After deciding to explore system trading, many traders are tempted to expedite the process by purchasing someone else’s system. These traders are often met with disastrous results.
In order to successfully trade a system, you must have unshakable confidence in that system and the system must fit your personality. The only way to achieve this is to build your own system.
Confidence In Your System
No trading system is perfect. All trading systems experience drawdowns. The difficult part comes when you try to determine if a drawdown is normal or if markets have fundamentally changed in a way that erases your system’s edge. The only way that you will be able to tell the difference is if you know your system inside and out. That only happens when you build it yourself.
There are many trading systems that you can purchase for a wide range of prices. Some are based on solid strategies. Some are over fitted to a specific style of market. The problem is that if you jump into using someone else’s system, you won’t know how it was designed to handle different markets. When the system experiences a drawdown – it’s going to happen – you won’t know whether or not that drawdown is normal.
Shaun wrote a post earlier this year discussing drawdowns. He referenced how Dustin Pedroia struggled when the Boston Red Sox first called him up to the big leagues. The Red Sox stuck with their young second baseman because they were able to identify that his low average was not sustainable because of his high contact rate.
Shaun compared the Red Sox sticking with Pedroia to a trader sticking with his system during a drawdown. The Red Sox were able to understand Pedroia’s slump because they were able to look deeper into his performance statistics. A system trader can do the same thing if he knows his system well enough to look deeper into its performance statistics.
By taking the time to backtest a trading system through different market periods, you will gain an understanding of how the system reacts to different types of markets. For example, if your system creates most of its profits during a trending market, then you won’t have any reason to panic if it experiences a drawdown during a non-trending period. That would be expected. However if the same system was struggling to produce in a trending market, you would be more concerned.
Building A System The Fits Your Personality
Another reason that you must construct your own trading system is that the system needs to fit your personality. The system used by The Turtles is probably the most famous system of all time, and you can purchase software that trades that exact system for less than $1,000. The problem with that approach is that you might not be a good fit to trade the way the Turtles traded.
The amount of trades a system makes, the time frame that those trades are held, and amount of capital risked on each trade are all factors that affect how a system suits your personality. While the Turtle’s system worked for some traders, if that system exposes your capital to more risk than you are comfortable with, then you won’t be able to sleep at night. While each of these factors can be adjusted during the process of building a system, many black box systems do not allow for adjustments. Also, without backtesting data, you won’t be able to determine how these adjustments will affect the system’s performance.
Going back to Shaun’s Dustin Pedroia reference, the Boston Red Sox were able to have confidence in the numbers of their short, odd-looking prospect because he fit their personality. They also had great success when they acquired corner infielder Kevin Youkilis, who was not an outstanding hitter, but had an exceptional ability to draw walks. If either of these players made the front office feel uncomfortable, they never would have been successful.
Acquiring players like Pedroia and Youkilis fit the personality of the Boston Red Sox, who were obsessed with crunching numbers and didn’t mind looking foolish if they were wrong. I would compare this to trading a system that focused on absolute return that also expects steep drawdowns.
On the opposite end of the spectrum, the New York Yankees are known for acquiring players that are already proven commodities later in their careers for much higher salaries. This approach is more in line with a trading system that trades for smaller profits with much less risk.
OneStepRemoved.com is dedicated to helping traders find a system appropriate for their personalities. Email firstname.lastname@example.org and let us know how we can help with your trading.