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IQP Template Trading System Development: Trading the 10 O’Clock Bulls An Interactive Qualifying Project submitted to the Faculty of WORCESTER POLYTECHNIC INSTITUTE in partial fulfilment of the requirements for the degree of Bachelor of Science by Eric Gehrken Youwei Hu Camden Mallette Justin Paprota Date: May 2, 2013 Report Submitted to: Professors Hossein Hakim and Michael Radzicki Worcester Polytechnic Institute This report represents work of WPI undergraduate students submitted to the faculty as evidence of a degree requirement. WPI routinely publishes these reports on its web site without editorial or peer review. For more information about the projects program at WPI, see http://www.wpi.edu/Academics/Projects. 1 ACKNOWLEDGEMENTS The Project Team would like to thank Professors Hossein Hakim and Michael Radzicki for their continuous support and help throughout the course of the project. The team would also like to thank TradeStation Securities for donating licenses of their TradeStation software to each group member for the duration of the project. By using this software, team members were able to gain real-world trading experience. 2 ABSTRACT The purpose of this IQP was to scientifically develop a profitable automated stock trading system. Through developing the system the group members implemented the tools and techniques commonly used to scientifically develop a profitable trading system. Initially the members researched the fundamental concepts and theories about trading and how to develop trading systems. Next, the members implemented these theories by scientifically developing a system that an average citizen can use to improve their trading. Lastly the team performed back testing and analysis on the system using historical data to determine how well the system would have previously performed. The back testing proved the system to be extremely profitable. As a result the team members would like to trade this own system with their own investment capital. 3 TABLE OF CONTENTS Acknowledgements ......................................................................................................................... 2 Abstract ........................................................................................................................................... 3 Table of Contents ............................................................................................................................ 4 Table of Figures ............................................................................................................................... 5 Introduction .................................................................................................................................... 6 Backround/Literature Review ......................................................................................................... 8 Asset Classes ............................................................................................................................... 8 Sources of Data/Exchanges ....................................................................................................... 10 Trading Platforms ...................................................................................................................... 13 Different Types of Trading/Active Investing Systems ............................................................... 15 Theories................................................................................................................................. 15 Manual versus Automated Trading Systems ........................................................................ 16 Fundamental versus Technical Trading Systems .................................................................. 16 Strategies .............................................................................................................................. 17 Trading Tools ............................................................................................................................. 17 Order Types ............................................................................................................................... 19 Methods ........................................................................................................................................ 21 Financial Instrument Traded ..................................................................................................... 21 System Criteria/Objectives ....................................................................................................... 22 Time Frame for Trading ........................................................................................................ 24 Scientific Journey Taken to Develop Trading System ................................................................... 26 Selection of Strategy Concept ................................................................................................... 26 Development of Strategy .......................................................................................................... 27 Description of System Components ......................................................................................... 32 Results ........................................................................................................................................... 35 Conclusion ..................................................................................................................................... 41 References .................................................................................................................................... 43 Appendix A: Easy Language Code for Trading System .................................................................. 44 4 TABLE OF FIGURES Figure 1. Comparison of Trading Platforms .................................................................................. 15 Figure 2. Price Chart with Support and Resistance Indicator ....................................................... 18 Figure 3. Japanese Candlestick with Components Labeled .......................................................... 19 Figure 4. Initial Back Testing Results ............................................................................................. 27 Figure 5. Back Testing Results Using Simple Moving Average to Confirm Breakouts .................. 29 Figure 6. Complete System Back Testing Results (Without Implementation Costs). ................... 31 Figure 7. Complete System Back Testing with Implementation Costs ......................................... 31 Figure 8. Back Testing Results ....................................................................................................... 39 Figure 9. Optimization Results ...................................................................................................... 40 Figure 10. Description of Optimization Parameters ..................................................................... 40 5 INTRODUCTION Since the late 1990’s there have been numerous computerized trading platforms, such as TD AmeriTradeTM and TradeStationTM that have emerged which enable one to have a greater control of their financial future. This technology allows an average citizen to take control of their own financial future from their personal computer. An individual can take control of their financial future by trading a wide variety of asset classes such as stocks, currencies, and commodities from the comfort of their own home. However, many of these traders have limited success as they do not have an understanding of how to trade systematically. This leads the majority of average citizen traders to trade based on recommendations from others without their own system in place to determine when the right time for them is to buy and sell a particular asset in order for them to continuously generate profits. The purpose of this project was to scientifically develop a profitable automated stock trading system. Through developing the system the group members used tools and techniques that are commonly implemented to scientifically develop a profitable trading system. Initially the members learned fundamental concepts and theories about trading and how to develop trading systems. Next the members gained practical experience by scientifically developing a system that an average citizen can use to improve their trading. Lastly the team performed back testing and analysis on the system using historical data to determine how well the system would have previously performed. The report discusses the background research that was performed and how a trading system was scientifically developed and tested. Initially the background research that was performed to gain an understanding of trading and trading system development is discussed. 6 Next the report describes how the group scientifically developed a trading system that an average citizen can implement to become a more successful trader. Then the report discusses how the system was tested to ensure that it could make an average trader more successful. Lastly the report provides recommendations of how the system can be further improved and if a trader should use it to trade. 7 BACKROUND/LITERATURE REVIEW This section of the report provides background information concerning trading and trading system development. The group utilized this information to familiarize themselves with topic of trading system development. Asset Classes There are a wide variety of asset classes
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