Trading Systems ....................................
This, in part, was a topic covered by BigTrends.com.
First, let's get everybody on board with what a trading system is. As it sounds, a trading system is just a mechanized way of generating buy/sell alerts. They're typically based on specific chart events, but there are also other ways of producing these unbiased signals. For this example, though, let's just assume that the trading system is based on a chart.
The only other thing you need to know - whether you're a novice or a pro - is that there are basically two kinds of mechanical trading signals. (This is possibly the most important thing to accept about trading, yet it's the first aspect that's forgotten.) The first kind of signal is one that assumes a trend will continue. Let's call those 'momentum signals'. The other kind assumes that a trend will reverse. We'll just call those 'reversal signals'. Here's why it's important to never forget this little duality........if one type of signal is right, then by default, the other type of signal is wrong.
A MOMENTUM-BASED SYSTEM:
Let's run through an example of a momentum-based system first.....a 'long only' system, just to make it easy. The most common of all of these systems is a MACD (Moving Average Convergence Divergence) crossover system. Basically, these signals assume that once momentum has been developed, it will stay in place. The buy signal is generated whenever the faster MACD line crosses over the slower one (we can't get into the mechanics of these lines today).
Does the system work?
BigTrends back-tested the system on Trade Station on a hypothetical account and the TradeStation software says it does work. Take a look at the system profitability report. Even though there were more losing trades than winners, the winning trades were almost three times as big as the losing ones were. The average trade gain here (including winners and losers) was $99.59 (an arbitrary amount - we just need to know if the system works, which it would for any account size.) Over the last two years, this system would have netted us $1693 in profits. In other words, given enough time, this system is one generally worth using.
A REVERSAL-BASED SYSTEM:
OK, so what about a reversal-based system? Let's build one using the stochastics oscillator - one of our favorites.
The bottom-line results are similar to those we saw with the MACD system. Using a reversal-based system, you would have netted gains of $1079 over the last two years with these signals.
BUT WHAT IF YOU USED BOTH?
It's tempting to use both systems, isn't it? After all, even if there is some overlap in the signals, it couldn't hurt. And where there's not overlap, you'll have an opportunity for more gains than you would with just one system, right?
Unfortunately, that's not true. The least profitable results were achieved when both of these systems were applied. The trade count more than doubled, but net profits actually went down! And more than that, this would have been a major burden to trade.
And the actual dollars made? Only a profit of $851 was achieved when both of these systems were used simultaneously - the worst results yet. Even when the entries were 'unlinked' with their original exits, the results were about as poor.
The point is just this.....besides being chaotic, following too many signals can be counter-productive (as we saw in our last multi-system results). That's not to say that we only follow one kind of system; we actually have several kinds of systems running at any given time. But any trader has to recognize how some mechanized signals can conflict with others. If you've got an oscillator and a momentum signal both 'on' at the same time, and you're waiting for both of them to agree, well, you've got a long wait. Over the long-haul, you're better served by using a system that works for you, and recognizing that there will be periods when that system fails. If you're an advanced trader, and can mentally handle both types of signals at the same time, we'd recommend that you keep separate charts for both systems. That way, one won't interfere with the other. In fact, some traders switch back and forth when the market environment changes.....which can be tricky to do. More than anything else, keep in mind that all systems will have periods of failure. If you can stick with them through those periods, you'll be far better off.
Bum's conclusion?
BigTrends back-testing program confirmed what my studies have already shown. Momentum trading brings larger results than reversal trading. Many of the Market Wizards have said the same thing. Yet, most traders on these message boards are always trying to find the bottom, the reversal pattern.
Secondly, it is usually better to decide on one style of trading for buy and sell signals. BigTrends research confirmed that mixing trading styles or plans, at the same time, brings in the worst results.
BigTrends.com
(This message is linked to previous articles.) |
