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Trading is Intellectual Property: the proof is Coke!

10 February 2014

Ever wondered what the common ingredient to trades, trading algorithms and Coke is? Easy! Intellectual Property! Agree that speculation is an IP industry? To understand the full implications for your trading income, look no further than Coca Cola: a lesson on capturing – or missing out on – the dividends accruing to intellectual property. The […]

Ever wondered what the common ingredient to trades, trading algorithms and Coke is?

Easy! Intellectual Property!

Agree that speculation is an IP industry? To understand the full implications for your trading income, look no further than Coca Cola: a lesson on capturing – or missing out on – the dividends accruing to intellectual property.

The origins of Coca-Cola (hat tip wikipedia)

Colonel John Pemberton was wounded in the American Civil War, became addicted to morphine, and began a quest to find a substitute to the dangerous opiate. The prototype Coca-Cola recipe was formulated at Pemberton’s Eagle Drug and Chemical House in Columbus, Georgia, originally labelled coca wine.

Insight 1: True intellectual property, like a successful trading strategy, is the valuable product of hard, sustained effort.

He may have been inspired by the formidable success of Vin Mariani, a European coca wine. In 1885, Pemberton registered his French Wine Coca nerve tonic (…) essentially a non-alcoholic version of French Wine Coca.

Insight 2: Your strategy’s IP could inspire others roaming the markets!

The first sales were at Jacob’s Pharmacy in Atlanta, Georgia, on May 8, 1886. It was initially sold as a patent medicine for five cents a glass at soda fountains.

Insight 3: IP has a value – no-one who has worked hard to develop a successful trading strategy gives it away for free!

With that in mind, look closer at the Coke ticket (a beauty, BTW)

First Coca Cola Ticket

Notice the Trademark Logo – IP Protection. This way you had no way to use the logo (IP!) without 1) advertising Coke and 2) incurring in legal risk.

Insight 4: Successful creators protect the IP they disclose!

Insight 5: Successful market the product of IP but do NOT, repeat DO NOT, disclose their IP!

The business model of IP is to disclose, for a price,  the product of the IP, not the IP itself! Coke buyers paid for a glass of patent medicine: they enjoyed the product of the IP (they drank it!), but NEVER, EVER got anywhere close to the formula (patent!). Pemberton (literally!) locked the formula in a vault to make sure that there was one and only one way to drink Coca Cola: to pay Pemberton for it, every time. 

Wonder what happens if you don’t do that? Look no further than… Coke!

Pemberton was diligent in withholding IP from customers… alas not from partners. By 1888, three versions of Coca-Cola were sold by three separate ¨partners¨ who laid hands on the formula.

Insight 5: IP, just like your trading strategy, benefits ANYONE deploying it. When disclosing your IP, you’re waiving (some or all of) the future profits it generates!

Result? The Pemberton family, like the inventor of Vin Mariani before them, lost Coca Cola to those who got access to the formula, and made the most of it.

Insight 6: IP benefits copiers as much (if not more) than inventors: IP leakage hurt Pemberton, but it hurt the inventor of Vin Mariani so much, that we even ignore his name!

Trading lessons?

If you didn’t already, now you know. Your trades ARE the product of your intellectual property.

If you absolutely must, tweet your trades, sell your algorithm or explain your strategy and charting set-ups in your blog. But beware:

  • If you disclose it all in one go, you could end up the unknown (= forgotten!) French guy who invented Vin Mariani (the Coca Cola),
  • If you disclose it trade by trade, remember that valuable IP WILL BE reverse-engineered. Trades are NOT the IP itself, they’re the key to the vault. Incidentally, this is the reason why Darwinex will NEVER publish the track-record of our members. We sure certify that it is true, but that’s no excuse to compromising your IP!
  • If you’re pitching to manage investor capital, DON’T disclose so much IP in your pitch that others can then replicate your strategy!

At all times, remember Pemberton:

  • By all means, rent the IP: allow investors to benefit from your IP via fees… but
  • NEVER give so much of your formula away that investors can replicate it without paying you going forward!
  • Before tweeting, realize that markets learn 24/7. Once you disclose IP you will (at best) share the success of your intellectual property.

PS: if the content of this post sounds too trivial to you… feel free to recommend it to good traders roaming forums, engaging in mirror-trading / copy trading / social trading sites. Looks like they missed it: trading is Intellectual Property!

 

Inside Darwinex – Performance calculation, explained

24 October 2013

Understanding your Performance Upon joining, many new movement members reach out stating: “hey guys, my performance statistics are different from Service Alfa (insert here your favourite alternative site to Darwinex) – they’re wrong!” Whilst occasionally stuff DOES go wrong, more often than not differences owe to the fact that returns at Darwinex are calculated differently from most existing […]

Understanding your Performance

Upon joining, many new movement members reach out stating: “hey guys, my performance statistics are different from Service Alfa (insert here your favourite alternative site to Darwinex) – they’re wrong!”

Whilst occasionally stuff DOES go wrong, more often than not differences owe to the fact that returns at Darwinex are calculated differently from most existing service providers.

Other services calculate performance on changes to account balance, which accounts for realised P&L (closed trades), but ignores unrealised P&L until open trades are closed.

Darwinex performance is measured on changes to liquidation value, which accounts for realised P&L (closed trades) as well as unrealised P&L (i.e. open trades).

This is the most common reason why returns “differ”. The rest of this post explains why we do things this way, and what implications this has.

Other services performance calculation – changes in account balance

Most services track changes to balance, i.e. accounting for

  • Starting account balance
  • Plus minus realised P&L
  • Plus minus cash flows
    • Cash paid in / deducted by your broker (swaps, commissions, etc.)
    • Monies deposited in / withdrawn by yourself

Performance over a given reference period is then driven by the % change in the resulting account balance.

Your Darwinex Performance – changes in mark to market

At Darwinex, all strategies’ Trading Journal reflect daily liquidation values, considering:

  • Starting account balance
  • Plus minus realised P&L: i.e. monies made or lost on closed positions
  • Plus minus cash flows as per above
  • Unrealised P&L: i.e. what-if P&L when closing ALL open positions at the end of every day

I.e. at the end of every day, regardless of whether trades are open or closed, we compute the hypothetical P&L for ALL open positions assuming that they were closed at the then going market price. The resulting account “balance” is called liquidation value for that particular day.

Your performance is calculated on changes to this liquidation value (purists would call this Mark-to-Market value) of equity. Which means, on any day where open positions are held overnight, the inputs into your performance calculation are different from the inputs at Service Alfa. Unsurprisingly, the output is also different!

Unrealised P&L – why do we care about it?

Darwinia rates strategies for DARWIN investor appeal (hence Darwinia): our standpoint is that of an investor replicating, with his own monies, all trading decisions in a strategy.

This makes us care about unrealised P&L as much as we care about account balance: let’s work through an example to illustrate why.

Market movements matter

Trader Ace with USD 10,000 balance opens a 5 lot long EUR/USD trade. For the next 3 days, this will be his only open trade.

This is what happens to the EUR/USD over the timeframe.

  • Trade open at 1.30135 on day 0
  • End of Day 0: EUR/USD is at 1.30115. Ace keeps the trade overnight
  • End of Day 1: EUR/USD is at 1.29250. Ace keeps the trade overnight
  • End of Day 2: EUR/USD is at 1.28815. Ace keeps the trade overnight
  • Day 3: trade is closed at 1.30250

Investor A replicates Ace’s trades with his own monies 1:1, i.e. using the same leverage as Ace. A uses Darwinex and service Alfa to monitor his investment.

This is the performance calculation investor A gets at Darwinex and Service Alfa [1]:

Snapshot EUR/USD TradeSlide Service Alfa
Liq. value  Daily Perf. Balance Daily Perf.
Trade open 1.30135 10,000.00$ N/A 10,000.00$ N/A
End of day 0 1.30115 9,900.00$ -1% 10,000.00$ Flat
End of day 1 1.29250 5,575.00$ -43,69% 10,000.00$ Flat
End of day 2 1.28815 3,400.00$ -39.01% 10,000.00$ Flat
Trade close 1.30250 10,575.00$ 211.03%(5.75% compounded over 3 days) 10,575.00$ 5.75%

Let’s get this straight: both methodologies are “correct”.

BUT: Darwinex performance contains more information than Service Alfa’s calculation – the unrealised P&L that drives changes to liquidation value.

This has implications that matter.

Implication 1: Performance “masquerades”

Investors are always keen for brilliant performance. As always in life, there’s two ways about it: the proper way, and a short cut.

The safe one is to develop trading skills, manage risk with discipline, and work 2,000 hours a year to develop and maintain a unique strategy that delivers risk-adjusted returns. But hey, we know that’s hard work …

So why not take the short cut? If performance equals realised P&L and unrealised P&L doesn’t matter, why not “short cut” mind-boggling balance growth as follows?

  • Trade winning? Close it and credit realized P&L
  • Trade losing? Keep “corpses” in the “unrealised P&L” closet
  • Repeat

Of course, too many losing trades will trigger a margin-call (the worse the strategy, the sooner). Meanwhile, high return, low risk growth in balance will have lured plenty of profitable investors using service Alfa…

Implication 2: Risk management

A more fundamental implication is risk measurement. Measuring risk on volatility in balance leads A to these conclusions:

  • Volatility: low – A’s money “only” moves from 100% to 105.75%
  • Drawdown: A “experienced” no drawdown in this trade
  • Rally: A “experienced” a rally of 5.75% of his money on this trade

I.e. A will completely ignore that his monies moved around 40% over the 2 days of the trade, and that at the end of day 2 he was 6,600 USD worse-off.

Of course, Ace could argue that the trade worked out just grand, with a profit of 5.75%. But what if A was leaving for a Himalaya trekking trip and asked Ace to close any open positions at the close of day 2? Boy that would have been ugly!

Summary: why?

Calculating net liquidation values requires us to source & maintain the mark-to-market price database for all the assets you ever traded, and that’s not a small & cheap database to populate, host and maintain.

Further, the way performance is calculated on the BASIC and the DARWINIA statistics is slightly different, as Darwinia is a lot more analytically involved. You will occasionally see a few decimal differences between one and the other, as they are updated with different precision and time frames… but they’re not wrong.

But then again, that’s the only way to create D-Leverage, no DarwinIA, no DARWINs, etc. If it requires us doing things differently from service Alfa – so be it!

 


[1] For simplicity, we’ve ignored swaps & any other overnight charges.

Inside Darwinex – your Trading Journal

14 August 2013

Imagine accessing the diary of a person you had never met before: wouldn’t this afford you in-depth insight into the personality traits of its owner? At Darwinex that got us thinking: how about a tool providing in-depth insight into any trading strategy? Thus came about the Trading Journal: it’s a visualisation containing all the trades in a trading strategy, providing insight […]

Imagine accessing the diary of a person you had never met before: wouldn’t this afford you in-depth insight into the personality traits of its owner?

At Darwinex that got us thinking: how about a tool providing in-depth insight into any trading strategy?

Thus came about the Trading Journal: it’s a visualisation containing all the trades in a trading strategy, providing insight into its main attributes – particularly its Risk Management – at a glance.

This is what it looks like (just click the image to enlarge it!) and these are its elements.

tradingjournal

Return:

Measures the strategy’s performance from inception, tracking the value of balance every time a trade is opened or closed (i.e. when a new position starts). The performance calculation takes into account (i) the performance of a trade when it has been closed AND (ii) the performance for the trades that remain open when a trade has been closed.

Range Return:

Shows a strategy’s performance over any user-selected period – offering any potential investor a way to track performance for any period of interest… which comes in handy since recent performance mostly differs from performance from inception!

For instance, a strategy initially losing 50%, the recovering to 100% of the initial deposit could yield 100% performance to investors entering at the lowest point! Range Return is designed specifically to get a more accurate impression of a trader’s performance.

D Leverage:

D Leverage is a measure of risk. It tracks the risk incurred by each position in a strategy in terms of average EURUSD volatility. What does this mean?

  • A EURUSD trade with 1:1 utilised leverage has a D Leverage of around 1
  • A EURJPY trade with 1:1  utilised leverage has usually a D Leverage higher than 1 – this is because the EURJPY is more volatile than the EURUSD in average – and thus riskier
  • What is TS Leverage for simultaneous trades in multiple assets? This is where it shines: D Leverage of 6 means “6 times as risky as the EURUSD over the period”, etc. It captures hedging effects, i.e. two highly leveraged trades in negatively correlated assets can result in a low risk trade

What does a constant evolution of D Leverage say about a strategy? The closer a trader sticks to a D Leverage, the better – this evidences that any positive returns are not engineered by leverage illusions (martingales), where winning trades randomly deploy higher leverage than losing ones.

The D Leverage chart on the Trading Journal uncovers strategies deceiving inexpert investors through such illusions: beware of strategies where D Leverage increases on losing positions.

Trading Journal - Martingale

Open trades:

Tracks the number of simultaneous open trades in a strategy. Combined with D Leverage, it is proof of a trader’s skill at keeping risk constant: good traders open new trades without affecting their D Leverage. In short, this is a powerful tool that evidences a trader’s ability to cover risk by opening new trades (hedging). Beware of strategies in which D Leverage increases with new trades: this is conclusive evidence of the presence of leverage  illusions (martingales).

D Score:

Tracks the evolution of a trader’s D Score. Our goal is to maximise the correlation between a strategy’s current D Score and future returns: our success will empower traders with a high D Score to investor capital!

For now, we offer users a predictive tool of immense potential: the evolution of D Score. Please remember that the D Score is driven by performance and skill: expert traders must prove both to be worthy of investors’ capital.

Distribution of trades:

This chart is useful to know at a glance what kind of strategy a trader uses: frequency of trades, assets traded, duration of trades and simultaneous trades.

It evidences whenever a trader has changed his strategy and is also helpful to find out whether a trader is disciplined when following a strategy.

The trading strategy below shows a good discipline. Note how this trader started trading short trades and kept the number of open trades at a time consistent. Note also how his strategy changed: he increased the number of trades open at a time, being the duration of the trades longer.

Disciplined change of strategy

In contrast to the disciplined strategy above, the strategy below shows no discipline at all. The number of open trades at a time varies constantly and the duration of the trades varies as well…you can tell at a glance there is no defined pattern.

Trading journal - Lack of discipline or strategy

Do you have any question about the Trading Journal? Feel free to e-mail info@darwinex.com, we’d love to improve on the above intro.