Strategy Design

Designing a trading strategy could be the focus of whole encyclopedia, what we discuss here will simply be a quick overview. In it’s simplest from a trading strategy is simply  a set of predefined rules for executing trading decisions. By using an automated trading strategy emotional bias is removed. There are several different types of trading strategies that have been used over the years and usually fall into one of the following categories: 

• Fundamental Analysis based systems.
• Technical Analysis Based systems.
• Volatility based systems
• Mean reversion based systems.
• Trend Following systems.

Building a Trend Following Based System

We will be building a Trend Following system, this will be a very basic system and will help highlight the development process. When developing a trading system it is very tempting to try and re-invent the wheel, however we will start with a tried and tested system that is publically available. The trading system we will be implementing is the original Turtle Trading System and you will need to download a copy of the rules in order to continue with the tutorial.

Learning to Write Pseudo Code

Before reading any more make sure you have printed out and read through the original Turtle Trading System Rules document. This step is very important as the only way to learn this materiel is by taking action and carrying out the steps outlined.

STOP!

Now we can get on with our discussion of pseudo code. When it comes to writing computer programs or in this case automated trading systems translating English into programming code can be fraught with danger. Pseudo Code on the other hand refers to a more structured English for describing a process or program. It is important that you learn to write quality pseudo code as it will make a big difference when you come to coding your system your self or hiring a programmer.

There are many benefits in writing your algorithms or trading logic in pseudo code these include:

• You will gain a detailed understanding of the program or algorithm you are developing.
• Errors in logic picked up early.
• Not constrained by a single programming language.

Below is a brief example of pseudo code:

IF movingAverage1 == movingAverage2 THEN
    SEND buyOrder
END IF

Structured Pseudo Code

In order for us to write quality code we have to take a step back and think about what it is we are actually trying to achieve. Rather then using a trading example we will use an example that everyone is familiar with. Think about the process of going to the shop and buying 1 item let’s say it is milk. What I will ask you to do is sit down and write a step by step process that you could give to a an alien that describes the process in as much detail as possible.

STOP!

Do not move on until you have done this.  Below is the first iteration of solving the get milk problem:

Get into the car –> Start the car –> Drive to the closest shop that sells milk –> Get Out of Car –> Lock Car

Enter shop –> Locate milk –> Determine quantity –> Pay for milk –> Locate car –> Unlock Car –> Drive home.

As you can see if you think about the steps required to carry out this task it is much more complex then first thought. Let’s try and make this a bit more detailed iteration two:

DEFINE approxMilkCost

DEFINE moneyInWallet

 

IF moneyInWallet < approxMilkCost THEN

           CALL enterCar WITH keys

           CALL driveTo WITH bank

           CALL leaveCar

           CALL getMoneyFromBank WITH accountDetails

           CALL driveTo WITH shop

           CALL leaveCar

ELSE

          CALL enterCar WITH keys

          CALL driveTo WITH shop

          CALL leaveCar

ENDIF

 

enter shop

CALL locateItem WITH milk

CALL payForItem WITH money

leave shop

CALL enterCar WITH keys

CALL driveTo WITH home

CALL leaveCar

You can quickly see that by using a more formal language it breaks down complex tasks into simple steps. If we wanted to write a program to solve this problem we would probably go through several more iterations of pseudo code before actually starting coding. I have created a PDF file and have uploaded it so you can fully understand the pseudo code presented and can practice writing some pseudo code for yourself.  In the next article we will be looking at writing our trend following system out in pseudo code so make sure you review everything presented here.

MetaTrader 4

The current version that is most widely used and supported is MetaTrader 4 however beta versions of MetaTrader 5 are currently in testing. In order to build an automated trading system using MetaTrader 4 we will need to write a program that will run inside MetaTrader. There are three types of programs that run inside MetaTrader, these are Custom Indicators, Expert Advisors and Scripts. The screen shot on the right shows the built in indicators that ship with MetaTrader.

MetaTrader- MetaQuotes Language

Custom Indicators, Expert Advisors and scripts are all written in a programming language called MetaQuotes Language, often abbreviated MQL.  Although all three application types are written in MQL there are slight differences between program types.

MetaTrader- Indicators and Custom Indicators

Custom indicators are written in MQL the client terminal will execute the indicator every time a tick is received. The main use of indicators is to graphically display some user defined or built in data relationship. The most common use for indicators is for Technical Analysis. Below are some screenshots which show a built-in indicator being applied to the daily AUD/USD currency chart.

1. With AUD/USD chart open double click on desired indicator.
2. Enter parameter settings and execute.

MetaTrader- Expert Advisors

An Expert Advisor or EA for short share similar properties to Indicators. Expert Advisors or EA’s are written in MQL and are executed on tick data. Expert Advisors or EA’s have trade logic written into them. Basically an EA does everything an indicator can do, however an EA will also open, close and modify trades programmatically. To attach an EA to a currency pair the process is exactly the same as it is for an indicator. There are two sample EA’s that ship with MetaTrader 4 these are the MACD Sample and Moving Average.

MetaTrader- Scripts

Scripts are the final type of application that are available in MetaTrader. A script is designed to be executed only once. Scripts are usually used to automate client side non-trading actions, like modifying data. They can however be used to perform simple trade logic tasks.

MetaTrader – MetaEditor

All the code we write for our automated trading system will be done MetaTrader’s Integrated Development Environment called MetaEditor. MetaEditor allows you to store and manage source code for all projects in an easy to use way. If you are used to Visual Studio or X-Code IDE’s then you will be disappointed with the functionality of MetaEditor. MedEditor does offer syntax highlighting and code completion which is very handy. There is also a built in on-line library that covers most topics. Below is a screenshot of the IDE:

To open MetaEditor from MetaTrader simply press F4 or from the menu bar:

Tools –> MetaQuotes Language Editor

Home Work

Before next article make sure you understand the three different program types that are used in MetaTrader. Also try attaching and using some of the built in indicators in MetaTrader. Before moving on I would also recommend downloading the MQL4 book from MetaQuotes. This is a free book that covers the basics of programming in MQL and in later articles I will assume you are up to speed with the concepts presented in the book.

In the next article we will discuss designing a simple trading strategy and pseudo code.

Before you start

Before we start designing the automated trading system I will assume you are familiar with some basic FOREX or currency market concepts. If you are new to the finance world you may like to read the following articles.

• What’s all this talk about money?
• The FOREX market, the exchange rate and bid and ask spreads.
• Pip’s, Lot’s and a little bit of math.
• Understanding the lingo: Spot market, traded currencies and other FOREX terms.
• The big three in FOREX: Leverage, margin and equity.

To get you quickly up to speed with MetaTrader you can download the software from MetaQuotes. You may also benefit from reading the following basic articles.

• An introduction to MetaTrader Part One.
• An introduction to MetaTrader Part Two.
• An introduction to MetaTrader Part Three.

So now you have a basic understanding of the FOREX or currency market and have MetaTrader installed on your computer we are ready to get started. Below is a roadmap for next few articles.

• What is an automated Trading System and how can we build one in MetaTrader?
• Expert Advisors and Indicators in MetaTrader.
• Designing a simple strategy and pseudo code.
• From pseudo code to a basic trading system.
• Garbage in garbage out: improving modeling quality.
• Testing, Testing, Optimization and more testing.
• Forward testing and performance evaluation.
• Automated Trading System version 2.0.
• So you are ready to go live: Choosing a broker.
• So you are ready to go live: Setting up a Virtual Private Server.

As you can see there is a lot of content that needs to be covered and I am sure as this series progresses there will be content added or removed depending on your input. If there is any materiel you want covered please send me an email or comment below.

What the Hell is Game Theory?

The wikitionary describes Game Theory as:

Game theory attempts to mathematically capture behavior in strategic situations, in which an individual’s success in making choices depends on the choices of others. While initially developed to analyze competitions in which one individual does better at another’s expense (zero sum games), it has been expanded to treat a wide class of interactions, which are classified according to several criteria.

I know what you are thinking, that sounds complicated and boring. Before you give up on it however you might like to look at Yale Universities FREE Introduction to Game Theory course. The course is highly practical and covers the basic concepts of Game Theory. You can download the videos and watch them at your own pace.

Topics Covered

1. Introduction: five first lessons
2. Putting yourselves into other people’s shoes
3. Iterative deletion and the median-voter theorem
4. Best responses in soccer and business partnerships
5. Nash equilibrium: bad fashion and bank runs
6. Nash equilibrium: dating and Cournot
7. Nash equilibrium: shopping, standing and voting on a line
8. Nash equilibrium: location, segregation and randomization
9. Mixed strategies in theory and tennis
10. Mixed strategies in baseball, dating and paying your taxes
11. Evolutionary stability: cooperation, mutation, and equilibrium
12. Evolutionary stability: social convention, aggression, and cycles
13. Sequential games: moral hazard, incentives, and hungry lions
14. Backward induction: commitment, spies, and first-mover advantages
15. Backward induction: chess, strategies, and credible threats
16. Backward induction: reputation and duels
17. Backward induction: ultimatums and bargaining
18. Imperfect information: information sets and sub-game perfection
19. Subgame perfect equilibrium: matchmaking and strategic investments
20. Subgame perfect equilibrium: wars of attrition
21. Repeated games: cooperation vs. the end game
22. Repeated games: cheating, punishment, and outsourcing
23. Asymmetric information: silence, signaling and suffering education
24. Asymmetric information: auctions and the winner’s curse

If you manage to get through these videos you will have and excellent understanding of the fundamentals of Game Theory and it might just help your trading.

Economic Calenders

When it comes to economic calendars you will find an assortment of them on-line. There are only two online calendars that I use on daily basis. They are the Forex Calendar @ Forex Factory and Bloomberg Calendar the screenshots of these calendars shown below:

Out of these two calendars my favourite would have to be the Forex Calendar it has more features and has a much easier workflow then Bloomberg. 

Forex Calendar Features

The first thing you will want to do with both these calendars is adjust your time zone. After I have done this I like to get out my trading notebook and I enter  the announcements that will be relevant to me on that given day. To get more detail about a specific announcement simply click on the detail button. The detail window gives you the following information:

• Source
• Measures
• Usual Effect
• Frequency
• Next Release
• FF Notes
• Why Traders care
• Derived via
• Acro Expand
• History
• Related items

The screenshot below shows the Forex Calendar detail feature in action:

The other unique feature the Forex calendar has is the ability to chart historical release data. Like the detail feature you simply click on the chart icon and an interactive chart will be generated within the same window.  The image below shows the chart feature in action:

Software Tools

I use the free tool FF Calendar to news software as it provides an easy way for me to build a database of future and historic news events on my local computer. This is very handy for some system design work I do. The screenshot below shows my news events history database:

Once my database is populated I can then run a script that overlays each of the economic events on the appropriate chart. This allows for me to graphically view the impact if any on the underlying markets. The screenshot below shows the auto generated chart content on the EUR/USD 1 minute spot chart:

In my next post I will talk about the classic reference book that I often refer to surrounding news releases The Secrets of Economic Indicators: Hidden Clues to Future Economic Trends and Investment Opportunities.

int handlFile;
handlFile = FileOpen(”symbol.csv”, FILE_CSV | FILE_WRITE | FILE_READ, ‘,’);
FileSeek(handlFile, 0, SEEK_END);
FileWrite(handlFile, Bid, Ask, Close[1], Volume[1]);
FileClose(handlFile);

Note: This code above is intended as a very rough solution. Time permitting I will write a proper EA with error checking and better features. This code however should be sufficient for basic tasks. For more information on EA coding I strongly recommend you download the getting started book:

MQL Tutorial

The Non EA Export Option

Can’t be bothered with that coding garbage? Never fear there is a very simple option. Go to the Tools Menu then History Centre a dialog box similar to the one shown below will appear simply chose the currency you wish to export and select a file name and your done. This process is shown below:

MetaTrader really is an excellent platform for learning the basics of trading and trading systems. I would recommend to anyone starting out in currency trading that they download MetaTrader and start exploring. If you want to learn more about Forex Trading I suggest you visit the Forex section of this website.

As you can see this is quite a substantial fall, this means that all my USD purchases will be more expensive. Bloomberg has an article on the dollars slide ahead of the release of the Reserve Bank of Australia’s quarterly monetary statement. As you can see from the order screen below TraderXL is not as cheap as it was last week due to the Australian dollar decline.

Not to worry I guess sometimes you have to spend money to make money. I am really looking forward to testing ClassifierXL and PredictorXL as the trial version of TraderXL Pro these applications are disabled. After all the order details are entered you will be emailed a link to download the software and will be issued a licence key. I received my email within 20 minutes and downloaded the application, it is a small 5.75 MB. I am off to continue reviewing this series of applications.

You can download a free 10 day trial of TraderXL Pro.

The Dollar

The Yen

The Euro

Forex Factory Calendar- This is one of the best free calendars around, previous result and forecast result are shown as well as a link to the page were the news announcement will be posted. The Forex Factory Calendar also allows you to alter the time zone settings to display what time a news announcement will occur in your region which is handy if you don’t have a program like ZoneTick. Forex Factory Calendar also allows you to setup email alerts for news events.

Bloomberg Economic Calendar- This is a very US centric calendar, market focus is highlighted for the current day at the top of the calendar. The Bloomberg calendar also has a very intuitive slider base interface for navigating day and date of interest. Boomberg calendar also goes into a bit more detail about each event and for the bigger events a consensus is provided. It should be noted that Bloomberg licenses the calendar data from Econoday.

Some of the bigger news announcements can tend to move the market anywhere from 20 to 100 pips. If you are a new trader I would definitely stay clear of trading around these times. I use ZoneTick to keep track of these news events, with the release of the new version including countdown timers and stopwatches.

My ZoneTick Setup

At the moment I am monitoring three time zones in the task bar Tokyo, London and New York. When a market is open the clock has a green background and when a market is closed the clock has a purple background. Alarms can also be set for each clock. This can be seen in the screen shot below:

In the screen shot above you will also notice the three countdown timers. These are new to ZoneTick version 4 and are very configurable. At the moment I am monitoring the AUD/USD So I have setup my countdown timers to countdown to these events. The real beauty of ZoneTick is that I can enter an event in the countdown timer and I can use any world wide time zone I wish without having to manually convert to my local time zone.

Unemployment Claims announcement will be occurring later this week. This announcement occurs at 8:30 AM New York time so I simply enter this in my location field. Then I set the countdown timer to automatically open the web page when the announcement is released. In addition to this you can add alarms to sound at a given time before the event and change the colour of the countdown timer for the last five minutes before news is released.

Taking it to the next level

This is a good start however I am working on a program that will download the latest announcement, use text mining and artificial intelligence and then recommend a buy or sell signal for the given currency(this is a long way off). I am very happy with ZoneTick for the moment and I would recommend to any currency trader.

You can download it and try it for 30 days: Download ZoneTick.

or

You can read more about ZoneTick on their web site.

When you first start Microsoft Excel 2007, you will be presented with a screen similar to the one shown below. The key areas and terminology are also highlighted.

1. The active cell has a square border surrounding it. A cell can be activated by single clicking.
2. The formula bar allows formulas or data can be entered in this area. If you wish to insert a formula, the first character in this bar must be the equals sign.
3. The cell format controls will probably be the most extensively used control. The format options include general (no specific format), number, currency, accounting, short date, long date, time, percentage, fraction, scientific and text.
4. The expand formula button is useful when entering complex formulas as it allows you to see the whole formula without having to scroll.
5. This button allows for the recording of a macro and is an easy way to tell if a macro is currently being recorded.
6. The active sheet is the highlighted sheet at the bottom of the screen. A sheet can be made active by simply single clicking on it. To rename the sheet you simply double click on it.
7. Inactive sheets are every other sheet that resides in a workbook that are not currently active. These have a gray appearance.
8. You can add new sheets to the workbook by clicking this button.
9. The status bar gives you instant feedback about the current operation.
10. Page layout allows you to change the layout of pages on screen. You have three options normal, page layout, or page break preview.
11. Page zoom allows you to dynamically zoom in and out of the current workspace.

This has been a very quick introduction to the main navigational components and terminology used in Excel.

Calculating the average closing stock price

In our new spreadsheet the first thing we will do is name the active sheet by double clicking on it, we will call the sheet “StockInfo”.

Click to activate cell A1 and enter the text “Day”.

Click in Cell B2 to activate it and enter the text “Adjusted Close”. You will need to adjust the cell to accommodate the text. The process is shown in the image below.

Click in cell A8 to activate it and enter the text “Average Closing Price”. You will have to follow the procedure outlined above to increase the size of the cell to accommodate the text.

Under the day column, starting in A2 enter each day of the week in a new cell.

Enter the following adjusted close prices in the adjusted close column, starting at B2 enter the closing price for each day.

Notice the closing prices do not have a preceding dollar sign. Before we move on, we need to change the format of these adjusted close prices from general. To do this select all of the adjusted close prices and click on the dollar sign in the cell formatting controls box.

As I am sure you all know a simple average is merely the sum of all of the individual observations divided by the number of observations. In this example it would be

MondayClose + TuesdayClose + WednesdayClose + ThursdayClose + FridayClose / 5

Excel makes this process simple with the use of formulas. Before we enter the formula, we will set the format of the cell B8 to currency as described above.

To indicate to Excel that we are entering a formula the first character you enter must be an equal’s sign. So activate cell B8 and enter the = sign. As we can see from the formula above, we need to add each day’s closing price and divide by 5. Enter the formula as shown below.

If everything has been entered correctly, you should have an average adjusted close price of $10.17.

Trainee Trader Homework

That’s right you have homework to do, first go through the worked example above.

1. Enter this data above into excel
2. Adjust the size of any columns so all the text is visible
3. Format the adjusted close price as currency.
4. Calculate week ones average adjusted closing price.
5. Calculate week twos average adjusted closing price.
6. Calculate the combined week one and two average adjusted closing price.

I have attached the answers in an excel spreadsheet download this after you have worked through the problem. If you have any questions at all please add them in the comments field below.

TraineeTraderTutorialOneHomeworkAns.xls