They Know Fractal About Trading

Today here’s one of my Technical Workshop Analysis Tuesday posts or TWAT for short. It’s part of a series of about one million articles to undo some of the damage done by sub-standard private investor training in the UK!

If you go on one of these courses you’ll be told about some strategy by someone who, if they even trade at all in real life, probably hasn’t used the strategy, didn’t design it themselves and doesn’t really know why it works. If the strategy is at all involved, and uses more than a frighteningly unsophisticated methodology (or sometimes because it doesn’t), they are usually sold as what are called ‘black box’ systems. In other words you can’t see how they work. Usually these black box systems are bought from people who’ve designed them, shagged them to death, and in doing so created a nice little track record while they did still work. Now you as a private investor are getting them. Do you seriously think they stand a good chance of working? Would you sell a successful trading strategy? Have a look on EBay and see how many geese that lay golden eggs there are for sale.

What you’ll often hear about trading systems is that they’ll work on any time frame. This is often followed by the buzzword “fractal”. Yes they love this word. It is however simply untrue.

Imagine you’re looking at a trading strategy. Let’s say it’s supposed to produce an average of 50 points per successful trade. We should be able to see by simply looking at the chart that 50 points is quite a realistic amount for the strategy to be able to work in the suggested time frame, if the strategy is sound. However, assuming the banal 3:1 risk:reward mantra, your stop loss here is 17 points plus the spread. Maybe that’s certainly going to get your position taken out in no time, again something we should be able to see quite easily with a cursory visual check. Perhaps the strategy is better suited to a smaller time frame. But the problem with shorter time frames is that you are starting to get into a difficult area because the Bid-Offer spread now gets too large for you to have a realistic stop loss. In fact your stop will tend towards your expected return the smaller the time frame, or vice versa, and your expected reward will become unrealistic.

And this is the basic problem: Chart patterns are fractal but trading costs and risk are not. But even that’s not quite true, because as you get smaller time frames you find the chart patterns become much more ‘pixellated’. The minimum price movement, for practical purposes, is measured in whole units or decimals, so there comes a point where that isn’t fractal either.

Why isn’t this obvious when you’re being sold the strategy? Because the standard is practice is to not include the costs in examples. So as the time frame gets smaller the trade looks just as attractive in the examples you’ll be shown.

So I would debate how scalable a strategy is and if you’re at one of these ‘seminars’, or as I prefer to call them, shameless sales pitches, then don’t be afraid to ask these questions, and tell them I sent you if you like!