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(Chicago Board of Trade), but each year Futures magazine publishes a Reference Guide, which gives the current futures and options markets traded around the worid. No doubt, all of this information will be available through Internet. For beginning or reviewing the basics, there is Todd Loftons Getting Started in Futures (Wiley, 1989); Little and Rhodes, Understanding Wall Street, Third Edition (McGraw-Hill, 199 1); and The Stock Market, 6tb Edition by Teweles, BratUey, and Teweles (Wiley, 1992). The introductory material is not repeated here.

A good understanding of the most popular charting method requires reading the classic by Edwards and ;, Technical Analj-sis of Stock Trends (John Magee), a comprehensive study of bar charting. Writings on other technical methods are more difficult to find. The magazine Tecbnical Analj-sis of stocks & Commodities stands out as the best source of regular information; Futures magazine has fewer technical articles, but many of value and many other commodity books express only a specific technical spproach. Current analj-sis of many market phenomena and relationships can be found in The Financial Analj-sts journal.

On general market lore, and to provide motivation when trading is not going as well as expeaed, the one book that stands out is Lefevres Reminiscences of a Stock Operator (originally published by Doran, reprinted by Wiley in 1994). Wyckoff mixes humor and philosophy in most of his books, but Wall Street Ventures and Adventures Through Forty Years ( & Brothers) may be of general interest. More recently. Jack Schwagers Market Wizards (New York Inatitute of Finance, 1989) has been very popular.

A reader with a good background in high school mathematics can follow most of this book, except in its more complex parts. An elementarj course in statistics is ideal, but a knowledge of the tjpe of probability found in Tho s Beat the Dealer (Vintage) is adequate. Fortunately, computer spreaddieet programs, such as Excel and (Quattro, allow anyone to use statistical techniques immediately, and most of the formulas in this book are presented in such away thai they can be easily adq)ted to spreaddieets. Having a computer with trading software (such as Omegas SuperCliarts. MdaStod;, or any number of products), or having a data feed (such as Telerate or CQG), which offers technical studies, you are well equipped to continue.


Before starting, a few guidelines may help make the tad; easier. They have been set down to help those who will use this book to develop a trading sj-stem.

1. Know what you want to do. Base your trading on a solid theory or observation, and keep it in focus throughout development and testing. This is called the underljing premise of your program.

2. State your hypothesis or question in its simplest form. The more complex it is, the more difficult it will be to evaluate the answer.

3. Do not assume anything. Many projects fail on basic assumptions that were incorrect.

4. Do the simplest things first. Do not combine sj-stems before each element of each sj-stem is proven to work independently.

5. Build one stqa at a time. Go on to the next stqa only after the previous ones have been tested successfully. If you start with too many complex stq)s and fail, you will have to simplify to find out what went wrong.

6. Be carefiil of errors of omission. The most difficult part of researdi is identifjing the components to be selected and tested. Simply because all the questions asked were satisfectorily answered does not mean that all the rigftt questions were asked. The most important may be missing.

7. Do not take shortcuts It is sometimes convenient to use the work of others to speed up the researdi. Check theirwork carefiilly; do not use it if it cannot be verified. Check your spreaddieet calculations manually. Remember that your answer is only as good as its weakest point.

8. Start at the end Define your goal and work backward to find the required input. In this manner, you only work with information relevant to the resiUts otherwise, you might spend a great deal of time on irrelevant iterns.


This book is intended to give you a complete understanding of the tools and tedmiques needed to develop or

choose a trading program that has a good chance of being successful. Execution skill and market psjchologj are not considered, but only the development of a sj-stem that has been carefully thought out and tested. This itself is an achievement of no small magnitude.

Not everjUiing can be covered in a single book; therefore, some guidelines were needed to control the material included here. Most important are techniques that are common to most markets, such as trend and countertrend techniques, indicators, and testing methods. Popular analytic techniques, such as charting, are only covered to the degree that various pattems can be used in a computerized program to help identify support and resistance, channels, and so forth. There has been no attempt to provide a comprehensive text on charting. Various formations may offer very realistic profit objectives or provide reliable entry filters, even though they are not included.

Some popular areas, such as options, are not covered at all. There are many good books on options strategies, and to include them here would be a duplication of effort. Also, those strategies that use statistics, such as price/eamings ratios, specific to equities, have not been included, although indicators that use volume, even the number of advancing and declining issues, you will find in the section on volume because they fit into a bigger picture. This remains a book on trading futures markets, yet it recognizes that many methods can be used elsewhere.

This book will not attempt to prove that one sj-stem is better than another, because it is not possible to know what will happen in the future. It will try to evaluate the conditions under which certain methods are likely to do better and situations that will be harmful to specific approaches. Most helpful should be the groupings of sj-stems and techniques, which allow a comparison of features and possible results. Seeing how analj-sts have modified existing ideas can help you decide how to proceed, and why you might choose one path over another. By seeing a more complete picture, it is hoped that common sense will prevail, rather than computing power.


There are quite a few stqas to be considered when developing a trading program. Some of these are simply choices in stjle that must be made, while others are essential to the success of the results. They have been listed here and discussed briefly as iterns to bear in mind as you continue the process of creating a trading sj-stem.

Changing Markets and Sj-stem Longevity

Markets are not static. They evolve because the world changes. Among those iterns that have changed during the past 10 years are the market participants, the tools used to watdi the market, the tools used to develop trading models, the economies of countries such asjspan, the union of European countries, the globalization of markets, and the rid; of par- ticipation. Under this changing situation, a trading sj-stem that works today might not work

far into the future. We must carefully consider how each feature of a trading program is affected by change and try to create a method that is as robust as possible to increase its longevity.

The Choice of Data

Sj-stem decisions are limited by the data used in the analj-sis. Although price and volume for the specific market may be the definitive criteria, there is a multitude of other valid statiatical information that might also be used Some of this data is easily included, such as price data fran related markets; other statiatical data, including the U.S economic reports and weekly energj inventories, may add a level of robustness to the resiUts but are less convenient to obtain.


Not all traders are interested in diversification, which tends to reduce returns at the same time that it limits rid;. Concentrating all of your resources on a single market that you understand may produce a specialized approach and much better resiUts than using a more general tedmique over more markets. Diversification may be gained by trading more than one method in addition to a broad set of markets, provided the programs are unique in stjle. Proper diversification reduces rid; more than returns.

Time Frame

The time frame of the data impacts both the tjpe of sj-stem and the nature of the results. Using 5minute bars

introduces considerable noise to your program, making it difficult to find the trend, while using only weekly data puts so much emphasis on the trend such that your trading stjle is alreadj determined. A shorter time may guarantee faster response to price changes, but it does not assure better results. Each technique must be spplied properly to the right data and time frame.

Choosing a Method of Analj-sis

Some methods of analyzing the market are more complex than others. This in itself has no bearing on the final success. All good trading methods begin with a sound premise. You must first know what you are trjing to extract from the maitet before you select a technique. If you want to cspitalize on long interest rate frends or on the result of govemment policy, then a weekly moving average or frend sj-stem win be the place to start. If you see false breakouts whenever price pendrates the high of the dsy in the second half of the trading session, youll want to look at a momentum indicator based on 5-, 10-, or 15minute data. First the idea, then the tool.

Trade Selection

Although a trading sj-stem produces signals regularly, it is not necessarj to enter all of them. Selecting one over another can be done by a method of filtering- This can varj from a confirmation by another technique or sjstem, a limitation on the amount of risk that can be accepted on any one trade, the use of outside information, or the current volume. Many of these add a touch of reality to an automated process. You may find, however, that too many filters result in no trading.


There has been a lot of emphasis on testing, and there is a complete discussion in this book; however, testing is most important to confirm, or validate, your ideas. It fails when

you use broad tests to find successfiil techniques. The pu ose of testing is to show robustness, that the method woits over a wide range of situations in a similar manner. A robust solution will not sppear to be as good as the optimal result, but performed properly, it will be a more realiatic assessment of expectations.

Rid; Control

Every sj-stem must control its rid;, and most analj-ds believe that nearly any sj-dem can be profitable with proper risk management. This also means that any sj-dem can lead to ruin without rid; confrols. Risk can be managed from the trade level, with individual stoplosses, to asset allocation, by varjing the size of the position fraded, and by leveraging and deleveraging. Some form of management is necessary.

Order Enfrj

A sj-dem that performs well on psper may be dismal when actually traded. Part of a trading program is to know the method of entering and exiting the market and the cost of each frade. Style and cost will have a greater impact on short-term sj-stems, which have a smaller profit per frade and are, therefore, more sensitive to fransaction cods. There is equal damage in overeatimating costs as there is in underestimating them. By burdening a sj-stem with unrealiatic fees, it may show a loss when it should be a successful frading method.

Performance Monitoring and Feedbad;

A sj-stem is not done when you begin trading, it is only in a new phase. Actual trading results must be carefiilly monitored and compared with expectations to know if it is performing properly. It is very likely that slippage will result in some changes to the sj-stem rules or to the size of the position traded. Performance monitoring provides the essential feedbad; needed to be successful. Even a well thought-out and tested program may start out badly, but proper monitoring can put it on frack.


In attempting to make the contents of this book more pradical for many readers, there are three tjpes of

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