The ultimate guide to trading systems, fully revised and updated For nearly thirty years, professional and individual traders have turned to Trading Systems and Methods for detailed information on indicators, programs, algorithms, and systems, and now this fully revised Fifth Edition updates coverage for today's markets. The definitive reference on trading systems, the book explains the tools and techniques of successful trading to help traders develop a program that meets their own unique needs.
Presenting an analytical framework for comparing systematic methods and techniques, this new edition offers expanded coverage in nearly all areas, including trends, momentum, arbitrage, integration of fundamental statistics, and risk management. Comprehensive and in-depth, the book describes each technique and how it can be used to a trader's advantage, and shows similarities and variations that may serve as valuable alternatives. The book also walks readers through basic mathematical and statistical concepts of trading system design and methodology, such as how much data to use, how to create an index, risk measurements, and more.
Packed with examples, this thoroughly revised and updated Fifth Edition covers more systems, more methods, and more risk analysis techniques than ever before.
- The ultimate guide to trading system design and methods, newly revised
- Includes expanded coverage of trading techniques, arbitrage, statistical tools, and risk management models
- Written by acclaimed expert Perry J. Kaufman
- Features spreadsheets and TradeStation programs for a more extensive and interactive learning experience
- Provides readers with access to a companion website loaded with supplemental materials
Written by a global leader in the trading field, Trading Systems and Methods, Fifth Edition is the essential reference to trading system design and methods updated for a post-crisis trading environment.
Table of Contents:
Preface to the Fifth Edition xv
Chapter 1 Introduction 1
The Expanding Role of Technical Analysis 1
Convergence of Trading Styles in Stocks and Futures 2
A Line in the Sand between Fundamentals and Technical Analysis 4
Professional and Amateur 5
Random Walk 6
Deciding on a Trading Style 8
Measuring Noise 10
Maturing Markets and Globalization 14
Background Material 16
Research Guidelines 18
Objectives of This Book 19
Profile of a Trading System 20
A Word about the Notation Used in This Book 23
And Finally . . . 23
Chapter 2 Basic Concepts and Calculations 25
About Data and Averaging 26
On Average 30
Price Distribution 33
Moments of the Distribution: Variance, Skewness, and Kurtosis 37
Standardizing Risk and Return 48
The Index 54
Standard Measurements of Performance 58
Probability 59
Supply and Demand 66
Chapter 3 Charting 79
Finding Consistent Patterns 80
What Causes the Major Price Moves and Trends? 82
The Bar Chart and Its Interpretation by Charles Dow 83
Chart Formations 92
Trendlines 94
One-Day Patterns 102
Continuation Patterns 113
Basic Concepts in Chart Trading 117
Accumulation and Distribution—Bottoms and Tops 118
Episodic Patterns 132
Price Objectives for Bar Charting 133
Implied Strategies in Candlestick Charts 139
Practical Use of the Bar Chart 144
Evolution in Price Patterns 148
Chapter 4 Charting Systems and Techniques 151
Dunnigan and the Thrust Method 152
Nofri’s Congestion-Phase System 155
Outside Days with an Outside Close 157
Inside Days 158
Pivot Points 158
Action and Reaction 159
Channel Breakout 167
Moving Channels 170
Commodity Channel Index 171
Wyckoff’s Combined Techniques 172
Complex Patterns 173
A Study of Charting Patterns 176
Bulkowski’s Chart Pattern Rankings 178
Chapter 5 Event-Driven Trends 181
Swing Trading 182
Constructing a Swing Chart Using a Swing Filter 184
Point-and-Figure Charting 195
The N-Day Breakout 222
Chapter 6 Regression Analysis 235
Components of a Time Series 235
Characteristics of the Price Data 236
Linear Regression 238
Linear Correlation 248
Nonlinear Approximations for Two Variables 252
Transforming Nonlinear to Linear 256
Evaluation of Two-Variable Techniques 257
Multivariate Approximations 259
ARIMA 267
Basic Trading Signals Using a Linear Regression Model 273
Measuring Market Strength 276
Chapter 7 Time-Based Trend Calculations 279
Forecasting and Following 279
Price Change over Time 284
The Moving Average 284
Geometric Moving Average 292
Accumulative Average 293
Reset Accumulative Average 293
Drop-Off Effect 293
Exponential Smoothing 293
Plotting Lags and Leads 307
Chapter 8 Trend Systems 309
Why Trend Systems Work 309
Basic Buy and Sell Signals 314
Bands and Channels 320
Applications of a Single Trend 330
Comparison of Major Trend Systems 336
Techniques Using Two Trendlines 350
Multiple Trends and Common Sense 356
Comprehensive Studies 359
Selecting the Right Trend Method and Speed 359
Moving Average Sequences: Signal Progression 363
Early Exits from a Trend 366
Moving Average Projected Crossovers 366
Chapter 9 Momentum and Oscillators 369
Momentum 370
Divergence Index 384
Oscillators 385
Double-Smoothed Momentum 404
Velocity and Acceleration 412
Hybrid Momentum Techniques 416
Momentum Divergence 418
Some Final Comments on Momentum 426
Chapter 10 Seasonality and Calendar Patterns 427
A Consistent Factor 428
The Seasonal Pattern 429
Popular Methods for Calculating Seasonality 430
Seasonal Filters 456
Seasonality and the Stock Market 478
Common Sense and Seasonality 483
Chapter 11 Cycle Analysis 485
Cycle Basics 485
Uncovering the Cycle 494
Maximum Entropy 514
Cycle Channel Index 520
Short Cycle Indicator 521
Phasing 523
Chapter 12 Volume, Open Interest, and Breadth 527
A Special Case for Futures Volume 527
Variations from the Normal Patterns 529
Standard Interpretation 531
Volume Indicators 535
Breadth Indicators 546
Interpreting Volume and Breadth Systematically 554
An Integrated Probability Model 558
Intraday Volume Patterns 559
Filtering Low Volume 562
Market Facilitation Index 564
Chapter 13 Spreads and Arbitrage 565
Dynamics of Futures Intramarket Spreads 566
Carrying Charges 567
Spreads in Stocks 569
Spread and Arbitrage Relationships 570
Risk Reduction in Spreads 571
Arbitrage 572
The Carry Trade 596
Changing Spread Relationships 600
Intermarket Spreads 602
Chapter 14 Behavioral Techniques 617
Measuring the News 618
Event Trading 623
Commitment of Traders Report 635
Opinion and Contrary Opinion 641
Fibonacci and Human Behavior 648
Elliott’s Wave Principle 651
Price Target Constructions Using the Fibonacci Ratio 660
Fischer’s Golden Section Compass System 662
W. D. Gann—Time and Space 666
Financial Astrology 671
Chapter 15 Pattern Recognition 685
Projecting Daily Highs and Lows 687
Time of Day 689
Opening Gaps 699
Weekday, Weekend, and Reversal Patterns 711
Computer-Based Pattern Recognition 732
Artificial Intelligence Methods 735
Chapter 16 Day Trading 737
Impact of Transaction Costs 738
Key Elements of Day Trading 744
Trading Using Price Patterns 753
Intraday Breakout Systems 759
Intraday Volume Patterns 774
Intraday Price Shocks 775
Chapter 17 Adaptive Techniques 779
Adaptive Trend Calculations 779
Adaptive Variations 788
Other Adaptive Momentum Calculations 793
Adaptive Intraday Breakout System 796
An Adaptive Process 797
Considering Adaptive Methods 798
Chapter 18 Price Distribution Systems 801
Measuring Distribution 801
Use of Price Distributions and Patterns to Anticipate Moves 805
Distribution of Prices 811
Steidlmayer’s Market Profile 822
Using Daily Distributions to Identify Support and Resistance 830
Chapter 19 Multiple Time Frames 833
Tuning Two Time Frames to Work Together 833
Elder’s Triple-Screen Trading System 835
Robert Krausz’s Multiple Time Frames 838
Martin Pring’s KST System 842
Chapter 20 Advanced Techniques 845
Measuring Volatility 845
Using Volatility for Trading 856
Trade Selection Using Volatility 861
Liquidity 867
Trends and Price Noise 868
Trends and Interest Rate Carry 871
Expert Systems 871
Fuzzy Logic 875
Fractals, Chaos, and Entropy 880
Neural Networks 886
Genetic Algorithms 895
Replication of Hedge Funds 902
Chapter 21 System Testing 905
Expectations 907
Identifying the Parameters 908
Selecting the Test Data 910
Testing Integrity 916
Searching for the Best Result 919
Visualizing and Interpreting Test Results 922
Large-Scale Testing 932
Refining the Strategy Rules 937
Arriving at Valid Test Results 938
Comparing the Results of Two Systems 946
Profiting from the Worst Results 950
Retesting for Changing Parameters 951
Testing across a Wide Range of Markets 954
Price Shocks 970
Anatomy of an Optimization 972
Summarizing Robustness 976
Chapter 22 Practical Considerations 983
Use and Abuse of the Computer 984
Extreme Events 992
Gambling Techniques—The Theory of Runs 1000
Selective Trading 1011
System Trade-Offs 1012
Trading Limits and Disconnected Markets 1018
Silver and NASDAQ—Too Good to Be True 1020
Similarity of Systematic Trading Signals 1021
Chapter 23 Risk Control 1027
Mistaking Luck for Skill 1027
Risk Aversion 1028
Liquidity 1033
Measuring Return and Risk 1034
Leverage 1046
Leverage Based on Exposure 1049
Individual Trade Risk 1050
Kaufman on Stops and Profit-Taking 1059
Ranking of Markets for Selection 1062
Probability of Success and Ruin 1072
Entering a Position 1076
Compounding a Position 1080
Equity Trends 1085
Investing and Reinvesting: Optimal f 1088
Comparing Expected and Actual Results 1092
Chapter 24 Diversification and Portfolio Allocation 1099
Diversification 1100
Changing Correlations 1105
Types of Portfolio Models 1105
Classic Portfolio Allocation Calculations 1107
Finding Optimal Portfolio Allocation Using Excel’s Solver 1109
Kaufman’s Genetic Algorithm Solution to Portfolio Allocation (GASP) 1114
Volatility Stabilization 1142
Appendix 1 Statistical Tables 1147
Appendix 2 Matrix Solution to Linear Equations and Markov Chains 1151
Appendix 3 Trigonometric Regression for Finding Cycles 1161
Bibliography 1175
About the Companion Website 1191
Index 1193
About the Author :
PERRY J. KAUFMAN has over thirty years of experience in the equity and derivatives markets. A prominent expert on systematic trading, he travels internationally, lecturing to funds, governments, and portfolio managers. He began his career in the aerospace industry, working on the navigation and control systems of the Gemini space program. The markets captured his attention in the early 1970s, and he was one of the first to develop computer models for making market decisions. Kaufman developed a portfolio optimization program that operates on disjoint equity series output from a trading environment. He has created market-neutral strategies, stat-arb trading methods, short-term program trading for cash, and derivative market instruments for institutional and commercial applications. Kaufman was the first chairman of the advisory board of the Vermont Securities Institute, and has served on the Director's Committee of Columbia University's Center for the Study of Futures Markets, founding the Journal of Futures Markets. In 2002, he taught a landmark course in systematic trading at the graduate school of Baruch College. Perry Kaufman is the author of several popular trading books including A Short Course in Technical Trading and Alpha Trading.
Mr. Kaufman can be contacted through his website perrykaufman.com.
