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The Dream of System Trading

January 12, 2009
System trading is not for the faint of heart. But its design can give vital trading edge over the other market participants. And after all if you have got the edge, you got the power!

Beginners and novices around the world share a common dream, when they first understand system trading. Admit it, if you have been there,you would have actually dreamt of a system which automatically trades and generates awesome returns, while you roam the world and try your level best to spend the income.

All right,  I will admit it. My dream was a bit more tame. It was to have a potential money printing press in my trading room.

In fact, I spent nights designing, rejecting, investigating and optimizing systems while keeping draw-downs to a minimum and returns maximum. At the end, all I had were lots of equations, a semblance of entry exit and stop and a huge back-test report. Which was mostly a dud.

System trading, might entice you into thinking  of great freedom, relief from emotional pain and also fantastic  returns from a minimal draw-down. But the truth could not be farther from fiction.

Often, systems break down and deviate from the theoretical results in the fog of war.Slippage (finance) is an extremely common phenomenon. And added to that, the issue of draw-downs on the equity is also a concern. As such humans are adept at pattern recognition and pattern visualization but a lot of such patterns might not be programmable for a system. Consider for example trading in a divergence. Its extremely difficult to encode it as its a qualitative signal.Yet divergences give one of the finest low risk setups.

Furthermore, system trading will and always involve a human supervision. Until unless we have expert systems coming into foray in a big way. Even though, I trade discretionary, often a times, I have to face a problem due to improper or failing connectivity infrastructure.

We as humans are lot more quick in improving our deficiencies but the issue of system trading is quite delicate in this matter. The question invariably arises, how much of imperfection is alright?

Novices think 0%, but an experienced trader will understand everything breaks down. Especially systems.

So the key in designing system strategies come through various challenges:

  • Testing and Optimization of the decision making setups
  • Exit conditions
  • Stop Loss definition
  • Time Frame of Analysis
  • Trade Expectations [that is the statistical average of profit[or loss] in a trade]
  • Profit Factor [reward to risk ratio in other terms]
  • Last but not the least, drawdown minimization

Of important consideration is the last because, this relates back to the question asked a para before.

How much imperfection is alright?

This imperfection statistics is a highly debatable one and has to be fitted along with the risk appetite, equity and a host of other considerations which is more of personality related and less of trading related.

But beyond a point, the imperfection might be too much to bear and too difficult to lessen. So what do you do?

Sophisticated traders will design another to compliment the previous ones problems and cover some of its deficiencies. In another time frame with another strategy, might be.

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2 Comments leave one →
  1. January 15, 2009 6:45 pm

    the picture in this post.. is absolutely hilarious 😀
    .. and soham.. you’ve seriously got to tell me how to get that super cool “share this post” bar you got going on here 🙂
    me trying to keep my blog updated when i can 😀
    Peace !

    • January 15, 2009 7:36 pm

      😉

      Try Googling for social bookmarking , I am using Live Writer. It has got its own social bookmarking plugin.

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