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Understanding Trading Systems
By matt | June 10, 2008
By Jake Bernstein
www.trade-futures.com
There are many things about traders that never cease to amaze me. Some traders never seem to learn from their mistakes. Some traders continue to do the same stupid things over and over. Some traders keep throwing good money to bad money. And what’s even worse is that they KNOW they’re making mistakes and keep making the same ones. We have been told that one way to add discipline to trading is to use a totally objective and mechanical trading system. The power of computers has facilitated the process of finding effective trading systems and implementing them in an organized and consistent fashion. Still, however, the trader remains the weak link in the chain. But why? It would seem logical that adding the power and organization of a computer to trading would overcome many limitations and immediately catapult traders from failure to success or from marginal success to outstanding success. But the reality of the situation is that it has NOT done so. Why? Here are my observations as to why:
• Many traders do not understand drawdown: Drawdown (defined as the amount of money lost on a series of consecutive losses) is part of every system or method. Traders are often unprepared to deal with a string of losses in spite of the fact that this is part of every trading system. They often begin with less trading capital than is realistically required in order to survive a period of drawdown.
As an example, the typical behavior of traders when it comes to all of the systems that I have developed and sold is that I rarely hear from anyone when the systems are making money – I only hear from people after a few losses have taken place.
• Most traders do not allocate sufficient capital to their trading systems. They have bought into the idea that success on a shoestring budget will help them achieve the “American Dream”. Yes, some will be lucky but most will fail. If you begin trading a system then begin with the amount of money that the system requires. Doing things “on the cheap” in any business lowers your odds of success.
• The “things are different this time” excuse: This is one of the most common excuses traders use as a means of intellectualizing their circumventing a system. They point to fundamentals that are supposedly different now than when the system was developed. My view is this: if you have done your due diligence in researching and/or developing a trading system. And if you have allocated pure risk capital to the system then let the system do its job. Deciding to override a system that you have developed or studied and that you have concluded as valid is like finding a good surgeon and stopping him or her during surgery. It’s not a good idea and it could lead to death.
• You have to not care: Sounds counter-intuitive doesn’t it! One of the greatest traders I have ever known always told me that in order to make money in the markets you have to not care. By this he meant that you need to be emotionally detached or clinically dispassionate. As soon as you begin to care you have emotional attachment and that means you are likely to make a mistake. I believe
that this is true in all areas of professional life. To be a good actor you need to not care what the critics say. To be a good money manager you need to not worry if you lose money for clients. In my work I have plenty of critics and detractors. Does it hurt when people spread vicious lies about me? Does it hurt when people attempt to uplift themselves by speaking badly of me? Once upon a time it was painful. Now I ignore it and consider it part of the process. The less I care about trading success – the less I care about the critics – the less I care about the lies – the more success I achieve. If you trade a system then you have to not care – you have to be cold and unemotional.
• Study the Details: You need to know your system. By this I mean that you need to know some of the unique qualities of your system. Every system has some characteristics that are unique to that system. As an example, the system may have low accuracy but it makes its money on a few very large winning trades. Knowing this you will be prepared to lose on most trades but you will also know that your money will be made on a few very large winners. And being prepared for this type of behavior you will be more patient and less willing to take small profits since the small profit you take today may be the big winner you should have kept. Another feature of your system is that it may do very well in long positions but poorly in sell trades. You may, therefore, want to take only long positions. And there are other aspects such as these that you need to consider BEFORE you trade a system.
Enter after a losing streak: I’ve found that most traders want to jump into a trading system when it’s doing well. The most conservative procedure is to find a system that is robust (i.e. it comes back strongly after a period of losses) and to begin trading that system AFTER it has had a series of losses. While some people will disagree with me, I have found this to be a very sensible approach.
Past performance is not indicative of future results. There is a risk of loss in futures trading.
Topics: Commodities General |
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