Trading Systems and Methods, 3rd Edition

by Perry J. Kaufman

• ISBN13: 9780471148791
• ISBN10: 0471148792
• Edition: 3rd
• Format: Hardcover
• Copyright: 1999-01-01
• Publisher: Wiley

Summary

For more than two decades, futures traders have turned to the classic Trading Systems and Methods for complete information about the latest, most successful indicators, programs, algorithms, and systems. Perry Kaufman, a leading futures expert highly respected for his years of experience in research and trading, has thoroughly rewritten and updated his bestselling guide, which remains the most comprehensive and instructional book on trading systems today. This detailed, hands-on manual offers a thorough analysis, using a systematic approach and explanation of each method of calculation or operation. Trading Systems and Methods continues to be the single best resource for the trader or market analyst who wants to create or choose a successful trading system.

Author Biography

PERRY J. KAUFMAN is a leading technical expert in futures markets. Renowned for his mathematical skills and insight, Kaufman has developed significant theories in the area of price forecasting. As a principal of Man-Drapeau Research, Pte. Ltd. (Singapore), he is actively involved in the practical analysis needed to support an international investment management firm. Throughout the past 20 years, Kaufman has helped to foster the education of research analysts and investors, publishing books and writing articles for Technical Analysis of Stocks & Commodities, Futures Industry, and Futures magazine. He has participated in the Dow Jones-Telerate Seminars world tours, professional conferences, academic programs, and has been an occasional guest on CNBC.

Table of Contents

PREFACE: CLOSING THE GAP BETWEEN EXPECTATIONS AND REALITY	xiii
1 INTRODUCTION	1	(8)
Technical versus Fundamental	1	(1)
Professional and Amateur	2	(1)
Random Walk	3	(1)
Background Material	4	(1)
Research Skills	5	(1)
Objectives of This Book	6	(1)
Profile of a Trading System	6	(2)
A Word on Notation Used in This Book	8	(1)
2 BASIC CONCEPTS	9	(28)
About Data and Averaging	9	(2)
On the Average	11	(2)
Distribution	13	(3)
Dispersion and Skewness	16	(4)
Standardizing Returns and Risk	20	(2)
The Index	22	(1)
Probability	23	(6)
Supply and Demand	29	(8)
3 REGRESSION ANALYSIS	37	(25)
Characteristics of the Price Data	37	(1)
Linear Regression	38	(1)
Method of Least Squares	39	(3)
Linear Correlation	42	(3)
Nonlinear Approximations for Two Variables	45	(1)
Second-Order Least Squares	46	(2)
Evaluation of 2-Variable Techniques	48	(3)
Multivariate Approximations	51	(4)
ARIMA	55	(5)
Linear Regression Model	60	(2)
4 TREND CALCULATIONS	62	(27)
Forecasting and Following	62	(1)
Least-Squares Model	63	(2)
The Moving Average	65	(9)
Geometric Moving Averages	74	(1)
Drop-Off Effect	74	(1)
Exponential Smoothing	75	(6)
Relating Exponential Smoothing and Standard Moving Averages	81	(8)
5 TREND SYSTEMS	89	(37)
Basic Buy and Sell Signals	89	(1)
Bands and Channels	90	(5)
Applications of Single Trends	95	(5)
Comparison of Major Trend Systems	100	(16)
Techniques Using Two Trendlines	116	(4)
Comprehensive Studies	120	(1)
Selecting the Right Moving Average	120	(2)
Moving Average Sequences: Signal Progression	122	(1)
Living with a Trend-Following Philosophy	123	(3)
6 MOMENTUM AND OSCILLATORS	126	(34)
Momentum	126	(7)
Oscillators	133	(11)
Double-Smoothed Momentum	144	(3)
Adding Volume to Momentum	147	(2)
Velocity and Acceleration	149	(3)
Other Rate-of-Change Indicators	152	(2)
Momentum Divergence	154	(3)
Momentum Smoothing	157	(1)
Some Final Comments on Momentum	158	(2)
7 SEASONALITY	160	(29)
A Consistent Factor	160	(1)
The Seasonal Pattern	161	(1)
Popular Methods for Calculating Seasonality	161	(13)
Weather Sensitivity	174	(2)
Seasonal Filters	176	(12)
Common Sense and Seasonality	188	(1)
8 CYCLE ANALYSIS	189	(24)
Cycle Basics	189	(4)
Uncovering the Cycle	193	(15)
Maximum Entropy	208	(1)
Cycle Channel Index	209	(1)
Phasing	210	(3)
9 CHARTING	213	(24)
Finding Consistent Patterns	214	(1)
Interpreting the Bar Chart	215	(2)
Chart Formations	217	(1)
Basic Trading Rules	218	(3)
Tops and Bottoms	221	(4)
Gaps	225	(1)
Key Reversal Days	226	(1)
Episodic Patterns	227	(1)
Price Objectives for Bar Charting	228	(4)
Candlestick Charts	232	(2)
Using the Bar Chart	234	(3)
10 VOLUME, OPEN INTEREST, AND BREADTH	237	(19)
Contract Volume versus Total Volume	237	(1)
Variations from the Normal Patterns	238	(1)
Standard Interpretation	239	(1)
Volume Indicators	240	(9)
Interpreting Volume Systematically	249	(1)
An Integrated Probability Model	250	(1)
Intraday Volume Patterns	251	(2)
Filtering Low Volume	253	(1)
Market Facilitation Index	254	(1)
Sources of Information	255	(1)
11 POINT-AND-FIGURE CHARTING	256	(25)
Plotting Prices Using the Point-and-Figure Method	257	(2)
Chart Formations	259	(2)
Point-and-Figure Box Size	261	(2)
The Problem of Risk	263	(1)
Trading Techniques	264	(4)
Price Objectives	268	(4)
A Study in Point-and-Figure Optimization	272	(9)
12 CHARTING SYSTEMS	281	(24)
Swing Trading	281	(9)
William Dunnigan and the Thrust Method	290	(2)
Nofri's Congestion-Phase System	292	(1)
Outside Days with an Outside Close	293	(1)
Action and Reaction	294	(4)
Channel Breakout	298	(2)
Moving Channels	300	(1)
Combining Techniques	300	(2)
Complex Patterns	302	(3)
13 SPREADS AND ARBITRAGE	305	(29)
Spread and Arbitrage Relationships	307	(1)
Arbitrage	307	(9)
Changing Spread Relationships	316	(4)
Carrying Charges	320	(2)
Technical Analysis of Spreads	322	(7)
Volatility and Spread Ratios	329	(3)
Leverage in Spreads	332	(2)
14 BEHAVIORAL TECHNIQUES	334	(48)
Measuring the News	334	(4)
Event Trading	338	(6)
Commitment of Traders Report	344	(2)
Opinion and Contrary Opinion	346	(4)
Fibonacci and Human Behavior	350	(3)
Elliott's Wave Principle	353	(8)
Constructions Using the Fibonacci Ratio	361	(2)
Fisher's Golden Section Compass System	363	(3)
W.D. Gann--Time and Space	366	(5)
Financial Astrology	371	(11)
15 PATTERN RECOGNITION	382	(37)
Projecting Daily Highs and Lows	383	(1)
Time of Day	384	(10)
Opening Gaps and Intraday Patterns	394	(6)
Three Studies in Market Movement--Weekday, Weekend, and Reversal Patterns	400	(16)
Computer-Based Pattern Recognition	416	(1)
Artificial Intelligence Methods	417	(2)
16 DAY TRADING	419	(17)
Impact of Transaction Costs	419	(4)
Applicability of Trading Techniques	423	(5)
Market Patterns	428	(8)
17 ADAPTIVE TECHNIQUES	436	(13)
Adaptive Trend Calculations	436	(8)
Adaptive Momentum Calculations	444	(2)
An Adaptive Process	446	(1)
Considering Adaptive Methods	447	(2)
18 PRICE DISTRIBUTION SYSTEMS	449	(16)
Using the Standard Deviation	449	(2)
Use of Price Distributions and Patterns to Anticipate Moves	451	(2)
Distribution of Prices	453	(5)
Steidlmayer's Market Profile	458	(7)
19 MULTIPLE TIME FRAMES	465	(6)
Tuning Two Time Frames to Work Together	465	(1)
Elder's Triple-Screen Trading System	466	(2)
Robert Krausz's Multiple Time Frames	468	(2)
A Comment on Multiple Time Frames	470	(1)
20 ADVANCED TECHNIQUES	471	(32)
Measuring Volatility	471	(11)
Trade Selection	482	(1)
Price-Volume Distribution	483	(1)
Trends and Noise	484	(1)
Expert Systems	485	(3)
Fuzzy Logic	488	(2)
Fractals and Chaos	490	(2)
Neural Networks	492	(6)
Genetic Algorithms	498	(4)
Considering Genetic Algorithms, Neural Networks, and Feedback	502	(1)
21 TESTING	503	(52)
Expectations	504	(1)
Identifying the Parameters	505	(1)
Selecting the Test Data	506	(2)
Searching for the Optimal Result	508	(2)
Visualizing and Interpreting the Results	510	(7)
Step-Forward Testing and Out-of-Sample Data	517	(2)
Changing Rules	519	(1)
Arriving at Valid Test Results	520	(5)
Point-and-Figure Testing	525	(2)
Comparing the Results of Two Systems	527	(3)
Profiting from the Worst Results	530	(1)
Retesting Procedure	531	(2)
Comprehensive Studies	533	(13)
Price Shocks	546	(1)
Anatomy of an Optimization	547	(1)
Data Mining and Overoptimization	548	(6)
Summary	554	(1)
22 PRACTICAL CONSIDERATIONS	555	(32)
Use and Abuse of the Computer	555	(7)
Price Shocks	562	(3)
Gambling Technique--The Theory of Runs	565	(7)
Selective Trading	572	(2)
System Trade-Offs	574	(5)
Trading Limits--A Dampening Effect	579	(3)
Going to Extremes	582	(1)
Similarity of Systems	583	(4)
23 RISK CONTROL	587	(44)
Risk Aversion	587	(2)
Liquidity	589	(1)
Capital	590	(1)
Measuring Risk	591	(5)
Leverage	596	(2)
Diversification	598	(5)
Individual Trade Risk	603	(6)
Ranking of Markets for Selection	609	(5)
Probability of Success and Ruin	614	(3)
Compounding a Position	617	(2)
Equity Cycles	619	(4)
Investing and Reinvesting: Optimal f	623	(3)
Comparing Expected and Actual Results	626	(5)
APPENDIX 1 STATISTICAL TABLES	631	(3)
Probability Distribution Tables	631	(2)
Table of Uniform Random Numbers	633	(1)
APPENDIX 2 METHOD OF LEAST SQUARES	634	(17)
Operating Instructions	634	(1)
Computer Programs	634	(6)
Least-Squares Solution for Corn-Soybeans	640	(5)
Least-Squares Solution for Soybeans Only	645	(6)
APPENDIX 3 MATRIX SOLUTIONS TO LINEAR EQUATIONS AND MARKOV CHAINS	651	(8)
Direct Solution and Convergence Method	651	(1)
General Matrix Form	651	(1)
Direct Solution	651	(6)
Convergence Method	657	(2)
APPENDIX 4 TRIGONOMETRIC REGRESSION FOR FINDING CYCLES	659	(10)
Single-Frequency Trigonometric Regression	659	(4)
Two-Frequency Trigonometric Regression	663	(6)
APPENDIX 5 FOURIER TRANSFORMATION	669	(4)
Fast Fourier Transform Program	669	(4)
APPENDIX 6 CONSTRUCTION OF A PENTAGON	673	(3)
Construction of a Pentagon from One Fixed Diagonal	673	(1)
Construction of a Pentagon from One Side	674	(2)
BIBLIOGRAPHY	676	(11)
INDEX	687