Only losers average in!

Or so Tudor Jones says right? Off Ernie Chan’s blog I found a ‘white paper’ titled “Does Averaging In Work?” which states that Averaging-In never beats an All In strategy.

Back in the day I did significant amount of work on an S&P timing strategy utilizing the VIX, like everyone else I know! As an aside and somewhat pessimistically, the last frontier in quant trading IMO is pattern recognition and strategy/regime switching strategies, everything else is pretty well documented. Anyway, the strategy generated beautiful equity curves but rare and very large draw downs. So I spent days devising averaging schemes to tackle these large outliers.

The effect though was merely an illusion, simply reducing the capital traded or increasing the available account reduces the draw down. Similar to adding a treasury bill to a volatile asset. To be fair in assessing trading systems, one needs to allow an All In strategy access to the same amount of capital as an average in strategy. When looking at the trade distributions, a larger frequency of gains in the ‘meat’ of the distribution at the maximum capital results in greater overall profit then a handful of outlier trades at max capital. A similar result holds true in trend-following strategies where one is better off applying the full capital at the onset of the breakout.

So to those new to systematic trading, hopefully this paper and post reduce your learning curve…

~ by largecaptrader on January 16, 2010.

2 Responses to “Only losers average in!”

  1. I trade systematic mean reversion on closely correlated financial instruments. I rely on temporary fundamental shifts to create these larger than ATR ranges. My game centres around averaging in to offside positions but have a fixed financial stop.
    My stats for the past 12 months are:-
    best day = +33,344.99
    worst day = -62,175.20
    avge = +2,112.72
    return on 500,000 capital = 85%
    sharpe ratio = 3.860.

    There is no right way to trade, you just need to find what suits you. It is however in my opinion important for survival to always have a solid emergency exit and stick to it. One that ensures you are capable of trading the next day.


    great piccy by the way. where can I get me one of those???

    regards CT72

    • Agreed on finding a style, and systematically (especially on shorter time frames or equities) mean reversion is far superior to trend following.

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