The Elements of an Automatic Stock Market Trading System

An Automated Stock Trading System is a process that makes assessments about the stock market based on historical performance patterns. There are all kinds of systems that can be purchased, but it is very instructive to build your own, and as your own system grows, it will begin to develop your personal trading style along with it. In the end, you will have a stock selection system that you understand, that matches your investment style and needs, and that hopefully will enable you to pick more winners than losers.

The first component of a trading system is input data. There are many places where you can purchase this data. A free source is Yahoo! Finance. Go to Yahoo! Finance. Type a stock into the little box and click Get Quotes. When the quotes show up, click on the Historical Prices link on the left-hand side. Now you can specify exactly what date range you’d like history for. When you get the results, go to the bottom of the page and click on the link called “Download to Spreadsheet.”

Most people split their data into two groups. Group 1 is the backtesting group. This could be, for example, three years of data from 2003 - 2006. With Group 1 you develop your patterns.

Group 2 is your validation group. After developing patterns using Group 1, you test them out in Group 2 to see if they still perform well. This group could be, continuing our example, from 2007 - 2008.

Once you’ve downloaded your data and put it into spreadsheets, you then add columns and calculate all the various indicators, such as running averages, MACD, and Bollinger Bands. How to calculate these is a topic for another article.

The second component of your trading system is patterns. A pattern is a collection of how stock prices and indicators move relative to each other. A simple example would be “A stock moves up three days in a row.” You would add another column to your spreadsheet which will have a value of TRUE if the stock went up three days in a row, and FALSE otherwise.

There are buy patterns and sell patterns. Maybe the pattern you’d like to test is to sell if the stock drops 3% in one day. Then you would add another column to the spreadsheet and mark it TRUE whenever the stock drops 3% in one day.

Finally, you need an evaluation process which looks at the two pattern columns, and then simulates buying and selling the stock, and calculating the Return on Investment (ROI) in every case.

The idea is to find a set of patterns that results in an overall ROI that is high enough to make you a profit. A system that returns 1% after 100 trades is not useful in real life, because it won’t cover trading costs. Each person will have their own style of how much money they have to invest, how much risk they can take, and what their trading window (the amount of time they feel comfortable owning a particular stock) is.

Of course, it is time-consuming (not to mention tiresome) to manually do all of this in a spreadsheet. As you develop your system further, it makes sense to start using Excel macros or even to write a computer program to do the analysis for you.

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Doug Wake is the manager of CastleFive
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Finding Stocks Poised to Rally

The key to success in the stock market is knowing how to find undervalued stocks that are poised to go up. Look for stocks that have just made a new low for the past 12 months. Find companies that are a candidate for liquidation. In the process of liquidation shareholders may get considerably more than the stock is selling for. Look for unsuccessful merger candidates. If one buyer thinks a company’s stock is a good value, it’s very likely that others may think so also.

Seek out companies that have just reduced or eliminated their dividends. These stocks are usually hit with a selling wave, which often creates a good buying opportunity. Financially troubled companies in which another major company has substantial ownership are also good candidates. If the stake is large enough, the major company will do everything it can to turn the earnings around and drive the stock price back up so that its investment will be successful.

Opportunities also exist in stocks that have been totally bashed, such as situations where all the bad news has been reported. These stocks usually have nowhere to go but up. The best way to verify that a stock has been truly battered is to check its trading volume. These stocks show an extremely low trading volume. In all likelihood, no Wall Street analysts are following the company anymore. No newsletters or advisory services are talking about the company. In many cases, you will find it that the company’s management and directors or other insiders have stopped selling the stock.

One of the best signs of a turnaround is that the company plans to get rid of a losing division or business. Try to find out if the company will be able to report a large increase in earnings after the losing operation has been sold. Determine if the company is selling off assets to improve its financial situation or to reduce debt. If a new management team comes aboard, it’s a good indication that the company is poised for a turnaround and an increase in its stock price is likely. Another indication would be if management begins buying the company’s stock on the open market.

Also check to 13d statements filed with the SEC. A company or individual owning 5% or more of a public traded company must report such activity to the Securities and Exchange Commission. If someone is acquiring a major position in the company, it’s possible that a tender offer at a much higher price is afoot.

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