Don’t count your chickens until they are incubated.
A trading system is only as good as your market intuition. You can formulate and test virtually any trading system you can imagine with today’s software. The previous chapters studied the basic principles of system design. This chapter develops and tests several original trading systems to illustrate the application of those principles:
- A simple trend following system—the 65sma-3cc system.
- A pattern-based system for long trades only—the CB-PB system.
- A trend-seeking, strength-of-trend system—the ADX burst system.
- An automatic mode-switching system—the Trend-Antitrend system.
- Intel-market systems for correlated markets—the gold bond systems.
- A system for picking bottoms—a bottom-fishing pattern.A system for increasing bet size—the extraordinary opportunity model.
In this chapter, each case illustrates a different design philosophy. The 65sma-3cc system is examined in the greatest detail; the same principles can be applied to all other systems. Long-term test results with continuous contracts are shown for every system.
This is not a recommendation that you trade these systems. These systems have all the limitations of hypothetical test results. They are discussed here only as examples of the art of developing systems that suit your trading style
The Assumptions behind Trend-Following Systems
The basic assumptions behind a simple trend-following system are as follows:
- Markets trend smoothly up and down, and trends last a long time.
- A close beyond a moving average signals a trend change.
- Markets do not have large countertrend price swings.
- Prices do not move too far away from an intermediate moving average.
- Whipsaws are relatively few and do not cause large losses.
- Significant price moves last many weeks or months.
- Markets are predominantly in a trending mode.
The reality of a trend-following system is that:
- Markets are often in ranging mode with choppy swing moves, so losses in trading ranges are significant.
- There are large swings in trade equity, since the model “gives back” a large proportion of profits before signaling an opposite trend.
- These systems need a relatively “loose” stop in order to avoid missing about 5 percent of trades that account for major profit-able moves.
- These systems often enter the market on strength or weakness, so that they can be stopped out during short but vicious countertrend moves.
The advantages of simple trend-following systems are:
- They provide guaranteed entry in the directions of the major trend.
- They are profitable over multiple markets and multiple time frames, as long as time frames are 6 months to 5 years in horizon.
- These systems are usually robust.
- These systems have well-defined risk-control parameters.