lecture 7: trading systems

Question 1

Designing a system (Non-discretionary)

Answer 1

An edge is needed because markets are dynamic

A trading system exploits a predetermined type of market activity

A trading system has objective buy and sell rules

Objectivity in a system removes emotion and enables a trader to stay focused on trading

Must be based on sound theory so that trader can detect if the underlying hypothesis of a system has changed and thus rendered a system ineffective

Question 2

An edge in trading

Answer 2

an exploitable statistical advantage based on market behavior that is likely to recur in the future

Question 3

Discretionary

Answer 3

Trading entry and exists determined subjectively by intuition and gut instinct

Question 4

disadvantage of Discretionary system

Answer 4

Your gut is many times wrong! Most people go broke or burn out, excitement and being right is more important than making profits

Question 5

Nondiscretionary

Answer 5

Trading entry and exists determined objectively mechanically by signals (computer generated) because it is a system that runs itself based on data that is continuously fed into it

Question 6

advantage of Nondiscretionary

Answer 6

Many successful traders use this

removes the emotion from trading

predetermine the decision rules

can back test results

prevents large losses and the risk of ruin.

Provides a mathematical edge

Question 7

disadvantage of Nondiscretionary

Answer 7

Operation is sometimes boring, requires periodic updates and adjustments….history does not repeat itself precisely.

Updates and modifications may be needed

Question 8

partially discretionary system

Answer 8

based on generation signals based on some rules that are acted upon by the investor based on personal confidence or experience. Some very successful traders and investors use a type of system like this – with rules

Question 9

4 things to consider when trading

Answer 9

1. What type of strategy are you using?
2. Determine a trend filter
3. Data and market selection
4. Analyzing Results

Question 10

What type of strategy are you using?

Answer 10

Trend following – ex. Moving average crossover system.

Counter-trend, reversion to the mean – ex: Selling overbought markets

Swing trading – Taking short term fluctuation in direction of trend.

Question 11

2. Determine a trend filter

Answer 11

The trend is the basis of all profits

Before determining an entry technique, you must properly define the trend – regardless of your approach.

Some entry rules include (thus assume) a trend direction – ex: N-day breakout.
Additional trend filters can be added however.

An example would be to buy a stock when prices exceed the highest high of the past 20 days if today’s close is greater than the 200 day moving average. This ensures news highs are in the direction of the longer term trend

Question 12

3. Data and market selection

Answer 12

Portfolio to test on – stocks, ETFs for futures & forex?

Time period to test – 1 year, 10 years ?

Time frame to test -daily, weekly etc..?

Question 13

why is Selling a position harder

Answer 13

what conditions will end a trade?

A system must identify;

1) Initial stop

2)Trailing stops

3) Profit Target(s)

4) opposite signals

Question 14

4. Analyzing Results

Answer 14

Are the historical results representative of a “good” system

Possible adjustment to the system – 1)

Abandon system completely 2) change in parameters for entry or exit criteria 3) change in tools

Need for money management: If not, risk of ruin

Question 15

The Turtle System

Entries: (opposite rules for short entries)

Answer 15

Short term system: Buy 1 unit if prices exceeded the highest high of the past 20 days by 1 tick.

Longer-term system: Buy 1 unit if prices exceeded the highest high of the past 55 days by 1 tick.

Question 16

The Turtle System

Stops: (opposite for short positions)

Answer 16

Initial Stop : No trade could incur more than a 2% loss of the account value

Trailing stop:
System 1 – exit prices exceed the lowest low of the past 10 days
System 2 – exit prices exceed the lowest low of the past 20 days