Most people invest in the stock market but only a very few go to the effort of designing their own stock trading system.
By "system", I mean a piece of software that automatically tells the trader when to buy and sell stocks.
There are several advantages to mechanical stock trading systems.
One of the big advantages is that it removes the emotion from the trading activities.
Or should I say, a mechanical stock trading system should remove the emotion from trading.
In fact, most system traders tend to seek the highest possible return on capital without accounting for the emotions experienced when real money is on the line.
As a result, many traders make fundamental mistakes including underdiversification, undercapitalization and overtrading.
One significant issue that novice system developers face is the assumption that live performance of a trading system will mimic system backtest performance.
It is very unusual to achieve similar performance live as was achieved in simulation.
A good rule of thumb is to expect 50% of the profit and 50% higher drawdown in live trading as opposed to backtest simulation.
Inevitably, a mechanically traded stock system will produce a fairly significant drawdown.
This is where emotion comes into play.
It is very easy to study a backtest simulation and come to the conclusion that you can tolerate a 25% drawdown.
It is a completely different situation when you are down 25% with real money invested.
In this situation traders typically begin to question whether their system still works.
With enough stress the trader will liquidate his (or her) holdings.
This is how traders end up buying high and selling low.
It complete cycle is greed and fear.
Greed comes into play because too much capital is put into the stock positions initially.
Fear comes into play when the positions move against the stock holder.
The root cause is typically deployment of too high a percentage of one's trading capital on non-diversified positions.
This is often compounded by use of capital that one cannot afford to lose.
Before embarking on the design of your own personal trading system you should first assess your personality, lifestyle and financial means.
There is no point in putting a great deal of effort into a trading system that is ultimately unsuitable for your life's situation.
By "system", I mean a piece of software that automatically tells the trader when to buy and sell stocks.
There are several advantages to mechanical stock trading systems.
One of the big advantages is that it removes the emotion from the trading activities.
Or should I say, a mechanical stock trading system should remove the emotion from trading.
In fact, most system traders tend to seek the highest possible return on capital without accounting for the emotions experienced when real money is on the line.
As a result, many traders make fundamental mistakes including underdiversification, undercapitalization and overtrading.
One significant issue that novice system developers face is the assumption that live performance of a trading system will mimic system backtest performance.
It is very unusual to achieve similar performance live as was achieved in simulation.
A good rule of thumb is to expect 50% of the profit and 50% higher drawdown in live trading as opposed to backtest simulation.
Inevitably, a mechanically traded stock system will produce a fairly significant drawdown.
This is where emotion comes into play.
It is very easy to study a backtest simulation and come to the conclusion that you can tolerate a 25% drawdown.
It is a completely different situation when you are down 25% with real money invested.
In this situation traders typically begin to question whether their system still works.
With enough stress the trader will liquidate his (or her) holdings.
This is how traders end up buying high and selling low.
It complete cycle is greed and fear.
Greed comes into play because too much capital is put into the stock positions initially.
Fear comes into play when the positions move against the stock holder.
The root cause is typically deployment of too high a percentage of one's trading capital on non-diversified positions.
This is often compounded by use of capital that one cannot afford to lose.
Before embarking on the design of your own personal trading system you should first assess your personality, lifestyle and financial means.
There is no point in putting a great deal of effort into a trading system that is ultimately unsuitable for your life's situation.
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