Moving Average Is More Than What You Think – Part 4

The trading system presented in Formula 301 #3 Intraday Moving Average Crossover with Position Sizing is a moving average based trading system that works year after year.

Following is a reprint of that article.

Many users are very interested in seeing example trading systems that utilize position sizing within NeoTicker. Personally I am extremely oppose to the idea of exposing beginners in trading system to the concept of position sizing as that is one of the most event dependent path leading to over optimization. Anyhow, here is a very good example showing you all what position sizing can do and cannot do.

Moving Average System Can Be Very Profitable Daytrading System

Most beginners in system design thought that moving average crossover does not work.

Here is a very simple moving average system that works.

1. Use Emini S&P 45 minute data series

2. Data range is 9:30 AM to 4:15 PM Eastern Time

3. Use NeoTicker’s moving average crossover system with moving averages set to 5 and 50 respectively

4. Single contract trading with $2.50 per side comission.

5. Most important of all, enable Close Position EOD in the Edit Indicator window, under System tab.

Here is the result.

Surprising, isn’t it?

The system is both stable and performing year after year. It is not something very complex either.

Position Sizing Based on Current Equity

Here is an indicator based on the same entry signal with position sizing.

I have not introduced any new trading system functions at all. As I mentioned in the previous tutorial, the basic trading system functions I have covered are enough for the design and implementation of many useful trading systems already.

The more interesting part of the code is the checking of current positions to see if you are over margin, if so, the system will do what your broker will do in real-life. That is, close out the part of the position that is over margin.

You can download the indicator here, Moving Average Crossover with Position Sizing, use indicator manager to install the downloaded script.

The main difference from the basic moving average crossover system is the use of currentequity as part of the calculation of the position size to be taken. This particular system takes a fixed amount as the basis per each contract to trade.

This method works best with system designed for trading with futures and other instruments based on fixed amount for margin.

I am going to show you a comparison chart of the system based on $5000 (5K System) and $9000 (9K System) risk per contract. Both systems will use the same Margin Requirement of $3000 per contract.

A few important points worth talking about here,

1. The 5K System does make 9 times the performance of the non-position sizing one.

2. The 5K System definitely performs much better than the 9K System one, but having the possibility of drawdown at 200K in a short period of time.

3. The 9K System performs way better than the reference equity of the original system.

4. We have not apply any money management rules to the trading system yet.

5. The 5K System has drawdown of about 50% of its equity multiple times. Do you think you can handle that?

The Overnight Risk

The basic moving average crossover system without position sizing actually performs better in terms of dollar value if traded by keeping overnight positions.

Then why do I emphasize that we are working on a daytrading system?

Here is a chart of the systems having their Close Position EOD option disabled.

Notice how bad it gets with the systems traded with position sizing.

Although I am always in favour of designing trading system with fixed position size, in this case, the position sizing version of the system exposed the weakness of the system when it is not traded as a day trading system.

We have a product called Equity Monaco that conduct this type of position sizing analysis. It works with NeoTicker’s system results, and text output from any other platforms. We offer this application for free because we believe that system traders should be aware of the risk of position sizing.

Why Does the System not Working Overnight?

The signal generated by the crossover is based on intraday data, thus, its directional bias has a shorter life span. When the unknown factor of overnight scenario changes is added to the equation, it is pretty obvious that the system will not be stable over time.

Summary

By applying position sizing rules to a trading system properly, you will be able to get spectacular returns for sure. That alone should not be the only reason you are trading a system at a particular size.

Position sizing is equity path dependent. In turns, the equity curve of your trading system is affected by extremely good (and bad) positions taken. Thus it is important to use position sizing correctly.

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