Other Articles...

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 Generation

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 systems.

1. 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.

2. 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 “turtle” system was purportedly based on channel breakouts.

3. 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 bars’ ranges, adjusted for opening gaps, over some past number of bars. The ATR is added to or subtracted from the current bar’s price to determine the breakout price.

4. 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 it’s above a support level, it will have difficulty falling below that price. It’s 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.

5. 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 method.

6. 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.

7. 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.

8. Time-of-day/day-of-week. Time-based 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.

9. 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 oscillator.

10. 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, it’s possible that other, less popular methods may be more profitable in some cases.
 

To comment on this article, click here.

If you'd like to be informed of new developments, news, and special offers from Adaptrade Software, please join our email list. Thank you.