Kevin Davey – Building Winning Algorithmic Trading Systems

Develop your own trading system with practical guidance and expert adviceIn Building Algorithmic Trading Systems: A Trader’s Journey From Data Mining to Monte Carlo Simulation to Live Training, award-winning trader Kevin Davey shares his secrets for developing trading systems that generate triple-digit returns. With both explanation and demonstration, Davey guides you step-by-step through the entire process of generating and validating an idea, setting entry and exit points, testing systems, and implementing them in live trading. You’ll find concrete rules for increasing or decreasing allocation to a system, and rules for when to abandon one. The companion website includes Davey’s own Monte Carlo simulator and other tools that will enable you to automate and test your own trading ideas.

A purely discretionary approach to trading generally breaks down over the long haul. With market data and statistics easily available, traders are increasingly opting to employ an automated or algorithmic trading system—enough that algorithmic trades now account for the bulk of stock trading volume. Building Algorithmic Trading Systems teaches you how to develop your own systems with an eye toward market fluctuations and the impermanence of even the most effective algorithm.

• Learn the systems that generated triple-digit returns in the World Cup Trading Championship
• Develop an algorithmic approach for any trading idea using off-the-shelf software or popular platforms
• Test your new system using historical and current market data
• Mine market data for statistical tendencies that may form the basis of a new system

Market patterns change, and so do system results. Past performance isn’t a guarantee of future success, so the key is to continually develop new systems and adjust established systems in response to evolving statistical tendencies. For individual traders looking for the next leap forward, Building Algorithmic Trading Systems provides expert guidance and practical advice.

Acknowledgments ix

About the Author xi

Introduction 1

PART I A TRADER’S JOURNEY 7

CHAPTER 1 The Birth of a Trader 9

CHAPTER 2 Enough Is Enough 15

CHAPTER 3 World Cup Championship of Futures Trading Triumph 23

CHAPTER 4 Making the Leap—Transitioning to Full Time 33

PART II YOUR TRADING SYSTEM 41

CHAPTER 5 Testing and Evaluating a Trading System 43

CHAPTER 6 Preliminary Analysis 53

CHAPTER 7 Detailed Analysis 61

CHAPTER 8 Designing and Developing Systems 71

PART III DEVELOPING A STRATEGY 77

CHAPTER 9 Strategy Development—Goals and Objectives 79

CHAPTER 10 Trading Idea 83

CHAPTER 11 Let’s Talk about Data 93

CHAPTER 12 Limited Testing 103

CHAPTER 13 In-Depth Testing/Walk-Forward Analysis 115

CHAPTER 14 Monte Carlo Analysis and Incubation 129

CHAPTER 15 Diversifi cation 133

CHAPTER 16 Position Sizing and Money Management 139

CHAPTER 17 Documenting the Process 147

PART IV CREATING A SYSTEM 153

CHAPTER 18 Goals, Initial and Walk-Forward Testing 155

CHAPTER 19 Monte Carlo Testing and Incubation 163

PART V CONSIDERATIONS BEFORE GOING LIVE 175

CHAPTER 20 Account and Position Sizing 177

CHAPTER 21 Trading Psychology 187

CHAPTER 22 Other Considerations before Going Live 195

PART VI MONITORING A LIVE STRATEGY 203

CHAPTER 23 The Ins and Outs of Monitoring a Live Strategy 205

CHAPTER 24 Real Time 219

PART VII CAUTIONARY TALES 233

CHAPTER 25 Delusions of Grandeur 235

Conclusion 243

APPENDIX A Monkey Trading Example, TradeStation Easy Language Code 247

APPENDIX B Euro Night Strategy, TradeStation Easy Language Format 255

APPENDIX C Euro Day Strategy, TradeStation Easy Language Format 259

About the Companion Web Site 263

Index 265

KEVIN J. DAVEY is a professional trader and a top-performing systems developer. He generated triple-digit annual returns of 148 percent, 107 percent, and 112 percent in three consecutive World Cup Championships of Futures Trading® using algorithmic trading systems. His web site, www.kjtradingsystems.com, provides trading systems, trading signals, and mentoring. He writes extensively in industry publications such as Futures Magazine and Active Trader and was featured as a “Market Master” in the book The Universal Principles of Successful Trading by Brent Penfold (Wiley, 2010). An aerospace engineer and MBA by background, Davey has been an independent trader for over 20 years. Davey continues to trade full time and develop algorithmic trading strategies.