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Unknown Market Wizards

Marsten Parker: Don’t Quit Your Day Job

Ed Seykota mentioned two trading rules in Market Wizards. They were:

 

1. Follow the rules without question.
2. Know when to break the rules. 

 

Marsten Parker's trading story is a proof to the truth in Seykota’s reply.

 

Parker’s average annual compounded return during the past 20 years was 20.0%, more than triple the return of the S&P 500 index at 5.7% during the same period. His return/risk numbers were concrete with Sortino ratio of 1.05 and a monthly Gain to Pain ratio of 1.24, again almost triple the corresponding S&P index levels. 

 

The most crucial factor in Parker’s long-term success is that he was willing to seriously change or even abandon systems when they may seem to have lost their potency. He made such major shifts many times in his career. It is striking that some of the systems that were profitable for so many years, stopped working and never recovered. 

 

Parker could survive only because he was flexible enough to alter his trading approach. A continuous recommendation given to systematic traders is to follow the rules of the system firmly. A system which has a definitive edge and can control risk effectively. In such cases, second-guessing will often have a harmful effect. It is in this context that Ed Seykota’s first rule is to be applied. Parker followed this rule in designing a trading process that was 100% mechanical.

 

However, the problem is that systems work for a time. This uncomfortable reality implies that the ability to radically change systems is an important factor to longer-term success as a systematic trader. Here Seykota’s second assertion—know when to break the rules —is meant to deal with. Parker again stuck to this principle by changing his systems and it proved significant to his longer-term success.

 

The trading strategies that Parker had revised were all substantive. For example, switching from entering orders on the close to entering intraday and changing from momentum to mean-reversion systems. These kinds of structural changes are very different from alterations like changing parameter values.

 

Parker often changed the parameter values in his systems to eliminate the downside. However, he realised that those changes did not bring much difference in future profitability. 

 

Traders who develop trading systems should be aware of the hooks inherent in optimization. Optimisation may not lead to worse results but it will give high expectations to the traders regarding the effectiveness of the systems. Another problem with over-optimization is that it can lead to designing systems that are too fitted to the past to work well in the future.

 

Initially, Parker was unaware of these pitfalls. With experience, he became wary of the shortcomings of over-optimization. This does not mean that optimisation has no value. It can be useful to define the suboptimal extreme ranges that should be eliminated from the selection of parameter values. Moreover, for some systems, optimization may provide some advantage in parameter selection, even after suboptimal extreme ranges are excluded. 

 

Risk management is an important part of success for both systematic and discretionary traders. Parker accepted numerous risk control rules as part of his process. These rules are:

 

  • Trading Stop— Initially Parker stopped trading if his equity declined by 20%. In 2016, after he resumed trading, he reduced this stop point to 10%. When the account is ahead by 5%, this stop is also increased to 15%. 
  • System Stop— Parker stops system trading if its equity curve falls below its 200-day moving average and waits to resume till it again rises above that level. The main concept is to apply technical analysis to the equity curve for controlling risk. This risk control strategy applies to systems as well as on the portfolio level. 
  • Position Sizing Adjustments—Trading size should be calculated using a consistent formula and should be based on daily net account value. Otherwise, the risk will get magnified. 

Trading for a living is hard. A continuous rise in cumulative profits is not enough. It has to climb more than the total taxes and total living expenses. Parker’s experience with this difficulty steers him to advise others to keep their day job as long as feasible.

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