iBankCoin
Joined Nov 11, 2007
1,458 Blog Posts

How To Build a Simple Pivot-based Trading System

I know many of you are becoming more interested in a trading a system, especially after what the markets have been doing over the past 1.5 years.

Henry Carstens over at Vertical Solutions is a phenomenal resource for systems traders. He recently published this simple pivot-based trading system. I like it because it demonstrates how traders can take a system that they trade discretionarily, use language to quantify the setup and exit, and voila! Describing the setup in terms that can be quantified is crucial, and any traders looking to build a system should spend some time describing their set ups in this way.

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A pivot based trading system defines a focus of trading action, the ‘pivot point’ and places support and resistance lines around that point where trades can are to be entered and, perhaps, exited.

Calculation of the pivot point can be quite intricate but using yesterday’s close is a simple place to start.

For support and resistance there are again a dizzingy array of choices, but the volatility over the last 10 days is another easy place to begin. So…

  • Support is: pivot – volatility(10), and
  • Resistance is: pivot + volatility(10)

The entry rule for pivot systems is simple:

  • Buy at support, and
  • Sell at resistance

The exit rule was a bit tougher, but this seems reasonable and works:

  • Exit longs at the highest close of the last 3 days, and
  • Exit shorts at the lowest close of the last 3 days

Results for the sp e-mini contract, daily bars, 01/01/98 – 02/24/09:

  • 200/285, 70%, avg 7.0 pts, sd 26.0 pts, t 4.4

The system is profitable in all years since 1998, it trades both long and short (important for adaptability to market changes), and is statistically valid (t score).

All it lacks are stops. Which are a problem…but may only mean that pivot points are better indicator foundations than trading system foundations. Note also how well the simple choice worked at each decision point in designing the system.
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Please click over to Vertical Solutions to see the equity curve for this system.

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Short Sellers Beware

In four years of actively shorting individual equities, I have never had something like this happen to me.

Tradestation called away my DLTR short. Or, to be more specific, they called away 3/4 of my position, booking me an egregious loss. My position, being 1/6 of my overall equity, wasn’t tiny, but it was by no means huge, as in thousands of shares. I was very surprised to find that a brokerage as large as Tradestation wasn’t able to handle this a little more professionally. No phone call, no email warning, no nothing. I just came home to “realized losses.”

Trying to turn a negative into a positive, I quizzed their trading desk dude about the recent frequency of them having to call away borrowed shares to meet the SEC’s rules. He said he has seen it happen more in the past three months than over the entire past year.

Hopefully this is an anomaly, but it really makes me wonder if this is happening to other traders across different brokerages. It also makes me wonder if there is not a concerted effort to stick it to the shorts.

Be careful out there.

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Big Bamboo Closes SKF Trade for Big Profits

The system closed out the SKF position at this morning’s open.

As I noted in previous posts, the win % is slowly climbing back up to where we would it expect it to be based on historical results (in the high 60% range).

This was the 21st trade. I would like to have 30 closed trades before I make too many assumptions based on the data, but I have to say that the average trade is looking pretty sweet.

Also, the 21.79% since inception is not too shabby.

Still, I think this system can be improved, as I noted here.

I do not see any signals for tomorrow’s open, but if anything changes between now and the close, I’ll update the site.

Stay tuned…

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Ironic Twist Department: Bankers Propose Robbing the People

From a recent Deutsche Bank research note (bolded portions added for emphasis):

“One main stumbling block to the purchasing of troubled assets has been pricing, specifically how does the government price a diverse set of assets in a way that does not put the taxpayer on the hook. However, this should not be the standard by which we judge the efficacy of the plan, because a more prolonged deterioration in the economy will result in a higher terminal unemployment rate and a greater deterioration of the tax base. As such, the decline in tax revenues will crimp many of the essential services provided by the government. Ultimately, the taxpayer will pay one way or another, either through greatly diminished job prospects and/or significantly higher taxes down the line to pay for the massive debt issuance required to fund current and prospective fiscal spending initiatives. We think the government should do the following: estimate the highest price it can pay for the various toxic assets residing on financial institution balance sheets which would still return the principal to taxpayers.”

Pretty clear, eh? Either buy our toxic assets now, deferring the cost over the next generations of citizens, or risk a prolonged period of unemployment. Your choice.

You see, if I thought that “dimished job prospects” meant only that, then I might be for just letting the banks take their own medicine. The truth is that “diminished job prospects” is a euphemism for social unrest, in my opinion.

Regardless, the taxpayer is on the hook for this mess. Any one saying anything to the contrary is a liar.

To see the original blog that broke this story, go here:

The Baseline Scenario: Robbery Note — From the Banking Oligarchs this Morning

The Planet Money Blog on NPR also has a good story on it:

Tax Payer Beware: Bank Bailout Will Hurt

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Big Bamboo System Update: Changes Ahead

Highlighted above in a pleasing blue hue is the latest Big Bamboo trade, marked-to-market as of Friday’s close. Personally, I’d be closing the trade on Monday’s open, even though the exit criteria has not quite been met (the exit criteria might change in the near future. See below).

The column “RealRisk” calculates the distance from the stop price to the entry. The system uses the previous night’s closing price as the entry price in order to calculate position-size for the next open. It shows that SKF gapped down over 6%. (Perfect RealRisk would be 8%) When the diETF gaps up, the RealRisk metric gets more interesting as it shows how much more risk the trade is taking on, should the stop not get adjusted. Worst case scenario is that it gaps up big and then reverses, taking out the original stop set for the approximate entry. This scenario ensures a loss greater than 8%.

When I trade these signals,  (I don’t always trade them. The BB is experimental) I use an offset stop which will automatically set 8% beneath my open no matter whether the diETF gaps up or down. This avoids the risk issues discussed above.

I’m Going to Be Making Some Changes In the Big Bamboo

I’ve really not put a lot of time into this system. I started out publishing it here primarily to deal with the psychology of system trading. Because of this, I have not applied any serious optimization, and I have not added any leverage or trend position-sizing to it. (For trend position-sizing, see the posts part 1, 2, and 3.)

A system that has been my primary focus over the last few months is finished, so I’m ready to move on to working on some new ones. I’ve been reviewing the Big Bamboo system results since 12/31/2007, and frankly I think it deserves greater attention as it seems to show promise.

What I’m Going to Consider Changing First

  • The exit: Currently the exit is a close with RSI(2) > 80. That is probably going to change to RSI(2) > 70. It needs more testing, but preliminary results show that it improves things a bit. Feel free then to sell SKF on the open Monday, not that anyone takes these trades! I have also developed a completely different exit for this system. I will continue testing it and will report progress as necessary.
  • The entry: As Technical Analysis of the Leveraged ETFs is not supposed to work, I’m going to try generating the entry signal from the underlying index or ETF rather than from the leveraged ETF. I have already done preliminary testing of the entry on the SPY, DIA, and QQQQs and it is has been consistently profitable over the past 15 years. It may be that the system improves, or does not, generating the entry from the underlying. I am also going to run some optimization over the entry signal to see what happens.
  • The trend filter: As currently configured, the system uses a rudimentary light-switch style trend filter which turns the system on when it gets a trade with the trend and turns it off otherwise. I believe I can configure the Big Bamboo to trade twice as often, both with the trend and against it, and generate even better returns using trend position-sizing.

Overview of Results Since 12/31/2007

8% stop used. A max of 2 new entries a day was allowed with no more than 4 total positions. These results use an exit of RSI(2)>70.

The results are simplified and should only be viewed as a proof of concept.

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Big Bamboo Signal for Thursday’s Open

Highlighted above in a pleasing green hue is the entry for Thursday’s open.

This trade is either going to work, or not, fairly quickly. Notice that the stop (assuming there is no gap up or down on SKF tomorrow) is just beneath today’s low. The stop level is 8% beneath the estimated open tomorrow. 88 shares will be purchased as that equals 2% risk assuming the entry is the same as tonight’s close.

I also wanted to note that the ATR(14) on SKF is 22.31 (pane beneath MACD). That means the average daily move can have a range of over 22 dollars. Again, this trade may get stopped out pretty quickly if doesn’t go in the expected direction right away.

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Obama Speaks; Futures Yawn

This is a 1 minute chart of the S&P 500 E-minis. The circled area shows how they acted as soon as Obama quit speaking.

I have no real opinion on the speech, and I’m not at all trying to be political, but am I the only one noticing that the markets seem to more and more “vote” with their dollars?

It seems pretty obvious to me that there is something more going on than just positioning. Could it be that the markets are being used as a conduit to communicate with the new administration?

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