Systematic Trading

Robert Carver
MTA webcast, 2nd March 2016
Why trade systematically?

Mistake #1: Overfitting

Mistake #2: Too much risk

Mistake #3: Trading too often

Why trade systematically?

Mistake #1: Overfitting

Mistake #2: Too much risk

Mistake #3: Trading too often

Why trade systematically?

Mistake #1: Overfitting

Mistake #2: Too much risk

Mistake #3: Trading too often

 Why trade systematically...
Human biases
Transferable
Repeatable
Automation is possible (lower running costs)
Large portfolios are easier more diversification
Back testing:
Confidence it would have worked in the past

(may in the future)

Understanding of likely behaviour

Knowledge of performance / behaviour

envelope
 Bias: Which brain do you trade
with?
System one (fast, instinctive, emotional)

System two (slow, effortful,

infrequent, logical, calculating)
Bias: Why trend following works...
 Why trade systematically...
Human biases
Transferable
Repeatable
Automation is possible (lower running costs)
Large portfolios are easier more diversification
Back testing:
Confidence it would have worked in the past

(may in the future)

Understanding of likely behaviour

Knowledge of performance / behaviour

envelope
Why trade systematically?

Mistake #1: Overfitting

Mistake #2: Too much risk

Mistake #3: Trading too often

Mistake #1: Over fitting
 Types of overfitting

Explicit: Fitted in the backtest

Implicit: Discarded, not in the backtest

Tacit: Included in the backtest with tacit knowledge

Explicit: Fit out of sample with
expanding window
Explicit: Use robust fitting
techniques
Explicit: Use robust fitting
techniques
 Implicit and Tacit
Reduce the number of alternatives considered
Every model / variation dropped will inflate past
performance
Reduce iterations:
Don't try and polish coal
Don't improve (overfit) if performance okay
Be aware of tacit overfitting no solution (?)
Why trade systematically?

Mistake #1: Overfitting

Mistake #2: Too much risk

Mistake #3: Trading too often

 Mistake #2: Too much risk

What percentage of capital is

safe to put at risk on each
trade?
 Mistake #2: Too much risk

What percentage of capital is

safe to put at risk on each
trade?

Answer: it depends.
 Determining bet %
Optimal target portfolio risk:
(Realistic) expectations of Sharpe Ratio

Type of trading / holding period

Skill

Diversification

Backtest degradation

Higher moments (skew, kurtosis)

Attainable, given leverage limits

Safe, given leverage required

Investor comfort zone

Portfolio size (average # positions)

Holding period
 Calculate correct bet size
SR: 0.5 Average number of positions
1 2 5 10 20
4 days 3.1% 1.6% 0.6% 0.3% 0.2%
Holding period

9 days 6.3% 3.1% 1.3% 0.6% 0.3%

17 days 9.4% 4.7% 1.9% 0.9% 0.5%
1.5 months 12.5% 6.3% 2.5% 1.3% 0.6%
3 months 25.0% 12.5% 5.0% 2.5% 1.3%
26 months 31.3% 15.6% 6.3% 3.1% 1.6%

SR: 1.0 Average number of positions

1 2 5 10 20
4 days 6.3% 3.1% 1.3% 0.6% 0.3%
Holding period

9 days 12.5% 6.3% 2.5% 1.3% 0.6%

17 days 18.8% 9.4% 3.8% 1.9% 0.9%
1.5 months 25.0% 12.5% 5.0% 2.5% 1.3%
3 months 50.0% 25.0% 10.0% 5.0% 2.5%
26 months 62.5% 31.3% 12.5% 6.3% 3.1%
Why trade systematically?

Mistake #1: Overfitting

Mistake #2: Too much risk

Mistake #3: Trading too often

 Law of Active Management

Pre cost
3
Typical future
Spread bet

0
1 month 1 week 1 day Half a day One hour
 Law of no free lunch

Pre cost
3
Typical future
Spread bet

0
1 month 1 week 1 day Half a day One hour
 Some lunches very expensive

10

0
1 month 1 week 1 day Half a day One hour

Pre cost
-5 Typical future
Spread bet

-10

-15

-20
 How do we get rich?
Increase pre-cost performance
Same stuff, done quicker
Different stuff, done quicker
Better stuff, at the same speed
Reduce trading costs
Reduce commissions
Increase AUM
Trade more
Provide liquidity
Reduce slippage
Patience
Provide liquidity
 Do same stuff quicker

3 Theoretical
Actual

0
1 month 1 week 1 day Half a day One hour
 Do different stuff

3 IMC / Virtu
Buffet

0
Years Months Minutes Seconds Milliseconds
 Do better stuff at same speed
Signal diversification
Market diversification
(We've already dealt with Time diversification...)
Better stuff - Signal diversification
Better stuff - Instrument
diversification
 How do we get rich?
Increase pre-cost performance
Same stuff, done quicker
Different stuff, done quicker
Better stuff, at the same speed
Reduce trading costs
Reduce commissions
Increase AUM
Trade more
Provide liquidity (rebates)
Reduce slippage
Patience
Provide liquidity (capture spread)
 Capturing the spread

Fast Slow (with algo)

Trend follower Pays Both (net flat)

Mean reversion Captures (normally) Both (net flat)

Pays (if stops hit)
My book is available from:

systematictrading.org
And / or, you can read my
blog:

qoppac.blogspot.com
Spreadsheets:

systematictrading.org/resources
My open source python backtesting software:

qoppac.blogspot.co.uk/p/pysystemtrade.html OR
github.com/robcarver17/pysystemtrade
My book, and other resources, are
available from:

systematictrading.org

Blog, and python code links:

qoppac.blogspot.com

@investingidiocy