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What is systematic trading?

Systematic Trading is the selection and execution of trades based on a predetermined set of rules generally drawn from a body of work known as technical analysis. In futures markets, such analysis utilizes a data base that includes market price, volume and open interest information. In the case of equitIes (stocks) the same base is used but could also include fundamental metrics such as earnings, cash flow, outstanding shares, short interest, etc.

Modern Systematic trading and the analysis and data largely originating in the late 1980’s with the arrival of the modern PC. Prior to the proliferation of personal computers, traders performed calculations by hand by recording data in tables and ledgers written by hand.

Today systematic trading primarily relies on the price data generated by the markets and provided by exchanges. Significantly, most systematic traders believe that all market information, including fundamental data e.g. earnings, etc. is is reflected in the market price. After all, once earning are announced price is instantly adjusted.

Why should we embrace systematic trading?

All successful traders have one thing in common – they all have rules that govern their trading. It is every trader’s mission to cut losses and to let profits run – yet few are able to do it due to emotion and ego. The stress of a chaotic market especially requires a predetermined set of rules to manage impulsive behavior. Success demands adherence to a well-researched system of rules. Systems can of course be changed, but not during a trade! Change it, alter it, abandon it for something different – all are viable. But not when in a trade! Just do it … until you find something better.

Rules are the enemy of emotion and ego. Many people make rules but they have a tough time following them. Following a bad set of rules is invariably better than having no rules at all. It was once told to me by a smart man “why would you spend all that time researching a trading system only not to follow it once you built it?” The reason? Because my ego and emotion told me not too! Somehow all that research was worthless once a trade went against me and I had to change it midstream. If anyone has done this, and we all have, you know what I’m talking about!

How to choose a system

We’ve all heard that hind sight is 20/20. Many trading systems show historical performance that is very pleasing to the eye in the form of a graph or to a spreadsheet sort in the form of Sharpe (Sharpe is reward/risk). So should we choose a trading system based on how it has performed in the past?

The answer is not so simple. Many variables need to be considered. For example, an assessment as to how the system performed historically when market conditions were as they are currently (today) would be nice. In times of market stress did the system perform well? Are we in those kinds of times now? Volatility seems to be something that is important to systems. How does a system perform in high volatility or low? What was the overall market doing during these times?

The above are all good and certainly reasonable questions. However, if we found that a system was great during a low volatility environment and bad in a high volatility one, would shutting it off during the latter help the performance? When would we do that? How would we do that – mathematically? Before you try to answer, let me point out that system designers have been trying to figure this out for some time – to no avail. Generally speaking, there is no simple relationship between volatility and performance. We all know it’s there but what is it?

For professionals this is difficult to discover. For most people this is out of the question. For the person using a system based approach to trading delving into the internal dynamics of systems is all but impossible. A tweak here will cause a change somewhere else. Continuous tweaking often increases the “degrees of freedom” suggesting “curve fitting”. So what do we do if we have all these systems and symbols to choose from? The answer is really quite simple. Choose lots of them!

Most people know that the best approach to trading or investing successfully is through a portfolio approach. Modern portfolio theory is well established and rationalizes to have some bonds some stock and some cash. And, at different ages you have different mixes of these. Classic diversification among assets of different types will generally smooth returns. The same is true for systems. By using different systems to trade your different assets you further diversify your portfolio and, in theory greater smooth your returns.

In the end the markets will never behave the way we expect them to. If we know this then the best we can do is manage our assets that depend on the market with sound principles based on disciple and risk management. You never want to look at your portfolio and find it littered with stocks that have lost 50% or more and wonder why you didn’t sell them. Systems don’t always win but they rarely if ever hold stocks that have lost this much of their value. And this happens all too often in the stock market.

System names & descriptions

First Profit
ST- First Profit enters a LONG Position on the Open if the previous days close was below the lower Bollinger Band. It exists the Trade either at a stop, a time limit or on the Open after the first profitable close.  Short Term.

Trend – Mesa enters a Long Position on the Open if the previous days Close was above a Bollinger band or a Long (Length) Moving average. It exits the trade after a close below the Moving average.

Trend – Turtle enters a LONG position on the Open if the previous days Close was above the Highest high over the last “x” bars. It exits the trade on the Open if the previous Days close was below the midpoint of the highest high and lowest low over the last ‘x” days.

Trend – Turtle enters a LONG position on the Open if the previous days Close was above the Highest high over the last “x” bars. It exits the market on a close below “y” volatility units above the highest high achieved while holding the position

Basic Stop
Trend – Basic STOP enters a LONG position on the open of the previous days close was above a moving average of Length “x”. It exits the market on a close below “y” volatility units above the highest high achieved while holding the position

Trend – Benchtrader enters a LONG position in the underlying market if the SPY has 2 closes above its 200 day moving average. It exits the market on 2 closes below 200 day moving average. It also takes profits if the market extends to far above its 200 day moving.