NEW MARKETS AND METHODS OF TRADING
The introduction of financial futures in the early 1980s, the proliferation of equities
in the American household portfolio, and the deregulation of various industries
such as energy marketing has spawned many new products and markets. With
these new markets have come opportunities.
Using quantitative analysis as a way to spot trading opportunities has become
popular. Such analyses study markets based on historical information like prices,
volume, and open interest.
System trading is one example of quantitative analysis. It involves traders
automating buy and sell decisions by building mathematical formulae to model
market movement. Among this method’s advantages is that the human element is
removed from trading positions, as discussed above. Even successful traders tend
to take profits too early in the trade, giving up a larger profit down the line. Or even
worse, traders hold on to losses that eventually cause their demise. The beauty of a
mechanical trading system is that no trades are executed unless the trading system
deems it necessary. This is the key to the success of mechanical trading systems:
removing the irrational emotional element.
Perhaps we’ve gotten ahead of ourselves. Let’s ask first: What are trading
systems?
A trading system is a set of fixed rules that provide buy and sell signals. A simplistic
example would be to buy a market if its price rose above the average of the
past 20 closes and sell if prices fell below its average of the past 20 closes. If the market
continually rises, you will be long in that market. The longer the market rises, the
more money you make. Very simply, you’re following the trend of the market.
Typically, returns using a trend-following approach applied to a diverse set of markets
are higher than returns of the S&P 500, with similar or even smaller risk.
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