Saturday, December 29, 2007

Expanding One's Trading Framework: Building on Strengths

I've written before on my basic framework for trading. I calculate various price targets, including the prior day's high, low, and average points as well as the R1 and S1 pivot points, and then handicap the odds of hitting those levels as the day unfolds. My major tools for handicapping those odds are relative volume (how volume compares to a 20-day average), the adjusted NYSE TICK (how TICK compares to its 20-day average), and Market Delta (volume transacted at market bid vs. offer).

This framework has proven sufficiently successful that I am experimenting with rolling it out to longer time frames. What this means is that, instead of using the prior day as the basis for calculation of the price targets, I will calculate the targets associated with any N-day lookback period. A simple example would be to calculate the price targets based on weekly bars rather than daily ones and use the indicators (as well as other ones, such as advances/declines for common stocks only) to handicap the odds of hitting those targets over the next five trading sessions.

Time is completely malleable in this framework. You can create bars and targets based on 45-minute periods, 3-day periods, or monthly periods--and everything in-between. The swing trades boil down to making bets on which of the price targets will be hit first based upon unfolding price action and volatility. By trading periods of very different lengths, it is possible to diversify bets even as you might be trading highly correlated instruments.

When developing new trading frameworks, it is important that these not only build on existing strengths, but also match your own needs and interests in the markets. My personal trading takes place entirely during AM hours, as I wish to free my days for writing, work with traders, and family life. I know from experience that sitting in front of a screen all day every day leaves many of my needs and interests unfulfilled.

By expanding the trading framework to an N-day level, decision-making and placing of orders can take place during the morning hours, even as the trades may last several days. This leverages a trading method without requiring additional screen time. It also keeps the number of trades I place down to a manageable number, minimizing commission overhead and allowing trades to be well-planned and thought through.

That, in a nutshell, is my trading project for 2008.