Making a 2+2 trading system

[kimchi]

NOTE: ahnuld: If you think I should just get a blog, then lock this and I’ll move on. Also, the main piece of advice I’ll give is for people not to follow my advice, but just consider it with reference to your own situation and try and test anything of interest yourself…... Then you can only blame yourself when you bust your wad.

I’d like to develop and implement a new trading strategy on this forum. There are regulars here who are much more qualified than me to do this, but I thought the process might be useful for others to watch and help me.. Besides, it’s something that must be done by me eventually anyway. The system will be mechanical in nature and probably non-discretionary, so I won’t be considering fundamental analysis (I suspect 90% of you will stop reading here). You can call it TA, but I won’t be using any classical chart-reading or Japanese candlestick techniques here as I’m still practicing those disciplines. Most of this will be relevant to anyone trading anything; whether by FA, TA, tea-leaves, solar flares, lunar cycles, or the Stu Ungar Method. I will be using some very familiar indicators and hope to look for an edge primarily from my exits and bet-sizing, and using the indicators to help maintain discipline and quantify prices beyond the noise. For the record, I believe using indicators is inferior to price alone since indicators are a derivative from price. Some are a derivative of a derivative (eg- MACD, TMA) and the further you depart from the price, the further you depart from the reality of the market.

I currently trade 2 systems. One is long-term (months/years) and the other is medium term (weeks/months). Both have had mixed but reasonable results and are by no means magic bullets, but they have met my (modest) objectives. I have a little more time on my hands, so I thought I’d try to make a shorter term strategy (days/weeks). Provided I trade each system on different markets I should be able to improve my overall risk/reward as the above 2 systems are quite different in nature, and hopefully this 3rd one will be to. Posting live trades for these 2 systems would be like watching paint dry for most people, but maybe daily positions (or at least market orders) might spark an interest amongst you gambooolers. I have neither the time, ability nor inclination to daytrade. I would probably have a better edge at an Absolute Poker blackjack table than being sat in front of screens full of 100s of blinking red and green arrows (aka-the world’s biggest slot machine).

I suggest the trading plan be written something like this: (and each section can be discussed/flamed in a separate sub-thread)

1. Introduction – finding a concept or an exploitable edge.
2. Objectives – I believe developing a trading system is like making your own clothes. I may feel good and look fantastic in purple and green jeans, but they may not be suitable for you.
3. Timeframe – tick by tick, hour by hour daytrading, EOD, weekly charts?
4. market(s) and trading vehicle - Commodities, forex,, stocks? Also, am I going to trade equities, futures, spread-trading, fruit & vege, CFDs,?
5. Trade set-up – What conditions need to be present before I place an order? This might involve various trade filters.
6. Entry – How, where, and why am I going to enter the market?
7. Exit – How, where, and why am I going to exit the market?
8. Stops – buy limit, stop-loss, GTC, GTS, OCO etc. How am I going to use stops to enter/exit the trade and protect capital/take profits?
9. Money management – Know how much to bet, pyramiding, ‘bankroll’ management. Experiment (play) with the Kelly Criterion. This section will probably overlap #7
10. Understanding my system’s performance – This will include back-testing, forward testing and paper trading and is very time consuming and difficult (for me). I need to know how my system will behave under various conditions, what the expected profits/losses are (EV), risk/reward, std.dev, sharpe, opportunity factor, blah blah. It is very important to be able to psychologically whether drawdowns knowing you still have an edge. (aka, my current 500BB downswing – FU MINBET)
11. Further concepts such as contingency planning, record keeping/reviewing.

All the above things need to be defined and considered before any trade is taken.

I will try and address some of the concepts discussed, but hopefully just keep to the bare details. I’m sure others here could do a better job than me explaining the intricacies and reasoning behind the various aspects of system development.

I have lots of ideas for systems and get more every time I stand and think in the shower. I’ll start by suggesting a basic concept around which a strategy can be developed. I don’t claim to have any specialist knowledge and I’m not planning to re-invent the wheel, but I will be developing something from the ground-up that I will be trading live (if it seems to work). Bear in mind this could all end in abysmal failure (happened many times), or I could find something that works well (happened a few times). Also, many of the above points may have to be re-visited as new information/data/discoveries/realities come to light.

It is my opinion that money management exits, and psychology are the most important parts to any trading system. Psychology however is not really in the scope of this trading plan and there are some excellent texts available on the subject.

Please leave any comments, ideas or suggestions before we get started.

[CallMeIshmael]

I wouldnt be able to add much/anything in terms of market knowledge, but if you want some programming/math guys, Id be interested in the experience.

[NickNick]

Sounds like a good plan.

I doubt I'll be able to add anything constructive as I'm really just learning at the moment, but will chip in if I think it'd be helpful1!

I'd ideally like to see something developed for Forex, as this is probably the most accessible market - I am currently learning trading 0.01 lots, so can buy/sell as lttle as $1000 at a time. Would it be suitable for any pair or for a certain one?

If there is any testing you'd like me to do, just let me know!

[eastbay]

Aside: I never understood the idea of "forward testing". It is just the slowest possible way to do backtesting: later.

eastbay

[stephenNUTS]

Kimichi,

Nice post covering alot aspects of TA...but there is NO magic bullet foolproof sytstem that will conquer the markets.....period.

This is what makes the best traders in the world what they are...they have the talent/discipline/split second ability making qualities needed to be flexible in their decisions,and not being tied into a numbers specific system or program.Their money management disciplines are uncanny as well

All the things you covered are GREAT tools in becoming/enhancing a traders chance of success....but the HUMAN element is what separates the great ones from the one hit wonders

Go ask the quant geeks with thier phd's in math,what happened during this recent market meltdown with their recent exposure to the CDO instruments tied to the sub-prime disaster?

They majority of these 'fool proof' long/short HIGHLY levered hedged vehicle "traders"....lol.... all scratched their heads saying ... what just happened?

"But we WERE UP almost 30% for the year ,and are now we are down 60%" .....as they had NO idea of a liquidation exit plan,with many of these so called quant programs crowding the trade.Many of them will now be looking for a new job to boot,or just leave WS.I cant tell you how many of thse ideas/programs eventually BLOW UP over the years

I am still in LV now...,as I have stated before ,I am going to start a thread about trading/investing when I return home,that covers ALL of the traits IMHO needed to be a successfull trader/investor(esp. the human/physcological importance of the markets)...not just some mathamatical theoried program ,that might work on paper for a short time frame.....when eventually "mr. market" decides to rear its ugly head and teaches this new system of the week a lesson as well

Sorry to say guys...I only wished it was that easy for ALL of us

TTYL,
Stephen [img]/images/graemlins/cool.gif[/img]

[eastbay]

[ QUOTE ]
Kimichi,

Nice post covering alot aspects of TA...but there is NO magic bullet foolproof sytstem that will conquer the markets.....period.

This is what makes the best traders in the world what they are...they have the talent/discipline/split second ability making qualities needed to be flexible in their decisions,and not being tied into a numbers specific system or program.


[/ QUOTE ]

Tell it to Jim Simons and his crew. He is on the record as saying they never override their automated systems.

eastbay

[Ps3tn0NcYk]

Start at a base system first.

3. Daily
4. Equity Index (to smooth for unexpected exogenous events)
5. Trade set up is the money engine obv
Start simple and expand from there
6,7,8,9 are all subsets of 5 imo
10. Rigorous back testing is a good idea
11. If you plan on writing a book, i guess

[kimchi]

[ QUOTE ]

4. Equity Index (to smooth for unexpected exogenous events)

[/ QUOTE ]
Stops can protect against nasty surprises and if I trade a volatile stock which regularly gaps overnight, then I have the option to use guaranteed stops.

My bias (illusion) is that any market can be traded in a simlar way, but I'm leaning towards liquid midcap equities with little or no dividends (dividends screw up my simple models). However, I'm planning on trading shorter term than I have previously and a quick eyeball at my broker's FTSE ex-350 quotes (ie somewhere between FTSE AIM and 250) shows spreads approaching 0.5% which may be too much like paddling upstream. I haven't checked other markets' small cap spreads but I imagine they're at best the same.

The upward bias in stocks however (and the limit on the amount a market can fall), has made trading from the short side significantly less EV than the long side during previous backtests.

I think following highly liquid, highly traded markets like some commodities, forex, DJIA puts you up against the high stakes pros:


from the above Simons article:
[ QUOTE ]
As the selloffs in July and August showed, many quant funds are chasing the same investments. For example, as of June, Renaissance and rival AQR Capital Management LLC had four of the same top 10 stock holdings: Johnson & Johnson, Lockheed Martin Corp., International Business Machines Corp. and Chevron Corp.

[/ QUOTE ]

These guys have to trade the same big markets as their position sizing limits their scope. The little guy with his piddly little account (me) can skip around these guys without worrying about slippage, but can probably also do so on relatively illiquid and less followed (less efficient?) markets.

[ QUOTE ]

5. Trade set up is the money engine obv
Start simple and expand from there
6,7,8,9 are all subsets of 5 imo


[/ QUOTE ]

I'm wondering why you think so. I believe money management is the most important part of a system as your edge is worthless if you bust out. Exits are also more important than entries as they define your initial risks and your profits.

It's evident from many threads on these boards that most people concentrate on entries. "When do I sell GOOG" suggests the investor bought without clearly defined exit criteria. He might have made a perfectly timed elegant entry, but appear not to have considered the exit. It's so easy to allow a winner to turn into a loser, or to prevent a small winner turning into a big winner without proper exits.

I think all the above points (1-11) are related, but need to be considered individually to meet whatever objectives are decided upon in #2

[mak15]

i think talking about points 2-11 is kind of pointless until you/we figure out point 1.

i'm quite interested in following such a project and possibly contributing and even putting some money into the market if we actually devise a decent system, but discussing exit points and money management seems silly when we havn't even begun figuring out an edge.

[Ps3tn0NcYk]

[ QUOTE ]

I'm wondering why you think so. I believe money management is the most important part of a system as your edge is worthless if you bust out. Exits are also more important than entries as they define your initial risks and your profits.

It's evident from many threads on these boards that most people concentrate on entries. "When do I sell GOOG" suggests the investor bought without clearly defined exit criteria. He might have made a perfectly timed elegant entry, but appear not to have considered the exit. It's so easy to allow a winner to turn into a loser, or to prevent a small winner turning into a big winner without proper exits.


[/ QUOTE ]

In short term trading entries and exits points are all you have- so we are agreeing here. The points sit at the center of a trading system. Specific price zones will define the risk of a particular trade- which is equally important.

Probably most important is stress testing a system for situations that might lead to a total blow-up of the account capital. The equivalent of a "major leak" in poker.

I always ask "how much can I lose" or "where am I going to sell and take a loss" before assessing the potential for upside opportunity. A randomly picked backroll number -- ie "$5000" -- is not a target or a stop loss because it runs the risk of being determined by your personal financial situation rather than the specific influences impacting the direction of the trade. One ought to size positions in a fashion where bankroll never faces a crippling loss with one trade.

But risk management is irrelevant in the absence of the logic layer that determines when one enters and exits a trade.