What Is a Trading System? The second part of this article will focus on clearly defining what a trading system is. In each case, one of the major distinguishing characteristics is how they deal with systems. There are systems for food delivery, preparing food, greeting customers, serving them within a minute, cleanup, etc.
And all of these systems can easily be carried out by a manager who has a college degree and employees who might even be high school dropouts. In other words, a system is something that is repeatable, simple enough to be run by a 16 year old who might not be that bright, and works well enough to keep many people returning as customers. Employees are basically motivated by security. They have a job and they do their work to get money.
Employees basically run the systems. Most employees do not understand systems. Instead, they just know what their job is.
And this is typical of employees who become traders or employees who work as traders. The self-employed person is basically motivated by control and doing it right.
The self-employed person is the entire system. And the more they work, the more tired they get. Like the employee, the self-employed are working for money. However, they like it a little better, because they are in charge. But mostly, working harder gets them tired. Nevertheless, they continue to plough forward thinking that they are the only ones who can do it right. As I said earlier, the self-employed person basically is the system.
And quite often they cannot see the system because they are so much a part of it. They are stuck in all the details. They are always looking for perfectionism and they believe that the perfect system must be complex. This is all they tend to know and they approach trading the same way. The self-employed person would be likely to have a discretionary system that is constantly being changed.
A good business owner should be able to walk away from the business for a year and come back to find it running better than before. While this is an ideal type of statement, it has some theoretical truth to it. This should occur because the job of the business owner is to design a group of systems to run the business so well that his employees can do the job by themselves or at least with a manager in place.
In other words, the business owner is someone who designs systems and these are usually simple systems. And, of course, the business owner would usually hire someone to run their trading system, at a much lower wage.
When he found such tasks, his job was to develop a program to take that task out of human hands. Routine computer programs are great examples of simple systems. The last person on the quadrant is the investor. Robert Kiyosaki describes this as the quadrant in which money is converted to wealth. Most traders are probably not investors by this definition. They buy low or sell high, trading stocks. As a result, there is something they must do to generate their money.
If you know how to get those types of returns, then you want to hold onto those investments as long as possible. The problem with such investments is they are not guaranteed to continue forever. Many of you have probably discovered that in the last few years. What most people think of as a trading system, I would call a trading strategy.
This would consist of eight parts: A market filter is a way of looking at the market to determine if the market is appropriate for your system. For example, we can have quiet trending markets, volatile trending markets, flat quiet markets, and flat volatile markets. And, of course, the trending markets can either be bullish or bearish. Your system might only work well in one of those market conditions.
As a result, you need a filter to determine whether your system has a high probability of working. Should you trade your system or not? The set up conditions amount to your screening criteria. As a result, most people employ a series of screening criteria to reduce that number down to 50 stocks or less. You might also have a technical set up, just prior to entry such as watching the stock to go down for seven straight days.
There are all sorts of signals one might use for entry, but it typically involves some sort of move in your direction that occurs after a particular set-up occurs. The next component of your trading system is your protective stop. This is the worst-case loss that you would want to experience and it defined 1R or your initial risk for you. Your stop might be some value that will keep you in the stock for a long time e. Protective stops are absolutely essential. You need stops to protect yourself.
As I said in Trade Your Way To Financial Freedom , entering the market without a protective stop is like driving through town ignoring red lights.
You might get to your destination eventually, but your chances of doing so successfully and safely are very slim. The fifth component of a trading system is your re-entry strategy. Quite often when you get stopped out of a position, the stock will turn around in the direction that favors your old position. When this happens, you might have a perfect chance for profits that is not covered by your original set-up and entry conditions.
As a result, you also need to think about re-entry criteria. When might you want to get back into a closed out position? Under what conditions would this be feasible and what criteria would trigger your re-entry? The sixth component of a trading system is your exit strategy. The exit strategy could be very simple. The stop is always adjusted up, never down. However, you may have many possible exits in addition to a trailing stop. For example, a large volatility move e. Crossing a significant moving average e.
Technical signals are good exits e. Exits are one of the more critical parts of your system. It is one factor in your trading of which you have total control. And it is your exits that control whether or not you make money in the market or have small losses. You should spend a great deal of time and thought on your exit strategies. The seventh component of your system is your position sizing algorithm.
Position sizing is that part of your system that controls how much you trade. It determines how many shares of stock should you buy. Finally, you need multiple trading systems for each type of market.
At minimum, you might need one system for trending markets and another system for flat markets. The Entire Trading System: Your Business Plan for Trading 3. Remember that I said that what most people consider a trading system, is simply a trading strategy that should be part of an overall business plan. Without the overall business plan, many people would still lose money. I have written extensively on this subject, therefore for the purposes of this article, the following is just a brief overview.
Here is a summary of what we consider to be essential for a good trading plan: This is usually the last section written. It reviews all of the material of the plan and presents it in summary form. It should describe in detail the objective of the plan and then briefly describe, without a lot of detail, how the objectives will be achieved. The business description should include the mission of the business, an overview of the business and its history, the products and services you provide which is growth of capital and risk control as a trader , your operations, operational considerations such as equipment needed and site location, and your organization and management of employees if any.
All of these topics are fairly self-explanatory, but you should take the time to write them out as part of your plan. In the industry overview you need to look at the factors influencing the market. For example, Ed Yardeni in his web site lists ten major factors influencing the market. These include a globally competitive economy, a revolution in innovation, wireless access to the Internet, low tech companies having access to high tech tools and changing their businesses as a result, the need to outsource to increase productivity, and many other themes.
Who are you trading against? What are their beliefs? You need to know your strengths and your weaknesses and list them in this section. You need to know how to capitalize on your strengths and avoid or overcome your weaknesses.More...