Understanding Systems Trading

I’d like to ask a question:  Thinking about casinos, would you rather have the house edge, or would you rather be the gambler??  Other than entertainment value, of course, being the house is the only way to consistently make money.

That’s what system trading is all about—developing a system that has a well defined, consistent edge—called expectation in the trading world.  That’s what we are going to explore in this blog, and we will look at real world examples along the way:

1)       Just what is a trading system??  Isn’t it just a handful of technical analysis tools??  Maybe, but how do you know if your idea will work??

2)      Testing is the foundation of all trading systems, and only those with a positive expectation—edge—will make money consistently.

3)      A mechanical system really is no different from a discretionary system, it’s just that a mechanical set of rules are written for a computer, whereas a discretionary set of rules is written for people.

4)      OK—sounds good, but how do we get started??

5)      Hmmm—sounds great—bet I could find a really cool way to use two dozen of my favorite indicators to build a trading system!!  Maybe not—simple is usually better.

6)      I’ll bet I can produce the perfect entry.  Maybe it doesn’t matter—exits could be far more important.

7)      My system loses money—bet I can make it profitable using stops.

8)      Some of the pitfalls—commissions, slippage, fills, curve fitting—these are the biggies.

9)      I’m not a statistician, but there are a few things that really matter—a lot.

10)   It’s not all about expectation—better focus on draw downs as well.

We will look at these ideas and many more over the coming weeks, and please ask plenty of questions, and if they are of general interest, we’ll deal with them in the blog as well.  And we will get to know each other along the way, and the way we think—some of us will be trend followers, some like to bet counter trend, and others prefer reversion to the mean.  We will look at all these approaches with our eye on the two most critical things—expectation and draw down.

Our first blog next week will examine the components that turn an idea into a money making system—or not.

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