Monday, February 05, 2007

Are You Testing a Strategy or a Stock?

Goldman Sachs hedge fund Global Alpha and Trade-Ideas have something important in common: both use quantitative mathematics to count cards in the marketplace.
Mark Carhart, 40, co-head of the quantitative strategies group at Goldman Sachs Group Inc., uses his July speech to poke fun at the Berkshire Hathaway Inc. chief executive officer's penchant for investing in market-leading brands like Coca-Cola and Gillette. He cites study after study showing that big-name companies with high price-earning multiples or rapid growth rates make poor bets.

Carhart himself has a pretty good story to tell. Though he doesn't like to talk about it, Carhart is one of the world's most successful money managers, a mastermind behind Global Alpha, a $10 billion hedge fund for wealthy clients and employees of Goldman Sachs. In 2005, Carhart and co-manager Raymond Iwanowski, 40, notched a 51 percent gross return at Global Alpha. Posting that kind of gain requires taking risks -- and last year, Alpha lost 6 percent, its first deficit since 1999.

Carhart, a former assistant professor of finance at the University of Southern California, helps oversee other hedge funds, four mutual funds and scores of separate accounts. In all, he and Iwanowski have $101.5 billion at their command. Carhart and Iwanowski use math-heavy trading tactics that fund consultant Sol Waksman likens to counting cards in a casino. The two lead a corps of computer-loving traders, statisticians and finance and economics Ph.D.s.
Source: Richard Teitelbaum, Bloomberg, January 31, 2007

The whole premise at Trade-Ideas with our Odds Maker software is to give individuals the ability to trade as if they were counting cards at a casino. In other words card counters at a blackjack table determine if the dealer's shoe favors their ability to place large winning bets. Each hand is not what's the most important - it's the dealer's deck. What makes The Odds Maker software so different from other back testing tools on the market is its ability to evaluate the market's shoe - not just the individual stocks that did well.

The more analysis we do of the marketplace, the more we see that people are guessing - and mostly based on emotions. The Odds Maker allows you to trade like a professional speculator rather than an emotional investor.

There is so much marketing out there about back testing strategies, and most of it sounds exactly the same. When you as a trader evaluate the different tools that are out there, ask yourself this question:
Am I testing a strategy or am I testing a stock?
That should provide some good starting points as to what might work best for your trading style.

As technology gets better and better, you don't have to have an army of Ph.D.'s testing models for you, you just need a good piece of software. We hope you choose The Odds Maker!

1 comment:

D TradeIdeas said...

We're quoting Dr. Brett Steenbarger's comments on The Odds Maker and our analogy in this post:

"Market Perspective:

Downside Breakouts of the Opening Hourly Range - In past posts, I've mentioned the Trade Ideas Odds Maker module, which they compare to card-counting in a casino. It's not a bad analogy: the goal is to see when the odds are stacked for and against you with a specific trade idea. Well how about downside breakouts of the opening one-hour range for the S&P 500 Index (SPY)? We've had 9 instances in the past three weeks of trading, and the trader who faded these downside moves made money 6 times. The average winning trade made $.22 or over two full ES points; the average losing trade lost -$.10, or one ES point. That provided a net profit of $1.11, or over 11 full ES points.

I found no such comparable edge in fading upside breakouts of the opening hourly range. My observations with Odds Maker are that during bullish market periods (such as we've had recently), it's profitable to fade downside breakouts of opening ranges and during range bound periods, it's profitable to fade all opening range breakouts in ES. What I like about Odds Maker is that it quantifies what trades have been working lately. It doesn't mean those ideas will work for all time, but as long as the market's trend is intact, you can go with these ideas and do a little card counting."

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