System Trading
System trading involves: (1) conduct of advanced quantitative analyses of historical price patterns, (2) prescription of rules for market entry, exit and risk management, (3) computerized surveillance of price activity and (4) transmission of electronic trade orders to exchanges (futures, forex and stocks) automatically, without any human interference.
The fact that this trading method requires diverse and advanced skills, such as time series analysis and computer programming; it is no surprise that only few non-professional traders benefited from automated trading systems until mid-2000s.
From then on however, some fin-tech companies as well as some brokers with extensive IT capabilities began to fill this gap by offering revolutionary databases that compile information of hundreds of professionally developed strategies, present quantitative and qualitative properties of trading systems, and transmit orders to the exchanges. Expansion of such facilities has made system trading available to regular investors.
Benefits of Futures Trading Systems
Trading systems are products in which experienced professional traders and highly skilled computer programmers blend their expertise in developing a real value added product. More specifically, trading systems use artificial intelligence and quantitative methods to discover market patterns, trends and price behavior; define strict sets of rules to enter and exit market accordingly and perform automated execution in the absence of human interference. This suggests that system trading investors exploit benefits of a product line that is highly sophisticated and also gain access to know how of experience traders.
Some investors prefer to take the control of trading without defining a game plan, simply because they lack knowledge and experience. In some cases, traders with knowledge and experience may seem to have a game plan but they are inclined to lose their loyalty to their plans as they avoid stop losses, increase the size of losing positions and taking early profits. Sounds familiar. Right?
Profits and losses are like two sides of a coin. Thus, there is no such thing as a trading plan that wins 100% of the time. Investors feel the joy of profits but also should accept the chances of losses and not override rule based trading systems since next trade can be a big winner.
Since exposures are taken in accordance with predetermined rules, trade plan is never interrupted, unless the system itself is exposed to a major revision or is interfered.
Experienced traders explore historical price patterns and price inefficiencies. They also perform back tests as well as forward tests to predict future price formations. Therefore, although past performance or hypothetical trade results are not necessarily indicative of future results, selecting well-developed systems may increase chances of trading in the right direction.
A trading system is unemotional, unbiased and lacks feelings. Decision making process is rational and depends purely on well-defined rules that have been tested using historical data series. A trading system does not have a second thought when entering and/or exiting markets. Therefore, system trading often allows investors to eliminate stress and retain peace of mind.
There are numerous types of trading systems using different approaches and markets. This allows investors to diversify their funds amongst different trading systems and amongst different investment vehicles.
What is compelling about trading systems in terms of their money saving property is that investors do not pay performance fees and/or management fees as they would if they were to purchase other forms of third party money management products such as pension funds, hedge funds, managed futures, etc.
System trading investors avoid spending time studying charts as trading system experts do all the job of formulating trading strategies based on historical perspective.
Trading systems are hosted in the servers that have direct market access to the exchanges. Therefore, the moment a trade signal is produced, orders are delivered to the exchanges immediately within milliseconds.
Drawbacks of Automated Trading Systems
Trading system developers are traders who observe price behavior, develop trading ideas accordingly, and test their ideas using historical data. When historical data do not fit their ideas, some developers make the mistake of fitting the idea to the historical data by over-optimizing the system. In those cases, trading systems may not yield satisfactory results when they go live. To overcome such problem, developers try to produce trading systems that are as simple as possible and employ not only back tests but also employ forward tests to achieve reliable results.
Because trading systems are hosted in servers, local internet disconnection or a broader technical problem may result in missing some trade opportunities.
Trading systems must be monitored closely to be able to react against all sorts of technological failures or even server bugs that may lead malfunctioning of the systems.
System Trading Q&A
Producing long run consistent returns through self-directed trading is probably the most difficult way of investing the financial markets. With this respect, award-winning fund managers get the support of well-educated, experienced and dedicated team of economists, traders and quantitative analyst in making their investment decisions, preserving discipline and avoiding emotions.
Trading systems involve computerized decision-making and automated trade execution in the absence of human interference. By deferring trading decisions to automated futures trading systems, investors benefit from the support and intelligence of professional traders who develop the systems. In addition, investing through trading systems enforce discipline and sets the investors free of emotions.
Picking the right trading systems is fundamental as in many other investments. Investing in systems without doing appropriate investigation may result in investment failures most of which depend on the reasons explained in the previous section where disadvantages of trading systems are explained.
To avoid failures, investors should be looking for trading systems that have long history of successful trading with actual money, limited drawdowns, consistent profits and losses, and high risk-adjusted return ratios. If developer has more hypothetical performance results than actual trading performance results, then investors should look at consistency between the hypothetical performance and actual trading performance.
Furthermore, investors should perform rigorous screening and due diligence of developers to see if they have a good business record and see if they had been complained in the past. In addition, if developers are registered with the NFA, basic research can be done regarding the business entity and its principals.
Once a list of invest-worthy trading systems are specified, investors should be looking to select the systems that have low correlation amongst each other. Besides highlighting the trading systems that will likely produce net positive returns, Strategy Finder also shares the ideal allocation of capital amongst futures trading systems.