The Motley Fool Discussion Boards

Previous Page

Investing/Strategies / Bonds & Fixed Income Investments


Subject:  Building a Trading System Date:  1/13/2013  3:59 PM
Author:  globalist2013 Number:  34665 of 35623

A ‘trading system’ is your ‘investment plan’. It’s the set of rules you’ve agreed to follow. The rules provide answers to the Five Essential Questions: “What?” “Why?” “When?” “How Much?” “Exit Point?” If you’ve proven through testing that your rule set has a positive-expectancy, then sticking to your rules will make you money. And not following your own rules is really, really stupid.

The number of markets that can be traded --err, ‘invested in’ -- is limited. Stocks, bonds, commodities, currencies, real estate, “collectables”, and some derivatives based on them, such as ‘volatility’. The rule sets are infinite in their variety. But they all share the same, two characteristics. They have to be ‘explicit’, and they have to ‘match the personality of their user’. Other than that, nearly anything can be made work. Fundamental analysis, technical analysis, quantitative analysis, ‘top-down’, ‘bottom- up’, etc. It just doesn’t make any difference how an edge is found and exploited.

But if your time is limited, focusing on the supply-and-demand dynamics of the market itself (aka, using ‘technical analysis’) is a good way to go. You make the assumption that you won’t have access to ‘insider info’ and that by the time any news that might affect price has gotten to you, the market has already reacted. This isn’t to say that the market has reacted correctly, and that becomes part of your ‘edge’. The abstraction called ‘the market’ (which is merely a shorthand way of describing the collective action of buyers and sellers) is going to get it wrong enough times for you to profit from their mistakes. OTOH, the market is also going to get it right often enough that you can piggyback on their buying/selling. They’ve done the fundamental work for you and voted their opinion by buying or selling shares. Your decision is simply to bet with them or against them based on how you read a price-volume chart.

Those price-volume charts can take a lot of formats: P&F, Bar, Line, Candlesticks, Renko, Heikin-Ashi, etc. And if you go to a charting site like , you can explore all of them. Additionally, ‘indicators’ can be applied to charts that range from traditional ‘line studies’ to more modern derivatives such as Bollinger Bands, MACD, etc., concerning all of which, there are two schools of thought. One says that none of them are needed. “Just read the tape. The info is there.” Another school says that selected indicators can be useful if they help you see the essentials of what the chart might be saying. It takes a practiced eye to read and trade off a bare chart. So most investors would be better off applying some indicators to charts to simplify what otherwise seems lot a lot of noise and clutter. (This is one of those rare instances where ‘more’ might really be ‘more’.)

Everyone’s going to have their favorite indicators, and there’s a good chartist (Quillnpenn) who hangs at the forum Ask a Foolish Question who freely describes his methods, and who is constantly creating charts for stocks that are asked about. By his own reports, he’s making killer money, and from what I’ve seen of his analytic work, I don’t doubt his claims. The chief decision-engine of his method is the cross of a 13-day Exponential Moving Average (EMA13) over/under a 50-day EMA, augmented by appeal to what indicators like True Strength, MACD, KST might be saying.

I admire his work hugely. But I don’t like trading systems based on MAV crossovers, because I’m not willing to let prices move that far against me. Inst