Monday, January 5, 2015

OmiCronFX Mandelbrot algorithmic software development (Pt 4) | Defining the trading strategy

While it is important to be aware of fundamental matters when trading, and in particular anything that would impact the timing of a high-probability trade, the Mandelbrot software is designed to respond primarily to price action. This means that it “decides” which direction price is likely to move in, and then takes on a position.

Much work has gone into the behavior of the routine in the event that we find ourselves in the market on a day when the exchange rate does not move in the strong directional manner of the trade in the chart above. Because of our policy of taking off some profit at the earliest practicable opportunity (when it is worthwhile to do so) and  moving the stop loss order to break-even, the trade will be profitable if it goes into profit to any appreciable extent.

It is those trades that turn around and go in the wrong direction quickly that we have to deal with. Then we have to give the trade enough space to become successful but also to ensure that, if this is ultimately not to be the case, the loss will be the smallest that it is possible for it to be. At the time that we take on the trade, we are unable to tell the future, as always. This also means that we have to be able, psychologically, to take a loss. The confidence in the strategy, and in the operation of the software in accordance with this strategy, must be such that a loss is regarded as something that hastens the arrival of the next win. This philosophy is in accordance with that of Dr. Alexander Elder, who provided much of the early inspiration for this writer. Dr. Elder also has much to say on the correct level of risk, i.e. position sizing.

The trading day shown above is a case in point. Here the price movement is sideways, which, while technically a direction, is not the kind of one we are desirous to have. Mandelbrot must ensure that it loses the smallest amount in these cases, so that it can capitalise on the days that have the characteristics of the one at the top of this article. We also have to bear in mind that direction may be lacking for part of the day, and then attain it later.

Risk control

The trading parameters, which are keyed into the program’s user interface, must the optimized to ensure that we (1) eliminate the danger of taking on too much risk, (2) trade only at those times when the market is buoyant and liquid (3) Lock in profit at all possible occasions and (3) be ready to react in the event that the market reverses, even if that means taking on a position in the opposite direction. We always have to be open to the possibility of trend change.

To be continued…

Coming soon:

An acceptable level of drawdown; drawdown defined; the high water mark principle

Coding and debugging the strategy

·           Some programmable platforms are better than others, but algorithmic trading is still a new industry outside of the major banks and hedge funds

Optimising the parameters

·           Historical research on the price action of different currency pairs
·           Simulated trading with historical data, and real-time trading

·           The place of Fundamental and Technical Analysis

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