Saturday, February 27, 2010

Performance Review NDX Fast Butterfly

Link to Live trades:
FEB NDX Fast Butterfly Day-by-day review (4 trades)

So, let me start with a log of all trades (Live and backtested) for this strategy, I’ve tested the NDX Fast Butterfly for a little over one year before I started trading live, here is my log:

This is fine, but let’s also look at a simulated equity curve chart based on this data:

You’ll notice in the above picture that despite the ups and downs, categorized by a relatively smaller win-ratio (60%), the strategy makes money over time because its good win-loss ratio. Therefore, moving forward it is imperative to control the win-ratio and do not let it run out of hand.

I’ve decided to go back to the most basic factors when determining if you have a positive edge: Win-loss ratio and percent wins. With these two numbers, and the average win, you can use a very nice tool that Henry Carstens put together to test your edge, go to and check it out for yourself, just plug in the variables and run a few scenarios to make sure your position is still a winner.

I hope you enjoy this new approach at looking at your trades from a different angle.



Carlos Felicio said...

Hi Gustavo,

Thanks for the link on the other post to your RSS Feed, now I can keep track of your blog! :)

I will start posting in english as your blog is in this language, so the other readers can understand :)

Thanks for posting the backtest on your strategy, that's pretty cool. I noticed you are using money management concepts as well, which helps a lot in the long run.

The question I have is, how are you calculating your ROI? Is it based on the value ($) of the position you opened, on the risk per position, or on the total capital you have?

By looking at the chart, it seems it is on the total capital, then I'd say this is a very high return.

What kind of risk are you taking per position? If NDX gapped up / down 300 points in one day (very unlikely, but let's say it happened), would you be wiped out or suffer a significant drawdown?

Thanks for your insights! :)


Gustavo's Trades said...

Hey Carlos, thank you for the comments, I hope the RSS helps you along the way.

For the backtesting and my live trading results I track the ROI relative to the initial position size. For instance, say I start an Iron Butterfly and allocate around $3K to begin with, my goal will be $300 and the max loss around -$450. If during the trade I add another butterfly, or make it an unbalanced butterfly (by rolling the side that is in danger) and such adjustments require additional margin to be posted, I continue to track my ROI based on the original position.

The main reason I do that is because of money management and consistency. If I trade the same ammount over several months, I want to make sure my max loss is around -1.5 times what I make in a winning month. If I keep changing the ROI based on the capital changes during the "in-flight" trades this would not add up.

The ROI posted is based on the position size. NOT on my portfolio. I use risk management to allocate only a portion of my portfolio on each position. Therefore, the Portfolio ROI is smaller and more contained within my risk parameters.

As far as your second question, for a huge gap, as long as the market is open and trading, I will have contingent orders to hedge the trade at certain levels. This is my first line of defense. The second line is an email alert, as soon as a hedge is triggered, I receive an email and make the point to check where we are in the market. Most of the times I'll have two levels of contingent orders, when the second level gets triggered, then I MUST watch to see what is going on..

So, To summarize my risk management: First level is to have contingent orders to hedge each position; Second level is to exit around max loss; Third level is to allocate only a portion portion of my portfolio per position. If nothing else works, my third level of risk management ensures I'll be able to continue to trade should a major black swan happens.

I am risk averse, and would not allow myself to allocate too much money so that a major event can wipe me out. That is key for any trader who wants to continue to trade. Make controlled bets, never bet the entire farm.

Hope that helps,

Chad said...

Hi Gustavo,

Thanks, as always, for taking the time to respond to questions. And thanks Carlos for the English :-)

Gustavo, I know from your earlier posts that the ultimate hedge you employ (other than contingent orders and getting out at 1.5 cash flow regardless of emotions) is capital allocation. What is the most you are/would allocate to one trade position? Do you have a rule of thumb you live by? Every month, do you try and allocate all of your trading capital and divide it among, for example, 5-6 trades? I was curious about this, mainly, as to whether you had a plan each month for capital allocation, and what the max you would allocate on one trade.

All the best,

Gustavo's Trades said...

Hey Chad,

I never allocate all my capital for trading options in any given month. First because you need reserves for adjusting, second because no matter how good you are, there is always a possible black swan event that you won't be able to defend against and that could potentially wipe out all the positions you have on.

Take 911 for instance, the market crashed, closed, and opened (AFTER expiration) way lower than originally. So, if you were not able to close/hedge your trade during the madness, you would likely be wiped out. I was not trading back then, but it is worth asking other traders about what did they do when this thing happened.

As far as what % do you or should you allocate for each trade. It ties back to your trading plan: How much are you willing to make per year, what trades you're planning on using, what is the performance you expect for each one of these trades, and ultimatelly, can you afford to lose all that you allocated if a black swan event happens and you got all bases loaded (i.e. all your trades still on the table). So, there is a lot more than a simple % or rule of thumb..

I spent several days discussing this with my wife and business partner. Can't provide you all the details, only that the questions above were the ones I had to have an answer before we put our plan together.

This is why I feel is imperative that as a trader I understand what I'm trading, that I backtest what I'm trading and that I have supporting information as to what kind of results I'm expecting.. all this is information that you need to take into account, trading is a lot of work, not just plop a position on and expect for the best. :)

Did I mention you also need to track and monitor the on-going performance? Does it tie back and agrees with your backtesting results? Are the expected results comming in-line with your original assessment? Are you doing something wrong that you can fix? etc..

Those performance reviews are not just to showcase possible revenue.. But to compare, contrast and make sure I'm trading the path I planned when I begun trading the strategy.


Chad said...

Thanks again Gustavo for the reality check which I needed. My weakness is that I haven't spent the hours upon hours back testing, and doing performance reviews, asking myself how I can improve... and I must admit that I need to change this if I every want to be successful as a trader. I need to put the time in.

"all this is information that you need to take into account, trading is a lot of work, not just plop a position on and expect for the best. :)" So well put Gustavo.

Thanks for sharing your experiences, your knowledge, your mistakes, your successes.


Chad said...

Forgot to mention: you have a great business partner! My dog doesn't ask the tough questions, which need to be asked! :)

Have a great week,

Gustavo's Trades said...

Hey Chad, don't beat yourself over it. It sure is easier said than done, but it is part of the business. Just like any other business you decide to own, it will require dedication..

Take care!