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Successful Trading Systems
The Smart Profits Report: Issue #441
Wednesday, July 25, 2007
Successful Trading Systems: How To Find The Cornerstones Of Investment Success
By D. R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research
During one of the trading courses that I teach, we were discussing various successful trading systems and execution platforms. Before long, a heated debate took place regarding the best type of trading strategy and then about the best brokers.
Ultimately, the essence of the debate was this: Just where does the responsibility for a successful trading performance lie? With the investor, the trading system, or the strategy?
Whether you use a specific strategy, trading system, or investment newsletter advice, there are many issues that are critical in finding out what works for you. Here are some of the most common and we’ll see if we can clarify the topics, using the good old “pro and con” format…
Find A Successful Trading System… But Don’t Neglect The Strategy
“If I find a successful trading system that works, then I can be a successful trader.”
- Pro: Every investor needs a strategy or system to form a framework for their trades. Simply put, without a repeatable way to identify and execute trades, you’re going to find it tough to become a consistent performer.
- But there’s more to it than that. It’s difficult to underestimate the importance of having full confidence in your trading, especially after going through a tough spell. But a solid trading system or strategy gives an investor the confidence to act decisively. In addition, a good system, when executed with discipline can produce good returns, especially when used in the right market conditions.
- Con: Studies have shown that even when groups of people have worked with proven trading systems, they’ve still not made money with them. But that doesn’t necessarily mean the systems don’t work. It’s because the system or strategy is only one part of the package that makes a successful investor.
Summary: Yes, your trading system is a key foundation for your investment, and you should spend serious time on developing it.
But it’s not the only important element. There are many folks obsessed with system development and never seem to find time to trade (the Internet bulletin boards are full of them!) So you must also develop other parts of your “tradecraft” - your investment psychology, execution skills, adapting to changing markets, etc.
While a trading system can support your trading discipline (as mentioned above), it cannot take the place of developing your trading psychology.
Finding A Trading System For Trending & Sideways Markets
“The best trading systems should work in trending and sideways markets.”
- Pro: While the markets are volatile and experience many different conditions, studies have actually shown that they trend as little as 20% or 30% of the time. So even the trendiest markets have significant amounts of time when they’re going sideways.
- That means a trading system that works in both trending and sideways markets is truly valuable. Most systems that endeavor to tackle both types of market conditions usually do so by first identifying whether or not the market is in a trend and then picking one trading algorithm or another. Others address the problem by trading less in one type of market or the other.
- Con: Products that try to “be all things to all people” usually do a mediocre job for everyone. Trying to design a “one size fits all” successful trading system that navigates all market conditions is a difficult proposition that has challenged even the best system designers, and it’s likely to end up giving results that fail to excel in any market condition.
Summary: If you want to optimize your investment success, understanding current market conditions is a key task. That way, you’ll know what types of markets best fit each trading system. It’s a good idea to design different systems that work really well in different market conditions. Then you can switch between trading systems.
Using High Percentage Trading Systems
“Trading systems designed to produce a high winning percentage are best.”
- Pro: Trading systems that produce higher winning percentages are certainly easier to trade from a psychological perspective. Losing streaks are shorter, and winning steaks are longer. During periods of extended losing streaks, trading systems that only produce a few big winners can seem like “death by a thousand cuts.” And because long losing streaks are less likely, high percentage trading systems can typically use more aggressive position sizing.
- Con: Almost all trading systems with high winning percentages have low reward-to-risk ratios. So even during times of extended winning streaks, they may only be adding to your wealth slowly. It’s the trading systems with big reward-to-risk ratios that tend to catch the really big trends and provide truly fat returns that can change a good year into an incredible year.
Summary: Really, there is no “best” trading system. You just have to find the one that is “best” for your own situation. So when deciding whether to design a successful trading system based on a high winning percentage, or high reward-to-risk ratio, there are only two factors to keep in mind:
- Figure out your own personality and investment psychology.
- Look at the combined expectancy and frequency-of-trade for each system.
For example, if you compare two trading systems on the basis of expected profit per month, quarter, or year, it can be quite an eye-opener. But great theoretical results really won’t matter if you can’t trade that type of system well. So if you’re looking at the results from a long-term trading system that has significant draw-downs, but you’re an anxious or impatient investor who needs plenty of positive reinforcement, that system probably isn’t the right one for you. The trading system has to fit you if you are going to successfully trade it well.
Trading Systems Should Successfully Fit Your Investment Plan
Obviously, trading systems and strategies are important tools, but they’re most useful when you understand their inner workings and how they fit into your investment plan. When you use a trading system that is successful for you and weaves the market conditions into your investment plan, it can be a real thing of beauty.
One attendee at my recent seminar summed up the discussion of where the responsibility for trading performance lies by saying, “It’s the dancer, not the dance floor.”
Great trading,
D. R. Barton, Jr.
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Today’s Smart Profits Action Center
- Don’t try to design one, perfect, all-encompassing trading system that can win in any kind of market - it’s often an impossible task. Instead find a trading system that successfully meshes with your investment strategy, so it offers the right blend of profit potential and risk mitigation to suit your style. Key questions to consider include: How much investment capital do you have? How much of it you can afford to risk - and potentially lose? What’s more important to you - grabbing short, frequent winners, or waiting for the home run investment?
- Trading tip: Before every trade, write down the reasons why you’re entering the position. Is it strong fundamentally? Is it strong technically? Is there some event that could move the stock? If the trade works out, you’ll be able to identify the reasons behind your success. If it fails, you can pinpoint your mistakes and see what you can do differently next time. You’ll usually be able to find something.
- Fast-track your investment success: If you want to invest like a pro, you have to learn from them. The world’s most successful investors all use specific trading systems and strategies that help them generate wealth successfully every single day. And now that they’ve passed on 31 top profit secrets in this exclusive special report, you can find out how to replicate their success. Get more details here…
Related Articles:
- The Perfect Trading System: 3 Ways To Break The Perfectionism Trap And Find the Blue Rose of Investing
- Trading System Design: Two Critical “Pre-Trade” Functions That Breed Success
- Trade Your Way To Financial Freedom: Reviewing The Holy Grail Of Investing
The Chart Of The Week
The U.S. dollar has made all-time lows against the euro and is struggling against other global currencies like the British pound and Canadian dollar, as well as the Aussie and New Zealand dollars. The chart below shows the U.S. Dollar Index (which measures the dollar against a broader basket of world currencies) now trading at the 80 level and bumping against 12-year support. A break below 80 should send us directly toward the low from September 1992. But until these two key levels are broken decisively, look for a near-term to intermediate-term bounce in the good ol’ greenback.
