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

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CHAPTER 5 Less Is More

Trend following aside, there are significant advantages to short-term trading. Being in the market less often can have important advantages.

Short-term trading can produce a much smoother equity stream than trend following. If you’re a long-term trend trader, you will suffer the big drawdowns even though the trend is intact. To hold on to the trade, you go through some nasty losses. Just to add more frustration, the end of a trend that is held for a long time is expected to give up 10% to 20% of the gains, sometimes more.

Most short-term trading will have a high percentage of profitable trades. The normal profile, whether you are looking for fast breakouts or fading the price move (mean reversion), is that both profits and losses should be small, and profits should be much more frequent, perhaps more than 70% of the trades. There’s no built-in expectation that you’ll give back a huge amount of your gains, so it’s possible to have a long, smooth, profitable period.

There is another, even more interesting benefit of short- term trading. If your strategy is in the market only 15% of the trading days, then you’ve avoided 85% of the price shocks. Just to be clear, a price shock is a large, violent, often unpleasant price move. It’s no small advantage to avoid a price shock. We can’t predict a price shock and some of them can wipe you out, so not being in the market is the only realistic way of avoiding them.

If you can make enough profit with less exposure ...

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