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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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In fact, successful entry levels often are diametrically opposed to the notion of a “perfect” price. Since the “perfect” entry would entail buying the low tick or selling short at the ultimate market high, this automatically rules out participation in any well-defined trend, because these trends almost always entail entry at recent highs or lows. And as stated earlier, trend-following systems are quite profitable because they enable participation in the amplified tails within a market’s price distribution.
Exiting the Trades: With Profits and Losses
The vast majority of novice technicians focus almost entirely on tools to assist them in entering trades for the reasons stated above. What makes
Dispelling Myths and Defining Terms
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successful trading so elusive is the lack of focus on exiting positions either with profits or with losses. Behavioral finance proposes that one reason for lack of success in exit strategies is an irrational emphasis on entry price.6 This focus on entry price leads to exiting profitable trades prematurely. We tend to think of our entry price as a comfortable, “realistic” level—after all, didn’t we recently enter at that price? This emphasis on entry price gives us a sense of comfort since we are able to focus on a quantifiable, known reference point. As profits accumulate and we move farther from our comfortable reference point, our fear of reversal becomes more acute and our confidence necessarily deteriorates. And so our irrational fear of allowing small profits to turn into losses prevents the realization of large profits.
This same emphasis on entry levels gives us a false sense of security as trades begin to deteriorate. We remind ourselves that our entry level was only recently achieved and therefore assume that a return to this level is highly probable. This irrational emphasis on our psychological reference point produces an unfounded sense of confidence and allows losses to escalate from manageable to catastrophic levels.
This psychological framework of “natural” and “comfortable” trading— using entry levels as a reference point—ensures small profits and large losses. Success in trading means training ourselves to fight our “natural” psychological frameworks by being “comfortable” with the unknown future as opposed to the traditional comfortable reference point of our entry price. In reprogramming ourselves to be comfortable with the unknowable and uncertain future, it helps to remind ourselves that the entry level is significant to us alone and that the sense of discomfort that we feel as the market moves into previously unknown territory is entirely subjective and illusory.
In summary, this use of our entry price as a reference point makes us fearful when we should be most confident—when the market is telling us that we are right by increasing our unrealized profits—and gives us an erroneous sense of security when we should be most cautious. And so we cut our profits and let losses run, which of course is the exact opposite of successful trend trading. This book offers a multitude of psychological and mechanical techniques intended to replace destructive behavioral patterns with ones that foster success in trading as well as a more harmonious outlook on life in general.
TECHNICAL ANALYSIS: A DEFINITION7

The goal of technical analysis often is said to be the forecasting of future price “trends.” I would qualify this definition so that the term trend encompasses all types of market activity, including trending, countertrending, and
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MECHANICAL TRADING SYSTEMS
sideways price action. The basic precept in all technical analysis is that by studying past price history and evaluating volume or number of trades and open interest or the number of contracts outstanding, traders can forecast future price “trends” and identify low-risk/high-reward trading opportunities.
This broad definition can be further narrowed into two distinct subcategories: interpretative or subjective technical analysis and mathematical or objective technical analysis. Subjective or “classical” technical analysis attempts to capitalize on visual price history patterns that are subject to interpretation. Examples of this type of analysis include the head and shoulders pattern, inverted head and shoulders, along with various diagonal trend-line formations, including triangles, flags, and pennants.8
Although interpretive technical indicators cannot be quantified objectively, they are nonetheless powerful tools, enabling both the quantification of risk and the identification of valid market trends. Despite their usefulness, the identification of such visual patterns is entirely subjective, as the name “interpretative” suggests. As a result, the validity of such interpretative indicators cannot be statistically verified, and their utilization for mechanical trading systems is severely limited.
In stark contrast to interpretative technical indicators, the success or failure of mathematical technical indicators is always indisputable because the buy and sell signals that they generate are based on objective and immutable rules. The simplest and most popular of these types of indicators is the simple moving average.
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