Advantages of Systems Trading:
There are many reasons why futures traders are turning to mechanical trading systems as their primary trading style. One of the biggest mistakes traders make is allowing emotions, excitement or fear, to overpower their logic and control over their trading. With systems trading, the trader relies on the system to select the trades; thus, freeing the trader from the burden of emotional fear and greed decisions.
Why there is NO Perfect System:
Selecting a trading system can be a difficult task. All system results are hypothetical, because they are based on past results and have the huge benefit of hindsight. The disclaimer for hypothetical results typically reads: “Past Performance does not guarantee future results.” Many trading systems seem too good to be true. Smart consumers know that when something looks too good to be true, it usually is.
Although trading systems are designed to select the most statistically desirable trades, they cannot completely or accurately predict market trends and cannot guarantee success. Countless factors contribute to market changes: price, volatility, news, shortages, wars, interest rates, increasing or decreasing money supply, etc. While some systems work in a bull market, some in a bear market, others do best during a choppy market.
What Goes Up Must Come Down:
While there is no system that can consistently assures success, that does not imply that systems trading is never profitable. Trading systems may deliver large profits during certain phases and then provide large losses later. Newton’s law of Gravity tells us that: “What goes up must come down.” Financial markets mimic this by having Bull markets and Bear Markets. Market prices will never continuously move in an upward trend. In the same way, the equity curve of any trading system will never continuously move positively. The equity curve for any high risk investment will fluctuate up and down; there will be winning and losing periods for any system.
While every trader will find himself in a losing period at times, there are strategic moves to attempt to minimize losses. A common strategy is diversification. By utilizing multiple trading systems, the trader is acknowledging that there is no trading system that can consistently make a profit. Many traders choose to use multiple automated systems, so that when one begins to lose during a certain market period, another may profit. The overall performance is not tied to only one set of rules.
Basic Techniques for Multiple Systems Trading: Portfolio vs. Selective
With portfolio systems trading, the “portfolio trader” runs multiple trading systems at the same time. The idea behind this style of multiple systems trading is that if one system suffers a loss then another system will hopefully receive a gain, thus minimizing or eliminating the loss. However, this style not only minimizes losses, but also minimizes profits: if one system is trending upward and profiting while another system is losing, then the losing system will reduce or eliminate the profit. The minimum account size for an individual trader using “portfolio trading” tends to be relatively high, because each system is trading a separate set of contracts each with margin requirements, thus portfolio system trading tends to be used primarily by high volume or high net worth traders.
The selective style falls into the category of multiple systems trading, because the trader utilizes several different systems, one at a time. Selective systems trading is designed to improve the trading performance of the systems based on modifications to the “working time” of any given system in the Market. The basic idea is to switch (turn one system off; turn a different system on) a trading system when the equity curve is expected to stop rising. While the strategy of the “portfolio trader” is to avoid taking major losses by balancing losing trades on one system with winning trades on another, the “selective trader” replaces a system that is losing or predicted to stop winning with a different system. There is no perfect method for predicting downward trends and ensuring consistent profit; profit cannot exist without loss. The process of predicting a downward trend in selective system trading is very complicated and will never be perfect; the goal is to minimize extended losing periods. A hypothetical example is detailed below.
Example: Hypothetical Selective Systems Trading Strategy for Determining when to Change Systems
Basic guidelines:
Switch system when the account has an overall daily loss at the close of the trading day.
Switch system after the account has a 5 consecutive days of overall daily profit.
Conclusion
While there are many advantages to systems trading, it must be acknowledged that there is no perfect system. While we would all like to hope that technology will advance to the point where a perfect system can be created, we must accept that the day may never come. Until that day, we feel the that the best approach is through the simultaneous use of multiple systems with a selective timing approach, so that if one system is not performing the other systems in the portfolio have an opportunity to potentially compensate and make for a smoother equity curve.
Risk Disclosure: Futures, and options trading contains substantial risk, is not for every trader, and only risk capital should be used. Any form of trading, including forex, options, hedging and spreads contains risk. Past performance is not indicative of future results. No representation is being made that any account will or is likely to achieve profits or losses. There have been no promises, assurances or warranties suggesting that any trading will result in a profit or will not result in a loss. Because there are no actual trading results to compare to the hypothetical performance results customers should be particularly wary of placing undue reliance on these hypothetical performance results.
