Posted by: Bevan | October 11, 2009

Market Type

Anyone who follows Van Tharp, especially his free newsletter will have noticed his increasing emphasis on market type, a theme that looks to be carried through in his new book.  He’s done a lot of statistical work on identifying market type (including the development of something called the SQN (TM) which gives a numerical readout revealing the current market condition).  Currently its pointing out that we’re in a strong bull market (something any number of trend indicators could have said) and I suspect its another example of Van Tharp’s penchant for adding unnecessary mathematical complexity to trading (the famous trend trader Ed Seytoka once unkindly referred to some of Van Tharp’s thoughts about money management techniques as ‘mathturbation’!).

The problem with any technique which attempts to read market condition before applying a fitting strategy is that you will tend to be constantly whipsawed.  Those who make money trading are those who apply a trend following strategy at a time when it doesn’t look as though the market is going to trend.  Likewise a mean reversion trader will need to sell when it looks as though the price is going to the moon in order to make decent profits.  Both actions are of course backed up by suitable position sizing and risk management to cover the times when they are wrong.

Eurodollardec09You could make an argument that by the beginning of August the Eurodollar was in a trading range.  If you had responded by switching to a countertrend system you might have completely missed a profitable, low risk entry into a sound uptrend since then.

There are plenty of both types of system around that will make money over the long term – whether by trend trading or countertrend and short term trading (the latter less common).  I believe that trying to ‘time’ these systems is about as effective as trying to time the bottom or top of the market – a low probability, low yield game.  The money is to be made in operating a diverse range of strategies so that in ranging markets where a longterm system is losing money another technique (perhaps a shorter term countertrend system, or the use of options) is making profits and lowering the total drawdown.  The great benefit of this approach is that drawdowns are reduced arithmetically, whereas total returns of the two systems are cumulative.  Thus the return to drawdown ratios of a trader can improve dramatically.

In my own trading I currently operate a medium term tren following strategy.  My aim is to complement it with a long term trendfollowing system in the future when my account size permits me to diversify across futures markets.  All I’ve got to do is do everything possible to build that critical mass of equity!

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