Ed seykota trading system

© Ed Seykota, 2003 - 2009 . Write for permission to reprint.
(formerly: Frequently Appearing Questions)
Trading Systems Project.
The Trading Systems Project is a response to many FAQ questions about mechanical systems.
TSP is an opportunity for readers of FAQ to participate in the design, verification, testing and implementation of an actual trading system, from the ground up.
To participate in the Trading Systems Project, just follow along with the evolution of the project and volunteer when you feel you have something to contribute or can cross-check the results.

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Ed Seykota’s Donchian Breakout Trading System.
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I’ve been researching and following Ed Seykota’s work for a while now (several years off and on actually). I first came across his name while reading Jack Schwager’s “Market Wizards”. From his interview you can tell that he is a unique thinker and a smart guy – but that is a common trait of all of the wizards that were interviewed. One of the things that stands out about Ed which raised my curiosity was that in their interviews, several other market wizards had referenced him as a source of insight and one that is worth to learn from. That in itself is impressive when you consider the caliber of those interviewed.
On his web site, the trading tribe, there is information that is interesting for traders and trading system developers alike.
One of the very first automated trading systems I developed is taken from Ed’s site. Ed publised the system as an exercise in developing a trading system and refers to it as “A Simple Trading System – Support and Resistance”.
I initially developed it as out of curiosity wondering if such a simple mechanical trading system actually makes money over a long period of time. Its provided here for educational purposes mostly. The intent is to see the type of thinking that goes into developing automated trading systems. Notice the usage of layers and the usage of states. This practice is quite common in trading in general although you might not be aware of it on a conscious level.
The previous link has a full description of the system but I’ll summarize the main characteristics and my own notes below.
The system is a long term trend following system. The exercise provided by Ed uses gold futures contracts on a daily chart. The system is layered – the first layer provides what I call the context. In this case its the overall trend direction. The second layer will help us time entries and exits. The only technical indicators utilized are Donchian channels. A long term channel is used for determining the trend direction – I call this the slow channel. A shorter term channel is used for triggering entries and exits – I call this the fast channel. Channel lengths are configureable – part of the exercise is to figure out the appropriate length for the market one is trading. The system can generally be in one of three states: long, short or flat. It initially starts out flat. If price breaks the upper long term channel the system goes into a long state. When in a long state, the system only takes trades on the long side. If price breaks the lower long term channel, the system goes into a short state. When in a short state, the system only takes trades on the short side. The fast channel is used for timing trades. The channel is composed of 2 lines, an upper line and a lower line. When in a long state, when price breaks the fast channel to the upside, we enter long. We use the fast channles lower line as a trailing stop. The opposite for short trades. Like a lot of long term trend following systems, there is no profit taking. You hold a position until the market takes you out by hitting a trailing stop.
Currently, we have an implementation available for Sierra Chart. Ninja Trader is on the road map for future release.
Example of how the system changes state from long to short.
see below how the system changes state from short, to long and then to short again. When it breaks the slow channel (magenta), depending if its the upper channel or the lower channel, it changes state to either long or short.
Example of 3 Trades.
See a sequence of 3 trades below. Once in a long state, we look to the fast channel for entries. See how we enter long at point 1 when price breaks the upper fast channel. At that point, the lower blue line is our stop. It trails and we finally get stopped out at point 2. We are then out of the market till we reach point 3 where we re-enter only to the short side. The stop trails and we exit at point 4 where we get stopped out.
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Ed seykota trading system

© Ed Seykota, 2003 - 2009 . Write for permission to reprint.
(formerly: Frequently Appearing Questions)
A Simple Trading System.
Support and Resistance.
Support and Resistance systems are among the easiest to compute. You can get your signals by inspecting a chart. Such systems perform about as well as much more complicated systems, indicating, perhaps, sticking to a simple system is much more profitable than trying to second guess a more complex one.
This exercise introduces several new concepts (not present in the Simple Exponential Lag System). I recommend you complete the Exponential tutorial before tackling this project.
Stop-Specific Position Sizing.
Long and Short Positioning.
Trading within the Trend.
Readers who would like to duplicate these results can follow the tutorial at the bottom of this section.
The system trades only one instrument: an Comex Gold continuous contract (Panama Style, last true). For information on continuous contracts, see the main TSP index, above.
The system trades from both the long side and the short side.
Signals issue right after the close. The system enters orders before the next open, to trade on stop, the following day.
The system uses a slow metric to determine the overall long-term trend and then a fast metric to trade in and out within the direction of the long-term trend.
Support and Resistance.
N-day support is the lowest low for the past N days. For example, the 50-day support is the lowest low in the past 50 days. The 50-day resistance is the highest high in the past 50 days.
When the price trades above the resistance, it defines the trend as up. The trend stays up until the price trades below the support. This defines the trend as down.
If you graph support and resistance on a price chart, it appears as a corridor around the price. Penetration of corridor on the upside defines the trend as up while downward penetration of the corridor defines the trend as down.
This system uses two sets of S-R lines: (1) long-term support and resistance to define the long-term trend and (2) short-term support and resistance to define the short-term trend.
When the long-term trend is positive, the system then enters the market with a stop just above the short term resistance and then places a protective stop below the short-term support.
When the long-term trend is negative, the system enters the market on a stop just below the short-term support with protection just above the short-term resistance.
Chart Showing Metrics for SR System.
red square = short sale . blue diamond = cover short.
blue square = buy long . red diamond = exit long.
The system awards trades with 50% skid. That is, it executes buy orders at a price half-way between best price and the high of the day. The best price is the highest of the open, the stop price or the low of the day. It executes sell orders at a price half-way between the best price and the low of the day. The best price is the minimum of the open, the stop price and the high of the day.
The system exits the final trade at the average of the final closing price and the worst price of the day.
The system does not charge commission for entering positions or for rolling forward.
This system uses stop-specific position sizing. It figures the entry stop and the corresponding protective stop prior to entering any orders. It figures risk-per-lot as the difference between these two levels; that is, it does not figure in an allowance for execution cost. The system then divides the equity budget by the risk-per-lot to determine the quantity.
The system computes equity at the close and then figures orders, after the close, for entry the following morning.
The system sketches the equity value, records the results in an equity log, the essential computations in a metrics log and the trades in a trade log. It also provides a computation dump to trace the workings of the programming for debugging purposes.
Note: before attempting this tutorial, study the tutorial at the Exponential Lag system to get the idea about how to trace through the metrics.
1. Download the Gold Continuous data at resources.
2. Program your testing software to duplicate the results for the system test, above.
3. If you do not have testing software, you can put the data in a spreadsheet and create the system in Excel.
4. When you succeed in duplicating this run, to the penny, send an to FAQ. Please identify the software you use (Excel, TradeStation, Proprietary, etc.)
5. Use your system to find the set of parameter values that optimizes Bliss (frequency) for this system. Send your solution to FAQ. See below.
To see how other readers are approaching this tutorial and contributing to the project, see Reader Feedback, above.
Coming up: Acknowledging Limits: equity and margin requirements.
for Simple Support / Resistance System.
Yellow (across) Trading Metric (5 to 105, step 5)
Green (down) Trend Definition Metric (20 to 420, step 20)
Trend definition lines shorter than 100 days don't work well.
Trading lines shorter than 15 days don't work well.
Trend lines around 140 days work best.
Trading lines around 30 and 40 work best.
The optimal solution is 120/30.
The solution at 140/20 appears for comparison.
Solutions where the trading line metric > trend definition metric,

Ed Seykota: Top Market Wizard and Trend Following Trader.
Wisdom from Ed Seykota:
The aha! process lies at the heart of price change. For instance, consider the series: OTTFFSSE. What is the next letter? This puzzle creates tension–until you see the first letters of the ordinal numbers–one, two. Aha! you say. A lot happens during an aha. The puzzle dies and the tension dissipates. A societal aha! drives price. Read the newspapers and the news magazines during a major move. At first, no one gets why the move is happening. There’s a lot of confusion. Part of the move’s way up, some people get it. At the end, everybody gets it. The tension is resolved and the move ends.
Mr. Seykota himself has put together a money management track record with returns of roughly +60% net of fees over the three-decade span of his trading career…
TurtleTrader is especially grateful for Ed’s guidance and influence. You can read much more about Ed in the book Trend Following. Trading as a trend follower, Ed Seykota turned $5,000 into $15,000,000 over a 12 year time period in his model account–an actual client account. Ed was self-taught, but influenced early on in his career by Richard Donchian’s writings. He has served as a teacher and mentor to some great traders including Michael Marcus, David Druz and Jim Hamer.
What makes Ed especially unique is his continual self-examination and commitment to studying the psychological components of trading while also helping other traders achieve their potential.
In the early 1970s, Seykota was hired as an analyst by a major brokerage firm. He conceived and developed the first commercial computerized trading system for managing clients’ money in the futures markets. An excerpt from and interview of Ed Seykota in Market Wizards by Jack Schwager:
Q. How did you first get involved in trading?
A. In the late 1960s, I decided that silver had to rise when the U. S. Treasury stopped selling it. I opened a commodity margin account to take full advantage of my insight. While I was waiting, my broker convinced me to short some copper. I soon got stopped out and lost some money and my trading virginity. So I went back to waiting for the start of the big, inevitable bull market in silver. Finally, the day arrived. I bought. Much to my amazement and financial detriment, the price started falling! At first it seemed impossible to me that silver could fall on such a bullish deal. Yet the price was falling and that was a fact. Soon my stop got hit. This was a very stunning education about the way markets discount news. I became more and more fascinated with how markets work. About that time, I saw a letter published by Richard Donchian, which implied that a purely mechanical trend following system could beat the markets. This too seemed impossible to me. So I wrote computer programs (on punch cards in those days) to test the theories. Amazingly, his [Donchian] theories tested true. To this day, I’m not sure I understand why or whether I really need to. Anyhow, studying the markets, and backing up my opinions with money, was so fascinating compared to my other career opportunities at the time, that I began trading full time for a living.
More on Seykota.
Seykota is another in the long line of alumni from the legendary Commodities Corporation.
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