Testing Trading System Entry Methodologies

Having a trading system, or a set of rules/guidelines to follow, is essential to the success of a trader; particularly a beginning trader. Not having a set of rules tends to have traders go take one trade on this signal while taking another signal on another trade. In end, you have a bunch of trades, all with no coherent pattern to them, and so you have no way to determine how to make changes.

While developing a trading system is a great step, you will want to test each part of the system separately to determine its effectiveness. If you don’t, you might have a great exit strategy, but your entries are below par. Not knowing this, you might throw out the whole system when all you would need to do is tweak your entries a bit.

So how does one go about testing entries? I like Chuck LeBeau’s method of entering trades based on your entry methodology, and then exiting after a certain number of bars. Chuck likes to test 1 , 5, 10, 15, and 20 bars determine your entry’s effectiveness. The basic idea is that your entry should put you into a profitable position as quickly as possible, and thus you want to see what percentage of your trades are profitable when you exit after X bars. If you are less than 50-55% correct, then you are probably better off with a coin flip rather than your entry methodology. LeBeau suggest that you want to average above 55% in a range of markets in order to be sure that you have an actual edge in your entries. In fact, it can be quite humbling to look at many so-called expert system and see how they are actually worse than a coin flip.

Exiting after 1, 5, 10, 15, and 20 bars offer you some data to analyze. First off, exiting after 1 bar lets you determine if the entry gets you profitable right away. If not, you may want to tweak your entry setting a little bit. Exiting after 5 and 10 bars gives the entry a little bit of time to work. You can then compare the 5 and 10 bar data with the 15 and 20 bar data and if you percentages are better for the 15 and 20 bar exits than the 5 and 10 bar exits, it means your entry is a little bit too early and you may want wait a bit to enter. If your 5 and 10 bars exits are good but the 15 and 20 drop off significantly, it can mean you have a good short term entry, but you may want to take profits sooner rather than later.

Additionally, you should not be depressed just because your favorite entry (Or any entry for that matter) yields less than stellar results. If the results are poor enough, you may have just found an entry for the opposite direction. Try running a backtest with the logic reversed and see what results you get.

As an example, I thought I would do an example of entry testing I have done with some indicators I have been playing around with. A client of mine is partial to the Jurik tools which includes a Jurik Moving Average (JMA) which the vendor claims is a superior moving average because it can better filter out noise and provide a lower lag indicator than other moving averages. You can find out more about Jurik research and tools at www.jurikres.com but be warned, the website looks like it was built in the 90s and hasn’t been updated since.

One particular strategy that was highlighted in the Jurik documentation was the JMA-SMA crossover. This takes a JMA and an SMA and has entry signals when the JMA crosses the SMA. To test this entry method, I coded up a simple NinjaTrader strategy to enter based on this crossover, then then exited after 1, 5, 10, 15, and 20 bars to determine the entry’s effectiveness. I tested with the default parameters: a period of 7 for the JMA and a period of 15 for the SMA. Additionally I tested the strategy across multiple futures contracts:

  • ES (S&P 500 E-mini)
  • NQ (Nasdaq 100 E-mini)
  • CL (Crude Oil Futures)
  • ZN (10 Year US Treasury Notes Futures)
  • E7 (Euro E-mini)

Finally, I wanted to test across a few different time frames, so I tested on a 1000 tick bar, a 5 minute bar, 2500 volume bar, and a 1 day bar over the past 1 years’ worth of data (August 29, 2011 to August 29, 2012).

Here are the results:

 

Some interesting results. First, look at the difference in values across different bar types. The CL and ES do very well initially with the 1000 tick bars, while the ZN does better with 5  minute and 2500 Volume bars. Additionally, with 1000 tick bars, the percentages for the ES and CL for 1 and 5 bar exits are high enough to warrant a look. But those percentages quickly drop off closer to the 50% mark. This could mean that an entry system could work here, but you may want to move to break-even quickly, or take some profit to reduce your risk profile before letting the trade run.

Of course, this is with the default parameter values for the indicator and one should look into if different parameter values or different time frame work better for a particular instrument. But this gives an idea as to how one could go about determining the effectiveness of a trading strategy’s entry methodology.

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3 responses to “Testing Trading System Entry Methodologies

  1. Pingback: Testing Exit Methodologies of Trading Systems | @ShaneBrewer·

  2. Pingback: Testing Stop Loss Methodologies in Trading Systems | @ShaneBrewer·

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