Stocks & Commodities V. 32:1 (10-14): The Benefit Of Hindsight by Ashot Hakobyan

The Benefit Of Hindsight by Ashot Hakobyan

It All Makes Sense

Find out how a hypothetical ideal trader who has the benefit of hindsight can help you make everyday trading decisions.

At every stage of each trade, from the initial market scan to look for trade opportunities, to the timing and sizing of the entries, to the continuous trade management, all the way to the final closure, a discretionary trader will be making decisions continuously. A system trader, on the other hand — after creating a system — will have those decisions made for him automatically.

Decision-making in discretionary trading often poses complex problems, especially during the initial stages. That’s when traders have to make intelligent choices among the myriad of modern financial markets and instruments and combine them in clever and innovative ways to generate profitable trading opportunities.

The ideal trader

It is fair to say, however, that no matter how complex the choices are, discretionary traders will always aim to maximize the expected profit while maintaining sustainable levels of risk. These criteria can be quantified using one of the few existing market theories and models. For instance, one widely accepted model that approximates market returns by normal (or log normal) random variables is embedded in the commonly used indicator, Bollinger Bands. Another, more advanced Black-Scholes model resulted in a formula that is now routinely used in option pricing for a wide variety of financial instruments.

I will present a somewhat more pragmatic and simpler concept for trading-strategy evaluation without backtesting, which I call the Ideal Trader. I use the Ideal Trader concept to assist in discretionary trading. Of course, the ideas discussed here can be incorporated in any style of trading, including system trading or statistical trading, since the focus is on the evaluation of trade performance rather than reasons for initiating a trade. But first, I will start with a brief overview of the concept before considering any of its applications.

Unlike real traders, Ideal Trader is a hypothetical trader who is allowed to place his orders at any time in the past. He correctly places his buy orders at the lows and sell orders at the highs, and in doing so, extracts maximum available profit from any market.