Why I took a 5-day Moving Average instead of the 9-day Moving Average?

As I promised in the last post, I will review my decision of taking a smaller moving average. My purpose wasn’t to overfit the model, I was looking for a drawdown in which I feel comfortable. 

How did I start?

I had an idea about a day trading system. My objective was a good performance with adjusted risk. I’m a big fan of the stop loss. If you, as a trader or an investor, can avoid drawdowns bigger than 20-25%, you will be successful over the time.

Our example

The good point about the way I run the backtestings is that it’s easy to change some parameters and adapt to different indicators. Obviously, I ran the strategy with different moving averages in order to know what parameters generated a smooth performance curve avoiding big drawdowns. 

       Max drawdown and final balance from the different MA, own elaboration

As you can see the best profit to drawdown ratio was the system based on the 5-day Moving Average. This seems logical as it’s a daily trading system. The reason behind the bigger drawdown, in the MA3 system, is that the there is more noise in the entry signals and it´s not accurate enough with the tight stop loss. In the case of the MA9, MA15, and MA50, the signals are more accurate but the retracements and the close stop loss don´t allow the systems to perform as well as the ones with lower moving average. If you see the MA9 system's figures, you will understand that the profit is exactly the same as the MA5 but the drawdown is worse. 

        Max drawdown  from the different MA systems tested, own elaboration

This chart is complementary to the table and the explanation above. Surprisingly, at least for me, the MA50 has a lower drawdown than the MA15. If we think about it, probably the best system would be between the 3 and the 9-day moving average. As I said before, I didn’t optimize the system. 

         Performance of the different systems tested, own elaboration

This chart is more important than the ones shown above. Here you can see how the MA5 system has barely stayed under the initial balance invested. Even after its worst drawdown the system was up more than 5% while the other ones went under 10K (and the worst one, under 9K) The main reason is that a “small drawdown” is not as painful as a big one, in simple terms, capital preservation will assure you better financial future. Imagine that you could have avoided all mistakes in the stock market (or futures) or at least you could have limited your loses. I’m sure that today, you will be better off. The reason is the asymmetrical leverage.

(second part of this post: First lesson for an investor )

 Having said that, I would like to add that I´m not questioning your investments decisions. I´ve made so many mistakes in the past and some of the trades were good considering the expected value of the trade. 

          Final balance of the systems tested, own elaboration

To finish, I wanted to show you the chart of the final balance after 3.56 years. The best system has returned 56.6% which is a little bit more than 18% per year.

Final thoughts

I hope that you like this post. The main purpose was to show you how to analyze the systems and even extrapolate the basis and test different indicators or the same indicator at a different level. The stop loss can be painful but I wouldn’t place an order without knowing my stop and target. As I said the asymmetrical leverage is very important because recovering small losses is easy while recovering big drawdowns can be really difficult. You have seen this concept with the system reviewed. Thanks.

Have a good trading!!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved

#trading #MovingAverage #Backtesting #Drawdown #Analysis #QuantitativeAnalysis

Why should we save money and invest it? First lesson for a new investor

Introduction

Even if you have a small salary you can become a wealthy individual over the time. In order to do it, or at least to try, you need to be disciplined and save a certain percentage every month. There is no rule to save a certain percentage of your income every month. It depends on your personal situation and the goals that you set up before starting this journey.  

Example

Let’s make a hypothetical example. A young person has a salary of 20000$ per year after taxes. This person knows that he/she can live with this salary but he/she can’t afford to pay certain hobbies. Let me call this person David to make it easier. One day, David decides to write in a paper his desired lifestyle for the future. He doesn’t want to change the job because he likes it and the workplace is nearby. He knows that saving money is not enough, so he starts looking for an extra income. He lives in a medium size town so there are limited opportunities. After thinking about it, he decides that is going to save 10% of his salary and invest it at the final of the year. In this case, he will be saving 2000$ every year and this amount will be added to the portfolio at the final of the year.

Let’s supposed 4 type of portfolios he can invest in and the returns that he can get if he is committed with one of them.

         Different portfolios, own elaboration

These calculations are made by the assumption of that 2000$ are saved and added every year, the interest rate is fixed (2%, 5%, 7% or variable in the case of S&P500), it’s calculated for 40 years and he doesn’t withdraw any money.

As you can see if he decides to invest in a portfolio that returns 2% per year, after 40 years, he will have 123220.05$. Considering that in his lifetime has saved 80000$, means that this portfolio has made 43220.05$. This is a very conservative portfolio that probably is not the best to meet your goals. Let me compare the last figure (accumulated savings + return generated) of the rest of the portfolios:

                5% per year = 253679.53$

                7% per year = 427219.14$

                SP500 annual return = 1212688.82$

The last portfolio is the riskiest, but what a great return.

What are the steps to start your own journey?

1. Set up your future goals
2. Evaluate your current situation, make a spreadsheet with your income and expenses and figure out how much money you save and how much money you will put in the investment portfolio
3. Choose an investment that suits your risk aversion and risk-reward ratio, make sure that you understand the chosen investment and the risk involved.
4. Ask for advice about the best way to set up your ideal investment account, with a risk and money management system (online, in your bank, with a financial advisor, in a brokerage)
5. Be disciplined, keep saving an investment as your plan dictates

Why is the Risk management important?

One of the most important things to succeed as an investor is the risk management. I can’t talk about this topic because I haven’t described a strategy to follow. It depends on the type of investment you choose. But probably, the first thing I would teach to a new investor is the Asymmetrical Leverage. It refers to the required gain to recoup from a loss increases geometrically. 

      Asymmetrical Leverage, own elaboration

This chart is a clear representation of the definition above. It means that if you lose 10% of your portfolio you need to gain 11.1%, which is more than the original 10% loss. Let’s imagine a 1000$ portfolio that loses 10%, so the portfolio is valued at 900$. The difference with the original portfolio is 100$ which is the same amount we need to gain to recoup the initial portfolio. If you divide 100$ by the new value of the portfolio, 900$, the result is 11.1%

As you can see in the chart the amount to recoup grows geometrically as soon as we incur in bigger loses. 

I think this is the first thing that an investor or a trader should learn. If you check, all the successful investors and traders have a sounding risk management and I guess that they have this chart on the wall.

Conclusion

Saving part of our income and investing it over the time is one of the best things we can do. Every time I say investing, it's in a responsible way. There are a lot of practices to avoid such as invest according to the media or the comments on the internet. You should generate your own ideas or reasons. If you are not ready or you don't have time, there are a lot of kind of investments and professional services that can help you. In that case, and depending on your resources, you can invest in Exchange Traded Funds, talk with your bank, open an account in an asset management or invest in hedge funds. If you want to try the joy of trading or investing on your own, there are a lot of resources to learn the basics. I would recommend spending several months with a paper trading account. This post shows only a hypothetical example of how lucrative can be. If you don't, believe me, Tony Robbins has a book with real examples of people that committed to saving part of their income and they became successful financially speaking. Please bear in mind that the past returns are not indicative of the future ones. As I said one of the most important things is the risk management. All the best of luck in your journey!

Have a good trading!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved

#asymmetricalLeverage #investing #journey #loses #profits #returns #rRskManagement #savings #TonyRobbins, #Trading #wealthy #creating value # compounding_interest