Trading Systems and Methods, 6th Edition

CHAPTER 17Adaptive Techniques

An adaptive technique is one that changes with market conditions. It could be as simple as using a percentage stop-loss or volatility based on an average true range. A true adaptive technique will change conditions or thresholds without manual intervention. One of the techniques in this chapter will be automatically changing the calculation period that determines the sensitivity and success of a trend or an indicator. Under some conditions, such as sideways markets, it may be best to use a slow trend or momentum indicator, and during explosive volatility those same methods may work better if they respond quickly. This shift from slow to fast (and back) due to changing market conditions is solved by using adaptive techniques.

ADAPTIVE TREND CALCULATIONS

We begin by looking at techniques that vary the length of the trend. These techniques are based on a common premise that it is better to use a longer-term trend, one that is slower to react to price change when the market is either in a sideways pattern, exhibits low volatility or, in the case of Kaufman, has high relative noise. This may seem a reasonable assumption, but identifying a sideways market is very difficult. A price may be unchanged from a week ago, yet during those 5 days it rose quickly for 3 days, then reversed sharply and, coincidently, was at the same level on the fifth day as it continued to plunge. Adaptive techniques can improve the basic performance of standard trend calculations, ...