TRADING SYSTEMS
Extending Your Trading System Toolkit
Managing Dynamic Portfolios
by Kevin Morgan
Here's how to build an automated trading system that reselects
its preferred trading symbols on a recurring basis.
Computerized trading system development
and execution platforms are oriented around trading a single or fixed set
of stock, index, or commodity symbols. Backtesting, walk-forward testing,
and real-time incremental execution occur against this fixed symbol set.
Changing the set is a manual process, and the backtesting and generation
of integrated results for a sequence of different symbol portfolios over
time are not typically supported functions.
At the highest level of its design, an advanced trading system may utilize
a methodology for regularly reselecting a preferred set of trading vehicles
(say, stock). By adapting the preferred set of stocks to be traded, a more
aggressive and adaptive "trade with the trend" approach can be implemented,
versus using a fixed set of trading vehicles and waiting for them to demonstrate
preferred trading behaviors.
$PECIAL-K
On a weekly basis, the $pecial-K trading system reselects its preferred
set of approximately 100 leading stocks from the NYSE, AMEX, and NASDAQ
universes based on technical and fundamental factors. The approach is to
trade short term, generating relatively small per-trade profits with a
high win/loss ratio. The entry management logic focuses strictly on short-term
price behaviors for entry selection. You achieve superior results by making
sure your entry takes place only on stocks that show strong and consistent
upward trends.
How? You need to select leading stocks with excellent technical and
fundamental characteristics. In order to efficiently backtest this system,
it is necessary to automate the process of shifting the stock portfolio
on a regular basis, generating correct trade reports and managing the complexity
of this system.
There are many examples of sources of dynamic portfolios over time.
Whenever changes are made in common stock indexes (DJIA, S&P 100, NDX,
and so on), asynchronous changes occur in widely used portfolios. Many
services generate regular (weekly, monthly, quarterly) preferred stock
lists of many types, such as the Investor's Business Daily and Value Line
lists. And finally, you can develop scanning and selection algorithms.
All such preferred trading vehicle selection approaches create a dynamic
portfolio management scenario.
SWITCHING SYMBOL SETS
I will assume that the dynamic portfolio selection process is operated
external to the trading system platform, and that you routinely modify
the specific portfolio of symbols within the trading platform. Another
feasible approach is to keep a complete universe of all possible symbols
internal to the trading platform and reselect subsets of them. The design
concepts presented in this article are applicable to both approaches, although
the implementation details described here focus on external preferred symbol
set selection.
There are two fundamental requirements for the trading system automation
using a dynamic portfolio. The first is the ability to incrementally, on
a real-time basis, generate trade information (new trades, continuing open
trades, and closed trades) via reports and historical results files. The
second is the ability to execute long-term backtests against a historical
landscape of portfolios.
Here I focus on the first requirement, real-time execution on a daily
basis. Backtest automation is a small incremental effort once your daily
execution support is in place. The presumption in this article and in the
algorithms presented is that the trading system is based on daily bar analysis,
and the periodicity of symbol portfolio reselection is weekly, occurring
on the weekend. However, the concepts and algorithms can be extended to
any time frame based trading system and any desired periodicity of
symbol portfolio reselection.
...Continued in the May issue of Technical Analysis of STOCKS &
COMMODITIES
Excerpted from an article originally published in the May 2007 issue
of Technical Analysis of
STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2007, Technical Analysis, Inc.
Return to May 2007 Contents
