A View on Technical Indicators and Trading Systems
ConclusionsWe draw several conclusions from the prediction analysis and the exploration of a variety of trading systems presented here, as well as other analyses we have conducted. First, when normal transactions costs are taken into account, most of the simple trading systems one reads about in books on technical analysis, such as those shown here, are unprofitable when tested on 100 stocks in the S&P 100 over 1000 market days.
Second, the best performing trading systems for this market, in terms of average profit per trade, can be characterized as contrarian or counter-trend. This performance comes at the price of substantially increased risk. Stop losses can be used to reduce this risk, but it is common for their use to completely eliminate the profitability of the initial system.
Third, more sophisticated techniques using filters and other screening mechanisms, such as those we use in our trading systems, result in viable trading systems. Many of the simple trading systems presented here and in a variety of technical analysis books can be viewed as building blocks for more sophisticated systems. Our statistical score, combined with MACD signal line crossovers, for example, results in a trading system with a favorable return to risk profile.
Finally, the results of any trading system should be carefully scrutinized for robustness, that is, whether the findings are very sensitive to the particular parameters, stocks traded, or the time period examined. In this overview, we did not focus much on varying parameters, largely because altering parameters does not change the main conclusions we draw. We have read about good results for many trading systems in some markets and narrow time periods, which did not bear out in our own testing across a wide group of stocks over a long time period. What works for some markets does not necessarily work for others, so it is critical to test systems in the particular market one intends to trade.
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Contents: A View on Technical Indicators and Trading Systems
- Common Technical Indicators and Interpretations
- Moving Averages of Closing Prices
- Wilder's Relative Strength Index (RSI)
- Moving Average Convergence/Divergence (MACD)
- Two Technical Indicator Scoring Techniques
- Predictive Value of Technical Scores
- Simple Trading System Performance
- Moving Average Crossover Trading Systems
- MACD Trading Systems
- RSI Trading Systems
- Systems Using the Traditional and Statistical Scores