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A Guide to Creating A Successful Algorithmic Trading Strategy by Perry J. Kaufman

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CHAPTER 2 The Idea

Where do you get trading ideas? They’re everywhere, but they require your intuitive sense to recognize, and they must be easy to explain. You can’t find a successful trading system by combining indicators, time periods, patterns, and other techniques in a computer. You will find something that worked brilliantly in the past, but with little hope of it working in the future.

BEGIN AT THE BEGINNING

You must start with a sound premise. That could be:

  • Trends based on interest rate policy set by the Fed.
  • Seasonal patterns that exist in agriculture, airline stocks, vacation resorts, heating oil, and other stocks and commodities.
  • Exploiting the difference between two similar stocks, such as two chip manufacturers, pharmaceutical companies, or home builders. That’s called stock arbitrage, or pairs trading.
  • Buying or selling price volatility before an earnings report or after a price shock.
  • Fading an upgrade announcement by a major firm (old news by the time it prints on the screen).
  • Same-time-next-month patterns, when funds redeem and add to their positions.
  • The 3-day cycle, based on human nature, but dependable for 50 years.
  • Weekly patterns, such as, “Up on Monday, down on Tuesday.”

There are many others, but to recognize these opportunities you must trade. Trading is the best way to concentrate your attention on the market and absorb the effects (on your money) of economic reports, geopolitical events, and specific company news. With money in the market, ...

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