This article seeks to explain some concepts related to Trading Systems. If you have further interest or questions leave your comments or, if you prefer, send an email to cztradingsystem@gmail.com or fill out the contact form in "Contact”.
The Trading Systems (TS) can be divided into two types: Trend Following Trading System and Oscillating Trading System. The Trend Following TS have their technical analysis basis grounded on trend indicators, for example, Moving Averages. The Oscillating TS have their technical basis grounded on indicators of oscillation, for example, the Relative Strength Index. These two types of TS have their validity and work better in certain market conditions. The Trend TS work very well at times when the price of the asset or security is in trend, but in other hand, functions poorly at times when the price is without a trend. The Oscillating TS work very well at times when the price of the asset or security is with no trend, but in other hand, functions poorly at times when the price is trending.
The prices of all assets or securities tend to alternate trending moments with oscillating moments. This applies for any frequency, whether intra-day, daily, weekly or monthly. The prices don’t trend or oscillate indefinitely and that is why it is possible to build trading systems that are profitable whether they are Trending or Oscillating Trading Systems. What makes a Trading System to be profitable is the efficient combination of three factors: 1) a refined methodology, whether focused on moments of trend or oscillation, 2) an operational strategy of entry, stop loss, stop gain and targets and 3) an operational excellence. There are no magical factors for creating a profitable Trading System, what exists is a lot of analytical work, study and monitoring of the market.
A refined methodology means that the Trading System must have a good basement of technical analysis. The tools of technical analysis should be used to understand what is happening in the market at the present moment. Wrongly, technical analysis is seen as a set of indicators that look at the past to predict the future behavior of prices when in fact the purpose of this tool is to assist the trader in identifying the current state of prices of the paper or instrument in which the trader is interested. In other words, technical analysis helps the trader to identify if, currently, the market is buyer, seller or neutral and based on this information defines the operations and market positioning.
The operational strategy refers to the points of entry and exit of the operations, in the case of exit it refers specifically to the stops and targets. In the formulation of a Trading System, the points of entry and exit are crucial to the profitability of the system and vary dramatically if the TS is of a Trending type or of an Oscillating type. The balancing between the points of entry and exit should be in a way that, in first place, doesn’t generate a overtrading and secondly, in those trades in which the market goes against the trader's position, there is no substantial loss that could shed an extensive part of the winning trades gains. There is no standard rule for the identification of the points of entry or exit, to identify them it is necessary to carry out backtests with the data series of the asset or security analyzed in order to conclude whether the proposed operational strategy is consistent.
Operational excellence refers to the apparatus of Information Technology used by the trader and the mental and behavioral structure of the trader. Information Technology deals with the trading platform, the structure of connectivity, the redundancy and backup structure and the contingency plan which consists of procedures that should be triggered when a fault occurs. The mental and behavioral structure of the trader refers to the emotional control that must be present in the trader so that the coordination and reasoning functions are not altered until a point that causes operational errors during the course of the market. The whole environment of Information Technology used by the trader and the structure of mental and behavioral structure of the trader should promote the good functioning of the Trading System, and minimize failures. All Trading System have a share of error embedded in its methodology that consists of the loosing trades since no TS have a 100% winning rate, and the operational excellence aims to prevent losses from failures outside the TS. It is worth noting that operational excellence is much more relevant for daytrade Trading Systems due to the fact that the daytrade operations have an average gain per trade smaller than other types of trades.
With this information exposed, it is possible to see that the Trading Systems are not miraculous tools or methodologies. Trading Systems are the result of hard work of the trader, requiring a huge analytical effort in addition to a high operational efficiency.
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