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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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MECHANICAL TRADING SYSTEMS
FIGURE 2.14 Spot pound/U.S. dollar with parabolic. Includes 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.
In this instance we made the fail-safe stop loss 2.5 standard deviations from the 20-day moving average and stated that all entries required the market to be trading at less than 2.5 standard deviations from the 20-day moving average (see Figure 2.15).
PRICE-TRIGGERED TREND-FOLLOWING INDICATORS: DONCHIAN’S CHANNEL BREAKOUT
Richard Donchian’s nth period or channel breakout system is not only a price-triggered trend-following indicator, but also a comprehensive stop and reverse trading system. Trading signals are generated whenever the market price is equal to or greater than the highest high or the lowest low of the past n periods (Donchian used 20 days).11
The reason this simple trading system is so successful is that it capitalizes on one of the primary psychological flaws of novice traders: their desire to buy bottoms and sell tops. Because channel breakout only buys or sells when a trend is already established, its entry and reversal points tend
Mathematical Technical Analysis
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FIGURE 2.15 Cash S&P 500 x 250 with “fading” of SAR and fail-safe stop at 2.5 standard deviations beyond the 20-day moving average. 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.
to gravitate to key horizontal support or resistance levels. As the trend matures, capitulation of those seeking reversal adds to the system’s profitability (see Figure 2.16).
MEAN REVERSION INDICATOR-DRIVEN TRIGGERS: OSCILLATORS

All of the most commonly employed mean reversion indicators are oscillators. The most popular oscillators can be categorized as percentage, differential, or statistical oscillators. In all instances the goal in using oscillators is to fade a temporarily unsustainable level of market emotionalism in hopes of mean reversion. Although a mathematical technical indicator may not be able to quantify extreme emotionalism with same the consistency as an experienced trader, as long as an oscillator can be linked to a solid risk quantification mechanism, it may prove a useful tool in the trader’s arsenal.
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MECHANICAL TRADING SYSTEMS
FIGURE 2.16 June 2004 IMM eurodollar with 20-day channel breakout. 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.
Percentage Oscillators
Stochastics Stochastics was developed by George Lane and is based on the principle that as a market reaches temporarily unsustainable extremes, daily closing prices tend to be closer to the upper (overbought) or lower (oversold) end of each day’s range. As a market loses momentum, closing prices tend to reverse these trends.
Fast %K or %K measures, on a percentage basis, where the latest closing price is in relation to the total price range over a specific period of days (9 and 14 days are the most commonly used default values). Fast %K is used in calculation of fast stochastics. The more popular slow stochastics is generated by calculating Slow %K (SK), which is a 3-day moving average of Fast %K and Slow %D (SD), which is a 3-day moving average of slow %K (SK).
Either version produces two lines that are charted on a 0 to 100 scale. Traditionally, buy and sell signals are generated when the slow %K line crosses over the Slow %D line in overbought or oversold territory. Overbought is usually defined as somewhere between 70 and 80, with oversold readings between 30 and 20. Although it is possible to develop a moderately successful trading system using the SK-SD crossover, my slow stochastics extremes trading system offers a simpler alternative.
Mathematical Technical Analysis
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The 14-day stochastics extremes generate buy signals whenever SD closes below 15 and sell signals when SD closes above 85. As with the fading of trend-following indicators, such as moving average envelopes and parabolics, to transform this mean reversion indicator into a comprehensive trading system, rules for exiting with profits and with losses are needed. For profitable exits, we will use SD closes above 30 and below 70, and our fail-safe exit will be designated as 2.5 percent of the asset’s value at time of entry (see Figure 2.17).
Relative Strength Index Chapter 1 highlighted RSI as a mean reversion indicator because it is among the most popular and well-known of the oscillators. Like stochastics, the RSI is plotted on a 0 to 100 scale, with the 70/30 combination as the most widely used overbought/oversold boundary parameters. As with stochastics, the most popular time periods are the 9-and 14-day versions. Traditionally, RSI generates entry signals whenever the index extends into overbought or oversold territory then falls below the upper boundary or rises above the lower boundary.
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