Monday, August 23, 2010

Easy Profit in Automated Trading, Logical Proof of its Nonexistence

Isn't hassle free profit from the forex market all we want ? Definitely the goal of every person that starts to look for an expert advisor - or most at least - is to find a trading system they can simply "set and forget", a trading system that just collects money from the market in a consistent manner with minimal or limited draw down. A "holy grail", so to speak. However, it becomes obvious after a while of being in this business that if it is too good to be true it probably is and that no trading system can provide the owner with profit without an effort to develop knowledge and understanding. However the fact that the other road seems plausible makes a lot of people continue to search for this nonexistent trading system, a quest that brings nothing but disappointment and financial loss for most new traders. On today's post I will be giving you a logic based demonstration that shows why easy profit in automated trading is impossible and why this search is meaningless and will never arrive at your intended result (a system that easily gets you money without any effort).

First of all we must understand the very basic aspects about logic based demonstrations. When we are faced with a given hypothesis there are several ways in which it can be demonstrated to be true. In mathematics this is done in several ways but one of them is of particular interest to my article. You can demonstrate that something is false if the assumption that it is true leads to absurd results. For example, let us test the hypothesis that the addition of two even numbers gives us an odd number (which is false).

Assuming this to be true :

n, m and k are integers (2n is the definition of an even number, 2k+1, the definition of an odd one)

2n+2m = 2k+1
2n+2m-2k = 1 subtract 2k from both sides
2(n+m-k) = 1 factor 2 out
2a = 1 since n, m and -k are integers their addition is another integer (a)

Since 2a is an even number by definition and it is said to be equal to 1, we have an absurd result. No integer times 2 is able to give us 1 as a result. The hypothesis has been proved false because the assumptions that it is true leads to absurd results.

When it comes to making money from a system without any effort we can do the exact same thing. Let us suppose that there is a system that generates a 200% yearly income which can be traded from 100 USD and used successfully by anyone who buys it. Looking into the sales of the most popular experts we could expect this system to be used by at least 30K people during the first 2 years. This means that 300K USD - assuming each person trades the minimum - will be traded within the first 2 years. After ten years the return of this system would have been 17714700000 which is around 17 billion which is above all other market participants for this same time period. If 300K USD were added each year (of course new sales), the results would be even more staggering nearing more than 100 billion USD.

After 20 years, results become even more absurd and the system is now making a return that would be equal to more than the volume available to be traded. That is, all other market participants would be losing money against this system. This reduces the result to absurd levels since the system's profits surpass the amount of money available from the market. In fact, all the money in the world roughly describes what this system would be making.

The conclusions of this thought experiment are therefore quite simple and straightforward. One of the following things must be true :
  • If a successful system exists that anyone can trade then there is an inherent - and quite small - volume limitation to its trading that will thereafter make it lose its profitability or its "tradable by anyone" character.
  • If a successful mechanical system exists then there must be strong psychological barriers that make it extremely hard to trade for most market participants
  • If a successful mechanical system exists then there is bound to be a maximum compounded yearly profit to maximum draw down limitation that forbids it from reaching the above scenario (a limitation on profits).
Through all my research and work I have found that it is certainly possible to have successful mechanical trading systems and I suspect all the above are in fact true statements. Systems that would be easily available for anyone to use would quickly lose this character as a function of volume and become hard to trade for some reason (psychological, increases in the maximum draw down to average compounded yearly profit ratio) and systems that are already successful are bound to be hard to trade or have an inherent profitability limitation that does not allow them to reach the above mentioned scenario.

In the end, logic is simply undeniable. The scenario portrayed before is an absurd outcome that cannot be reached and therefore limitations to its achievement must be contained within the systems themselves. Systems that may seem to show extremely high results must be volume limited and later become much less profitable and harder to trade while mechanical systems that are profitable in the long term are hard to trade by definition. The above logical reasoning also shows us that there is bound to be some form of profitability to draw down limitation which comes from the simple assumption that the above scenario must be avoided. In conclusion, there is simply no easy long term profit in automated trading.

As you see, the simple power of the "reduction to absurdity" logical reasoning allows us to gain a lot of information about the world of automated trading systems merely by the use of a very simple thought experiment. If you have any comments, suggestions, opinions or other similar reasoning exercises, please feel free to leave a comment !

If you would like to learn more about my journey in automated trading and gain a true education around this type of systems, their uses, limitations and possibilities please consider joining Asirikuy.com, a website filled with educational videos, trading systems, development and a sound, honest and transparent approach to trading systems. I hope you enjoyed this article ! :o)

2 comments:

Tcxmon said...

Daniel-

Your argument makes logical sense, however its an example of a non-constructive proof->

http://en.wikipedia.org/wiki/Constructive_proof

Some philosophies reject all but constructive proofs. BTW i'm not a expert on logic, I just looked it up on Wikipedia!

I do agree that even if there was such a system it would soon loose its effectiveness once enough people traded it.

I'm also convinced that if the system was that good, the broker would shut you down once you started to take money out of their pocket.

That's one of the challenges of Forex (and futures and options) in that they are a "zero sum" game. You can't make a dollar without taking a dollar from someone else. This is versus the Equity and Real-Estate markets where values is created out of nothing assuming you make the right choices and stick around long enough.

Anyway, my point is that it makes more sense to spend time trying to improve your systems than to prove someone else's claims are unreasonable.

Also, I spent some time on Asirikuy today watching your videos. So much great content and not enough hours in the day to absorb it.

Thanks and keep up the good work,

Chris

Daniel said...

Hello Chris,

Thank you very much for your comment :o) Oh yes, you got me there, this is a non-constructive proof which does have certain weaknesses but it is the best logical argument I could come up with. It would be extremely difficult to come up with constructive proof in this case since I am attempting to proof nonexistence.

One of my sisters is actually a philosophy major and currently working to get her PhD so I'll make sure I discuss my argument with her when we meet :o)

About brokers, the zero sum game, etc. I have to say that you strike me as a little bit pessimistic there. Realistically profitable systems will most likely not get killed by the broker and most likely at the equity you would achieve in the long term you would later change to a more reliable and direct solution which involved less possible foul play from brokers. I know that I am sometimes too optimistic about brokers and the business in general (maybe because my systems very rarely seem to have problems with them) and you are just the total opposite. It is great that you provide this view :o)

Regarding your point about how to spend time. I would have to agree :o) my time is better spent developing systems (in regards to my profitability) but I believe that making these arguments helps inexperienced and new traders and provides some hopefully entertaining reading to my regular visitors (thank again for all the visits by the way !!).

Also thank you very much for your comment on the Asirikuy videos, I am glad you enjoy them and I hope you can get the most out of the website and its contents. Definitely a lot of effort goes into the videos each week as I always attempt to come up with something interesting to increase the knowledge and chances of achieving long term profitability of all Asirikuy members. Thank you very much again for your comment and kind words,

Best Regards,

Daniel

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