About Positive Expectation

MODUS Mini-Course PART 1

Introduction

Richard Dennis, the legendary trader who was arguably the best of them all, proved that trading can be taught, in that famous Turtles Experiment.

If you would like to read more about the Turtles Experiment and the history of systems trading, you can read my article The Evolution of Systems Trading

Since that time, systems trading has advanced by leaps and bounds as ever faster computers and communications systems have enabled professional traders to improve their knowledge and experience of trading the futures markets.

This mini-course includes a typical example of how newcomers choose to evaluate system rules and contrasts this with the approach taken by professional traders.

Setting the Scene

Consider someone who is keen to find out about trading commodities and has perhaps read a couple of books about the subject. Most of us start that way.

After this they purchased some software that allows input of the ‘rules’ for entering and exiting the market and then obtained historical prices to enable simulated trading to be carried out.

This person could well be you. Let’s imagine that it is.

Your System Rules

You are interested in testing some system rules that you have obtained. There are plenty of rules around and it is quite easy to find them without spending money.

The rules you wish to test are for a straightforward trend following system that uses two parameters called ‘long term moving average’ and ‘short term moving average’.

It is of a type known as a Crossover System and is very commonly used - but is none the worse for that.

Historical prices spanning a 10 year period will be used in the evaluation tests, for a list of 26 commodities.

These are what is known as daily ‘OHLC’ prices, for the period from 1st January 1994 to 31st July 2004.

The 26 commodities are a selection of ‘heavily traded’ markets, as follows:

Code	Commodity Name	Code	Commodity Name
AD	Australian Dollar	HU	Unleaded Gas
BO	Soybean Oil	JY	Japanese Yen
BP	British Pound	KC	Coffee
C	Corn	MP	Mexican Peso
CC	Cocoa	NG	Natural Gas
CD	Canadian Dollar	PA	Palladium
CL	Crude Oil	S	Soybeans
CT	Cotton	SB	Sugar
ED	Eurodollar	SF	Swiss Franc
EU	Euro FX	SI	Silver
GC	Gold	SM	Soybean Meal
HG	Copper	US	US Bonds
HO	Heating Oil	W	Wheat

Reproduced from the MODUS Commodity Trading Course

Your First Attempt to Evaluate Rules

In order to test these rules over an extensive range of markets, you decide to select 20 commodities from the given list and load your software with their daily prices for the 10 year period.

Next, you set up the ‘entry and exit’ rules in the manner required by your software, using parameter settings of 200 days for the long term moving average and 100 days for the short term moving average.

A Single Commodity Approach

The software will now make one run for each of the commodities and will generate trades according to the buy and sell signals produced from employing the system rules.

All of this is very typical of what is done.

Working one commodity at a time is a fairly laborious process but when the tests are completed you extract the results information and summarize it as follows:

TRADE RESULTS - 1 st January 1994 to 31 st July 2004

		Winning	Losing	Total	Profit
Commodity	Code	Trades	Trades	Trades	$
Soybean Oil	BO	5	31	36	24,582
British Pound	BP	5	18	23	54,556
Corn	C	4	19	23	33,259
Cocoa	CC	8	27	35	23,602
Canadian Dollar	CD	8	26	34	36,212
Cotton	CT	4	20	24	41,176
Euro FX	EU	1	1	2	54,321
Gold	GC	4	13	17	40,911
Copper	HG	5	21	26	30,544
Japanese Yen	JY	7	17	24	63,479
Coffee	KC	8	20	28	58,161
Mexican Peso	MP	4	18	22	30,614
Natural Gas	NG	6	29	35	-16,485
Soybeans	S	6	22	28	41,124
Sugar	SB	3	5	8	25,920
Swiss Franc	SF	4	14	18	67,821
Silver	SI	11	43	54	4,911
Soybean Meal	SM	5	5	10	56,145
US Bonds	US	5	29	34	23,352
Wheat	W	8	29	37	29,541

	Totals	111	407	518	$723,746

(These results were produced using Trading Blox, single contract trading)

It all looks good but I'm not so sure ...

The summary shows that a profit of $723,746 is produced by the test.

These appear to be very promising results – you are impressed. The rules certainly seem to have a positive expectation (Read About Positive Expectation).

What are you going to do now?

Being somewhat cautious, you are not about to start placing orders with a broker straight away.

You don’t feel you know enough about trading futures to start doing so yet. You decide to find out more and you want to look at some other system rules too.

Part 2 explains how you proceed after your research leads you to a complete method which guarantees you avoid the mistakes most newcomers to systems trading make.

Modus Commodity Trading Course

Modus Trading
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