Adrian Reid answers how to choose an entry price for trades: use the exact entry rule you backtested (e.g., buy at next-day open, close, limit, or stop). If you backtested entries at the open, attempt to execute at the open; if you prefer a different execution (close, limit, stop), backtest that approach. If gaps between close and open occur, either accept them (they are already reflected in long backtests) or codify a filter (e.g., avoid entries when the open gaps beyond a threshold), then backtest the filter and adopt it only if it improves performance. The guiding principle Reid repeats: ask "What would your system do?" and follow the system unless a tested rule shows improvement.
Chapters
If the system tells us to buy at the next day, what price should we buy at on the next day? How do we decide the entry price?
And this is a really great question and we'll talk more about systems in other questions later on. But when you, when you design your system, you have to know what your exact entry rules are. Often we focus on the indicators, but we miss the execution. And so when I'm trading a system and I trade end of day systems, so I don't look intraday, I only look at daily charts. So when I trade systems at the end of the day, I download my data, I run my scans, I get my signals for the next day. And I'm always entering at the open the next day, almost always.
Because that's what I've back tested. And so the price that you should be looking for is the price that you've back tested. Now some systems will enter at, in your, in your backtest you'll, you'll say okay, if this crosses over this, then buy at the open on the next bar. If that's what you've backtested, then you're going to trade exactly the same way. You're going to try and get as close as possible to the opening price. But if you have a different idea, like let's say you want to enter at the closing price, then you back test that and see how profitable it is, or maybe you want to enter on a limit or a stop order, then you're gonna back test that. So the answer is not simple. I can't just say buy the open. The answer is what did you back test in your system? And if you back tested with an entry price at the open, then you should be trying to get in at the opening price, necessarily try and make it better. And certainly, you know, don't wait for later in the day to see let the price settle down. Because your system was designed and backtested using the opening price as the entry point. And same for your exits. Okay, you just want to act on the system. And so one of my favorite phrases or sayings for my students again in the trader success system is when they ask a question, my response is what would your system do?
What would your system do? And if your system would enter at the open, you enter the open. If your system when system would enter at the close, you entered the close, and so on. So that's how you deal with that. And if the price spikes or drops dramatically from the close to the open, again you have to ask yourself what would my system do? Because if you've back tested your system over 20 or 30 years, over several thousand trades, you coded your system to enter at the open. Don't you think that in that time, in that 20 or 30 years over those several thousand trades, that there was a fair few trades where the price jumped up between the close and the open the next day or gaps down between the closing next day? Absolutely there was. So all of those behaviors, market behaviors, are in your backtest. So what do you do? You follow what the system would do? The system says you buy at the open. So if the open is gapped up, you buy at the open. If it gapped down, you buy at the open. Unless you've got a rule in your system that invalidates that. Now again, if we go back to the fear that that might generate if it's gapped up, the fear might be, oh, I've missed out on the move. If I buy now, it'll fall and I'll lose money. Right. So what do you do with that fear? Well, you observe, the chart is, oh, there was a big gap up. Maybe that's not a profitable signal. Maybe I shouldn't buy at the open. If the open moves up beyond a certain level. So you can then codify that, convert it to a rule, back test it and compare it to the system without that rule. And if the system with your, you know, rule that avoids that gap up on your entry, if that system is more profitable, then don't take that, don't you don't take those trades. From then on, you add that rule to your system and you avoid that, that situation. But if you do the backtest and adding that rule, that filter makes it worse, then you just ignore that and you just take the trade. Right? Just follow the system. Follow what the system says.
