Beyond Technical Analysis: How to Develop and Implement a Winning Trading System (Wiley Finance)

177 Pages·1997·3.11 MB·English

by  Tushar S. Chande

Beyond Technical Analysis
Beyond Technical Analysis:
How to Develop and
Implement a Winning
Trading System
Tushar S. Chande, PhD

John Wiley 61 Sons, Inc. New
York • Chichester • Brisbane •
Toronto • Singapore • Weinheim
This text is printed on acid-free paper.
Copyright © 1997 by Tushar S.
Chande. Published by John Wiley &
Sons, Inc.
Data Scrambling is a trademark of Tushar S. Chande.
TradeStadon, System Writer Plus, and Power Editor are trademarks of
Omega Research, Inc.
Excel is a registered trademark of Microsoft Corporation.
Continuous Contractor is a trademark of TechTools, Inc.
Portfolio Analyzer is a trademark of Tom Berry.
All rights reserved. Printed simultaneously in Canada.
Reproduction or translation of any part of this work beyond that permitted
by Section 107 or 108 of the 1976 United States Copyright Act without
the permission of the copyright holder is unlawful. Requests for
permission or further information should be addressed to the Permissions
Department of John Wiley & Sons.
This publication is designed to provide accurate and authoritative
information in regard to the subject matter covered. It is sold with the
understanding that the publisher is not engaged in rendering legal,
accounting, or other professional services. If legal advice or other expert
assistance is required, the services of a competent professional person
should be sought.
Library of Congress Cataloging in Publicaton Data:
Chande, Tushar S., 1958-
Beyond technical analysis : how to develop & implement a winning
trading system / Tushar S. Chande.
Includes index.
ISBN 0-471-16188-8 (cloth : alk. paper)
1. Investment analysis. I. Tide. II. Series. HG4529.C488 1997
332.6—dc20 96-34436
Printed in the United States of
America 10 98765432
Contents
Preface xi
Acknowledgments xiii
1 Developing and Implementing
Trading Systems 1
Introduction 1
The Usual Disclaimer 3
What Is a Trading System? 3
Comparison: Discretionary versus Mechanical
System Trader 4
Why Should You Use a Trading System? 5
Robust Trading Systems: TOPS COLA 6 How
Do You Implement a Trading System? 7 Who
Wins? Who Loses? 8 Beyond Technical
Analysis 9
2 Principles of Trading System Design 11
Introduction 11
What Are Your Trading Beliefs? 12
Six Cardinal Rules 14
Rule 1: Positive Expectation 15
Rule 2: A Small Number of Rules 17
viii Contents
Rule 3: Robust Trading Rules 22 Rule
4: Trading Multiple Contracts 29
Rule 5: Risk Control, Money Management, and
Portfolio Design 32
Rule 6: Fully Mechanical System 36
Summary 37
3 Foundations of System Design 39
Introduction 39
Diagnosing Market Trends 40
To Follow the Trend or Not? 44
To Optimize or Not to Optimize? 48
Initial Stop: Solution or Problem? 52
Does Your Design Control Risks? 60
Data! Handle with Care! 64
Choosing Orders for Entries and Exits 66
Understanding Summary of Test Results 67
What the Performance Summary Does Not Show 70
A Reality Check 71
4 Developing New Trading Systems 73
Introduction 73 The Assumptions behind Trend-
Following Systems 74
The 65sma-3cc Trend-Following System 75 Effect of Initial
Money Management Stop 88 Adding Filter to the
65sma-3cc System 93 Adding Exit Rules to the 65sma-
3cc System 99
Channel Breakout-Pull Back Pattern 101
An ADX Burst Trend-Seeking System 111
A Trend-Antitrend Trading System 116
Gold-Bond Intermarket System 123 A
Pattern for Bottom-Fishing 132
Contents ix
Identifying Extraordinary Opportunities 140
Summary 144
5 Developing Trading System Variations 147
Introduction 147
Channel Breakout on Close with Trailing Stops 149
Channel Breakout on Close with Volatility Exit 152
Channel Breakout with 20-Tick Barrier 155
Channel Breakout System with Inside Volatility Barrier 159
Statistical Significance of Channel Breakout Variations 161
Two ADX Variations 165
The Pullback System 168
The Long Bomb — A Pattern-based System 173
Summary 177
6 Equity Curve Analysis 179
Introduction 179
Measuring the "Smoothness" of
the Equity Curve 180
Effect of Exits and Portfolio Strategies
on Equity Curves 186
Analysis of Monthly Equity Changes 194
Effect of Filtering on the Equity Curve 200
Summary 204
7 Ideas for Money Management 207
Introduction 207
The Risk of Ruin 208
Interaction: System Design and Money Management 212
Projecting Drawdowns 218
Changing Bet Size after Winning or Losing 221
Summary 224
x Contents
8 Data Scrambling 227
Introduction 227
What You Really Want to Know about Your System 227
Past Is Prolog: Sampling with Replacement 229
Data Scrambling: All the Synthetic Data
You'll Ever Need 231
Testing a Volatility System on Synthetic Data
236 Summary 239
9 A System for Trading 241
Introduction 241 The Problem with
Testing 242 Paper Trading: Pros and
Cons 242 Do You Believe in Your
System? 243 Time Is Your Ally 244
No Exceptions 245 Full Traceability
245
"Guaranteed" Entry into Major Trends 246
Starting Up 247 Risk Control 248 Do You
Have a Plan? 248 How Will You Monitor
Compliance? 249 Get It Off Your Chest!
249 Focus on Your Trading 250 Trading
with Your Head and Heart 250 Summary
252
Selected Bibliography 253 Index
255 About the Disk 261
Preface
This is a book about designing, testing, and implementing trading sys-
tems for the futures and equities markets. The book begins by develop-
ing trading systems and ends by defining a system for trading. It
focuses exclusively on trading systems. Hence, I have assumed that the
reader has at least a working knowledge of technical analysis and is
familiar with software for developing technical trading systems
The book is broadly divided into two parts. The first half deals
with development and testing—how the system worked on past data—
and discusses basic rules, key issues, and many new systems. The
second half explores how the system might do in the future, with a
focus on equity curves, risk control, and money management. A key
contribution is a new method called "data scrambling," which allows
unlimited amounts of synthetic data to be generated for true out-of-
sample testing. The last chapter brings all of the material together by
offering solutions to practical problems encountered in implementing
a trading system.
This book goes beyond technical analysis—it bridges the gap be-
tween analysis and trading. It provides a comprehensive treatment of
trading systems, and offers a stimulating mix of new ideas, timeless
principles, and practical guidelines to help you develop trading
systems that work.
Acknowledgments
I thank Nelson F. Freeburg for twice reading this manuscript.
Nelson's meticulous attention to detail, outstanding grasp of the
subject, sharp eye for inconsistencies, and love of the language have
helped to improve this book immeasurably. Nelson edits a monthly
newsletter, Formula Research, which is "must-reading" for serious
students of the financial markets.
A good editor is essential to guide a book to completion. I want
to thank Pamela Van Giessen of John Wiley & Sons for being the
accessible, cheerful, and resourceful editor every author loves.
Beyond Technical Analysis