Test Before You Invest
Five Steps To A Winning Trading System
by Matt Blackman
Whether you use your own system or someone else's, a big part of the development of any trading strategy is testing to see how well it works. Here we go through the step-by-step process of how to test a system that uses Martin Pring's Know Sure Thing (KST) indicator.
As part of a continuing education in technical analysis, there are two books that should not be overlooked by serious traders. They are Technical Analysis Of The Financial Markets by John J. Murphy and Technical Analysis Explained by Martin J. Pring. Both are, in fact, required reading for those who wish to obtain the Chartered Market Technician (CMT) designation awarded by the Market Technicians Association.
Pring is also the creator of a custom indicator he refers to as the "KST (Know Sure Thing)," which plots the moving averages of a series of rates of change (ROC) with various weightings. The indicator is designed to analyze trend and warn of impending change. Like other momentum indicators, divergence is an important component in the KST to provide warning of impending trend reversals. The KST combines a momentum indicator with an analysis of time cycles, so it works best with equities that are more cyclical in nature. By using short-, medium-, and long-term parameters, the best indicator term length can be chosen depending on the user's preferred trading or investing style.
The KST also consists of four other components: moving averages of four different rates of change with weightings from one to four. Signals are generated when the KST crosses over a 10-period moving average of itself. This may sound complicated, but it's not; each component can easily be recreated in any charting program. Figure 1 outlines the terms of each version of the KST.
Most important, how well does the KST indicator work? The only way to know for sure is to test it on actual data. Here is a step-by-step process for testing this or any other trading system. (To calculate KST, see the sidebar on page 86.)
FIGURE 1: TERMS OF EACH KST. Here you see the rate of change (ROC), moving average periods, and weightings for each time frame.
...Continued in the July 2003 issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the July 2003 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2003, Technical Analysis, Inc.
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