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Development Cycle: An outline of the cycle used in designing, testing, and optimizing trading systems.

Methodology: Company principles, analytic techniques and trading strategies used.

Sample System: A detailed example of a basic trading system.

Services: An outline of services provided by Prudent Trading Systems.
Note:
This basic sample system is for illustration purposes only and is not a 'typical' trading system as developed by PrudentTradingSystems.Com


Sample Trading System: The Four Week Rule

Most market technicians will agree that the simplest technical market analysis rule is the Four Week Rule. The Four Week Rule (4WR) was originally developed for application to futures markets by Richard Donchian, and can be expressed as follows:

Cover shorts and go long when the price exceeds the highs of the four preceding full calendar weeks and conversely liquidate longs and go short when the price falls below the lows of the four preceding full calendar weeks1.

The rationality behind this rule is that the four week or 20-day trading cycle is a dominant cycle that influences all markets.

Buy if the price exceeds the highs of the four preceding full calendar weeks and liquidate open positions when the price falls below the lows of the four preceding full calendar weeks.

Let us formally define our modified mechanical system:

 1. Money management rule - Equal allocation rule
Use $100,000 of capital into one hundred SP 100 stocks, allocating an equal amount of money into each stock ($1,000).
 2. Technical analysis rule - Buy
Buy a stock if its closing price is higher than the high of last 20 trading days.
 3. Technical analysis rule - Sell
Sell a stock if its close price is lower than the low of last 20 trading days
 4. Money management rule - Redistribute profits equally
If the profit from the sale of a stock are greater than the initial allocation of capital to this stock, then that profit is equally distributed among all stocks which are in a potential Buy position.
 5. Money management rule - Earn interest on cash
All cash on hand earns fix rate interest @ 5% per annum.
 6. Money management rule - Transaction costs
A fixed transaction cost of $50 is applied to each transaction (this cost represents a fair average of commissions and slippage).

The following performance statistics were measured for each case:
 Average annual compounded return (R)
 Sharpe Ratio (SR)
 Return Retracement Ratio (RRR)
 Maximum Loss (ML)


Results:

System Timeframe Money Allocation Days used for Buy/Sell Rules
NS-20BS-EQ 01/01/1984 - 01/01/1989 Equal 20
 
  System Index
Average Annual Compounded Return 7.58% 9.00%
Sharpe Ratio 4.15% 3.85%
Return Retracement Ratio 0.45 0.34
Maximum Loss 0.36 0.58

After several cycles of testing and optimization the following modifications were made:

 1A. Money management rule - Proportional allocation rule
Use $100,000 of capital into one hundred SP 100 stocks, allocating money into each stock ($1,000) according to its percentage participation in the index at the starting date of the testing period (01/01/1984).
 3B Money management Stop Loss Rule - Sell losing positions
Sell a stock if it is losing more than y% of its buy price, where y is a system parameter


Results:

System Timeframe Money Allocation Days used for Buy/Sell Rules % Loss used in rule 3B
NS-50B-P-S25 01/01/1984 - 01/01/1989 Proportional 50 25%
 
  System Index
Average Annual Compounded Return 14.78% 9.00%
Sharpe Ratio 4.48% 3.85%
Return Retracement Ratio 0.52 0.34
Maximum Loss 0.64 0.58

The last system which is the result of several cycles of modifications to the initial 4WR outperforms 'SP100 Buy and Hold strategy' by a good margin. 


Graphs:

Below is a graph of the optimal Four Week Rule trading system:


[1] John Murphy, Technical Analysis of the Futures Markets, New York Finance, 1986


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