164Exponential moving average, 130,141
247
Index
Exponential smoothing formula, 229False anticipation, 225False signals, filter for:impact of, 144-145self-adjusting filter, 144Fanning industry, storage facilities, 16FastK, 9Fast market, 22-23Fast-moving averages, 134Feedback, 189,221Fibonacci spirals, 1050-year rule, 49-50Filtering:expectations and, 234false signals, 144-145price levels, 227, 230-232programming rules for, 234-235utilizing, 234volatility, 232-233Forecasting:computer technology and, 33-35correlation coefficients and, 63globalization and, 28-29indicators and, 35-37price, 5-7Foreign exchange markets:adaptive moving average example, 139,142-143automation and, 4maturing of, 13risk and return dilemma, 51Forex trading, 13FORTRAN, 186,196Frequency distribution, 64Fundamental analysis:defined, 5-6trend-following and, 130-131Futures contracts, testing data, 194Futures market:foreign exchange, 16locked-limit moves, 25Fuzzy logic:defined, 12,171deoptimization, 173fuzzy reasoning, 172practical solutions, 172-173state of the art, 173suboptimization, 173
Fuzzy logic (Cont.):terminology, 171-172Gann lines and angles, 10Gap-adjusted data series:building, 195-196testing, 195Generalized fractal efficiency, 134Globalization:change and evolution, 28-29effect of, 26-27inflation and, 27noise factors, 27seasonality, 28Goldman Sachs Commodity Index, 37Government policy, impact of, 5Graphics, split-screen, 11Great Britain, 27Gross National Product (GNP), 5Hang Seng Index, 13,179High-volume trading, execution problems,23Histogram, 64Historic testing, 111, 126,178IBM, 4,13,15IMM (International Monetary Market), 21,108,238Index data series, 195Indicators:function of, 35-37stock market advance/decline, 9-10types of, 8-9Inflation:effect of, 4globalization and, 27Interest rates:during recession, 19,57economic trends and, 5Intraday trading:estimated fills, 25execution problems, 23Isolationism, 26Japan, fuzzy expert systems, 173
248Japanese Government Bond (JGB), 238
Lane, George, 9Largest drawdown, 202Learning by feedback, 5Leverage:performance monitoring and, 238-239risk reduction and, 106risk and return, 46Limit orders, 20,22-23,221Liquidity, 103,221London International Financial Futuresand Options Exchange (LIFFE),238Long-term trends, profit-taking and, 81Long test period, 188Lotus, 147,186
MAR Dollar-Weighted CTA Index, 55-56MarketView, anticipated price calculation,227Market volatility (see Volatility)Mathcad, 186MATIF CAC-40 Index, 13,190-191Mature markets:new markets compared to, 13,15price trends and, 12-13Maximum drawdown, 48,202Maximum volume, calculation of, 26MetaStock, 10,107Momemtum (price difference) formula,229Moving average:adaptive (see Adaptive moving average)calculation of, 8declining stock and, 9-10defined, 7formula, anticipation signals and, 228software programs, 10trend identification, 129Multiple decision-making programs, computer technology and, 38Multiple regression analysis:answer to, 5-6application of, 5-6price forecasting, 6standard econometric analysis and,37
Index
Neural networks:artificial, 165-166defined, 12forever learning, 170-171regression analysis and, 12,34terminology, 164-165tests, 169-170three-layer system, 166-167threshold analysis, 37training:example of, 168process, 167-168trial and error, 168Nikkei, 26Noise:globalization and, 27stop-losses, interference with, 91-92trend trading, 131NYMEX crude oil, 15OPEC (Organization of PetroleumExporting Countries), 12,15Optimization:defined, 178,235performance example, 179reversal of, 235-236Options:on futures, 16leverage and, 46Orange juice industry, seasonality, 16-17Overfitting, 177-178,213,216Overnight risk:opening gaps, 237primary markets, 236,238Overtesting, 216Parameters (see Robustness testing, parameter selection)Parity, 16Pattern recognition, 12,34-35,37-38,160Pension funds, 12-13People's Republic of China (PRO:emergence of, 3,28world trade and, 17Percentage of profitable trades, 202Performance curve, test results, 208Performance data, significance of, 37-38
249
Index
Performance monitoring:chi-square test, 221-223deltas, 220feedback, 221liquidity, 221significance of, 219-220Performance profile, 67,92,105Perpetual contracts, 213Portfolio diversification:benchmark, 54correlation coefficients and, 58globalization and, 27return/risk ratio, 53-55as risk reduction strategies, 53-60Price(s):bundling, 16changes, 5quote screen, 19-20Price levels, filtering:profits and risk, 232trade patterns and, 227,230trend longs, 231-232trend shorts, 230-232Price shock(s):assumptions and, 113elimination of, 111,113expectations and, 107-109,115frequency of, 115-117gaps, 115-117handling strategies:artificial data, creation of, 119-120risk assessment, 119high risk, 107-109historic testing, 211-212impact of, 110-111,115,117key concepts, 118management of:large losses, 124,126long-term systems, 126-127obligations, 126qualification of, 121risk reduction, 124short-term systems, 126-127structural changes, 124ranges, 115-117recognition of, 103short tests and, 115types of, 61,109-110,112-115unpredictability of, 39-40Producer Price Index, 37
Professional traders:performance of, 105price shocks and, 49Profits per trade, 199Profit-taking:adaptive moving average and, 146advantages, 73disadvantages, 73profit objective:more than one objectives, 83-85one objective, 81-82risk and, 85-86time vs., 81-82reasons for, 80-81stop-losses, 87-88test for:coding system, 77profit-taking levels, 76results, 77-79trend formulas, 75-76trend and profit-taking rules, 76time interval and, 81-82trading strategy, improved, 86-88Quattro, 44,147,186Quote screen:function of, 19-22spread profits, 20r, 58Recession, impact of, 19,57Relative Strength Index (RSI), 8-9,198Resting orders, 20,225Return/risk ratio:asset allocation, 53best choice test, 47defined, 68formula, 199Risk:acceptable, 50,212business risk, 61-62control of (see Risk control)correlation coefficients:forecasting, 63risk reduction and, 58^60time periods and, 62-63diversification and, 53-65
250Risk(Cont.):evaluation of, 65fair approximation evaluation formula,67-68graphing:frequency distribution, 64function of, 51skewed distributions, 63-64profit goals and, 66-67 ,reduction strategies (see Risk reductionstrategies, diversification and)risk of ruin:defined, 65-66profit goals and, 66-67risk protection (see Risk protection)semivariance, evaluation method, 65stop-losses and, 89Risk-adjusted returns, 202Risk assessment:50-year rule, 49-50guidelines, 119maximum drawdown, 48Risk control:need for, 90protective stops, 227worst-case scenarios and, 215Risk protection strategies:correlations, 58-60portfolio diversification, 57stop-losses, 90-91,117-118Risk reduction strategies, diversificationand:adding assets, 54-55asset allocation techniques, 53asset selection correlations, 57common sense, 61-65correlation coefficients and, 58-60derivatives and, 55-56simple, 53stock and bond portfolio, 53-54Risk and return:acceptable risk, 50best choice, 47calculating) 44-45currency vs. bond portfolios, 46foreign exchange dilemma, 51leverage, 46risk preference, 41-42,227standardizing, 42-46trend-following system test, 47
Index
Risk and reward:"best" choice, 52graphing risk, 51Risk-to-time curve, 48Robustness testing:overfitting, 177-178,213,216overnight risk, 236-238parameter:optimized performance example, 179principles, 179robustness determination, 180-181selection (see Robustness testing, testing process)testing process:deciding how to test, 186-204deciding what to test, 182-186guidelines for, 213-217parameter selection for trading,209-213performance, trading and monitoring,212-213results evaluation, 204-209Russia:economic growth in, 3,17globalization of, 28Moscow coup, impact of, 108,114
S&P:monthly equity change example, 48price shocks and, 115-117Screen trading execution lag, 26Seasonals, 4,15-17,28SENSEX, 47Shares, fundamental analysis and, 6-7Shock-adjusted price series, creating,122-123Short-term trading:execution problems, 23losses from, 89Short test period, 186-188Significance, illustration of, 36-37Slippage:calculation guidelines, 26defined, 22-24execution problems and, 23impact of, 24normal, 25reduction strategies, 24-25stop-losses and, 94
251
Index
SlowD, 9SlowK, 9Slow-moving averages, 134Small lot stop orders, 26Smoothing, two-dimensional, 204Spectral analysis, 10Spread price, 20Spread profits, nonexistent, 20Spreadsheets:adaptive moving average programming,147-149strategy-testing software, 10-11Standard deviation:annualized, 43equity and equity changes, 45formula, 199loss, determination of, 43-44test performance and, 181time intervals, 48Statgraphics, 186Step-forward test:hidden problems, 189long test vs., 188-189parameters and, 192Stochastics, 9,198Stock and futures market, special situations, 193Stock index:fundamental analysis and, 6-7futures, 16Stock market crash (1987), 40,117,124Stop-losses:conflicts with strategy, 103-104expectations, 93-94market noise interference, 91-92performance profile, 92professional traders and, 105profit-taking, 87-88risk management, 104risk reduction, 33, 89setting stops, 90-91system testing:being out of the market, 98,100-102intraday stops with daily system,96-98results, 95short test period, 95-96value of, 4Stopped-out position, reentering, 104Stop orders, 20, 22,225
Strips, computer technology and, 38Structural changes:price shocks and, 121seasonality, 15-17Supply and demand, 5Survivor bias, 214-215Sw'ss franc, 21System Writer.price shock, impact of, 107risk and return calculation, 44strategy testing, 186technical analysis, 10-11Technical analysis:automating, 7defined, 7indicators:stock market advance/decline,9-10types of, 8-9moving average, 7new technology and, 11-12purpose of, 39status of, 10-11trend trading and, 8Technical trading, 39Technological advances, impact of, 4-7,33-34TeleTrac:adaptive moving average programming,147,150anticipated price calculation, 227efficiency ratio calculation, 11optimization, 111, 179price changes, 107profit-taking test, 75risk and return calculation, 44technical analysis and, 10Test of reasonableness, 164Tests/testing (see specific types of tests)Threshold analysis, 37Time intervals, significance of, 48,81-82Time periods, risk and, 48,62-63,68Time to recovery, 203Trade-offs:neural networks, 170risk and reward, 32-33types of, 31unreasonably good results, 33
252TradeStation:adaptive moving average programming,147anticipated price calculation, 227Trading floors, computerized trading and,4Trading safety, 49-50Trading signals (see Anticipation;Filtering)Transaction costs:brokerage fees, 22losses and, 94testing process, 197trend systems and, 238-239Trend-following:adaptive approach:market traits and, 133-134specific to general solution,134-135traditional solution, 133trend speed ranges, 136,138adaptive moving average (see Adaptivemoving average)cost estimation, 25execution problem, 23fast, 22,238fundamental analysis and, 130-131profitability, 14-15pure, 31skewed distributions, 63-64trade-offs, 32trading rules, 143-146trend identification, 129-130Trend speed:distribution, test selection, 200-202efficiency ratio and, 141performance monitoring, 238-240
Index
Trend speed (Cont.):ranges, 136,138Trend systems, stop-losses and, 103Trend trading:lags, 131-132noise, 131slow trends, 131-132technical analysis and, 8Two-dimensional displays, 203-204Unables:defined, 22execution problems, 23reduction strategies, 24-25test results, impact on, 197United Kingdom, 4U.S. dollar, decline of, 16Volatility:economic changes and, 4-5filtering, 232-233globalization and, 28measurement, 137noise and, 140price trends, 12,15
Weighted average, 130Weighting factors, 5Wilder, Welles, 8Windfalls, profit/losses, 121,124,236Worst-case scenarios, 25, 111, 119,215WTI trend system:price level filtering, 231volatility filtering, 233
About the AuthorPerry Kaufman has more than 20 years of successful tradingexperience. He is the founder of Kaufman Diamond &Yeong, international consultants to financial institutions. Thecofounder of The Journal of Futures Markets, he is one of themost highly respected authors of professional trading bookstoday, with six books to his credit.
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