Keep It Simple And Make Up Your Losses

05/30/12 08:41:25 AM

by Donald W. Pendergast, Jr.

In so many ways, the simpler the system, the easier it is to work with --provided it is based on a sound principle.

Security: AAPL
Position: N/A

"Keep it stupid, simple" may more often be known as "Keep it simple, stupid," but the two phrases do a good job of emphasizing the importance of keeping the details and goals of your daily life as straightforward and uncomplicated as possible. The same "KISS" acronym can just as easily be applied to the world of system trading, both for developers and end-users. Here's a look at a simple, uncluttered daytrading system that shows some real promise for stock traders. See Figure 1.

FIGURE 1: AAPL RESULTS. Although these are hypothetical, backtested results, this six-month run of a simple 10-period moving average crossover day trading system in shares of Apple Inc. shows good, consistent performance characteristics.

Graphic provided by: TradeStation.

Without giving away any "secret" formulas, the basic premise of this system is this:

1. Calculate an optimum moving average crossover entry trigger
2. Calculate an optimum profit target for each trade
3. Determine how many trades per day should be taken
4. Use a moving average crossover as an exit trigger
5. Exit all open trades by the end of each day's trading session
6. Figure out how to make all of this to work in concert to make for a reliable and profitable intraday trading method.

The testing basics were as follows:

- 25-share lots of Apple Inc. (AAPL) per trade
- Commissions were set at 0.04 per share
- Slippage was set at 0.01 per share
- Time frame was a five-minute bar
- Long and short trades were enabled

TradeStation 9.0 was the platform used for all tests. Running the strategy over six months of intraday data produced some fairly convincing proof that the strategy is:

A. Not overly influenced by the dominant daily trend in the stock (which in the case of AAPL has been mostly bullish for the last six months)

B. Very nearly equally profitable on both the long and short sides of the market.

You can see the weekly backtested profit statistics. Note that the strategy produced profits during 21 of the 26-week test run and that there were only two times when the strategy lost money in two consecutive weeks.

The ideal moving average trigger chosen was a 10-period exponential moving average (EMA) and the ideal profit target came in at $440 and a maximum amount of three trades per day were allowed. Again, all open trades were closed at the end of the trading session, no matter if they were winners or losers. (Remember, we are only using a fixed 25-share lot for each hypothetical trade to "keep it stupid, simple"!)

Here are the primary trading performance stats of interest:

Net profit: $2,599
Profit factor: 1.38 (1.36 for longs and 1.40 for shorts)
Number of trades: 389
Winning pct.: 41.59%
Average profit: $6.68
Ratio avg. win vs. avg. loss: 1.94
RINA index: 1366.32
Net profit as % of drawdown: 459.19%
Annualized return: 47.66%

Yes, the average trade profit is modest, but given that we have a 389-trade sample, at least the results are somewhat statistically reliable. Also, as shown (Figure 2), the equity curve is decent, if not spectacularly straight.

FIGURE 2: AAPL. After evaluating the concepts discussed here, can you think of ways in which your own testing procedure might be able to help straighten out this system's equity curve, thus boosting all of its performance statistics?

Graphic provided by: TradeStation.

This basic system concept can no doubt be improved upon, but it will take a lot of thoughtful analysis to know how best to proceed. Obviously, it would be nice if we could find a way to make it trade less often to bring up the average trade profit even as commissions/slippage costs are commensurately reduced.

Straightening out the equity curve would also be another goal for a serious developer. Perhaps expanding or contracting the moving average input parameters would be one way to accomplish that goal. Maybe using a trading window of 9:30 am and 1:30 pm ET, Monday through Thursday, could be another change that might help bring the profit factor higher and bring the aggravation factor lower. Only serious, diligent and methodical testing can hope to answer these and other questions that a serious developer or trader might be asking themselves about this system.

Are you up to the task of trying to improve upon this system? The rewards could be substantial if you choose to persevere as you attempt to create a workable system that in the end works for you and not against you.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
	Jacksonville, FL 32217
Phone # for sales:	904-239-9564
E-mail address:	lineartradingsys@gmail.com
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Keep It Simple And Make Up Your Losses

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