 Trading Tip
Systematic
Trading � Part II
What Style Is Right for You?
by D.R. Barton, Jr.
Last
week we discussed the different types of systematic
trading. My
belief is that systematic trading is any trading strategy
that follows a defined a set of rules.
This
means that one CAN trade systematically, even if the rules
are not readily programmed into computer code.
Bu
there are also some key advantages to being able to
convert trading rules into programmable code.
Since there are pluses and minuses to each style of
systematic trading, let�s run through them.
This exercise should help you decide which is right
for you.
Purely
computerized trading
By
way of definition, this is any strategy that can be
programmed and executed via computer.
For some diehard adherents, this is the only
�true� systematic approach.
But this is a very constrictive and less useful
belief about systematic trading.
Pros:
*If
trades are executed by the computer then any
psychological or emotional issues are removed from the
decision points of entry and exit.
*Can
be easily back tested to add to a trader�s confidence.
*Rule
set can be applied across a wide variety of instruments
to test for robustness.
Cons:
*Automatic
systems must be monitored consistently for proper
operation of order routing and other interface
components.
*Parameters
must be monitored and updated as market characteristics
change. Failure
to do this inevitably leads to system failure.
*The
system�s automatic nature can give the trader a sense
of complacency, leading to improper system performance
monitoring, which can lead to significant losses if not
caught in time.
Mechanical
Trading
In
this subset of systematic trading, the rules are
completely mechanical (all decisions are either �yes or
no�). But
some of the rules may be difficult or impossible to
program. In this style one may ask questions like, �Is
there news on this stock?� or Has Market Profile shown
time/price contraction or a similar rule that is tough to
program?
However, those type of questions can have a binary
�yes or no� answer, making the system purely
mechanical in both design and application.
Pros:
*Binary
decisions help reduce psychological or emotional issues
at decision points such as entry and exit.
*Some
components of the system can be back tested to add to a
trader�s confidence.
*Rule
set can typically be applied across a wide variety of
instruments to test for robustness.
*A
broader set of inputs can be used since all parameters
don�t need to be reduced to code.
Cons:
*Parameters
still must be monitored and updated as market
characteristics change.
Failure to do this inevitably leads to system
failure.
*It
can be difficult to reduce non-mechanical decisions to
binary ones without introducing significant subjective
input.
Now
we need to stop (again!) and add a definition� one that
makes mechanical traders wince.
A rule CAN BE a decision that requires trader input
(even subjective input).
And to be honest, I know many more traders who have
rule-based systems that aren�t purely mechanical than
those that are.
For
example, traders will look at various market breadth
inputs (advancing issues versus declining, new highs
versus new lows, up volume versus down, etc.) and make a
subjective judgment on which is the most important at the
time. But
their rule might be that they will go long (or short)
without supporting market breadth.
Hybrid
Mechanical / Rule-based Trading
I
added this category, which is a combination of mechanical
rules and rules that require a trader�s input, because
lots of traders use this style of systematic trading �
more than any of the others.
Pros:
*Some
components of the system can be back tested to add to a
trader�s confidence.
*A
broader set of inputs can be used since all parameters
don�t need to be reduced to code.
*Experienced
traders can build in flexibility to take signals that
satisfy subjective criteria that aren�t clearly binary
(yes / no) answers.
This is a key to many good traders' ongoing success.
Cons:
*Parameters
still must be monitored and updated as market
characteristics change.
Failure to do this inevitably leads to system
failure.
*With
subjectivity comes added responsibility to manage
emotions, psychology, and data overload.
Rule-based,
Non-mechanical Trading
Here
is the style where a trader follows rules, and follows
them every time, but those rules aren�t a mechanical
set. My belief
is that the most successful intuitive traders fit into
this category as well.
They have rules that they follow, but they just
haven�t formalized them in a way that a linear/logical
thinker would understand.
Pros:
*A
broader set of inputs can be used since all parameters
don�t need to be reduced to code.
*Experienced
traders can build in flexibility to take signals that
satisfy subjective criteria that aren�t clearly binary
(yes / no) answers. This
is a key to many good trader�s ongoing success.
*Experienced
traders can use their skills to identify points where
other participants are in trouble and capitalize on
these moments.
Cons:
*With
subjectivity comes added responsibility to manage
emotions, psychology, and data overload.
*This
style of trading is difficult to repeat or model.
Some of the core beliefs and intrinsic rules may
be buried deep in the other-than-conscious mind of the
trader.
*This
style takes the longest time to develop.
My
firm belief is that all successful traders have a rule set
that they follow consistently.
Some traders through experience, natural ability
and self-mastery are able to have wider latitude on their
rules. The
important element is that you, as a trader, identify your
own trading style that fits you best.
Great
Trading!
D. R.
About D. R. Barton:
D.R. will be presenting his upcoming �Professional E-Mini Futures Tactics�
workshop, November 10-12.
A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena where he is one of the most widely read and followed traders and analysts in the world.
He is a regularly featured guest analyst on both Report on Business TV, and WTOP News Radio in Washington, D. C., and has been a guest analyst on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine.
You may contact D.R. at [email protected].
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