System Development

Building a system from ground up is not easy. Anyone can pull together a few widely known parts and construct a system with “okay” results. Or you can purchase one…

The idea of developing your own system is a good topic as it stretches out to other areas like psychology. Although you can buy systems available online, it is to many professionals a “not so good idea.” To me its like a parent adopting a 18 year old teenager. Without being in their lives for the first 20 years its tough to understand their personality and the reason for each peculiar behavior. I guess what I am trying to say is that if you built your own system you will be able to know what each part is for and how each part fits as a whole. 

I am in this stage. In building up a system I following Chuck Lebeau’s steps. He has outlined it very clearly and I have found it to be a easy way of translating my ideas into code. Here it is…I hope Lebeau wont mine sharing his wisdom!

STEP I: Market Selection. We need to be able to select the best markets to trade at any given time. We want to focus our trading attention on those markets that offer a high level of liquidity and a high level of potential profitability. Good markets will have a combination of high trading volume, clear direction, and enough volatility to make potential trading profits worth the risk and expense of trading. 

STEP II: System Selection. We want to have a wide choice of systems and we need to know how to select the right system for the current market conditions. We want to have long term, short term and intermediate term systems to choose from. We also want to have trend following and counter trend systems available. We want to be capable of buying dips or following strength. We need enough systems in our systems inventory to take advantage of whatever market conditions currently prevail and be able to change systems promptly if those conditions should change. 

STEP III: Entry selection. We view the entry process as having three logical functions that will require us to assemble three or more important parts from our system parts warehouse. 

  • Direction identifiers. Tell us if the market we have selected is going up, down or sideways.
  • Setups. Alert us when a good trading opportunity is getting near. 
  • Triggers. Signal us that the best time to enter the trade is right now. 

STEP IV: Exit Selection. We also view the exit process as consisting of several logical functions that will require us to assemble even more parts from our warehouse. 

  • Risk control exits. Usually some fixed dollar amount or “worst case” stop order is necessary to clearly limit our maximum loss and protect our trading capital. 
  • Trailing exits. These useful exits gradually move in our favor as the market moves in our favor and reduce our initial risk level so that our “worst case” stops are no longer exposed. If the market moves far enough some profits are eventually locked in. 
  • Trend reversal exits. These exits signal us when there is an indication that the direction may have changed and our logic for entering the trade is no longer valid. 
  • Profit protection exits. Once the trade has become sufficiently profitable, these logical exits keep our profitable trades from turning into losers. 
  • Profit taking exits. Large profits eventually must be taken. These critical exits try to take profits as near as possible to the point of maximum potential profit. 

For the rest of the post I’d like to talk about portfolio selection. Having spent time for the last few days thinking about this, I have been hitting road blocks. It is important to have a basket of assets to trade as to diversify since when one market performs bad, another will make up for it. The idea seems easy to grasp but then when it comes down to actually trying to put markets together for trading, its a whole new thing. How do you determine which to include? Do I place markets that generally trended well in the past into considerations or do I just use my own gut feeling. Slowly morphing into a quant, I am starting to feel the unease of using my guts to make decisions.

A more mathematical way of approach this may be the following. Wilders Commidity Selection index gives a systematic way of selecting markets that have above average relative strength. Another is employing the use of portfolio theory? Are there any other ways of doing this? When it comes to selecting the portfolio for a set of quantitative models to trade, I have really seen little to no work on this subject. Yea, the idea of carefully selecting it is widely available, but when it gets down to the nuts and bolts and specifics, theres nothing hard I can rely on. Maybe I can dig deeper to develop a systematic way of selecting trading assets so as to maximize returns.

This again is new grounds for me, but I believe I have spent enough time playing around with trading setup ideas. It is time to actually do the boring stuff if I am to realistically implement a successful long term diversified program on my own.

**i havent updated system 1 trades as theres is NONE! There seems to be trend emerging in several pairs therefore my system 1 stands on the side lines. 

Good hunting,


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