Order Management Strategies – Fading

Order Management Strategies   FadingIn a recent Blog post we talked about the order management part of the Trade Plan strategy design to be as much as 40% of the Trade Plan design. Lets explore this a little more and look at some back test results we have done to demonstrate how important this is for your Trade Plan design.

First lets take a generic Trade Plan trigger that is break even. Let say its is a 33% winner with a 2 to 1 profit to stop ratio on a single contract size entry. I trust you can do the math here and validate this point. So this is not great but lets see how taking this same trigger Trade Plan design strategy and turn it into a winner with some order management strategies.

What would happen if we would apply a fading order management strategy that will effectively double the position contract size at the stop point and then resetting the new stop point and profit target in the same 2 to 1 ratio scheme?Remembering that as you fade the trade, the point of the trade fade point you are down on 1/2 the 2 contract position by the amount of the stop amount. So we will need to get back to the orginal entry price plus 1/2 the stop tick amount to make a profit, as we did on the single contract position on this same trigger strategy.

Wow a month full, let see what happens on the back test. I have tested this on a variety of triggers and the results are nearly the same. What you will find is that of the 66% of the losers in the above Trade Plan trigger above, nearly 40% of the above 66% losers become winners. Not forgetting that the 60% of the 66% losers from above now become triple losers. The net? You will find that this order management strategy will typically improve any trigger by 10 to 20%. Market movements (oscillations or no oscillations) within these trade windows make this highly variable, but in the longer run over many trades, you have made the break even trigger strategy now profitable.

Further improvements? If 2 is better than 1, then 3 must be even better then 2. Yippes, another mouthful. So what would happen if as in the case above with the 2 contract strategy, we go with a 3 contract strategy? So trying to achieve the same profit target objective of 2 times the stop tick value (on 1 contract), we fade the trade with 2 contracts, for a total of 3 contracts. Remember now we need to just get back to break even, we reset our profit targets accordingly. We know from above, that this trade trigger yields 33% out right winners. Then 40% of the 66% losers can be made winners with the fading strategy. However now we do not have to get back to break even plus 1/2 this stop amount, rather just back to break even. Thereby moving some of the 60% of the 66% losers into the winner column. Remember however we have quadruple the loss as well. The net of all this is that with back tests again we can see that  this order management strategy improves that original strategy by yet another 5 to 15% overall. Again market movements (oscillations) make this difficult to predict 100%.

Easy? Well no, as you must be prepared to risk the extra margin capital for the same amount of potential gain. This extra capital reduces the overall return on investment (ROI), but makes the trading more sure in its profitability out comes, if your triggers are not that profitable to start with. So either have very good triggers or make up for poor triggers with order management  and accept lower ROI. But what ever you do – be profitable of course. In this example we have done two things to improve a break even strategy by 15 to 35% via order management. For all you software developers, give this a try on your automated back test system and see if you don’t find similar results.

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