Basic Structure of a Rule-based Financial Trading System

The two possible trading actions and the associated minimum basic rules for a financial trading system are:

1) Opening a position:

a. Buy rule

b. Sell rule

2) Closing a position

a. Stop/Take Profit rule

According to R. S. Freedman [Freedman 1991], the two general trading rules for profiting from trading in securities markets are:

i Buy low and sell high.

ii Do it before anyone else.

Most trading systems are trend following systems, e.g., moving averages and momentum. The system works on the principle that the best profits are made from trending markets and that markets will follow a certain direction for a period of time. This type of system will fail in non-trending markets. Some systems also incorporate trend reversal strategies by attempting to pick tops or bottoms through indicators that signal potential market reversals. A good system needs to have tight control over its exit rules that minimize losses while maximizing gains.

Opening Position rules

Only one of the following rules below can execute for a specific security at any one time, thus creating an open position. None of these rules can be executed for a security that has an existing open position. A position is opened if there is a high probability of a security price trending. A position is said to be open if either a buy or a sell rule is triggered.

a. Buy Rule This rule is generated when the indicators show a high probability of an increase in the price of the security being analyzed. Profit can be made by buying the security at this point in time and selling it later after the security price rises. Buying a security opens a long position.

b. Sell Rule This rule is generated when the indicators show a high probability of a drop in price of the security being analyzed. Profit can be made by selling the security at this point in time and buying it later after the security price declines. Selling a security opens a short position.

Prof. Clarence N W Tan