Systematic Trading: Benefits and Risks
Getting Starting With Systematic Trading
Elements of a Profitable Trading Strategy
Top Ten Systematic Trading Methods
Tools for Strategy Building
Building Trading Systems Using Automatic Code
Top Ten Systematic Trading Methods
by Michael R. Bryant
Systematic trading methods are the basis for trading
systems and automated trading strategies. They consist of technical indicators
or other mathematical methods that are used to generate objective buy and sell
signals in the financial markets. Some of the most popular methods have been in
use since before the advent of computers, while other methods are more recent.
This article lists ten of the most popular systematic methods found in trading
Moving average crossovers. Trading
systems based on the crossover of two moving averages of different
lengths is perhaps the most common systematic trading method. This
method also includes triple moving average crossovers, as well as
the moving average convergence divergence (MACD) indicator, which is
the difference between two exponential moving averages. The moving
averages themselves can be calculated in a variety of ways, such as
simple, exponential, weighted, etc.
Channel breakouts. In this method, a
price channel is defined by the highest high and lowest low over
some past number of bars. A trade is signaled when the market breaks
out above or below the channel. This is also known as a Donchian
channel, which traditionally uses a look-back length of 20 days. The
famed ďturtleĒ system was purportedly based on channel breakouts.
Volatility breakouts. These are similar
in some respects to channel breakouts except that instead of using
the highest high and lowest low, the breakout is based on the
so-called volatility. Volatility is typically represented by the
average true range (ATR), which is essentially an average of the
barsí ranges, adjusted for opening gaps, over some past number of
bars. The ATR is added to or subtracted from the current barís price
to determine the breakout price.
Support/resistance. This method is based
on the idea that if the market is below a resistance level, it will
have difficulty crossing above that price, whereas if itís above a
support level, it will have difficulty falling below that price.
Itís considered significant when the market breaks through a support
or resistance level. Also, when the market breaks through a
resistance level, that price becomes the new support level.
Likewise, when the market drops through a support level, that price
becomes the new resistance level. The support and resistance levels
are typically based on recent, significant prices, such as recent
highs and lows or reversal points.
Oscillators and cycles. Oscillators are
technical indicators that move within a set range, such as zero to
100, and represent the extent to which the market is overbought or
oversold. Typical oscillators include stochastics, Williams %R, Rate
of Change (ROC), and the Relative Strength Indicator (RSI).
Oscillators also reveal the cyclical nature of the markets. More
direct methods of cycle analysis are also possible, such as
calculating the dominant cycle length. The cycle length can be used
as an input to other indicators or as part of a price prediction
Price patterns. A price pattern can be
as simple as a higher closing price or as complicated as a
head-and-shoulders pattern. Numerous books have been written on the
use of price patterns in trading. The topic of Japanese candle
sticks is essentially a way of categorizing different price patterns
and linking them to market behavior.
Price envelopes. In this method, bands
are constructed above and below the market such that the market
normally stays within the bands. Bollinger bands, which calculate
the width of the envelope from the standard deviation of price, are
probably the most commonly used type of price envelope. Trading
signals are typically generated when the market touches or passes
through either the upper or lower band.
trading methods, based either on the time of day or the day of week,
are quite common. A well known trading system for the S&P 500
futures bought on the open on Mondays and exited on the close. It
took advantage of a tendency the market had at that time to trade up
on Mondays. Other systematic approaches restrict trades to certain
times of day that tend to favor certain patterns, such as trends,
reversals, or high liquidity.
Volume. Many systematic trading methods
are based solely on prices (open, high, low and close). However,
volume is one of the basic components of market data. As such,
methods based on volume, while less common than price-based methods,
are worthy of note. Oftentimes, traders use volume to confirm or
validate a market move. Some of the most common systematic methods
based on volume are the volume-based indicators, such as on-balance
volume (OBV), the accumulation/distribution line, and the Chaiken
Forecasting. Market forecasting uses
mathematical methods to predict the price of the market at some time
in the future. Forecasting is qualitatively different than the
methods listed above, which are designed to identify tradable market
tendencies or patterns. In contrast, a trading system based on
forecasting might, for example, buy the market today if the forecast
is for the market to be higher a week from today.
Please keep in mind that this list is based on popularity, which is not
necessarily the same as profitability. Successful trading systems often employ a
combination of methods and often in unconventional ways. Also, itís possible
that other, less popular methods may be more profitable in some cases.
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