Part 1: Designing a Trading System
three article series, I am going to guide you through the process
I use to design a trading system using MetaStock's Converter. I'll
cover the four major components that every successful trading system
has in common, and then I'll show you how to code these components
into the program. Please note that this is by no means investment
advice and any information I cover is purely for MetaStock Converter
I am a technical analyst by trade. It is my belief that all fundamental and economic
influences on a stock price are taken into consideration by the market. Therefore,
I focus my attention on price action. All my MetaStock Converter trading systems are
based on this understanding of the market, and the rules of my systems are built to
respond to price actions. In this article I'll cover the basic rules of trading:
- Entry rules (when you get into a position)
- Exit rules (when you get out of one)
- Money Management rules (how much do you put in a trade?)
- Back- Testing (does the system work historically?)
These four MetaStock Converter components make up a proven formula for designing
profitable trading systems. Let's start with the first part.
Entry signals are created by a stock passing through a precise set of conditions
before you will enter a trade on that security. I believe the rules set to signal
an entry into a postion should leave no room for individual judgment. They should
also follow the KISS principal - that is they should Keep It Simple Simon.
Remember, there is no Holy Grail of entry systems. There is no MetaStock Converter
formula that will get you in at exactly the right time, every time. With this in
mind, it's your goal to construct a simple, yet robust entry system.
Even though I always say that the MetaStock Converter entry is the least important
component of any trading system, you still must have some way to enter a trade.
Here are the points that I think are important to consider when identifying possible
MetaStock Converter entry points.
Price: It is important to set price maximums/minimums because a stock's price can
determine its attributes. For example, speculative stocks tend to be cheaper, and
blue chip shares tend to be more expensive. The MetaStock Converter make it
extremely easy to identify these conditions.
Liquidity: This is a measure of how much money the stock trades. You need to set
minimum levels of liquidity to keep you out of stocks that simply don't trade enough.
You can risk being trapped in stocks where the market is moving against you if they
have a low liquidity.
Volatility: This is a measurement that tells you how much
a stock moves. It is important to trade stocks that move enough for you to make a
profit, yet aren't so erratic that you can't sleep at night.
Trend: This is the cornerstone of technical analysis. Remember that the trend is
your friend and that you always want to trade with it, not against it. You will
need a way to measure trend in your MetaStock Converter system.
Trigger: This is the point that will indicate it is time to enter a trade. The
trigger condition occurs only at one point in time and doesn't hold true
over extended periods of time, such as with a moving average cross over.
When combined, these components are going to make up your entry rules. But before
we even begin coding this into MetaStock Converter, you need to determine one of
the most critical elements of any system. What time frame are you going to trade?
Short-term, such as a reversal trader, or long-term, such as a trend follower.
There are distinct differences between these two types of systems and your choice
here will have a marked effect on every other decision you make about your system.
Short-term MetaStock Converter systems tend to require a greater time commitment,
and more money. However, the benefit of trading more often is that usually your
profits are more consistent, and are realised more frequently.
Conversely, longer-term MetaStock Converter systems tend to require less time,
and less money. However, since you are keeping your positions open longer, you
need to wait until positions are closed out before you can collect any profits.
Generally I steer my clients, particularly those who are just starting out, to
a longer-term MetaStock Converter trend following system. It takes less time,
less money, there is less risk and it is easier to do than short-term trading.
In addition, MetaStock Converter trend following systems tend to have a higher
win to loss ratios and are psychologically easier to follow because of this.
For the sake of this example, let us construct a trend following system. In
the next two articles I'll explain how to code the four entry components of
a trend following system into MetaStock Converter.
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