Traditional market indicators are typically
based on price. Moving averages, for example, are calculated using a specific
number of bars of price history. Traditional indicators can be useful for
gauging price action in the market, but I wanted indicators to measure
how my system was performing. So I tried out a combination of indicators
based on the profit/loss stream of a trading system.
These money management indicators are plotted on a price chart just
as any other indicators. But instead of being used to analyze the market,
they analyze trading systems and provide information about how a trading
system is responding to the market. They are particularly useful for risk
and position management. In effect, money management indicators are derivative
indicators, since they are based on how the trading system responds to
the market rather than on the market itself.
Figure 1: Average trade indicator (N=20) for an e-mini Nasdaq100 trading system. The green area of the indicator line is where the average of the last 20 trades is significantly less (within a 95% confidence level) than the overall average trade.
WHAT MAKES THEM UNIQUE?
Generally, system performance measures are calculated using the entire
trade history. The indicators I created are calculated using the most recent
trades going back a specific number of trades. This is similar to the way
price-based indicators are calculated, which specify the number of days.
Because they use only the more recent trades, these money management indicators
represent the most recent behavior of the system.
It is well known that financial markets are dynamic; that is, the properties
of the markets change over time. Money management indicators capture this
dynamic behavior because they are updated after each new trade and represent
only the most recent trades. This gives them the ability to detect the
most recent market behavior.
Virtually any measure of system performance can be used in a money management
indicator, provided it is based on the sequence of profits and losses from
a trading system. The most basic such an indicator is a simple moving average
of the profit and losses of a system - the average of the last N number
of trades. Others are based on the momentum of the equity curve, the percentage
of profitable trades, and a runs test indicator. A discussion of each of
these indicators follows. You will find that all of these indicators contain
an input N that represents the moving window of trades used to calculate
the indicator value.
...Continued in the October 2001 issue of Technical Analysis of STOCKS
& COMMODITIES
Michael R. Bryant, Ph.D., has a background in engineering and biomedical
research. He trades stock index futures for his own account. He also offers
software, trading systems, and consulting services to traders through his
website at BreakoutFutures.com. He can be reached via e-mail at mrb@BreakoutFutures.com
or by phone at 310 370-4069.
Excerpted from an article originally published in the October
2001 issue of Technical Analysis of STOCKS & COMMODITIES magazine.
All rights reserved. © Copyright 2001, Technical Analysis, Inc.
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