An illustration of our trading system is presented below:

The system consists of two major parts: a forecast model and a trading model. The forecast model reads daily market data, like the Dow Averages, earnings, foreign exchange rates, and other technical and fundamental data. It then uses these data to make a forecast of the DJIA. The forecast is given in terms of the probability of a positive forward slope and the Average Network Output (ANO). Only the ANO is input to the trading model. The output of the trading model is a suggested trading action.

The trading model assumes that your trading position is one of three possible states:

        1) You are long the Dow DIAMONDS (symbol DIA) or the SP500 SPDRS (symbol SPY)

        2) You are short the Dow DIAMONDS or the SP500 SPDRS

        3) You are in cash (money market fund).

A long position occurs when an investors buys a security in the expectation that the price will rise. A short position occurs when an investor borrows a security (from his broker) to sell it in the expectation that the price will decline and buy it back later at a cheaper price. A cash position means that the investor is neither long nor short and has his cash sitting in a money money account.

You use the trading model each day to see if it indicates an action to move from your current trading position to some other. You may move one position a day in the order indicated in the graphic below.

To use the trading model, you must first fetch the ANO value computed six trading days ago from the forecast page. This delayed ANO value along with your current trading position are input to the trading rules given below.

We highly recommend that you set trailing stops when you are not in cash. This is to protect your investment from unexpected market behavior. You might also want to use a hedging strategy (like the purchase of call or put options) to further reduce risk. The trailing stop is set at some percentage below the security purchase price when a long position is entered and a percentage above the security price when a short position is entered. The percentage you use should depend on the volatility of the security and your risk tolerance. We normally use two percent for the Dow DIAMONDS, although the percentage may be higher depending on market volatility. The stop value is raised (to maintain the percentage) for long positions when the price increases and lowered for short positions when the price decreases; otherwise, the stop value is not changed. If the price of your security hits the stop price, you have been stopped out which means that you should to exit your position and go to cash for at least two days.

The trading rules are given in the list below. Work down the rules in the order shown. When a rule fires, exit the list. All trades are done at the close of the current trading day.

Rule 1: If you were stopped out in the last two trading days, do nothing and remain in cash.

Rule 2: If you were stopped out and the delayed ANO is moving towards a cash position, do nothing and remain in cash.

Rule 3: If in cash, establish a long position (buy DIAMONDS or SPDRS) when the delayed ANO value moves above +0.0005 (positive 0.0005).

Rule 4: If long, close your long position (sell the shares you purchased) and go to cash when the delayed ANO value moves below +0.0005 (positive 0.0005).

Rule 5: If in cash, establish a short position (sell DIAMONDS or SPDRS) when the delayed ANO value moves below -0.0003 (negative 0.0003).

Rule 6: If short, cover your short position (buy back the shares you sold) and go to cash when the delayed ANO value moves above -0.0003 (negative 0.0003).

Rule 7: If long, close your position should the price of the security falls below the trailing stop. Your position has been stopped out.

Rule 8: If short, close your position should the price of the security rises above the trailing stop. Your position has been stopped out.

When you exit the trading rules, you should have a suggested trading position.

If you don't want to go through all of the above analysis, we do publish the current suggested trading position on our forecast web page.

All of the parameters used in trading model have been determined by a non-linear, optimization procedure. Input to this procedure are the ANO values and the DJIA closing values. The trading parameters found maximize the total return. These parameters are specific to forecast model that we used to compute the network outputs and therefore are subject to change when we update the networks in the forecast library or modify the forecast model.

Trading parameters were updated on Saturday, February 16, 2008, for forecast version 16.

Click here to learn about our forecast model.

Contact us should you have any questions, suggestions, or comments.

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