Choosing Orders for Entries and Exits

You have three basic choices for orders that you use to initiate or exit your trades: market, stop, or limit orders. There are three philosophies at work here. One says to get your price, implying you should use limit orders or stop limit orders to get into the trade. Another philosophy says to guarantee entry into trade, implying you should use market orders or stop orders. The third philosophy insists that you should exit positions with market orders, but can enter on a stop or a limit.

Timed-market orders on the open or the close are a good way to both exit and enter positions. Many traders recommend entering on the open, and avoiding the rush of orders at the close. Using stop orders can cause you extra slippage if the market opens beyond the stop price.

Remember that there can be divergences between what the testing software assumes and what actually happens in practice. You may get a fill from the software, but not from the floor due to the peculiarities of the market. For example, the software testing daily data has no idea if there were fast market conditions on a particular day. Hence, you may or

Understanding Summary of Test Results 67

may not get a fill when the software says you did. It is important to un­derstand how the software fills a particular order.

One other important feature is the difference between the signal day (or date) and execution day (or date). This means you can get your signal and open the trade the same day. For example, if you are trading a simple moving-average crossover system, you can calculate that a close beyond a particular point will give you a crossover today. Hence, your order may say buy (or sell) at x, stop close only. Alternatively, you can generate your signals after the close, and enter them the next day. The latter approach is preferable only because it is simpler, and when coupled with an order to enter on the open, it is a reliable way to measure system performance.

Entering tomorrow on a stop above the high or low of today is an effective filter when compared to buying tomorrow on the open. In ef­fect, it filters out some whipsaw trades. Generating orders today and en­tering on the next day on a stop, on the open or on the close, is a con­sistent and realistic way to assess model performance.