What is a trading system?
For some traders, building a trading system means that they focus on finding the best indicators they could get their hands on or the one trading setup that is backtested to work 99% of the time. All I can say is, to each his own.
For me, the keyword of a trading system lies not with trading, but with system. Remember, it is a system. First of all, it is a system for trading. Not a system to trade. What do I mean by that?
Consider this saying, “traders don’t go broke by missing opportunities, they go broke by taking too many.” A trading system needs to be selective. It needs prudent risk management.
Secondly, you need to generate your own market view to trade. Rather it be technical, fundamental, sentimental, or just following some joe, you trade based on your view. Trading is a test of your market hypothesis using money. If you think the market will rise, you buy. If you think the market will fall, you short.
Lastly, a trading system needs to execute trades. Otherwise you’d be an anlayst. It needs to time entries and exits. Again, this could be as simple as on a whim or as complicated as some n-th order algorithm.
Thus we have the three pillars of a trading system.
- Risk Management
- Market Analysis
- Trade Execution
What’s more, if we combine some of these pillars we get some well known concepts. For example, market analysis + trade execution = trading signals, wherein you derive signals based on market conditions to execute trades. Or risk management + trade execution = position management, wherein you manage your holdings by manipulating your trades based on your risk profile.
All these relationships and composition of a trading system can be summarized with a Venn diagram. So, this is my view of a trading system:
Trading system Venn diagram
Story of a bad trade and a missed opportunity
The market took a big bite out of me this week just as when I am not giving it its fullest attention.
I took a short-side trade in Manulife Financial (MFC.TO) last Thursday simply because of a price pattern. I did not seek to confirm my hypothesis with short-term price action and intermarket analysis like I usually would because I’ve been so consumed with setting up my trading system on the cloud. I became careless because of my recent win streak and my involvement in so many matters. I lost my focus.
My short in Manulife Financial (MFC.TO) is deep in red as of this writing. The market gapped above my stop loss price over the weekend and never eased back for me to exit at my stop as planned. I’ve placed in a limit order to target a retracement to $14.50 because there’s not much left to recuperate if I dump my position now. MFC.TO is well above $15, so I am prepared for the worst. Judging by the volume, this looks like a valid breakout too.
At least my put options don’t expire until January. If my puts expire, this will be a loss of $372 + $9.90 commission = $381.90 = 3.9% of my RRSP account. To put this into perspective, according to my trade log, this may become my biggest single loss in a trade in this account. Three folds greater than my previous biggest loser at 1.23%. Ouch!
Manulife Financial (MFC.TO)
Manulife is only half of my blunder this week. The real killer is in Ventana Gold (VEN.TO). As you may recall, I have been very bullish on VEN.TO. In fact, I’ve been stalking this gem for months by nibbling on small bullish positions to test the water now and then.
Just as when I dug myself into a hole because of this extended loss, VEN.TO launched off on a rocket (Fig. 2). I am just staring at its takeoff outside the fence without the ability to take a position because of my self-regulated risk exposure limit. There goes a few weeks of research and analysis out the window. Double ouch!
Ventana Gold (VEN.TO)
As bad as my trading can be, at least I am adament with my risk management and traded within my limits. A 3.9% loss in a trade is horrible, but it’s not catastrophic. I will survive this one, redo my research, regain my focus, and be able to fight on another day. This is what trading is about.
read more3 reasons why I even bother trading a small account
If you look closely at my trade log, you will see that the amount that I trade is small. I am not going to get rich anytime soon even if I can maintain my 10% return or so every half a year. My wife was asking me the other day why I don’t plunk in more money to my trading accounts since I have even won a trading contest and all.
With accounts and trading sizes so small, I am appearing to be just wasting my time. For example, it took 2 to 3 hours of research and analysis the night before this recent trade in gold and then just to see it make $35. At least it’s slightly better than the minimum wage here.
The real trial though, is in facing a losing streak. Imagine spending hours and hours pouring over price charts, economic news, and financial data only to see your account shrink and shrink. Those are the times when you wonder why you even bother putting in the hours. It just won’t make a difference, right?
Well, here are my three motivations for trading a small account.
- Slow and steady. The fact is, trading is about aiming for consistency and not scoring that one-in-a-lifetime trade that’ll make you rich. That took me a few years to realize. It is a lot easier to make pocket change than score a jackpot. Don’t make trading harder on yourself.
- Trading comfortably. Hey, this is a hobby. I wouldn’t last too long in this game if I’m sweating my palms with every position. If I bet my farm often, either my account will go broke or my sanity will. I prefer to keep my risk small enough to lasts and make trading enjoyable. If I want thrills, I go to a casino (there is actually a big casino 15 min. from my house).
- Walk before you run. Eventually though, as I become consistently profitable, I increase my risk ever so slightly step by step. Couple that with the effect of compounding, I may eventually be able to replace my salary with my trading income. That is probably still years away for me, but as people say, everybody has to start somewhere.
So no, I don’t think trading a small size is a waste of my time. It is a good risk management, psychological mediation, and learning technique for amateur traders such as myself.
read moreThird Quarter 2010 Trading Review
Markets hitched a one-way train in the third quarter. TSX opened in July at 11200. It closed September at 12368. A whopping 10% jump in three months! S&P500 made a similarly impressive 9.7% jump. We simply don’t get 10% moves even in most years.
I made fewer trades this quarter but held each one for longer to ride the trend. However, I am not as successful as I’d hope. In particular, my worst trade this quarter was in Ventana Gold (VEN.TO). The position was profitable, but the money made was only a quarter as what I should have made. I was too aggressive to go long when VEN.TO was heading into a brick wall.
Ironically, my best trade this quarter was one that didn’t make money. In hindsight, I was wrong in the direction of a position but managed to escape with just a scratch. If I had been stubborn in this failed Manulife short, my profit this quarter would have been wiped out. It was a close call (technically, it was a put contract). It looks as though I did learn something in the past year.
My main focus this quarter has been the backend of my trading work. Namely in quantitative finance study and development. My automated strategy performed well in the Dukascopy JForex contest. I won sixth place in July and first place in August. My win streak (I also won in April) garnered the attention from the people at Dukascopy and they kindly invited me to the Geneva Forex Event for a TV interview. By far the most impressive thing that happened to me this quarter was this trip to Geneva.
Quarterly Metric Q3 Q2
Sarting Fund $9,404.87 $8,000.00
End of Quarter Fund $9,630.75 $9,404.87
Total Net Profit $225.88 $1,404.87
Gross Profit $381 $1,800
Gross Loss -$155 -$395
Profit Factor 2.45 4.56
Net Profit % 2.40% 17.56%
Max. Drawdown % 0.85% 3.36%
Total Commission 121.1 $155.1
Commission / Net Return 53.61% 11.04%
I’ve said this in the last quarter, commissions are the bane of my trading. Last quarter it took away 11% of my total return. This time it’s 54%! The structure of my equities commission requires that I trade less but punch hard. This isn’t my style. My intention is to trade less by being more picky in my RRSP trading account.
The 0.85% max. drawdown this quarter is impressive though. I sometimes lose more than that in a single position.
Sterling Ratio 0.22 1.44
Excess Return 2.29% 17.46%
SDev Return per Trade 1.01% 2.21%
Kurtosis 1.89 -0.93
Skewness 1.65 0.72
Despite my modest 2.4% return this quarter, it’s not a good number in light of the market liftoff. My low modified Sterling Ratio says so. On the other hand, the statistics from my trades improved. I achieved consistency by lowering the standard deviation of my trades and skewed my trade returns more to the positive. Yet another thing to caution is my high kurtosis value. Which means my total returns are due to big profits from a couple of trades.
Other than these, there is not much to add about the rest of the data.
95th Percentile P&L $193.49 $421.15
5th Percentile P&L -$50.37 -$102.13
Net Profit Mid 90% Only -$60.56 $824.07
Total # of Trades 9 14
Percent Profitable 28.57% 61.54%
# of Winning Trades 2 8
# of Losing Trades 5 5
# of Break-even Trades 2 1
Average Trade Profit % 0.27% 1.18%
Average Winning % 2.01% 2.59%
Average Losing % -0.32% -0.83%
Ratio Win% / Loss% 6.25 3.12
Max. Conseq. Winners 3 5
Max. Conseq. Losers 3 3
Largest Winning Trade $228.25 $464.05
Largest Losing Trade -$58.19 -$116.75
Avg. Time Held [days] 8.30 5.17
Goal for the Fourth Quarter
My goal from the previous quarter is to learn and build my first indicator in JForex. I achieved that just this week. However, I plan to change direction in my work by using less JForex and using more custom tools.
My goal for the next quarter is to learn R programming and implement a JForex to R data exchange system (done, good old CSV files).
read more
Recent Comments