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A Guide to Creating A Successful Algorithmic Trading Strategy by Perry J. Kaufman

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CHAPTER 1 A Brief Introduction: The Ground Rules

Everything should be made as simple as possible, but not simpler.

—Albert Einstein

If you haven’t heard it, a classic example of trading experience is the difference between a statistician and a trader. You flip a coin 99 times and it comes up heads each time. You ask the statistician, “What are the odds that it will come up heads next time?” The statistician answers, “50:50.” You ask the trader the same question and he answers, “100 percent.” Surprised, you ask the trader, “Why?” He responds, “Because it couldn’t possibly be a fair coin. The odds of getting 99 heads in a row are too high to have happened by chance.” Experience transforms theory into reality.

When I first started trading using automated systems in the early 1970s, the very idea was demeaned by professional traders as “ridiculous,” “the market just doesn’t work that way,” “you can’t make money if you don’t know the value of the stock.” Now that opinion seems to have been turned upside down. High frequency trading, the algorithmic trading system on steroids, has “an unfair advantage,” “it’s stealing money from the ordinary investor.” Times have changed, but attitudes have not.

MY OBJECTIVE

This is a no-frills book. It’s short because it just deals with the most important issues of developing a successful trading system and because you’re more likely to read it all. It is intended to be a painless lesson in reality, those critical steps that you learn over ...

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