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

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CHAPTER 7 Take Your Profit If You’re a Short-Term Trader

As you know from the previous chapter, I don’t think profit-taking works with macrotrend systems, but they are important for short-term traders, very important. At the same time, they tell you something about using stops.

Why doesn’t profit-taking work for trend following? Because you cut your profits short and give up the fat tail, the extremely big profits. I talked about that in Chapter 6. But for short-term trading, there is no fat tail, only small profits and small losses. In fact, there is mostly noise. If you remember, I believe that trend following is a long-term concept and that trends don’t exist in the very short term. Even if you could point to a real trend starting after a few days, the market noise is overwhelming. You would know it only after the fact. Over a few days, or a week or two, you can’t separate the trend from the noise. It’s only later, when the trend continues, that you can see it. Let’s look at the SPY at the very bottom of the 2008 decline (Figure 7.1).

Graph with vertical axis ranging 50-90, horizontal axis ranging 1/2/2009 to 6/2/2009 has fluctuating curve starting above 80, dips at 1/20/2009, 3/9/2009.

FIGURE 7.1 SPY at the Lowest Point in the Financial Crisis

Trying to be objective, prices were still falling at the beginning of 2009 and dropped another 15% in a few days, bottoming at about 70 on January 20. Do you go long on the next day, the 21st, because prices closed higher? Not likely. But then we get a bigger drop of 22%, from about ...

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