Automated Trading Theory Discussion

[permanentjaun]

Hello all

Here's the next of my open discussion threads. This time it is about automated trading systems. I'll start off by saying I do believe automated trading systems can work but with help. In time I think I will be able to h out business cards that title me as a Foreign Exchange Currency Automated Trading Systems Manager. Sounds nice right? So my belief is that automated trading systems can work but will need to be monitored tweaked to maintain efficiency reliability.

This thread is to discuss why most automated systems fail however. It's to discuss their limitations their abilities. Let me begin the discussion.

A computer can not make discretionary decisions. In my opinion this should rule out many indicators that need much discretion in making a decision based on them. Essentially eliminate any indicators that do not follow price discreetly. RSI CCI MACD stochastics fibs bollinger bs nearly all indicators should be thrown out. Why do I say to eliminate just about every indicator out there? They don't follow price. They can form divergences. They can reach levels where their mathematical formulas are ed out such as in RSI can give neutral signals of being overbought oversold. I believe it is asking too much of a computer to decide what to do in these situations.

Can a computer effectively recognize divergences? Chart patterns? It would add more to the confusion of the system when you must tell a computer by how much an indicator must have diverged before entering a trade. At what point does the divergence become effective in predicting a future market movement? If MACD diverges down for 2 periods is that a long enough divergence to base a decision? 5 periods? Perhaps only when it has diverged for 10 periods. There are many situations that must be accounted for. This is setting up for more possibilities for the system to fail.

Many times we look at several indicators decide to throw out one of them since another indicator is giving more reliable signals. Can a computer decide which of these indicators to use? I will assume that to program a computer to do so would be too much of a project to profficiently carry out a trading system. There would be too many "what if" situations where you're only setting up the system to fail.

I will go so far as to say support/resistance levels should be thrown out of the equation. Get rid of fibs other similar tools. There are plenty of times that prices explode through support/resistance levels easily. Even if resistance/support is confirmed as movement is stalled the trend can continue through said levels. To program a computer to try recognize support/resistance levels is just creating another "what if" situation for it to fail at. Can you correctly tell me why sometimes support/resistance levels are held while other times they mean nothing? If you can't do so with 100% accuracy how can you tell that to a computer which has no thought process?

Thus I believe that the way to program a trading system is to keep it simple. The system needs something that follows price solely since that is what we are concerned with predicting. We need something a computer can make decisions off of such that the indicator does not get ed out follows price doesn't diverge is indiscretionary.

My conclusion is to use moving averages. They are based directly off of price can not get ed out do not diverge computers can easily make decisions off of them.

Many will say that this is too simple to base a trading strategy off of. In fact it can be as complicated as you want for yourself. Do you create MA's off of the open high low or close? Are they weighted simple exponential triangular etc.? Do you create it off of price closing above/below a MA or when another MA crosses? What period do you set the MA for? What time frame? I think those options right there are enough for you to think about. The point is that you create the system such that all the decisions were made by you. The computer can easily tell you when a cross or price movement will have triggered the trade. It doesn't need to recognize chart patterns divergences etc.. It simply needs to monitor price. The difficulty in deciding has been done by you.

[permanentjaun]

Now on to my thoughts on setting up the system.

We want a system that works well in any market ranging trending. To this I reply a market is never ranging a market is never trending. It is simply moving. I say this because what chart are you looking at to say a currency is ranging or trending? It has been shown that price movement slows down during times when major markets are closed then explodes in movement when they open. Looking at a 10 minute chart would show many periods of inactivity or tight movement which could be categorized as ranging. Take a step back to a 2 hour chart or even a daily chart. Does the chart still show a ranging market? Conversely look at a 1 or 2 hour chart. Does the currency look like it's trending? If so take a step back to a weekly or monthly chart. GBP/USD has been trading in between 1.4000 2.000 since 1986. I argue that prices are just moving up or down. That is all we should be concerned with.

Many times I hear to exit a trade when the chart tells you to. This means don't set profit limits. If you exit with 10 pips be happy don't a trade to make 100. If a chart shows 100 pips then don't cut yourself short with 10 pips.

I'm an economist so a lot of how I think comes down to efficiency. To make it clear I'll describe extremes. You don't want to trade a daily chart with a 100 MA cross because it may be too slow. You don't want to trade a 1 minute chart with a 5 MA because it is too fast. Both situations present inefficient situations. In the first you're missing many opportunities to imize profits in the latter you're presented with too many signals which don't allow you to ride a price movement.

So my thoughts are that a chart needs to be used such that periods of inactivity are eliminated. If a price is "ranging" then its a large enough range that MA's can effectively keep up with price to play it just as equally as if it were "trending." This can be accomplished on many charts. We could use a 4 hour chart with a fast MA such as a weighted 5 MA. Would this give us too many whipsaws? We could also use a 30 minute with a 50 MA. Would this be too slow? That is where I believe the success of the system lies.

Find a MA that is overall quick enough to give a signal early but not slow enough that the price movement is missed. It's not just the MA either. For the chart is a 2 hour too slow such that each new cle allows too much movement so that when the next cle forms you enter a position the run is already over? I'll present the converse of a 30 minute chart being too quick to enter a position.

[permanentjaun]

Lastly I'll discuss limits. In my previous post I discussed how we should not cut our winners short. How would the system hle whipsaws or drastic movement against us to protect ourselves profit loss?

One option I present is that the system is ALWAYS in the market. We want the chart that doesn't trade flat is always going up or down. So if there is a cross to enter short we assume it will go down when it crosses long we expect the market to continue going up. I assume this because why do we exit positions? We do so because we expect our profits to be imized further market movement is not strong. When we exit a long position its because we expect the market to reverse head down. Would you not enter a short position if you trade a chart such that there is no sideways movement only up or down? It doesn't make sense.

The system is based that we enter a long only in the belief that the market is going to go down.

So profits are protected by closing a position for only a few pips loss or even because of a whipsaw entering a new oppositie position. So if you entered long protecting profits would involve a new position short. This allows us to maintain a position in the overall movement to make such losses insignificant.

What if the MA is too slow then? First off we should be managing the system to eliminate this problem in the first place. Secondly well I'm not so sure about secondly. I don't have a definitive answer to this problem. Certain ideas running through my head right now include exiting positions before the MA cross if price retraces 50% the position entered in a certain amount of time. I'm taking suggestions on this part as well. Although again a lot of this problem can be minimized by finding the most efficient chart time MA settings to make profits most efficient. It's sort of a 2 steps forward one step back approach. We want to position ourselves to ride the 100 pip movement while taking small losses of 5-10 pips to guarantee ourselves a front row seat on the big ride.

Strategies could also include entering 2 lots. One that is exited with a profit of only a few pips to guarantee some pips. The other could be exited when the MA crosses or for an even close on the position. This would be difficult because of the typical problems associated with being "stopped out." Price can swing large enough to exit a trade but not warrant the movement to reverse.

I'll conclude by summing up the problems of the system.

1. There is no clear profit protecting strategy. What happens when price reverses before the MA's can clearly tell us that? How do we protect ourselves?

2. Somewhat the same problem is telling the computer when to enter a trade. The computer would likely need a cle to complete confirm the cross before entering the trade. Unfortunately what happens if we're looking at a 2 hour chart the movement happens in that two hours then stops? We would have entered at the peak of the run are vulnerable to a drop in price.

I believe the solutions are to finding the efficient chart intervals type of MA or MA's used. It needs US. We need to tell it what to do not what it tells itself to do. Automated systems will need us.

Ok. Those are my thoughts. What do you all think? Thanks in advance. Matt

[Trevman]

check out http://www.learncurrencytrading.com/...?t=1215&page=5 theres an auto trader that trades ok but when it doesnt trade certain days of the week it does really well theres also a rom entry experiment. also check out http://championship.mql4.com/ i think you may be right with MA trading as its one of the easiest next to price movement such as cle patterns.

[permanentjaun]

Not sure if I was really looking to pick up someone elses system. Unfortunately on the championship site I can't read a lot of the information there. It's such an international competition that many of the leading competitors are typing in different languages.

I'd like to get more of a discussion the theories people have. I presented several on the use of MA's as the only tool in automated systems.

I still haven't come up with a conclusive exit strategy for a system yet.

One of the problems is protecting profits. If I set a trailing stop many times it will be hit even though the overall trend hasn't reversed. So I could get stopped out while the move continues for another 80 pips as the chart suggests.

Another problem I'm seeing is that many times a strong trend ensues where it is easy to make over 150-200 pips by trading the system. Then one cle closes the position as it has crossed the signal MA to open a new position in the opposite direction. The problem is the new cle has erased most of the profit made. A prime example would be on October 12th. A signal to buy was made in my setup on a 4 hour chart. The signal to open a position in the opposite direction was made on the 22nd. The system would have banked almost 100 pips BUT it lost the opportunity to bank nearly 370 pips.

That is an extreme instance but the situation is still not uncommon. Banking only 10 pips when a pip profit of 60 was possible.

Like I mentioned a trailing stop loss may not be good because of getting stopped out. I'm considering a system where a slower MA produces the initial signal a faster MA produces the closing signal.

I'm also considering have one MA that is significant on a chart say 100. When a currency closes above the MA then enter a long position. Look for a certain amount of pips exit the position no questions asked. I still don't like the idea of missing out on huge pip runs. Although for longer charts such as 4 hour I could look for 100 pips. On a shorter chart such as 30 minute only look for 20 pips.

One problem with that is many times a price will stall around a strong MA thus closing above below it many times to whipsaw several times. These situations must be considered. I still haven't found my ideal MA automated strategy. Any help please? TIA. Matt

[Trevman]

the links i quoted above were to show that it is just as important infact MORE important knowing where to get out rather than get in. in reference to your
3 MA are the below examples we'll call them 123 for ease.

1 = signal line
2 = trade line
3 = trend line
when 1 crosses below 2 both are below 3 sell. when 1 crosses above 2 both are below 3 close but do not buy.

OR

1 = signal line
2 = close line
3 = open line
when 1 crosses below 3 sell. when 1 crosses above 2 close but do not buy.

OR

the vegas tunnel method (ive heard) is quite succesful (more info http://www.moneytec.com/forums/f14/t...vegas-19312/)i also found this while searching http://www.moneytec.com/forums/f14/5...trategy-17895/.

finally an idea i toyed with a while ago was using eg a 21EMA on the open a 21EMA on the close. the idea is in a down trend the close is on average less than the open vice versa but never got much past that idea oh well.

[permanentjaun]

I think I've toyed with that idea as well. Say have a 50 MA. Then a 3 15 MA. Buy when the 15 MA is above the 50 the 3 crosses above the 15. Close The position when it crosses to below the 15. Buy back in when it crosses back above the 15 MA. This would allow several entries exits on the way to the top.

The idea was only enter long positions if the price action is above the 50 MA a bullish signal. Only enter short positions when the price action is below the 50 MA.

I assume this is what the tunnel method is similar to? I wasn't a member of forexfactory so I could not download the files to read about it. It seems to have a huge following though. Matt

[permanentjaun]

By the way I underst that exits are more important than entry. I was trying to find a system that was always in the market though. So one entry would be anothers exit. So if I found the right entry on one I also found the right exit on the other. Is it even possible to automatically get the correct entry/exit? Perhaps only with discretion a human face? I'm trying to find the alternative.

I'd like the system to always be in but perhaps it's not necessary. The system will probably have to have insurances or costs. If the system is always in then we take on costs of losing profit imization. If the system is not always in then we lose on some of the battle. For example while it may have exited at a peak it would not have taken a converse position as it falls 100 pips until it crosses the signal line then a position is entered. For security we'd have to give up those 100 pips.

We would have given those up anyways perhaps on the always in system? Also need to find the system that works well most of the time. Trying to satisfy every situation is impossible. In doing so we probably would require the computer to make decisions that only a human can make.

Is the best system the most conservative then? Adding costs of lost potential pips to only gain the most certain? I still think MA's are the only filters we can add effectively to correctly follow price. What are some ways they can protect us? MA crosses may not be enough. Even with MA crosses what about using price crossing an MA instead of an MA. Just throwing ideas out there. Matt