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Stocks & Commodities V. 28:9 (8-9, 67): Letters To S&C by Technical Analysis, Inc.

The editors of S&C invite readers to submit their opinions and information on subjects also at the Traders Resource database
relating to technical analysis and this magazine. This column is our means of communica- at our website,, under
tion with our readers. Is there something you would like to know more (or less) about? the Consultantscategory).Editor
Tell us about it. Without a source of new ideas and subjects coming from our readers, this
magazine would not exist. ARTICLES ONLINE?
Address your correspondence to: Editor, Stocks & Commodities, 4757 California Ave. Editor,
SW, Seattle, WA 98116-4499, or email to All letters become the Is it possible to retrieve articles from
property of Technical Analysis, Inc. Letter-writers must include their full name and address past issues of S&C via the web?
for verification. Letters may be edited for length or clarity. The opinions expressed in this John Dueweke
column do not necessarily represent those of the magazine.Editor
Yes. You can purchase individual past
articles from the Online Store at our
CALENDAR SPREADS will shift the risk curves higher (that website at
Editor, is, farther in a positive direction), while You can use the search feature there to
Perhaps in a a decline in implied volatility will push help locate articles.
sequel to The the risk curves farther into negative
Double Cal- territory.
endar Spread In sum, if implied volatility is extremely
(Stocks & Commodities, July 2010), high, favor the iron condor. Under
author Jay Kaeppel might compare the any other circumstance (and as long
double calendar to the iron condor. as you have some reason to think the
Ive had limited success predicting the implied volatility will not fall sharply),
outcome of calendar spreads, primarily a double calendar is a strategy worth
because their risk curves do not accu- considering.
rately reflect the spreads value as the Hope this helps.
near-term option approaches expiration.
With their sag in the middle, the risk VWAP code for Real Tick? You can also access some of our
curves for the double calendar seem to Editor, regular features and departments from
be far more uncertain than the plateau- As an avid reader past issues for free at our website. Visit
like risk curves of the iron condor, of your maga- our back-issue archive (http://www.
whose risk/reward is comparable to the zine, I particu-
double calendar. larly enjoyed the docs/backissues.html) to browse past
Incidentally, Kaeppels book, The article by Andrew Coles in the July tables of contents.
Option Traders Guide To Probability, 2010 issue, An Anchored Vwap For Another alternative is to purchase
Volatility, And Timing, has an excellent Congested Markets. In the Traders our S&C On DVD if you have a need
chapter on calendar spreads. Tip section of that issue, you give the for many of our past articles, since one
Chris Pflum code for various trading platforms, but price gives you access to 27 yearsworth
Las Vegas, NV unfortunately, not the one that I use for of articles.
my stock trading. Thank you for writing.
Jay Kaeppel replies: Do you or does someone else there
The primary difference between a have the code equivalent for us Real- The Forex Gambit
double calendar and an iron condor is Tick users? Editor,
the circumstance in which they should Ray Thank you to author Walter
be utilized. Toronto, Canada Downs for an excellent
In a high-volatility environment, the article in the June 2010 is-
iron condor is generally preferable Unfortunately, we are not able to provide sue (The Forex Gambit).
because: a) it allows the trader to take the code. You might try the RealTick tech- When I saw that he had an
in the most premium, and b) a double nical support forum or user forum, or try advanced education in esoteric math-
calendar spread is susceptible to a requesting the code equivalent directly ematics I was afraid I would be lost within
volatility crush if volatility falls after from RealTick technical support. two sentences. On the contrary, his article
the trade is entered. When entering a Alternatively, you could try posting is one of the most clearly written and
double calendar, the trader ideally wants your request for RealTick code at a gener- understandable articles about any kind
implied volatility to either rise or at least al forum for traders or technical analysts, of technical analysis I have read in the
remain relatively unchanged. or use a private programming service for past 15 months of daily study.
For any calendar spread double or your particular needs (some are listed Leroy Cook
otherwise a rise in implied volatility in our magazines classifieds section and Ann Arbor, MI
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 28:9 (8-9, 67): Letters To S&C by Technical Analysis, Inc.

QUESTIONS ON THE Forex Gambit that do not destroy his message, but do This represents a startlingly high 62.5%
Editor, raise some questions of mathematical gain per trade. What I think the author
I really enjoyed reading the article The correctness. neglected to point out is that the equity
Forex Gambit by Walter T. Downs in Downs presents a standard deviation drawdown (Mdd) and the concurrent
the June 2010 S&C. However, I have (std) formula that I believe is flawed. Por associated with each trade are all
some queries. The formula is: rather large. I calculated the following
values for the three trades:
1. Is this a two-bar strategy (that is, two Std=[((pct.*(Win*Win)) +
consecutive lower lows and a close ((1-pct)*(Loss*Loss))]^0.5. Trade1: Mdd = -60%, Por = 16.2%
above the midpoint of the second bar Trade2: Mdd = -74%, Por = 27.6%
and above the simple moving average)? By inspection, this formula doesnt Trade3: Mdd = -82% (wow!), Por =
If there are two bars of lower lows, seem correct, since if one expands pct 19.4%
and a third one is an inside bar, having to 1.0, std approaches win (all $39s)
closed above the midpoint of the bar when, of course, such a condition The generally accepted pain level
and above the simple moving average, actually leads to std=0. I believe the for Mdd is 30% (some would argue
can this setup still be valid? correct equation is: for higher values). Balsara suggests
Por=10% as a maximum reasonable
2. Can I use this strategy to trade stock Std= (1+R)*Loss*((W*(1-W))^.5 Ror. I also believe it is fallacious to argue
index futures, where the leverage is (where Loss=Bet, and W=pct) that these Mdds are of no consequence
approximately 1 to 10? If yes, do I as it is house money. As for myself, I
need to change the bet/position size which is an equation I derived in my S&C could tolerate a 100% loss of the initial
formula? article, Trading Tradeoffs With Risk Vs. $100 (or $300) before I could stomach
Vinod Nadoda Reward (S&C Bonus Issue 2010). It is a -82% equity drop. Then there is the
Ahmedabad, India quadratic in form, going to zero at both generally unfavorably high Por values
W=1 and W=0 as I believe the std should. to contend with. These trade gain results
Walter Downs replies: The difference is not trivial, since they are extraordinary but they also entail
In response to your first point, it is produce different results for std. high risk not unsurprising, since the
important for the bar that completes Since Downs uses std to then calculate author is trading forex with 100-to-1
the pattern to have reversed from its his Por (risk of ruin percentage), that leverage and betting at close to the Kelly
lows and closed above the midpoint of throws into doubt the resulting Por optimum (a reference from page 27 of
the bar and also formed a lower low. calculations. He mentions only one Por Downs article). Perhaps it comes down
I would not consider your suggested value, 0.000055. The generally accepted to ones definition of risk?
setup a strong enough indication that values for risk of ruin were presented Finally, I believe there are a couple
the trend was resuming. Of course, this by Nauzer J. Balsara in his December of errors (or perhaps lack of clarity)
is my preference. One of the tenets of 1992 S&C article, Appreciating The in Figure 3, when converting from the
highly systematic discretion (Hsd) Risk of Ruin. In this case, the Balsara pip linear trade data to the exponential
analysis and trading is that you utilize Ror is 0. trade data. In trade 1, row 7, the -150 loss
your own knowledge of the market in I was able to replicate Por in Excel, du- should be bet at a 60% loss level, whereas
your decisions. plicating the authors results, and found the actual reduction is only 30%. This
In response to your second point, the that for Bet(loss)=50%, R=3, W=.65, lowers his final equity from $11.4 mil-
leverage afforded isnt nearly as attrac- Por=8.6%, and Ror=1.6% a rather lion to $6.5 million, a huge decrease, but
tive as in the forex market, and also, large difference. More disconcerting is still an excellent return. One explanation
with a market that is closed overnight, the fact that if R is set to 1.0, Por=8.4%, for this lower bet level (30% in lieu of
a sudden price shock and resultant large a value less than 8.6%, in contradiction 60%) would be if the program knew
gap could be dangerous to your account. of the fact that Por (and Ror) always ahead of time that it is a high-loss bet
Personally, I would feel that the gambit decrease as R is increased (for fixed W). and thus could cut back the number of
is too aggressive for these markets, Still more important is that this is the lots traded before the trade occurred. But
given the greatly reduced leverage and only Por value the author gives, and it this is clairvoyant, and I dont see how
overnight exposure. could imply that his trade results have it could be achieved. In fact, if it could
such a low Por when, in fact, they have be achieved, the author should bet the
MORE ON The Forex Gambit rather high values of Por (data presented following up bet (+200) at double the
Editor, below). lots (or higher) to maximize that (and
I found Walter Downs article in the June In Figure 3, the author presents rather subsequent) returns. Obviously, there is
2010 issue, The Forex Gambit, infor- extraordinary trading results. In the first no margin call when equity is so much
mative and well presented. I do believe, trade, $100 becomes $11.4 million in greater than the margin to trigger such
however, there are a few errors in concept only 30 trades (six of which are neutral). a reduction.
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 28:9 (8-9, 67): Letters To S&C by Technical Analysis, Inc.

The same problem exists for trade 3. Balsaras formula, and the formula I you can ascertain that, logically, even
Starting at row 10, three consecutive used exactly as I used it, I deemed the without further calculation, this system
losing bets (-200, -250, -200) drop the differences between the two formulas would have very low Por/Rors.
equity by 82%. Here, it might be possible as trivial since the differences were As to the actual risk entailed in the
to minimize the -250 bet (which should both considerably less than 1% and trading of this system, you and I would
decrease equity by itself to zero!) as the amounted to differences of fractions of probably go round and round on that
two preceding drops signal the danger, a percentile. point. I maintain that since you are
but it doesnt explain why the first bet It seems to me that your differences essentially playing with profit and not
(-200) has a loss of equity of 40% when in results stems from your attempts to your initial risk capital, this represents
the pip value indicates it should have a monkey with the values used in the as close to risk-free investing as you
loss of 80%. Either the conversion from production of those results. can get.
pips to equity is wrong (in these four In further analysis of the formula, in In the adjustments made in the data
trades), or the authors program is power- response to your concerns, I derived an runs, I made some allowances for
ful enough to anticipate big decreases, even lower expected Ror of 0.000022. trades that carried a higher initial
and lower the lots bet to mitigate such If I compare this to your results, the risk than the average risk of about 100
losses (but not upswings). lowest of which you claim is 16.2%, if pips. In these cases, in actual trading,
Norm Brown we divide 0.162 by 0.000022, we get I would have reduced my exposure to
a difference of 7,363 times the risk! 2030% instead of the full 40% risk.
Walter Downs replies: This cannot be accounted for by either In these cases, I would not have been
The formula used in the article was cre- Balsaras formula or the formula I use, foretelling the future, as the risk
ated by Teresa Lo and a Cfa. I am not and suggests a serious error in logic on the trade would have been known
familiar with the work of the Cfa, but on your part in the calculation of your beforehand to the trader before the
Teresa Lo is a well-known and respected Por/Rors. From the appearance of trade was executed based on his entry
market analyst with an advanced degree your results, I suggest that you are not price and stop-loss price, and without
in engineering. You should probably accurately calculating the fractional which, in fact, he would not have been
direct your concerns about her formula betting portion of the system as a figure able to properly size his bet.
to her. that represents the probability not of
I noted several of the shortcomings you Ror, but a probability that the account Editor replies:
mentioned during my own use of the for- will ever return to the reserve level. Readers are also encouraged to explore
mula and took these into consideration As such, this probability is multiplied alternative formulas for calculating the
during the analysis process. by the reserve betting probability to Ror. Here are several references that
Some comments on your analysis: derive the final Ror of the system, and may touch on formulas for Ror, including
Pardon me, but at the higher std that is not considered as an Ror factor in Norm Browns article:
you claim for the formula versus the qua- future calculations in and of itself.
dratic approach, it seems to me that my In other words, if the reserve Ror is Brown, Norman [2010]. Trading Tradeoffs
results would represent a more pessimis- 0.01, and the fractional bet Ror (risk With Risk Vs. Reward, Technical
tic view of system outcome rather than of returning to reserve level) is 21%, Analysis of Stocks & Commodities,
Volume 28: Bonus Issue.
a more optimistic view of the outcome. to average the two results, producing
Kaufman, P.J. [1998]. Trading Systems
First, you claim the formula overstates an Ror of 11% would be incorrect. And Methods, 3d edition, John Wiley &
values of Ror, then you claim it under- Instead, you multiply 0.01 by 0.21 and Sons.
states values of Ror a flip-flop that is derive the correct Ror of 0.0021. Kaufman, Perry J. [2003]. A Short Course
bound to drive any logician crazy. All mathematics aside, if you just In Technical Trading, John Wiley &
That aside, if you apply the formula consider the possible Rors of a system Sons.
exactly to the figures in the article, you that wins 67% of the time, and has a win- _____ [1994]. On Profit-Taking, Techni-
will produce exactly the same results to-loss ratio of 3 to 1, and has trading cal Analysis of Stocks & Commodi-
I did. When comparing the results of characteristics as specified in the article, ties, Volume 12: April.


Copyright (c) Technical Analysis Inc.

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