I decided to create a journal to keep track of my process with my automated trading. For the past six months, I have implemented some profitable automated trading strategies in a simulated IB account. I backtested the trading strategies during the same period to see if there are any major difference between the simulated trading results and backtested results. The results were almost identical which is good.
However, I’m not comfortable running these strategies with real money. These trading strategies do not use stops. My research shows that using stops are counterproductive with mean reversion strategies. The problem with mean reversion systems and stops is your trading system will continue to buy the stock if it trends against you. Ex. Your trading system buys the stock at $50, and then you get stopped out at $40. The stock keeping falling and your system retakes the position at $35. Stops also do nothing to protect you against overnight risk.
My solution is to convert my trading strategy to trading options instead of the underlying stock. I prefer buying options for many reasons. Options cost a fraction of the stock. Your risk is limited to the premium while your upside is unlimited.
Options have their own problems though. The data is very difficult to work. They have finite life spans, are irregularly traded, and there are many different strike prices and expiration dates. I don’t think it will be possible to backtest option trading strategies in Multicharts.
I am going to keep things simple for now. I’m going to buy call options when my trading strategy generates a long position, and buy put options for short positions. I’m going to trade the first out of money option that has at least two months left until expiration.