tag:blogger.com,1999:blog-35364652.post1084490103207740141..comments2020-05-30T17:04:20.982-04:00Comments on Quantitative Trading: Does Averaging-In Work?Ernie Chanhttp://www.blogger.com/profile/02747099358519893177noreply@blogger.comBlogger36125tag:blogger.com,1999:blog-35364652.post-31780289150667897022014-12-16T06:59:18.825-05:002014-12-16T06:59:18.825-05:00Hi SeanP,
I unfortunately have not saved their art...Hi SeanP,<br />I unfortunately have not saved their article. But I have summarized some important points in my book Algorithmic Trading. I don't believe the authors are involved in publishing their research any longer.<br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-58035977245682040602014-12-16T00:14:15.014-05:002014-12-16T00:14:15.014-05:00Hi Ernie,
The link to the original paper is broke...Hi Ernie,<br /><br />The link to the original paper is broken. Can we get a new link or a copy via email?<br /><br />Many Thanks.SeanPnoreply@blogger.comtag:blogger.com,1999:blog-35364652.post-27957157368259769572014-09-14T09:51:34.226-04:002014-09-14T09:51:34.226-04:00Hi manuka,
That's a good observation. Yes, opt...Hi manuka,<br />That's a good observation. Yes, option A (averaging-in) is always in the middle of profit ranking.<br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-21671640962973113842014-09-14T03:34:48.544-04:002014-09-14T03:34:48.544-04:00I realise this is an old thread. I just looked thr...I realise this is an old thread. I just looked through the original post, and saw that irrespective of p, the average down strategy is always the second best (whether p>0.25 or p<0.25). Which sort of makes sense. Averaging down avoids extreme outcomes, which means you don't maximise the return, but in a relative sense you minimise the variance of the outcome.manukahttps://www.blogger.com/profile/05199985243335949245noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-9467442976254528772010-12-23T11:05:21.099-05:002010-12-23T11:05:21.099-05:00Hi,
Yes.
The technique is momentum based, being sp...Hi,<br />Yes.<br />The technique is momentum based, being specific it is based on post momentum analysis and how larger players will often try to get in at a better price and will hunt stops to do so.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-35364652.post-51274758254783544992010-12-14T08:12:27.737-05:002010-12-14T08:12:27.737-05:00Hi Anon,
Thanks for your contribution. I am assumi...Hi Anon,<br />Thanks for your contribution. I am assuming you are thinking of a momentum (trending) strategy, am I right?<br /><br />The averaging-in technique applies only to mean-reverting strategies. I have not thought about how we might go about averaging in if we are trading momentum.<br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-28463242496943749852010-12-11T07:05:32.989-05:002010-12-11T07:05:32.989-05:00What about the following scenario:
We trade based ...What about the following scenario:<br />We trade based on a known market phenomenon. We observe something, following this, we usually see price pull back before going up. BUT it does not always do this. This is something that happens usually within 2 bars on a chart, depending on time period we trade this can happen within 5 minutes, 15 minutes, 1 hour etc. we are not talking about huge swings and averaging down, we are talking about averaging IN. <br />Our total risk for a trade will be 3%. Our ideal entry is in the pullback area. If price pulls back there immediately that is where we enter at full size with stop level N. However sometimes price does not pull back and continues up, we are expecting it to pull back but sometimes it does just blow away. In this instance we put on 1% (1/3) position at stop level N. If it then blows away we are still in but if price pulls back afterwards to the level we were looking for (50%) we enter in at double size for another 1%, if price falls to 25% we enter in again at quadruple size for another 1% with stop still at level N. If we are wrong we still only lose our 3% assuming no gapping, slippage etc. If we are right, based on the phenomenon we are trading on price will explode upwards and we are in for much larger size than we would have otherwise been in for. Of course we could just miss out on the trade entirely and wait for the next one that's 'textbook' but that is not such an easy thing to do when day trading\scalping for example.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-35364652.post-19670143275823912942010-09-15T08:16:44.790-04:002010-09-15T08:16:44.790-04:00Thanks, Marc, for the insightful comment. Yes, I a...Thanks, Marc, for the insightful comment. Yes, I agree with your first observation. But not exactly sure about the second.<br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-29289410746864870882010-09-14T06:02:00.971-04:002010-09-14T06:02:00.971-04:00main problem is that the best strategy assume the ...main problem is that the best strategy assume the price to go back to 3$ somehow, which is less probable from 1$ than from 2$. so the bigger pnl is balanced by the probability of never seeing 3$ (or even 2$ for that matter) again... The other issue is that the existence that there's a better strategy por p<1/4 and ANOTHER better strategy for p>1/4 doesn't make the averaging down a suboptimal strategy.Marcnoreply@blogger.comtag:blogger.com,1999:blog-35364652.post-67756912651235382202010-02-26T09:51:33.687-05:002010-02-26T09:51:33.687-05:00Anon,
My example stated that we have $4 to invest,...Anon,<br />My example stated that we have $4 to invest, which is the maximum buying power. Since we anticipate the possibility of buying up to 2 contracts, we would not have invested all the buying power into the first contract.<br />Best,<br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-83353304821568268592010-02-24T12:56:51.855-05:002010-02-24T12:56:51.855-05:00The original question doesn't state (1)where t...The original question doesn't state (1)where the capital is coming from or (2) whether there is any cost of using the capital (which is indirectly addressed by the comment regarding risk).<br /><br />Question: Let's say that if one is running a fully invested portfolio, to have capital for a "new" position, one must sell the old position. It seems intuitive that as the expected return of the new-example position increases (i.e. as the price declines), it makes sense to sell increasing amounts of the old open position. This argues for the averaging in approach, doesn't it?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-35364652.post-47570914418343359792010-02-19T08:18:33.603-05:002010-02-19T08:18:33.603-05:00Great discussion here. It echoes what I have foun...Great discussion here. It echoes what I have found in my systems development: that averaging-in is too often just a repair for habitually bad entries.<br /><br />My studies have shown that with most GOOD systems, a larger initial entry size beats a number of smaller entries averaged-in. This is because when a trade moves in the intended direction soon after initial entry, planning to "average-in" later on leaves you with a smaller position as the trade takes off.<br /><br />In essence, find a good system in which a favorable move occurs sooner rather than later - and "load the boat" early on.Unknownhttps://www.blogger.com/profile/09566740646010258740noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-28244262141747735022010-02-07T09:00:05.800-05:002010-02-07T09:00:05.800-05:00Yes, MPConvert, I agree. Indeed, the future is unk...Yes, MPConvert, I agree. Indeed, the future is unkownable, which is why what's optimal in backtest may not be optimal in the future.<br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-87434596488554360572010-02-06T13:28:27.645-05:002010-02-06T13:28:27.645-05:00The explosion in the market on Friday was a good e...The explosion in the market on Friday was a good example of how averaging in can work, because the future is unknowable. P is make believe. I've found that by averaging down - I'm able to lower my basis enough, so that on normal volatility, I'm able to exit a trade at close to B/E, if I want out. It has worked for me and against me, but I would never rule it out based on a mathematical equationAuthorhttps://www.blogger.com/profile/00828169881002489757noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-3786407984037978532010-01-20T21:38:19.874-05:002010-01-20T21:38:19.874-05:00Hi Crazy Hog,
p can certainly be estimated with m...Hi Crazy Hog,<br /><br />p can certainly be estimated with many statistical techniques. In fact, in a crude way, you can simply backtest your strategy with different assumptions of p, and the value that gives you the best Sharpe ratio is the estimated value of p. (This is similar to a Maximum Likelihood Estimation.)<br /><br />As I have said in my article, price series is generally not stationary. So if p has a borderline value, decisions based on past estimation of p do not guarantee optimal future performance. However, in other cases, the value of p is stable and far from borderline. In such cases, backtest and past performance does predict the future. In this second scenario, there is no rational reason to follow your suggestion, and I would agree with Ron and Al's analysis.<br /><br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-49210714082638708082010-01-20T15:47:48.667-05:002010-01-20T15:47:48.667-05:00Hi Ernie,
Here is the question I don't know t...Hi Ernie,<br /><br />Here is the question I don't know the answer to. <br /><br />Can p be determined reliably? What I mean is this. There are various techniques (mean reversion, correlation, fundamental analysis, etc.) that allow us to predict current price at A should be at B. On the other hand, I honestly don't know any reliable way to determine the probability p (and the magnitude) of further price drop before reverting back. Is there a way to determine p?<br /><br />I think p is usually is not knowable in practice. Therefore, if given a guranteed profitable trade, a bird in hand is better than waiting for the 2 in the bush. Especially since good opportunities are usually fleeing.<br /><br /><br />-Crazy Hog<br /><br />p.s. I don't think technical analysis can be used to reliably determine p.狂猪https://www.blogger.com/profile/16599529315620633684noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-81293338755182530272010-01-19T12:38:18.258-05:002010-01-19T12:38:18.258-05:00Hi Crazy Hog,
Whether your suggestion is optimal u...Hi Crazy Hog,<br />Whether your suggestion is optimal under realistic market conditions is not what I was discussing in this example.<br /><br />Under the assumptions of my example, if p is close to 1, you would have forgone close to half of your profits when you go all-in at $2, regardless of what leverage you deploy. On the other hand, if p is close to 0, then indeed we should follow your suggestion.<br /><br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-74055141146364555322010-01-19T11:42:53.303-05:002010-01-19T11:42:53.303-05:00Hi Ernie,
On your point of all-in at what price,...Hi Ernie,<br /><br /><br />On your point of all-in at what price, the answer should be don't wait and go all in at $2 and with maximum leverage immediately. Waiting is just risking not to profit at all. Don't be greedy by waiting for better price. Be greedy by leveraging up. <br /><br /><br />-Crazy Hog狂猪https://www.blogger.com/profile/16599529315620633684noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-54376575811507670712010-01-18T21:51:20.581-05:002010-01-18T21:51:20.581-05:00Hi Crazy Hog,
You are right in saying that the bes...Hi Crazy Hog,<br />You are right in saying that the best strategy is the one that maximizes Sharpe ratio (a point which I made repeatedly in my book). However, this is not the point of my example. My example is not to tell you the ideal strategy, it is merely to compare the profitability of averaging-in vs all-in (at different thresholds).<br /><br />Also, I disagree with your assertion that just because mean-reversion is assured, you should go "all-in", because it begs the question: all-in at what price? In the face of uncertainty, you would not know whether to go all-in at $2 or at $1, since you may or may not reach $1.<br /><br />Finally, there is a theory that dollar-cost averaging is an optimal investment strategy, though it is more relevant to a buy-and-hold portfolio than a trading strategy. For details, see http://epchan.blogspot.com/2007/01/universal-portfolios.html.<br /><br />Ernie<br /><br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-31232857881159792962010-01-18T20:12:37.229-05:002010-01-18T20:12:37.229-05:00Hi Ernie,
A correct comparision must be risk adju...Hi Ernie,<br /><br />A correct comparision must be risk adjusted. When method A is handicap with up to 50% of capital not put into play, the risk profile of methods A, B & C are very different. The conclusion draw from this is misleading. <br /><br />Also, I think it is fair to assume mean reversion will happen. However, it isn't fair to assume mean reversion will happen before investor capitulation. This is the important missing piece in the probability model. After all, if you are certain of mean reversion and certain you'll survive to profit from it, the right play should be to go all in with maximum leverage. <br /><br />By the way, your description of average in is based on price. Why this approach and not the approach of average in base on time? For example, buy a fraction (say 1/10 of the account equity) every week for 10 weeks regardless of price movement. What are your thoughts of this method of average in to minimize a major timing mistake?<br /><br /><br />-Crazy Hog狂猪https://www.blogger.com/profile/16599529315620633684noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-88777218971820243922010-01-18T11:01:49.107-05:002010-01-18T11:01:49.107-05:00Pratik,
An overall point in my example is to illus...Pratik,<br />An overall point in my example is to illustrate whether averaging-in generates more profit (when mean-reversion does happen) with the same account equity, not whether the returns on investment (i.e. gross market value) is higher. Whether or not you actually invest in the second position, you still need a fixed account equity to prepare for that event. Therefore returns on equity is a more useful measure than returns on investment, especially for futures trading example that I constructed.<br /><br />If you assume there is no mean-reversion, you can of course construct a different example to illustrate whether the loss will be greater or less with averaging-in.<br /><br />Note that I constructed an example for illustration, not a proof, so the example would not encompass all possibilities of future price movements. For a proof, you should refer to Ron and Al's original paper.<br /><br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-74587515365573716762010-01-18T10:41:58.977-05:002010-01-18T10:41:58.977-05:00Korben,
I have no idea how many records there are ...Korben,<br />I have no idea how many records there are in the US historical tick database. However, you can certainly ask Tickdata.com about that.<br />ErnieErnie Chanhttps://www.blogger.com/profile/02747099358519893177noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-15566952483276154902010-01-18T01:23:40.947-05:002010-01-18T01:23:40.947-05:00I do not when it is not averagedI do not when it is not averagedCalculatorhttp://futuresbasis.comnoreply@blogger.comtag:blogger.com,1999:blog-35364652.post-27566503925186086832010-01-17T11:49:01.366-05:002010-01-17T11:49:01.366-05:00Right.. Thanx a ton..
Pratik
http://pratikpoddarc...Right.. Thanx a ton..<br /><br />Pratik<br /><a href="http://pratikpoddarcse.blogspot.com" rel="nofollow">http://pratikpoddarcse.blogspot.com</a>Pratik Poddarhttps://www.blogger.com/profile/11577606981573330954noreply@blogger.comtag:blogger.com,1999:blog-35364652.post-56561162397130447562010-01-17T11:45:50.810-05:002010-01-17T11:45:50.810-05:00Pratik,
I think you are right (I didn't check...Pratik,<br /><br />I think you are right (I didn't check your math). <br /><br />Just to add to your point about the 2nd fatal flaw, if we knew apriori the outcome is 3 with certainity, forget averaging-in! We should go in with everything and leverage up as much as we can muster!<br /><br />The description from Ernie above is not the correct dollar cost average approach. <br /><br />The idea of a diversified portfolio is to minimize idiosyncratic risk of a particular company. The correct dollar cost average approach is a way to minimize the risk of a single entry timing. If we accept the idea of a diversified portfolio, we should also accept the idea of a diversified entry timing.狂猪https://www.blogger.com/profile/16599529315620633684noreply@blogger.com