Trading Trends

Thinking Trend-Following Machines

Crowd path following may not always be advisable, but when it comes to trading, going with the trend is usually a good idea.
Trend following is probably one of the oldest approaches to investment, still widely and successfully implemented in modern days trading.
The approach is based on making trading decisions solely according to the observed market trend.
A trend is an observable direction of the market – up, down, or sideways and by acting in concert with the market trend, we significantly increase our odds of success.
A trend is determined by comparing current data with previous data, in order to evaluate the price direction.
The accuracy of the evaluation depends on the methods used for comparison.
Patterns change on daily, monthly and yearly basis, providing an enormous amount of data, which often makes it difficult to recognize a trend.

Trend-following is a reactive trading method in response to the real-time market situation.
It does not attempt to forecast the market direction, but activates the trading rules once the trend is identified and adheres rigidly to the rules until the next trend is identified.
The nature of trend-following makes it ideal for implementing in automated trading software where human intervention is not required.
Over the past decades, manifestations of automated trend-following, such as Turtle Trader software, emerged in the financial industry.
Nowadays there are many types of trend-following algorithms, that can be used with different timeframes (intraday to long-term) and different indicators (moving averages, support and resistance, Bollinger bands, parabolic SAR, etc.). Algorithms do not predict the market movement, but merely identify a trend at early stage and trade automatically afterwards by a pre-defined strategy regardless of the changes in market direction over the set timeframe.
Automated trend following has been growing in popularity and for a good reason.

Software is able to analyze a vast amount of data in a short period of time, which greatly increases the chances of correct identification of a trend.
However, algorithmic trend following remains to be dependent upon the human judgement applied in setting the rules (strategy) manually. Artificial intelligence (AI) systems employ various trend following software, including the “trend recalling” models that work by partially matching the current trend with one of the proven successful past patterns – a method that has proved to be highly profitable.

But artificial intelligence takes trend-following much further than any previously known and tried algorithmic trading strategies. Previous systems, limited by market volatility and prone to false signals, are surpassed by behavior -based artificial intelligence. Trends are based on certain human elements and the quintessential of artificial intelligence technology is its ability to identify, with high accuracy, both human patterns and market trends.

Learning and Thinking Machines

Artificial intelligence trading systems employ neural shells that operate similar to the brain’s neural network.
Neural shell consists of sophisticated algorithms that imitate certain aspects in the functioning of the human brain.
This unique self-training quality enables them to make forecasts based on historical data they are provided with.
Each “neuron” in a neural shell performs complex calculations, capturing and organizing historical and statistical data. A neural shell consists of layers of interconnected nodes. Each node is a perceptron and resembles a multiple linear regression. The perceptron feeds the signal generated by a multiple linear regression into an activation function that may be nonlinear. A neural shell analyses a vast amount of data, evaluates trading opportunities and makes trading decisions based on the calculations and thoroughly analyzed data.

The neural shells are able to detect subtle interdependencies, co-relations and patters that are too difficult to find and quantify using other methods, with high level of precision and in extremely short periods of time. Trend-trading strategies used by artificial intelligence systems vary widely, in accordance to many different factors – timeframe, bullish/bearish markets, price fluctuations (volatility) and more, but any AI trend-trading strategy will be based on two main characteristics:

1.Winning psychology.

One of the key benefits of artificial intelligence trading is that while being highly adaptive to real market conditions, it never breaks the rules. Anyone who ever tried to trade trends manually is likely to have encountered common problems, such as false starts, early shakeouts, premature or late exits. The reason? Psychological factors.

  • False starts, also known as whipsaws, occur when a positive signal is received, immediately followed by reversal. A trader no sooner stopped out of his position when he receives another call (buy) signal. Contradictive signals are frustrating and many manual traders lose heart and fail to take the second entry, only to see the trend spiking sharply upwards, making them want to throw their PC out of the window. Contrary, artificial intelligence system will exhibit perfect discipline and persistence and trade with a winning trend based on evidence of price action.
  • No matter how strong the trend is, there will be times when a trader will be shaken out – such is the nature of trends. Shakeouts occur when an asset is trading strongly and the trader attempts to accumulate a large position and starts placing buy order in the pool, chasing the trend up sky high, without building enough line. Artificial intelligence system will analyze the situation and wait for the asset to consolidate, thus “outdoing” the trickery of the trend.
  • Late exits almost always are the results of human bias. Artificial intelligence system isn’t prone to stubbornness or other human emotion, therefore it will effectively manage the risk on a per trade basis, as well as on longer timeframes.
  • Taking profits too early is another systematic problem resulting from psychological pressure, when the trader witnesses repeated gains followed by significant retracements and frequent late exits at trend reversals. Pressure can build to such an extent that the trader overrides his system, attempting to take profits at a perceived high point in the trend, following the emotions rather than a system -- a recipe for disaster. Artificial intelligence system has a benefit of perfect patience and discipline and will never prematurely exit a profitable trade without sufficient evidence of adverse price action.
2.Quantitative Advantage:

Diversifying your trend following opportunities is absolutely vital for a long-term success. With artificial intelligence systems, it is possible to diversify investment by adding different time frames, different entries on a per market basis, or different markets and asset classes. You can choose to use one or all three of these approaches.

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