What Is A Trading System And How Do I Get One Working For Me?

By Michael Levin

1. A Trading system is a defined set of rules that trigger entries and exits in a particular market or group of markets.
   
   
2. Most systems use algorithms, setups or "situations" that occur in the market that trigger an entry (long or short).
   
   
3. An example of a simple system called an "Opening range Breakout" would be to wait until a stock or index has opened for the day and after the first 30 minutes of trading, if the market being tracked breaks above or breaks down below that 30 minute range, the "system' would enter a buy order if breaking above or a sell/short order if breaking below.

Here is an example - S&P 500 ETF Friday December 17th

1. Opening range established between 9:30 am EST
2. Low 123.91 - High 124.11
3. A break of the high will trigger a buy and a break of the low will trigger a low.
   
   
   
   If you cannot view the above chart, go here.
   
   
4. Notice the breakout "A" was just by a few ticks or so. Some systems will buy a breakout by even the smallest of increments, other systems have rules that further trigger, such as volume, Stochastics, MACD, Relative strength, CCI, etc.
   
   
   
   If you cannot view the above chart, go here.
   
   
5. Notice that there was no follow through on this breakout and it went and broke through the lows by just a bit soon after in area "B"
6. If a system isn't robust enough it will be buying breakouts that aren't strong and then get washed out on the subsequent pullbacks that break to new lows.
7. Notice that on this day, that "washout" of area "B" had a nice recovery and moved up again to a brief new high at area "C", traded sideways and then had a "real" breakout in area "D"
   
   
   
   If you cannot view the above chart, go here.
   
   
8. I drew a trendline under the range of the breakout in area "D" that proved to be the "tipping point" at which the bulk of the move was over that area "E" shows as the breakdown of the days move and also gives a chance for late day reversal signals to take place as another type of stand alone system.

The point I want to make here is that there are so many types of trading days that can occur. In an article I wrote for www.FutureSource.com in early December 2010 ( go here to read the article) I talk about how easy it is at the END of the day, to look back and see what one could have done, than it is to be trading well AS the market is open and trading.

By using a system that is programmed to take advantage of "certain" moves in the market, WITHOUT the human emotions that usually have a bias associated with it that often are triggered by greed or fear (should I buy before I miss this move or should I not sell because I don't want to get stopped out) a system is more reliable over time and has the added advantage of waiting until all the signals (metaphorically) are green (for a buy) or red (for a sell).

Systems that trade for a client directly into their own account are highly valued by those that havemoney and know how to make it work for them . Those who have never had a system working for them; seem suspect these days, as I speak to literally hundreds of investors per month and because of the Bernie Madoffs of the world and other "scammers" that exist on the internet, they can be reluctant to try one.

One particular person wanted to "watch" the system over time and see if he liked it. He saw a track record of 4 years with returns averaging 60% per year Net and yet that wasn't good enough for him, he was too skeptical.

After 4 months of watching the beginning of 2010, the system was up almost 28% (that he missed) and begrudgingly he set up his account, only to see the system draw-down 20% in 45 days after he got in. He jumped out and closed his account swearing that he always loses when he does things like this.

I'm sure you know what happened right after he got out; the next 3 months the system went up 55% without him, giving the best 3 month performance stretch in over 2 years. Had he started when he was presented with the system, he would have been up a Net 67% on his account, instead, because of HIS EMOTIONS (which is why we use systems) HE stepped out of a winning system and wound up with losses of 22% (right at the lows I might add). Summing up systems; Find a system with a verifiable track record that you can live with over the course of a few YEARS. Define the worst draw-downs and fund your account so you don't get scared out when a draw-down occurs, because they WILL happen to everyone. Lastly, let it ride, compound your gains and you may find as I have that trading systems are the way to go for a portion of a smart portfolio. I adjusted these lines from the movie the Terminator to fit with how I view automated systems trading. Here are the original lines from the Terminator: That Terminator is out there. It can't be bargained with, it can't be reasoned with. It doesn't feel pity or remorse or fear and it absolutely will not stop, ever, until you are dead. My version: This system is traded for you; it hasn't been optimized or changed since it was invented. It trades whether you are sleeping or working or driving on the highway and it doesn't stop crunching the numbers until the trading day ends. It has no fear, no greed, it doesn't care what Ben Bernanke or Barrack Obama or China does. It doesn't argue with the boss, it doesn't have a bias of where the market is going and it doesn't take coffee breaks. It just keeps on spitting out results day after day after day and it will not ever stop until you tell it to. Systems are your designated hitter; you can stay in the stands and watch them do the heavy lifting... Just don't sit there and watch these systems winning for others while you are still "thinking about it". Featured Article from FutureSource.com