Ultimate Algorithmic Trading System

■ Oscillators
Oscillators are normalized, in most cases, to fall between two extreme levels,
and are usually plotted in a subgraph. Certain indicator-based levels are then
superimposed on the oscillators as benchmarks. The relationships of oscillator value
and the benchmarks are then used to predict short-term market direction. The
normalization process allows the oscillator family of indicators to be universally
applicable to all markets. Oscillators are most often used to predict but can also be
used as lagging indicators.
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STOCHASTICS AND AVERAGES AND RSI! OH, MY!
Average Directional Movement Index (ADX)
This oscillating indicator is one of the more popular as it measures a market’s
trendiness. The underlying concept of Directional Movement was introduced in
J. Welles Wilder’s 1978 book, New Concepts in Technical Trading Systems. Asaside
note, this was the book I first used to help program many of the more popular
indicators into our Excalibur software in the late 1980s. Many algorithmic traders
are trend followers, even though it is been proven that markets only trend a very
small portion of time.
If this is the case, then why do many traders claim that ‘‘the trend is your friend’’?
Trend followers hope that by diversifying across many markets, they will hit upon
one or two markets that sufficiently trend enough that they can negate all of the other
losing markets and still make enough money to provide a profitable year. While
trend followers tread water by capturing a few trends a year, they are constantly
waiting and hoping they will be poised for that once-in-a-lifetime trend event. These
once-in-a-lifetime trend events do happen more frequently than once in a lifetime,
and most trend-following algorithms are more than capable of catching and holding
on for the long haul.
The realization that commodities are limited resources and the fact that trend
following has had success in the past has promoted this trading algorithm class as the
most widely used in the managed futures arena. However, commodity markets over
the past few years have been unkind to trend following, and if this ‘‘trend’’ continues,
then you might see a gradual exodus of these types of traders. Stock traders, as of
the writing of this book, have been riding a bull trend for several years, which has
bolstered the buy-and-hold mentality. I guess the phrase about the trend could be
changed to, ‘‘The trend is rarely your friend, but it’s the only friend in town.’’
The main weakness of trend following is, of course, whipsaw trades—the ones
you get into and very quickly get stopped out or, worse in some cases, reversed.
Another common weakness is lack of profit retention when the ride is over. The
ADX indicator is here to save the day—well, sort of. This indicator attempts to
define the current market’s trendiness over the past n-days into one simple value.
The ADX value is high when the market is trending and low when it is in congestion.
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