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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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Other Indicator-Driven Trend Following Methods
Moving Average Convergence Divergence The moving average convergence/divergence indicator—better known as the MACD—was devel-
FIGURE 2.10 February CME live cattle futures with 3 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.
Mathematical Technical Analysis
27
oped by Gerald Appel and is commonly used as a trend-following indicator that attempts to minimize trading range whipsaws. The MACD line is the numerical difference between a shorter-term, 13-period exponential moving average and a longer-term, 26-period exponential moving average. A third exponential moving average, known as the MACD’s signal line, is a 9-period exponential average of the numerical difference between the 13- and 26-period exponential moving averages. MACD is commonly used as a trend-following stop and reverse trading system in which stop and reverse signals are generated whenever the MACD line closes beyond the MACD’s signal line (see Figure 2.11).
Directional Movement Indicator and Average Directional Movement Index The directional movement indicator (DMI) is a trend-following indicator developed by Welles Wilder that attempts to measure market strength and direction. Instead of using the closing price for each period as an input, DMI uses each period’s net directional movement. Net directional movement is defined as the largest part of a period’s range that is outside of the previous period’s range and includes separate calculations for positive movement (+DI) and negative movement (-DI).9
FIGURE 2.11 July 2004 CBOT soybeans with MACD crossover. Includes data from April 7, 2003, to April 15, 2004.
Note: All trade summaries include $100 round-turn trade deductions for slippage
and commissions. ©2004 CQG, Inc. All rights reserved worldwide.
28
MECHANICAL TRADING SYSTEMS
If the +DI is greater than the -DI, then the market is said to be trending higher; if -DI is greater than the +DI, then the indicator suggests a bearish trend. Because market direction is determined by whether DMI is above or below the zero line, it is another stop and reverse trend-following system (see Figure 2.12).
The average directional movement index, or ADX, is an index of the relative strength of the market’s trend. It is derived by applying a 9-period smoothing of the result of dividing the difference between the absolute value of +DI and DI by the sum of +DI and DI. If the resulting percentage is above 20, the market is viewed as trending, whereas readings below 20 suggest sideways activity (see Figure 2.13).
When comparing Figures 2.12 and 2.13, it is interesting to note that inclusion of ADX resulted in inferior system performance. Although it is impossible to draw conclusions from a single example, I offer it to readers here as a caution flag. Just because data vendors or indicator developers link two studies together does not necessarily mean their combination will increase profitability.
FIGURE 2.12 March 2004 CBOT T-bonds with the difference between +DI and -DI shown as a single line and DMI crossover system. Results include data from December 31, 2002, 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.
Mathematical Technical Analysis
29
FIGURE 2.13 March 2004 CBOT T-bonds with DMI crossover system and ADX filter Results include data from December 31, 2002, 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.
Parabolic The final indicator-driven triggered trend-following method that we will examine is Wilder’s parabolic, or stop and reverse (SAR). This is another trend-following system that is always in the market and whose stop-and-reverse trigger points take on a parabolic shape as the trend matures. The parabolic curve of the stop and reverse levels is achieved through the indicator’s incorporation of an acceleration factor.10
The key to success with parabolic lies in the ability to determine whether the market is in a sustainable trending environment. Chapter 3 examines these issues in more detail; for now, suffice it to say that specific asset classes display a greater propensity to trend. Unless a trader’s superior grasp of fundamentals suggests a high probability of a sustainable trend, Wilder’s parabolic probably should be used with such vehicles (see Figure 2.14).
If SAR performs poorly in many markets, it seems logical to fade its stop and reverse signals, as we did in our work with moving average envelopes. To review, we successfully transformed the moving average envelopes from a trend-following system into a mean reversion system by fading all trading signals generated and adding a fail-safe exit to prevent unlimited risk in the event that the market continued trending.
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