lvainik
52 posts
msg #46872
- Ignore lvainik |
9/12/2006 10:35:07 AM
The 4 Week Rule: Simple and Good
The 4 week rule, developed by Richard Donchian, is one of the most successful systems tested by time. The 4 week rule is used primarily for futures trading but might also work in your stock trading system. This system is simplicity at its best:
1. Cover short positions and buy long whenever the price exceeds highs of the four preceding full calendar weeks.
2. Liquidate long positions and sell short whenever the price falls below the lows of the four preceding full calendar weeks.
This system would be continuous for our trader in that he would always have either a long or short position open. Therein lies the weakness of this continuous system. Staying in the market, our trader will get "whipsawed" during markets that are trendless or in a sideways trend. Trend-following systems, such as this, do not work as well under those two conditions.
The 4 week rule can be modified to make it non-continuous by using a shorter time span - such as a one or two week rule - for liquidation purposes and possibly for day trading. With this system, a four week "breakout" would be needed to initiate a new position, but a one or two week signal in the opposite direction would warrant liquidation of the position. Our trader remains out of the market until the next new four week breakout is registered.
This system is based on sound technical principles with signals that are mechanical and clearcut. It is trend-following so our trader is virtually guaranteed to be on the right side of every trend. It also follows the often quoted maxim - "let profits run, while cutting losses short". Another feature is fewer trades, which means less commission, not to mention, this system can be done with or without the aid of a computer.
Being a trend-following system, it is not going to catch market tops and bottoms. Keep in mind, however, the 4 week rule works as well as any other trend-following system but with the benefit of incredible simplicity.
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