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I've been working on this problem recently, myself. Here's the
answer I've come up with: Use a filter unrelated to and independent
of the system itself.
Here's a specific example: If you were trading an index ETF like the
SPY or QQQQ using a breakout system, there would unquestionably have
been a great deal of "strength" to a recent long signal. However,
that doesn't necessarily mean it's a "stronger" signal
than "normal." A rally caused by short-covering will be very
powerful in the short-term, but the strength will suddenly,
unpredictably evaporate and stocks will drop again. A rally caused
by serious accumulation might generate a "weaker" signal, but the
rally would be more sustainable. Nothing related to your mechanical
system or derived from the signal generated by your mechanical system
would help you honestly distinguish between "strong" and "weak."
However, using indicators unrelated to your mechanical system (market
breadth, valuation, earnings growth, seasonals, etc.) would help you
distinguish between "strong" and "weak" signals. A "buy" signal from
your mechanical system at a time of serious undervaluation in the
stock market would be a stronger signal than if it comes at a time of
serious overvaluation, for example. A "short" signal would have
more "strength" to it if it occurs in the summer months than in the
winter months, and so on.
JMO and FWIW.
Luck,
Sebastian
--- In equismetastock@xxxxxxxxxxxxxxx, mgf_za_1999 <no_reply@xxxx>
wrote:
> Hi there,
>
> This is a general, almost philosophical question, but some of you
may
> have had to deal with it before or may have some ideas on it. It
> pertains to automated trading and system building. If you build an
> automated trading system, you often create some 'signal' and trade
> based on this. Now, this signal could be say the difference between
> two moving averages, and you trade whenever they cross which will be
> exactly when the signal crosses the zero line.
>
> When you evaluate such a system, you buy when the signal goes
positive
> and sell when it goes negative. All of this is fairly general and
> fairly common. Note in this example, however, that the actual value
> or magnitude of the signal does not play any role - the important
> thing is when it crosses the zero line. Again, no rocket science
in this.
>
> I am toying with the idea to build a system based on the *strength*
of
> the signal rather than when it crosses zero, which introduces some
> problems. The question really is, when do you then enter a trade?
>
> One obvious way is to put some band around zero and trade when the
> signal goes outside of this band. This complicates matters as you
> also have to create this band. Another way is to still trade on the
> zero-line crossover, which is fine but then you could just as well
> stick with the original where the whole system is built around
this.
> You could use a moving average of the signal line and trade when
they
> cross, but this is just the same as trading a zero line crossover.
>
> What ideas do you have for automatically trading a system using some
> signal, that are not triggered by this signal crossing zero?
>
> Regards
> MG Ferreira
> TsaTsa EOD Programmer and trading model builder
> http://www.ferra4models.com
> http://fun.ferra4models.com
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