is a fixed plan that is designed to achieve a profitable return by goinglongorshortin markets. The main reasons that a properly researched trading strategy helps are its verifiability, quantifiability, consistency, and objectivity.
For every trading strategy one needs to define assets to trade, entry/exit points and money management rules. Bad money management can make a potentially profitable strategy unprofitable.1
Trading strategies are based onfundamentalortechnical analysis, or both. They are usually verified by backtesting, where the process should follow thescientific method, and by forward testing (a.k.a. paper trading) where they are tested in a simulated trading environment.2
The term trading strategy can in brief be used by any fixed plan of trading a financial instrument, but the general use of the term is within computer assisted trading, where a trading strategy is implemented as computer program for automated trading. Technical strategies can be broadly divided into themean-reversionand momentum groups.3
Long/short equity. A long short strategy consists of selecting a universe of equities and ranking them according to a combinedalpha factor. Given the rankings we long the top percentile and short the bottom percentile of securities once every rebalancing period.
Pairs trade. A pairs trading strategy consists of identifying similar pairs of stocks and taking a linear combination of their price so that the result is astationarytime-series. We can then computez-scoresfor the stationary signal and trade on the spread assuming mean reversion: short the top asset and long the bottom asset.
Swing trading strategy; Swing traders buy or sell as that price volatility sets in and trades are usually held for more than a day.
Scalping (trading); Scalping is a method to making dozens or hundreds of trades per day, to get a small profit from each trade by exploiting the bid/ask spread.
Day Trading; The Day trading is done by professional traders; the day trading is the method of buying or selling within the same day. Positions are closed out within the same day they are taken, and no position is held overnight.
End of Day Trading; Trading strategy which requires a trader to place trades once a day.
Trading the news; The news is an essential skill for astute portfolio management, and long term performance is the technique of making a profit by trading financial instruments (stock, currency…) just in time and in accordance to the occurrence of events.
Trading Signals; Trading signal is simply a method to buy signals from signals provider, is a very effective strategy to determine the best time to buy or sell a stock or currency pair. Aggregate analysts forecasts are often used in momentum trading strategies.
Social trading; using other peoples trading behaviour and activity to drive a trading strategy.
All these trading strategies are speculative. In the moral context speculative activities are considered negatively and to be avoided by each individual.56who conversely should maintain a long term horizon avoiding any types of short term speculation.
The trading strategy is developed by the following methods:
Automated trading; by programming or by visual development.
Trading Plan Creation; by creating a detailed and defined set of rules that guide the trader into and through the trading process with entry and exit techniques clearly outlined and risk, reward parameters established from the outset.
The development and application of a trading strategy preferably follows eight steps:7(1) Formulation, (2) Specification in computer-testable form, (3) Preliminary testing, (4) Optimization, (5) Evaluation of performance and robustness,8(6) Trading of the strategy, (7) Monitoring of trading performance, (8) Refinement and evolution.
Usually the performance of a trading strategy is measured on the risk-adjusted basis. Probably the best-known risk-adjusted performance measure is theSharpe ratio. However, in practice one usually compares the expected return against the volatility of returns or themaximum drawdown. Normally, higher expected return implies higher volatility and drawdown. The choice of the risk-reward trade-off strongly depends on traders risk preferences. Often the performance is measured against a benchmark, the most common one is anExchange-traded fundon a stock index. In the long term a strategy that acts according toKelly criterionbeats any other strategy. However, Kellys approach was heavily criticized byPaul Samuelson.9
A trading strategy can be executed by a trader (Discretionary Trading) or automated (Automated Trading). Discretionary Trading requires a great deal of skill and discipline. It is tempting for the trader to deviate from the strategy, which usually reduces its performance.
An automated trading strategy wraps trading formulas into automated order and execution systems. Advanced computer modeling techniques, combined with electronic access to world market data and information, enable traders using a trading strategy to have a unique market vantage point. A trading strategy can automate all or part of your investment portfolio. Computer trading models can be adjusted for either conservative or aggressive trading styles.
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The Evaluation and Optimization of Trading Strategies
Samuelson, P. (1971). The fallacy of maximizing the geometric mean in long sequences of investing or gambling. Proceedings of the National Academy of Sciences, 68(10):24932496
Measuring Performance of a Trading Strategyat Signal Plot
Example of Trading Strategy Design Methodologyat
This page was last edited on 14 October 2019, at 15:34