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Mechanical trading systems - Weissman R.L.

Weissman R.L. Mechanical trading systems - Wiley publishing , 2005 . - 240 p.
ISBN 0-471-65435-3
Download (direct link): mechanicaltradingsystems2005.pdf
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Note: All trade summaries include $100 round-turn trade deductions for slippage and commissions. ©2004 CQG, Inc. All rights reserved worldwide.
FIGURE 2.5 DM -euro-U.S. dollar with entry at 2.5% moving average envelope of a 21-day MA and exit at a 21-day MA. Includes data from December 31, 1997, to December 31, 2003.
Note: All trade summaries include $100 round-turn trade deductions for slippage
and commissions. ©2004 CQG, Inc. All rights reserved worldwide.
22
Mathematical Technical Analysis
23
indicators (see Figure 2.6). This concept of “fading” trend-following signals to capitalize on the market’s propensity for mean reversion is a theme that we will revisit throughout the book. Although simply fading the moving average envelopes provides a method of generating entry signals, it does so without defining an exit method. Two distinct types of exits must be introduced to transform this indicator into a comprehensive trading system. First, we need to determine where we will exit the trade if mean reversion does occur as anticipated. Since our intention was to fade the envelopes, the obvious answer is exiting either at the moving average or with a percentage profit (i.e., 1 percent of the asset’s value at entry).7 The other, more critical exit criteria is the introduction of a fail-safe exit, which will prevent unlimited risk in the event that the market continues trending. Our fail-safe stop-loss level can be determined in numerous ways, such as the introduction of wider moving average envelopes or a percentage of the contract’s value at the time of position entry.
Two and Three Moving Average Crossovers We have already examined two moving average crossover trading systems in some detail. The
FIGURE 2.6 Spot S&P 500 x 250 with fading of the 2.5% moving average envelope of a 21-day MA and profit targets of the MA or 1% of entry and 5% of entry price fail-safe stop loss. Includes data from December 31, 1997, to December 31, 2003.
Note: All trade summaries include $100 round-turn trade deductions for slippage
and commissions. ©2004 CQG, Inc. All rights reserved worldwide.
24
MECHANICAL TRADING SYSTEMS
Ichimoku Kinkou Hyou is similar to the traditional western moving average crossovers except that the moving average parameters are specifically set to 9 and 26 periods. Ichimoku also has a whipsaw waiting period built into it, as entry signals require not only that the 9 closes beyond the 26-period moving average, but also that the 26-period moving average starts moving in the direction of the crossover (compare Figures 2.7 and 2.8).
Jack Schwager, who writes extensively on technical analysis, incorporates this concept of following the momentum of the moving average by suggesting that traders can add to existing trend-following positions when the market’s close violates the moving average. Although such violations traditionally trigger stop and reversals, Schwager argues that if the violation is not confirmed by a reversal of the moving average’s trend, it offers traders a low-risk entry point.8
Except for moving average envelopes, so far the examination of the moving average has focused on stop-and-reverse trading systems, meaning that whenever conditions required the exiting of an open position, entry into an opposite position also was triggered. By contrast, the three moving average crossover system allows for neutrality (see Figure 2.9). Trade entry requires that the shortest moving average closes beyond the middle moving average and that the middle is beyond the longest. Whenever the shortest
FIGURE 2.7 February 2004 CME live cattle futures with 9- and 26-day moving average crossover. Includes data from December 31, 1997, to December 31, 2003.
Note: All trade summaries include $100 round-turn trade deductions for slippage
and commissions. ©2004 CQG, Inc. All rights reserved worldwide.
FIGURE 2.8 February 2004 CME live cattle futures with 2 moving average Ichimoku. Includes data from December 31, 1997, to December 31, 2003.
Note: All trade summaries include $100 round-turn trade deductions for slippage and commissions. ©2004 CQG, Inc. All rights reserved worldwide.
FIGURE 2.9 February 2004 CME live cattle futures with 9-, 26-, and 52-day moving average crossover system. Includes data from December 31, 1997, to December 31, 2003.
Note: All trade summaries include $100 round-turn trade deductions for slippage
and commissions. ©2004 CQG, Inc. All rights reserved worldwide.
25
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MECHANICAL TRADING SYSTEMS
moving average is between the other two, it triggers liquidation of open positions and neutrality until all three are again correctly aligned.
Ichimoku Kinkou Hyou also has a three-moving-average version that includes the introduction of a 52-period moving average. As with its two-moving-average system, this version contains a whipsaw waiting period that requires that both longer-term moving averages have turned in direction of crossover prior to entry.
Although it is impossible to draw any definitive conclusion from a single case study, it is interesting to note that in both of our examples the Ichimoku versions produced inferior results when compared with the traditional moving average and the three moving average crossovers. In addition, both versions of the three moving average systems generated inferior track records when compared with the simpler, more robust two moving average crossovers (compare Figures 2.7 to 2.10). This concept of simple is better will be revisited throughout the book.
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