Connors Research Traders Journal (Volume 18): 10 Smart Ways To Improve Your Trading; Part 7 – Quantify, Quantify, Quantify
In this issue of the Connors Research Traders Journal we’re going to cover Part 7 of our 10 Part Series on 10 Smart Ways To Improve Your Trading.
Before we do, I’d like to let you know that I just completed a new book which is available now. The title is Buy The Fear, Sell The Greed – 7 Behavioral Quant Strategies for Traders.
My new book quantifies fear and greed in money managers, investors and traders. We’ve developed a number of quantified strategies around those high probability trading opportunities. The edges in the book are high – a number of the strategies have been correct well over 90% of the time in predicting prices in stocks and ETFs. As you know, fear and greed is inherent in the market place and when it occurs, substantial opportunities exist for you.
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This is Lesson 7 of our 10 part Series on Smarter Trading. Today’s lesson is Quantify, Quantify, Quantify. For some of you, this will be a reiteration of the message. For the majority who either trade with discretion, or straddle the world of trading both with discretion and systematically, I’m hopeful this lesson resonates strongly with you.
Let’s now look at the value of quantifying trading strategies.
Here’s a hypothetical choice for you to make. Let me know which choice you’d make.
Let’s say you have a medical situation that may require surgery. Nothing life-threatening but it is something that’s going to require you to make a decision whether or not to move ahead with the surgery.
You can take two paths in making the decision. Path one is discretionary and path two is data driven.
Path 1
You go to a recommended surgeon. He/She looks at you, looks at the tests that have been taken, and tells you they recommend you having the surgery.
You then ask some basic questions.
You – “How sure are you I need the surgery?”
Surgeon – “Pretty sure.”
You – “What does pretty sure mean?
Surgeon – “I’ve been doing this for 25 years. I’m suggesting surgery”
You – “What percentage of the time that you’ve done this surgery has it been successful?”
Surgeon – “It depends on the patient. It’s a high percentage.”
You – “Can you be more accurate?”
Surgeon – “I’m sorry, I don’t have exact numbers. It’s pretty high.”
You – “So you’re telling me if I have this surgery it’s going to take care of my problem – yes?”
Surgeon (and now they’re looking at you like you’re a pain in the a**) – “Well it may. There’s a number of factors and every patient is different.”
You – “Can you be more accurate…”
And this conversation will go around and around because you’re going to get a judgement call. There is no data to support their decision. “Pretty sure” is not data-based! And if you go for a second opinion, you’re likely going to get another judgement call and it may be completely different from the one above.
How do you feel right now? How confident and knowledgeable are you of making this decision?
Path 2
Same as above. But the surgeon supports his decision based on data. They tell you that based on the facts, there’s and a 94% chance of full recovery and a 99% chance that the recovery will be complete in 10 days. They back it up with hundreds (possibly thousands) of identical cases of patients like yourself. They’re not basing their decision on their gut – they’re basing it upon data.
Now how do you feel? Better? Which approach would you prefer?
I’ve lived through the first scenario with a family member (there’s a good chance you have too). It sucks. And guess what? The surgeon was wrong. No one died but the course of this family member’s life changed because we went with the surgery. Many months later, with the assistance of a friend in the medical industry, I was able to find studies which documented the results of the surgery that was done. Had I had that data ahead ahead of time, there’s not a chance in the world the decision to have the surgery would have been made. The risks outweighed the reward. The data showed that to me.
Let’s now move this same decision making process to trading. In many, many cases the above types of decision making occurs every day with trading. Discretionary versus data-driven. You have the opportunity to make data-driven decisions in your trading. You won’t get that from CNBC or Fox Business or from the large universe of discretionary analysts out there. Their approach is no different than the well-meaning, but non-data-driven surgeon I mention above.
You will get it from data-driven trading, though. Well-researched, correctly-tested data that allows you to see statistically, in a rule-based manner, whether or not the trade you’re about to take has had a historical edge. There’s no guarantee anything is going to work out in the future as it has in the past . But with all things being equal I’d rather have the data-driven, historical test results in front of me instead of someone who wears a tie and says “trust me – I know best.”
None of the above is intended to be a criticism of anyone in the medical industry. Two of my children’s godfathers are doctors and I hold the entire industry in high esteem. The example I give is to hopefully allow you to see that if you’re given a choice – opinion versus data – in most cases, the data-driven approach is better.
The opportunities to obtain data-driven results for strategies is the best it’s ever been in history. There are so many platforms now available to everyone. And it gets better and better. Just this weekend, a professional trading friend of mine emailed me. In spite of the fact that he has over 30 years of professional level experience, he still tests every directional-based strategy before he trades it. In his email he was excited because he was able to automate a well known long-term market timing strategy onto a platform that’s not known for it’s backtesting abilities. He relies on this platform for data – not testing – yet in a few hours he was able to do something that literally would have taken us more time to test on our own platform (and our testing platform is advanced and was primarily built by one of the original senior team members who built Excel for Microsoft). The platform he did his test on is nowhere near as robust as ours – it’s a testament to the technology industry that this firm was able to offer him what they now have.
Lesson 7 is aptly titled Quantify, Quantify, Quantify. I’ve written this before: “opinions are fine, data is better.” Having strategies that are supported by data is how many of today’s largest hedge funds run their business. If you have a STEM background you have a head start. If you don’t, it may be worth it to put in the time learning how to quantify. Or you can outsource the process either by purchasing quantified strategies from trusted sources or having a trusted source do the programming for you.
The days of discretionary trading and investing are fading away. Data-driven trading and quantification is the way the world works today. This is not only true in our industry – it is also true in most other industries. Making quantified data driven decisions is in my opinion, and many other professionals’ opinion, a much better and smarter way to trade.
I hope you enjoyed and learned from this lesson. In our next lesson we’ll focus on trading VXX.
Enjoy your trading!
Larry Connors
Connors Research LLC