sarily true. The only thing which should dissuade a day trader fromtrading certain markets is lack of liquidity. I will be more specific later.For now, however, suffice it to say that all reasonably active futuresmarkets have potential to be day traded at one time or another. Thereare some markets which are suitable for day trading almost every day,and some markets should be day traded only at certain times. I will tellyou how. to know when given markets should be day traded and whenthey should not.
Why Day Trade?
Given the volatile market environment which I have previouslydescribed, day trading offers many advantages over position trading,although day trading is not recommended for all traders. Several partic-ularly cogent reasons support day trading as a viable orientation withinthe limitations which will be presented later.
1. Maximized Equity
Day trading allows traders to maximize their trading capital by avoid-ing the need to post overnight margins. Many brokerage firms willallow traders to trade actively and very aggressively within the daytime frame, provided these individuals have the financial resources, thedemonstrated responsibility, and the maturity to do so. If your brokerand/or brokerage firm has the confidence that you will not accumulatea large deficit, you will be permitted to trade many markets, and fairlylarge positions during the day, without needing to post the large marginrequirements which would be necessary if the positions were heldovernight.20 = Chapter Two
It is therefore possible for a trader to maintain a relatively small cashbalance in his or her account and to day trade considerably larger quan-tities in terms of total number of contracts than might be the case were itnot for day trading.
2. Reduced Risk Exposure
Although some individuals would vehemently argue this point, I main-tain that day trading affords less exposure to the risk of loss than doesposition trading. The position trader is often a victim of considerableprice volatility which results from news or fundamental developmentsoccurring after trading hours. It is not uncommon for a position traderto find that a trade which showed considerable profit at the end of theprevious trading session shows a substantial loss on the opening of thenext trading session as a result of overnight news or market-relateddevelopments.
This is, of course, a two-sided coin (it can work for you or againstyou), but it is far better to avoid the exposure of risk than to gamble onovernight news. Certainly news can occur during the trading day; how-ever, the day trader can respond within the day time frame, since themarkets are open and the position can be closed out. In other words,news can be used to the advantage of the trader or to indicate that theday trade should be closed out.
Opening price gaps, although potentially negative for position traderscan be used to the advantage of the day trader. Although these gaps fre-quently work to the disadvantage of the position trader, there are open-ing price gap methods (to be discussed later) which provide many prof-itable opportunities to the day trader, opportunities which are eitherunavailable to the position trader or which are actually injurious to theposition trader.
3. Advantages of Forced Exit
Day trading forces traders who follow their rules to exit positions by theend of the day, win, lose, or draw. This, in effect, forces traders to taketheir losses no matter what excuses may be conjured up in favor of hold-ing positions. Consequently, a day trader who holds a position beyondthe close of trading knows that he or she has broken one of the cardinalrules of day trading and that the consequences may be negative.
I do not suggest, by any means, that positions which show a loss at theend of the day and which are then held through to the next trading ses-sion invariably show a loss the next day. The odds are probably 50/50.What a Day Trader Is; What a Day Trader Does 21
However, losses are frequently larger than profits, and, furthermore, car-rying a position overnight leaves the day trader uncertain as to whatshould be done the next day. This is why the day trader who follows thetules will be spared the pain of loss as well as the often debilitating anxi-ety and uncertainty which are part and parcel of riding losses.
Those who are committed to day trading and who follow the rulesaccordingly will not carry losing positions overnight and, in so doing,will avoid one of the most serious problems traders encounter in theirspeculative ventures. It is far better to close out a position, even at aloss, if this will prevent the loss from becoming larger the next day.
4. Reliability of Timing Signals
A third reason for considering day trading is that many signals and trad-ing systems appear to be more reliable in shorter time frames than theydo in longer-term time frames. I find it considerably less difficult todevelop trading systems, methods, and timing indicators which are moreaccurate within the day time frame than indicators which attempt totrade for intermediate-term moves. As a point of information, I have alsofound more trading systems and timing methods that work well on avery long term basis than those which work well in the intermediate term.
5. Immediate Feedback
Another substantial benefit of day trading is the fact that feedback inthe form of profits or losses is much quicker than it is in the case of posi-tion trades. This is important to the trader who is concerned aboutlearning from his or her errors (i.e., losses). A position trader who entersa bad trade may not get feedback (in the form of a loss) until manyweeks, possibly months, later. The day trader, however, will know nolater than the end of the day and frequently within minutes or even sec-onds that the trade is not a profitable one. Such positive or negativereinforcement (in the Skinnerian sense) is important in learning how totrade. Frequently, position traders will close out a losing trade so longafter the position was entered that the original reason for entry has beenforgotten (or repressed), and, therefore, very little if anything can belearned from the loss.
6. Faster Development Time
A day-trading system can be tested and developed in real time morequickly than can a position-trading system. The availability of continu-22 = ~=Chapter Two
ous contract, tick-by-tick data makes system testing by computer fasterand, I feel, easier. It is possible to test literally thousands of cases. Thisincreases the statistical reliability of test results.
7. Trader Personality
A less technical reason for preferring day trading relates to the personal-ity of the trader. I find day trading to be considerably more enjoyableand frankly much less stressful than carrying positions overnight. Somemethods of day trading are more time- and attention-intensive thanposition trading, but there is a certain pleasure derived from knowingthat no positions are kept overnight and that any unexpected interna-tional or domestic developments cannot impact me, since I do not haveany open positions. Day trading appeals to certain individuals such asyourself. It is probably more closely suited to your specific needs thanare either position trading or short-term trading. That’s why you’rereading this book.
In Summary
In summary, the day trader seeks to capitalize on moves which occurwithin the day time frame. Many techniques may be used, but many,unfortunately, prove to be nothing but blind alleys. The rest of this bookgoes on to teach and explain some of the methods I’ve developed overthe years. Some of my techniques are highly specific and objective; oth-ers are more subjective and fall into the category of trading methods ortechniques as opposed to systems. The day-trading methods and systemswhich follow are ones which I’ve developed during my more than 20years.as a futures trader. I sincerely believe that those who take the timeto learn them, to use them, and to refine them will benefit handsomely.The Illusion ofSystem Testing
There is perhaps, no other area in the field of futures trading which hasbeen as abused or as misrepresented as trading system development.Futures traders generally pride themselves on being a group of objec-tive, analytical, and logical people. They gloat in their skepticism anddogged insistence upon scientific validation of trading methodologies.Wherever possible, they insist upon the hard facts of system perfor-mance. This orientation to the validation of futures trading systems andmethods has been growing in intensity and popularity since the adventof affordable computer hardware and software.
A number of authors, of whom the most prominent is Perry Kaufmann,have written extensively on the subject of system testing and systemdevelopment. Great emphasis has been placed upon the importance ofadequately testing trading systems in order to validate their use in realtime. Furthermore, the area of system optimization has received consid-erable attention as well. Both areas should be studied carefully by seriousfutures traders, since the issues involved are likely to significantly impactthe systems and methods you trade as well as your market performance.Perhaps my input will assist you. Possibly you may not agree with every-thing I’m saying. But my words come from the voice of experience—experience which spans nearly one-quarter of a century in the futuresmarkets. First, let’s deal with the issue of system development.
System Development
With a few thousand dollars’ worth of computer software and hardware,it is now possible for virtually any semi-computer-literate individual to24
Chapter Three
develop seemingly profitable trading systems. I use the words “seeming-ly profitable” because, in my experience, the development of trading sys-tems which have shown profitable back-tested results does not in any way,shape, or form guarantee that these results will be reproducible in the futureunder real-time market conditions. Please note a system test is merely theanalysis of a particular model which is imposed upon the market. The morecomplex the model, the more it will reflect a fit of the past data, but thisfit is not necessarily applicable to future market conditions.
Curve fitting, as the procedure of developing seemingly effective trad-ing systems is called, can produce spectacular results which are nothingbut hypothetical and which have no bearing whatsoever on the future.Hence, system testing deserves attention and close scrutiny if test resultsare to be taken seriously and used for the purpose of actual trading.
Several important issues must be understood if you are to avoid thetrap of trading based on system tests. I realize that my point of viewregarding the issues of systems, system testing, and system optimiza-tion will not be shared by all readers or for that matter by all traders ormarket analysts. I feel it is necessary, nevertheless, for me to expressthese ideas so that you will, hopefully, achieve a better understanding ofmy orientation to the markets, and to trading futures. You will find thatmy point of view regarding the subject of system development is notnearly as rigid or institutionalized as is the current thinking of my col-leagues. Although I am not opposed to system testing, I do believe that thereare inherent dangers in taking the results of system tests too literally. Let meexplain what I mean.
What Is a Trading System?
A trading system is merely an approach to organizing facts and under-standing relationships about markets. Presumably, the idea behind atrading system is to arrive at a series of steps which, generally translat-ed, result in expectations based on if-then scenarios. It is presumed thatby following the procedures and rules of a trading system which hasbeen effectively back-tested, the trader will, assuming perfect adherenceto the rules, produce profitable results. At the very least, it is hoped thatthe trader will stand a better chance of profiting through the use of atrading system than through the use of no system.
I have serious doubts about both assumptions. Here’s why. A tradingsystem is developed by imposing a hypothetical and artificial frameworkupon a set of data which has a considerable amount of built-in randombehavior. The course of trading system development consists of trial anderror until an effective combination of market indicators has been ascer-The Illusion of System Testing 25
tained. These indicators, frequently combined with principles of riskmanagement, purportedly indicate what would have happened histori-cally had they been applied to the particular market or markets. In thevast majority of cases, the trading system themselves do not reveal anyunderlying truths or realities about the markets but rather reveal that a superfi-cially imposed set of rules can result in acceptable results provided the twoessential elements of all trading are contained within that system. And thesetwo elements are the limitation of losses and the maximization of profits.
In other words, extensive system testing reveals that the vast majorityof trading systems produce results which are accurate 50 percent of thetime or less. Trading systems which are correct 60 to 75 percent of thetime are fairly rare, and those which are correct 70 percent of the time ormore are extremely rare (assuming a reasonably large data sample). Thelengthier the historical test, the less accurate the results. Statistically, thisis called regression to the mean. Putting it in plain old-fashioned English,most trading systems don’t work. And again, in plain old-fashionedEnglish, trading systems which have the principles of risk managementbuilt into them increase the odds of success dramatically.
The random walk hypothesis as proposed by Malkiel in his classicbook A Random Walk Down Wall Street (Norton, New York, 1973) poses aparticularly cogent argument in opposition to system development.Malkiel’s thesis is that the vast majority of market behavior is random, and,hence, attempts to predict prices are essentially useless and moreover unprof-itable. Although I