Developing a Volatility-Proof Strategy
11/14/2011 8:30 am EST
A trading strategy that works in all levels of volatility is not a pipe dream, explains Stanley Dash, citing adjustments that can be made to existing strategies to stay in these or any markets.
In high-volatility markets, your trading strategy may change a bit. But how much adjustment do you need to make versus a low-volatility environment?
Our guest today is Stanley Dash to talk to us about that. So Stanley, if we’re in a high-volatility environment, do I need to tweak my trading system to make adjustments?
Ideally you shouldn’t have to. Now that’s an ideal, and it’s a pretty tough goal to reach, but let me explain why I say that.
Ideally, a trading strategy should be built so that it reacts automatically to the changes in volatility. Now although it’s an ideal, it’s not as out of reach as you might think.
We encourage strategy developers to use things like percentage movements instead of looking for a certain number of points. A certain percentage movement; average true range for a stop or for a profit target, so we’re gauging price movement differently; or even standard deviations as a calculation.
That way instead of just looking for a fixed number, if the market is more volatile, we have to take a little more risk with our stops, but we may also be able to achieve a little more profit. When things quiet down, those numbers will automatically collapse in a little bit.
So rather than try to build a separate system for a high-volatility environment or low-volatility environment, I should just adjust my existing system to take advantage of either one?
Well that’s the ideal. The one thing to remember, of course, is that if a strategy is built and progressing and it seems to not be following its historical norms—because market characteristics change—a trader has to be responsible.
Cut down the position size, maybe stop trading altogether, and have a fresh look at it.
If the characteristics of the market are so extremely different than what the strategy is used to, and if the historical norms or performance change, you really do have to back off and be responsible for it.
The beauty of technology like Tradestation is that I can make infinite number of adjustments and backtesting. The downside is also that I can make an infinite number of adjustments. How do I have a balance there?
Yeah, exactly. You know, I mentioned historical norms, and I think one of the ways to use the backtesting is not just to find a strategy that works and see how it worked in the past, but to find the benchmarks against which to measure the strategy going forward.
Whatever a strategy may have produced in theoretical profit historically, it may not produce tomorrow. But if a strategy tends to keep losing streaks short, keeps losses within reason, if it tends to trade with a certain personality, that’s the part you really want to look at going forward for historical norms.
When those don’t happen, then you do have to back off a little bit.
We alluded to trade size in there, and that’s really probably one of the best things a trader can do. If you’re miffed by the volatility, not sure about the kinds of adjustments that I was talking about, at the very least, trade a little smaller.