TRADING SYSTEM DEVELOPMENT

PRECISION TRADING SYSTEM

An Interactive Qualifying Project Report

Submitted to the Faculty of
Worcester Polytechnic Institute
In Partial Fulfillment of the Requirements for a
Degree of Bachelor of Science

BY
MARK YANDIAN JOHN DOWNEY SHAWN POPIESKI

ADVISED BY:

PROF. MICHAEL J RADZICKI

MAY 17, 2014

Abstract
The purpose of this IQP was to scientifically develop a stock trading system in an

attempt to beat the market, generate alpha. During this process, group members researched

the fundamental concept and theories about step-by-step processes related to how to develop

a trading system. Team members then determined which process was to be taken to identify

just what system they wanted to create. The system was then back-tested to determine its

effectiveness and profitability.

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 TABLE OF CONTENTS

Chapter 1 _____________________________________________________________ 4

Introduction _______________________________________________________________ 4
Purpose of Project ___________________________________________________________ 5
Obtaining Alpha
Beat the Market
Method of Madness
System Objectives ____________________________________________________________ 5
Winning Percentage
Annual Return

Chapter 2 _____________________________________________________________ 6
Position Sizing ________________________________________________________________ 6
Our Sizing System
Why we Chose Certain Numbers?
Selecting Stocks ______________________________________________________________ 7
Stock Screener
Share Price
Market Cap
Beta Volatility
Profit Margin
Current Events

Chapter 3 ____________________________________________________________ 10
Trade Station Application______________________________________________________ 10
Pros and Cons
Asset Classes _______________________________________________________________ 11
Stocks
Bonds

Options
Trading and Investment Strategies ______________________________________________ 12
Dow Theory

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 CAN Slim

Technical Analysis______________________________________________________14

Precision Trading System

Support and Resistance Strategies
Order Types _______________________________________________________________17
Market Orders
Limit Orders
Stop Orders

Chapter 4_________________________________________________________________19

Strategy Structure____________________________________________________19

Regression Analysis

Short Term

Long Term

Gapping

Gapping up and down

Full Gaps

Partial Gaps

Chapter 5_____________________________________________________________24

Implementation of Strategy____________________________________________24

Half Hour Regressions

Full Day Regressions

Gap Up Examples

Gap Down Examples

Chapter 6_____________________________________________________________32

Conclusion__________________________________________________________32

Final Spread Sheets

Analysis

Would We Use This Strategy Again

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Chapter 1

Introduction

The Stock Market is not something that has just come around in the last 20 years. It is

something that has been around for hundreds of years. Over the years, the way people trade

the market has developed to greater and greater heights. Way back when trading just came on

the scene, everything was done in the “pits”, where investors had people manually put their

trades into the market. Since the “old” ways of trading started it all, many new forms of trading

have been developed.

Since the late 1990’s, the invention of the internet changed the world of trading forever.

The internet has allowed everyday people to directly invest into the market. Platforms that

were once only available to brokers and financial investment groups are now available

worldwide to everyone. Computerized trading platforms, such as TD Ameritrade™ and

TradeStation™, have emerged and given people a more hands-on tool to control their own

financial futures. However, that could also be a negative effect on people’s financial futures.

Most everyday citizens do not understand the process of actually handling their own

investments. As a result, the majority of people are unsuccessful while trading. The greater

percentages of citizens end up just listening to others’ recommendations without taking their

own situation into consideration (Economides).Page?

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 The general population does not understand all the scientific reasoning behind

managing their own trading platforms. The purpose of this project is to help people try to get a

general idea of what it takes to develop their own criteria to successfully beat the market and

generate a consistent profit.

Purpose of the Project

Due to a lack of information, many people do not fully understand all the ins and outs of

just exactly how much it takes to develop and manage their own stock portfolios. With this

project, we hope to help people realize all the scientific testing and reasoning that goes into

managing their investments. This report discusses the amount of background research and how

a trading system, scientifically, is constructed and tested. Initially, background research is

performed to gain an understanding of trading and generating a trading system. Next, the

report goes into what steps are taken so any average citizen can implement the steps and

become a more successful trader. Then how the system was tested to ensure that the system

was profitable; to make sure the system can generate alpha. Alpha is generated when a trading

system generates a rate of return that beats a benchmark such as the S&P 500. Lastly, the

report provides further information on how the system could further be improved if a trader

was to use it to trade.

System Objectives

With this project, we are hoping to help everyday citizens understand a few concepts to

determine the successfulness of their systems. Winning percentage, annual return, and low

draw-down are just a handful of goals people should consider prior to building a system. Most

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people think if you do not have a high winning percentage, the system is a failure. On the

contrary, consistency over a long period of time is more important. Annual return is a very

important factor when building your system; a good annual return, over a long period of time,

shows consistency and as a result a very successful system. Keep these facts in mind while

building and analyzing a system and success is in your future.

Chapter 2

Position Sizing

When applying a system to trading, the amount being traded is just a valuable as the

price of the stock (Bryant 5). This is where position sizing comes into play. We decided to use a

fixed-fraction formula to give us a specific number of shares to purchase based on a few

factors. There are various methods of developing a position sizing formula but we decided on a

fixed-fraction formula (Bryant 5). This is what the formula looks like:

N = ff*Equity/[Trade Risk]

Where N is the quantity of stock, ff is our fixed fraction (5%), Equity is the current amount of

money willing to risk, and Trade Risk is the price of the unit we are looking at (Bryant). This

approach is considered Martingale due to there not being a direct correlation between a

winning streak, and the quantity of the stock performing the streak. However, due to total

equity being included in the formula, the more equity the user obtains, the larger any given

position size will be (Investopedia Anti-Marg). We decided to choose five percent for the fixed

fraction because it is low enough to not make a huge dent in a person’s account if they lose, but

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has an average risk per rate on return. This is an example of how to apply the formula: Say we

are interested in Facebook at $62.70 and want to buy the correct amount of stock.

N= .05 * 400,000/[62.70] = 318

Based on our formula, 318 shares would be the correct amount to purchase. Position sizing is

very useful because it keeps the amount of shares organized and it keeps total equity organized

(Bryant 6). However, before position sizing even begins, choosing the correct stock is an entire

different process.

Selecting Stocks

Deciding specifically what to trade can be a very overwhelming process with all of these

different markets and stocks out there. As a trader, you want to have a sense of the tendencies

and history of a stock before partaking in it. Part of our system for this project was to pick out

which stocks we felt were going to succeed based on outlines that we deemed appropriate. We

would listen to advice from the web, speculate based on current events, and we even had our

own stock screener to set us up with worthwhile stocks.

Stock Screener

A stock screener is a system of standards for a stock to meet before it is traded. Our

stock screener was designed to have parameters that appropriately fit what we wanted for our

system. The challenge with creating a stock screener is formulating the parameters so that it

can produce a correct number of options. As a trader, you do not want less than 4 or 5 stocks to

appear because that limits the potential of making money. However, if there are more than 20

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stocks it can become very overwhelming and your focus can be lost. The standards in our

particular screener have proven to give us an appropriate number of options right around 10-

15. Below is a description of the 4 steps of our screener:

Share Price: Min: $40 Max: $75

We deemed this as an acceptable range due to the average price of the NYSE being

$28.65 (CNN). Our range is set greater than that, and based on market trends it makes more

sense to go above the average than stay with or below it.

Market Cap: Min: $500 Million Max: $10 Billion

The market cap is the share price multiplied by the total volume of that particular stock

(Yahoo Screen Settings). This range gives us some flexibility because there is a great difference

between the numbers. Although the difference is great, since we already set the share price, it

makes sure that the volume plays more of a factor for the market cap than the price.

Beta Volatility: Min: 1.5 Max: 3.0

The beta volatility is a ratio of a stock’s price in relation to the entire market (Yahoo

Screen Settings). A beta ratio of 1 determines that the share price is changing at the same rate

as the market (Yahoo Screen Settings). Our range is setup so that the share price is moving up

and down faster than the market rate, therefore giving us a greater opportunity for high risk –

high reward.

Profit Margin: Min: 20% Max: 30%

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 Our final standard is profit margin, which is the percent of income kept from sales

revenues (Yahoo Screen Settings). This is a critical component because it gives a sense of what

companies are staying active internally beyond just what the market depicts. This range was set

because it is a solid indication of whether a company is succeeding and does not put too much

pressure on any given stock.

The parameters of the screener are implemented for a trend-following system. The

large market cap range gives the screener the ability to look at a wide range of stocks. Beta

volatility is factored to make sure that the stocks that fit the market cap range are also being

traded frequently. The standards of our beta volatility bring about stocks that fluctuate in value.

This means that the stocks being presented are more susceptible for a trend in either direction.

The profit margin is the final standard to prove that the companies behind each share are

actually producing results. It gives a confirmation that not only is the share price at a good

range, and the share is highly traded, but that the company is also finding some success.

Companies that find profit will tend to have more positive trends.

Ex. List of stocks that fit our requirements. (Yahoo)

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Stocks from current events

The media is a powerful tool when it comes to trading in the market. When news breaks

about a certain company, there is a very high chance the market will react to it. This is why the

stock screener was not our only method of selecting stocks. There were various times over the

course of this year when reports would come out regarding a new product, management

change, IPO release, or just general news about a company. The next step for our team was

applying our system appropriately to these company’s stocks, whether it was buying or selling.

This method was not used heavily in our system, however it was appropriate because the news

would predict breakouts of either upward or downward trends for any given stock. Although

this was not our primary method, it proved to be a viable option if the opportunity came about.

Chapter 3

TradeStation™ Online Platform

TradeStation™ was the designated platform for the project. Each student was given a

mock $400,000 account to manage a portfolio. TradeStation™ has multiple tools to help

develop a trading platform. The multiple indicators, canned systems, and other tools to view

trades, make it quite easy to begin making your own system. On the contrary, it is not all

positives with the online platform. TradeStation™ is geared more toward automated trading,

not manual. With manual trading, TradeStation™ does not automatically generate a

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spreadsheet when you get in or out of the market. You have to track your own personal trades.

Where as in automated trading, TradeStation™ keeps all trades stored in a file. For the most

part, TradeStation™ is very helpful with learning the basics, but could greatly improve the tools

for manual traders.

Stocks

Stocks are a type of security that signifies ownership in a corporation and represents a

claim on part of the corporation's assets and earnings. Also knows as “shares” or “equity.”

There are two main types of stock: common and preferred. Common stock usually

entitles the owner to vote at shareholders' meetings and to receive dividends. Preferred stock

generally does not have voting rights, but has a higher claim on assets and earnings than the

common shares (Stocks). For example, owners of preferred stock receive dividends before

common shareholders and have priority in the event that a company goes bankrupt and is

liquidated. Stocks historically outperform, over the long run, other asset classes (Stocks).

The major markets (Indexes) in the United States, just to name a few, are Dow Jones

Industrial Average, S&P 500 Index, and the NASDAQ Composite Index (Radzicki).

There are multiple stock exchanges in the United States for investors to get involved

with, but some are more profitable. The major Stock Exchanges in the U.S. are the New York

Stock Exchange (NYSE), the NASDAQ, the American Stock Exchange (AMEX), and Over the

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Counter Bulletin Board (Penny Stocks) (Learnstocks). During this project, stocks traded on the

NYSE were predominantly used.

Bonds

A bond is a debt investment in which an investor loans money to an entity (corporate or

governmental) that borrows the funds for a defined period of time at a fixed interest rate.

Bonds are used by companies, municipalities, states and U.S. and foreign governments to

finance a variety of projects and activities (Bonds).

Bonds are commonly referred to as fixed-income securities and are one of the three

main asset classes, along with stocks and cash equivalents.

The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will

be paid and when the loaned funds (bond principal) are to be returned (maturity date). Interest

on bonds is usually paid every six months (semi-annually). The main categories of bonds are

corporate bonds, municipal bonds, and U.S. Treasury bonds, notes and bills, which are

collectively referred to as simply "Treasuries" (Bonds).

Options

An option is a financial derivative that represents a contract sold by one party (option

writer) to another party (option holder (Options). The contract offers the buyer the right, but

not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon

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price (the strike price) during a certain period of time or on a specific date (exercise date)

(Options).

Call options give the owner the option to buy at certain price, so the buyer would want

the stock to go up in price (Options). Put options give the owner the option to sell at a certain

price, so the buyer would want the stock to go down (Options) (unless the put is being used as a

hedge).

Trading and Investment Strategies

It is argued that there are many different ways to “beat the Market.” (Eugene Fama

(Nobel Prize in economics) and the other efficient market guys say you can’t beat the market)

Investors and other traders have been determining many different ways to exploit the market,

therefore the amount of resources available to start building a system on your own is in

abundance. A few helpful strategies that have been developed and used for many years are

Dow Theory and CAN SLIM.

Dow Theory is a trend following strategy. Dow Theory breaks the Market into two

categories, industrial and transportation. The theory claims if one category surpasses a previous

set high, then the other category is sure to follow, telling investors to buy more shares.

However, it also works in reverse as well. If one category surpasses a previous set low, then the

other category is will follow suit, telling investors to sell short until the upward turn comes back

(Dow Theory).

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 CAN SLIM, less of a canned system, is used to lay-out criteria to determine what stocks

to use when choosing companies. CAN Slim, C-A-N-S-L-I-M, is an acronym showing steps to take

while looking up investment ideas (Investopedia Again…). The CAN SLIM stock picking criteria

were created by Investor's Business Daily founder William J. O'Neil. They include:

C - Current quarterly earnings per share have increased sharply from the same quarters' earnings
reported in the prior year. (Beware of items in financial statements that can cause earnings distortions.)

A - Annual earnings increase over the last five years.

N - New products, management, and other new events. In addition, the company's stock has reached
new highs.

S - Small supply and large demand for a stock creates excess demand, and an environment in which stock
prices can soar. Companies acquiring their own stock reduce market supply and can indicate their
expectation of future profitability. Look for low debt-equity ratios.

L - Choose leaders over laggard stocks within the same industry. Use the relative strength index as a
guide.

I - Pick stocks who have institutional sponsorship by a few institutions with recent above average
performance. Be cautious of stocks that are over owned by institutions.

M - Determining market direction by reviewing market averages daily.

Technical Analysis

Precision Trading System (PTS)

After careful research, we decided to use Precision Trading Systems (PTS) to “beat the

Market.” PTS is said to be more than a trading platform, it is a complete system used to

evaluate trades and be very precise for taking entries and exits (Training Software Setup). PTS is

designed to take both long and short-term trades. This flexibility allows for quick scalps, day,

long or even swing trades. Meanwhile, if the trader has a hunch to go long, Precision Trading

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System permits that tactic. Due to PTS being a linear platform, you can see ahead of time to

confirm whether the current trade will be a short or long (Training Software Setup). With the

regression channel, if one identifies a break out of the channel, a short position should be

taken. On the other hand, if one identifies a trend developing inside the channel, then a long

position should be taken.

Precision Trading System allows a trader to know how much of a profit is expected,

allowing the proper risk to reward ratio. “Rather than use technical analysis, the platform is

based entirely upon the real-time statistical analysis of price movement in multiple time

frames, thus allowing the trader to accurately calculate the potential movement (edge) of a

stock's price prior to taking the trade (Training Software Setup).

Support and Resistance Strategy

Precision Trading System was the main system used during the process, but as a group

we decided to combine a few other strategies in attempt to maximize the profits, as well as, the

consistency. Support and resistance are from the technical analysis side of trading.

Support and resistance can show up in various forms. One being ceilings and floors. A

ceiling is a common price that a certain stock seems to get to and then take a downward turn.

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Chart 1: Ceiling Example Chart 2: Floor Example

As you can see in chart 1, the ceiling price would be approximately $39. Whereas a floor

is a common price a certain stock approaches and then takes an upward turn. As you can see in

chart 2, the floor price is around $51.25. Seeing this as a trend tells a trader when and how to

trade the stock and for how long (Murphy).

Another example of support and resistance are trend lines. During the project, our

group used trend lines for a large part of the reasoning behind what trades we took. Trend lines

are a group or series of inclining or declining peaks/troughs. If the peaks/troughs look like they

are trending upward or downward, a trader will attempt to connect the peaks/troughs and

determine the trend. An upward trend tells a trader to get in for a long trade. If a downward

trend begins to develop, the correct call is to sell short and stay short until you see a change in

the trend. Precision Trading System is based on stocks trending upward or downward. Knowing

that, trend lines became very important to this project. As an example, the following chart

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shows an upward trend, therefore the correct play would be to buy in and stay in until the

trend changes.

Chart 3: Trend line Example

Chart 4: Moving Average Moving Averages are a more

technical approach to support and

resistance to use in trading. As you can

see from Chart 4, a moving average is a

constantly changing line that flattens

out past price data while also allowing

the trader to identify support and

resistance (Murphy). Notice how the

price of the asset finds support at the

moving average when the trend is up, and how it acts as resistance when the trend is down.

Most traders will experiment with different time periods in their moving averages so that they

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can find the one that works best for this specific task (Murphy). In the project, a two-line

moving average is used to determine when a new trend is beginning. With a two-line moving

average, when the lines cross a change in trend is beginning to happen. Just by using this

indicator, a first-time trader can identify these changes and begin building a system based of

support and resistance.

Market Orders

A market order is an order to buy or sell a number of shares at the best available price

(U.S. Securities and Exchange Commission). Mostly, a market order gets an investor into the

market immediately. However, the price at which a market order will be executed is not

guaranteed. It is important for investors to remember that the last-traded price is not

necessarily the price at which a market order will be executed. The quicker moving markets

usually cause the last-time traded price to deviate from “real time” quotes when the market

order is filled (U.S. Securities and Exchange Commission).

Limit Orders

“A limit order is an order to buy or sell a stock at a specific price or better. A buy limit

order can only be executed at the limit price or lower, and a sell limit order can only be

executed at the limit price or higher. A limit order is not guaranteed to execute. A limit order

can only be filled if the stock’s market price reaches the limit price. While limit orders do not

guarantee execution, they help ensure that an investor does not pay more than a pre-

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determined price for a stock” (U.S. Securities and Exchange Commission). A limit order could

cause a trader to miss big jumps if the price is set to high or too low.

Stop Orders

A stop order is used to buy or sell a stock once the price reaches a specified price, the stop

price, set by the investor (U.S. Securities and Exchange Commission). When the stop price is

reached, a stop order becomes a market order. A buy stop order is an order to buy a market that

is entered at a price above the current offering price and that is triggered when the market price

touches or goes through the buy stop price. Investors generally use a buy stop order to protect a

profit on a stock that they have sold short. A sell stop order is entered at a stop price below the

current market price. A sell stop order is generally used to avoid a huge loss or secure the set

profit margin the investor wants to achieve (U.S. Securities and Exchange Commission)

Chapter 4

Regression Channel

The main part of our group’s strategy was making use of the regression channel through

TradeStation. A regression channel is made up of three parallel trend lines, with the center line

using the linear least squares method to best fit to the given data points. This method

minimizes the sum of squared residuals, which is the distance between an actual value and the

line of best fit, and shows how which direction the stock is trending; bullish, bearish or not at
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all. The support and resistance lines run parallel to the center line and are 2 standard

deviations apart. For short term trading the regression channel includes 30 bars of data or 30

minutes of data. To create the channel, parallel lines are drawn two standard deviations higher

and lower to the regression line (Raff). Using two standard deviations account for 95 percent of

the data points within the start and end points of the regression line. This method works well

on trending stocks with low to moderate volatility because it is optimal to have the data points

stay within the support and resistance line and move consistently in the trending direction. If

the slope of the regression channel changes then it shows that the stock is starting to trend in a

different direction. Our group decided to use this strategy, because it is effective, not overly

complicated, and can easily compliment other strategies. Each member of our group decided to

use the regression channel in a different way; short-term trading, long-term trading, and long-

term trading with the gap strategy. Figure 4a is an example of an optimal trending stock (Raff).

Figure 4a

Gap Strategy

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 The gap strategy is another method of trading that was implemented in one part of the

overall system on a 60 minute bar time frame. A gap is the difference between the price of a

stock at the open of the market and the close price of the stock from the day before. If the price

of the stock gaps up from the closing price of the day before, the trader can choose to go long

or short on that stock. If the price of the stock is higher than the high of the previous day the

trader should observe the chart on a one minute scale for at least one hour and then enter the

market on a long two bars higher than yesterday’s high (Gap). Similarly, if the price of the stock

opens higher than yesterday high, but does not sustain the rise on the one minute scale, the

trader can choose to enter the market at a short two bars below the low of opening hour of

that day. This strategy also works when the stock gaps down from the day before. If the stock

opens at a price lower than the previous day’s low, then the trader should observe the chart on

a one minute scale for an hour. If the price of the stock sustains the low and continues to drop,

then the trader should enter the market on a short. If the price of the stock gaps down, but

does not sustain the low in the first hour, then the trader can choose to enter the market on a

long at two bars higher than the low of yesterday’s price (Gap).

Stocks do not always gap up higher than the previous day’s high or down lower than the

previous day’s low, but there is a price difference between the open and close. This is called a

partial gap, and the trader can use the same rules as the full gap strategy to enter and exit the

market The difference between trading full gaps and partial gaps is potential gain and risk.

Stocks that gap up higher than yesterday’s high tend to affect the market’s desire to own or sell

the stock and if demand is high enough to make the floor specialist change the price of the

stock to sustain all the unfulfilled orders. This applies vice versa to stocks that full gap down. If

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the stock has a full gap then it tends to trend for a longer in a given direction than partial gaps.

If there is little demand for a stock the price from close to open will only change partially to

trigger buying and selling and fill on hand orders (Gap). The price of the stock will usually

bounce back to its original trading price range. Trading full gaps works better on longer time

frame basis, while trading partial gaps requires more attention or closer trailing stops.

Time Frames

TradeStation charts allow the user to select different time frames, or how many bars the

chart displays on a daily basis. Our group made use of two different time frames; one minute

bars and 60 minute bars. Since our system is a trend following system and makes use of

regression channels, different time frames will show trends that occur over a longer periods of

time and trends that occur over very short periods of time. Both time frames have their positive

and negative aspects. Trading on longer time frame allows the trader to negate all the noise

that is shown on one minute charts, and requires the user to spend more time in the market.

This time frame allows the trader to catch the long term trends that may happen over days or

weeks. However this means there will be less trades on a daily basis.

Using a shorter time frame, allows the user to catch the trends that happened

throughout the day. This requires the trader to pay more attention throughout the day, and to

have strict enter and exit rules. Trading a shorter time frame can me more beneficial, because it

allows the trader to be in the market only when the stock is trending sharply in a certain

direction, and out of the market if the stock’s price is neither trending up or down. Longer time

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frames require the trader to be in the market even if the stock is neither going up or down on

the short-term.

Short-Term Trading

The first part of our strategy uses fixed fractional position sizing, and regression analysis

on a one minute bar time frame. The trader selected stocks based on the results of the stock

screener. The trader observes the first hour of the market after it opens. At 10:30 AM ET,

regression channels are then set to cover the previous 30 bars or 30 minutes of the selected

stock’s price. This allows the trader to see if the stocks are trending up or trending down and

will indicate if he should go long or short into the market. If the regression channel is trending

up, then the trader waits for the price to exit the regression channel either above the second

standard deviation mark acting as the resistance or lower than the second standard deviation

mark acting as the support. If the price exits the regression channel on the low standard

deviation mark, the trader waits until the price drops to the same price as the start point of

your regression channel. Enter the market and short at this price. If it never reaches this point it

is likely the stock is still trending upward, and wait till it re-enters the regression channel where

you should enter the market in a long position. If the price does drop to the price of your start

point, this is indication the stock is trending in a different direction. If the stock is trending up

and the price exits the high standard deviation line, wait until the price drops back into the

regression channel and enter the market at a long, because this is an indication that the stock

will continue to trend upward. If after 10 bars, the stock continues to rise and does not re-enter

the channel the trader should enter the market on a long. Once the trader enters the market,

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the regression channel needs to be reset. The regression channel is then set at the time the

trader entered the market and 30 bars before the entry point. If the price ever drops below the

regression channel wait 10 bars to account for the noise, then exit the market. If the price exits

the through the higher standard deviation bar wait 15 bars, then re draw the regression

channel at the high point and 30 bars previous.

If the original regression channel is trending down, then it is likely the trader will enter

the market at a short. The same enter and exit rules apply as the regression channel that trends

upward, just in the opposite direction. Wait for the close of the bar to exit the regression

channel, if the bar exits through the lower second standard deviation line wait for it to re-enter

the channel than short the stock. If the stock price continues to drop and does not re-enter the

regression channel after 10 bars the trader should enter the market. If the bars exit through the

high standard deviation line wait till the price either reenters the channel and short the stock or

wait for the price to reach the price from the regression channel start point to go long. After the

trader enters the market, redraw the regression channel from the time of market entry to 30

bars previous.

Long-Term Trading

The other parts of our system involve using fixed fractional position sizing with

regression analysis, but on a 60 minute bar time frame or 30 minute bar time frame. One part

of the long-term system also included the use of the gap strategy. The rules for our long- term

strategy are similar to the rules for our short-term strategy, except for the trader who used the

gap strategy to find different entry points into the market. When trading 60 minute bars, we set

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the regression channel over 7 bars, to account for an entire trading day. When trading with 30

minute bars, we set the regression channel over 8, to also account for half a day. Trends in the

market occur in every timeframe, and the trends that sustain themselves for a longer period of

time net more profit per trade. The trader has to be careful not to let emotions blur the rules of

the system, because with more profit comes a higher risk. However, when traded correctly, the

long term aspect compliments the short term system, by catching trends that cannot be seen

on a one minute bar chart.

Chapter 5:

Implementation of Strategy

This chapter consists of different examples of how we applied each strategy. The images were

taken from each team member at different periods over the term. We found that these images

were the best representation of how we penetrated the market.

Half Hour Regression Model

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 (Figure 1)Figure 1 is an example of our half hour regression model. The graph is set to 1

minute bars and we were presented with a buy long situation. This is because the trend initially

fell below our regression channel and was heading towards our buy indicator. We bought

prematurely and had to pay for it. We bought in a few points above the indicator. Since the

stock did not fully hit our sell indicator we stuck with the shares for another hour. This stock

was ROSE and we lost around a dollar per share.

Full Day Regression Model

Below are examples of how we assessed each appropriate stock before trading the next day:

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(Figure 2)

(Figure 3)

27
 (Figure 4)

(Figure 5)

(Figure 6)

(Figure 7)

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(Figure 8)

(Figure 9)

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 (Figure 10)Each stock is looked at over a full day period. Either by 30 minute bars with

the regression length set to 13 bars, or 60 minute bars with a length of 7. Both methods

measure the same amount of time; however we wanted to see if there was a difference when

measuring with different graph intervals. When we looked at these models the day before

trading, we created our indicators based on the location of the 2 standard deviation lines.

Based on the results from yesterday’s market, we would use the upper regression line as a

short indicator, while using the bottom line as a long indicator. The middle regression line is our

indicator to buy back in or sell the stock.

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 (Figure 11)This is an example of when we would sell short. The stock is CMA and once

the price hit the upper interval we decided to sell short. CMA falls into our screener and the

stock is held until the price falls back onto the white regression line. Unless the price reaches

our ceiling, it is monitored until it falls back down.

(Figure 12)

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 The stock above is IPGP. This is an example of when we decide to buy long. Based on

yesterday’s performance, we find our buying mark and when to sell. We bought in at 65.44 and

had not decided to sell yet due to it not reaching our floor, nor reaching our selling indicator.

Gap Up

(Figure 13)This shot is from a chart representing CNX. CNX is one of our stocks and we applied

our gap up strategy in this scenario. When the price opened up that much higher from the day

before, we decided to sell short. We sold short at 44.17 and then bought back at 43.60.

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Gap Down

(Figure 14)This is a prime example of where we applied the gap down strategy. Since

there is a dramatic drop from one day’s closing price, to the next day’s opening price, we can

interpret this as a sign that the stock is going to jump back up. Our interpretation was correct.

This chart represents CIT, and we bought in at 43.35 and sold at 45.74.

Figures:

Figure 1 – ROSE Chart (Trade Station)

Figure 2 – CNX Chart (Trade Station)

Figure 3 – CMA Chart (Trade Station)

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Figure 4 – GEOS Chart (Trade Station)

Figure 5 – HOS Chart (Trade Station)

Figure 6 – IPGP Chart (Trade Station)

Figure 7 – OAS Chart (Trade Station)

Figure 8 – ROSE Chart (Trade Station)

Figure 9 – TAL Chart (Trade Station)

Figure 10 – UBNT Chart (Trade Station)

Figure 11 – CMA Chart (Trade Station)

Figure 12 – IPGP Chart (Trade Station)

Figure 13 – CNX Chart (Trade Station)

Figure 14 – CIT Chart (Trade Station)

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Chapter 6

Conclusion

Popieski’s Trades (Long Term):

35
Downey’s Trades (Long Term):

36
Yandian’s Trades (Short Term):

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 The images above are the results from our team’s trading versus the index from the S&P

500. The S&P 500’s year-to-date return was 2.61%. This is a good standard to go by because it

represents the top traded companies in the market. The S&P 500’s 1-year return is larger than

all 3 of ours; however the spreadsheet has only been recorded since the beginning of C-term.

Analysis

Compared to the S&P 500, it seems that our strategy is ultimately ineffective. Although

two of the traders we able to generate a small profit, it was not very significant and none of the

members were able to generate enough profit to beat the S&P 500. Along with this, one of the

member’s return ended-up being a negative difference. This is a signal that something is wrong

with our system, whether it is the position sizing, screener, or actual strategy. The most difficult

part is determining which section needs the improvement. We believe that our biggest flaw in

the system was using the regression channel to manually trade versus automated trading.

There were instances when errors would occur in readjusting our indicators from the regression

channel due to us misjudging trends that could have been solved from automatic trading. The

stock screener still seems efficient due to the volatility we observed from each stock. Volatility

works both ways; a trader can use it for their advantage to come across a quick sizable return,

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but also if the trader’s attention is not appropriately applied than the investment can go south

quicker than a non-volatile stock would.

Overall, we would not decide to implement this system again. Although one of the

members had a solid return, the other two did not. One objective we were not able to

accomplish was the ability to implement our system completely into EasyLanguage. This

program through TradeStation could have proven to be more effective than us simply manual

trading. This experience of building and implementing a system has shown our team how

difficult it is to actually beat the market. We have learned that adjustments need to be made

from time to time to maintain the quality of a system. The knowledge we have gained from this

project should be very useful when we are creating our own personal portfolios later on in life.

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References

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CNNMoney. “NYSE Composite Index.” Cable News Network. 1 April 2014

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Investopedia. "Regression Analysis - CFA Level 1 |." Investopedia US. 21 April 2014

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Learnstocks. "Major U.S. Stock Exchanges." 26 February 2013. Hot Penny Stocks Finders. Web.
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Murphy, Casey. "Support and Resistance Basics." 10 March 2013. Investopedia. Web. 25 April
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Radzicki, Michael J. The Breadth of the Market. 2012. PowerPoint. 27 April 2014.

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