Building Trading Systems

[Leth]

Many traders spend a great deal of time and expense searching for information on trading system(s) design. It can not be stressed enough how important it is that you use a system (whether its your own creation or someone elses) that works in harmony with your psychological make-up. My only wish is that this article will be of some use to you on your broad/narrow path to market success. Now that we have the intro out of the way; let's begin...

A good trading system will always answer the following questions (in no particular order):

1. How and when do I enter the market?
2. How many contracts/shares do I trade?
3. How much money do I risk per trade?
4. How and when do I exit with a profit?
5. How and when do I exit with a loss?

Using a loss limiting mechanical system which factors in the questions listed above can help eliminate the emotion that goes along with descretiony trading.

Below you will find some examples of simple mechanical systems. If you are inclined to use and/or backtest these systems, please feel free to do so. Although the systems are extremely simple, they are considered robust for any/all markets.



Simple System 1

EMA (Exponential Moving Average) Crossover with a set period of 15 days (fast EMA) and 50 days (slow EMA); using daily charts. This system is always in the market and is considered a Mid-Term Trend Following Method. Only trade in the direction of the long term market trend.

System Rules:

1. Check your positions EOD only.
2. Go long at the market the day after the fast 15 day EMA crosses above the slow 50 day EMA.
3. Go short at the market the day after the fast 15 day EMA crosses below the slow 50 day EMA.
4. Always exit and reverse position the day after the fast EMA and the slow EMA cross.


15EMA50EMA.jpg


Bet Size:

1. Minimum Starting Capital: $10,000.00
2. Add only as much outside capital to your trading account as you can afford to risk.
3. Bet no more than 2% of total capital on any one position depending on your risk threshold.

How Many Assets to Trade:

1. Trade only 20 equities/commodities of your choice (using a diverse portfolio).

Failsafe:

1. If you have more than 10 losing trades in a row, cut back .5% of your total per trade capital.
2. When you feel that your trading is going well again, add .5% back to your total per trade capital.

Alternatives:

For a shorter term method: Set parameters to fast EMA (5); slow EMA (30) and risk only 2% of your total capital per trade.
For a longer term method: Set parameters to fast EMA (15); slow EMA (150) and risk no more than 2% of your total capital per trade.



Simple System 2

Simple price breakout system using Bollinger Bands with a set period of 40 days and a 20 day SMA trailing stop; using daily charts.

Using Bollinger Bands can accomplish 2 things:

1. Provide support and resistance, and
2. Measure volatility.

The BB overlay can help you choose whether or not you want to be in the market based on your volatility threshold. The purpose of the 20 day SMA trailing stop allows you to cut losses short. This system is considered a Mid-Term Trend Following Method.

System Rules

1. Check your positions EOD only.
2. Go long at the market the day after the price closes above the upper Bollinger Band.
3. Go short at the market the day after the price closes below the lower Bollinger Band.
4. Always exit position the day after the price closes above/below 20 day SMA trailing stop.


40BB20SMA.jpg


Bet Size:

1. Minimum Starting Capital: $10,000.00
2. Add only as much outside capital to your trading account as you can afford to risk.
3. Bet no more than 2% of total capital on any one position depending on your risk threshold.

How Many Assets to Trade:

1. Trade only 20 equities/commodities of your choice (using a diverse portfolio).

Failsafe:

1. If you have more than 10 losing trades in a row, cut back .5% of your total per trade capital.
2. When you feel your trading is going well again, add .5% back to your total per trade capital.

Alternatives:

For a shorter term method: Set parameter to a period of (15) days and a 10 day SMA trailing stop; Risk only 2% of your total capital per trade.
For a longer term method: Set parameter to a period of (100) days and a 30 day SMA trailing stop; Risk no more than 2% of your total capital per trade.



As you can see, these systems are trend following in nature and therefore are not conducive to intra-day trading. I chose to create these particular systems (as examples) because trend following works in harmony with my personal trading psychology and philosophy. However, the same building blocks can be used in creating any trading system. Indicators dont really matter that much, its rules and money management that makes you a winner in the market.


*Disclaimer: Your personal choice in trading methods should be based on your evaluation and understanding of risk. The author of this article (Leth) is not liable for any personal losses accrued as a result of the above system(s) utilization.

[Alchemist]

I wanted to congratulate Leth on his first article for Trading-Lab. It perfectly fits the high quality requirements we have here at Trading-Lab. We are looking forward to many more articles from you!

thanks for sharing your trading insight with us!

[hedger]

great example of how to properly approach and build the foundations of a sound trading system. Those questions are exactly what a good trading system should answer.

[BoneFishGA]

........Bet Size:

1. Minimum Starting Capital: $10,000.00
2. Add only as much outside capital to your trading account as you can afford to risk.
3. Bet no more than 2% of total capital on any one position depending on your risk threshold.............

200 dollars per trade does not buy much stock. Is the 2% limit for getting used to and or tweaking the system?
Or are you looking at 2% spread out over 20 stocks making up the low number of shares per trade?

[Leth]

lets say for educations sake i do use these systems and a 10k capital account. for 200 (2% of 10k), i can go long or short up to 200 shares + or - with options depending on the option premium of the underlying stock. for 200, i can also buy/short stocks outright at 15 a share, therefore owning a total of 13 or 14 shares (26 or 28 with margin). it all depends on the instrument one decides to trade.
the purpose of this thread is to show people how to construct a trading system. rules are different for everyone. my psychology and understanding of risk may not be the same as someone elses. thats why there is a disclaimer at the bottom as well as the last part of rule #3 you quoted from my post, "Bet no more than 2% of total capital on any one position depending on your risk threshold." only you can decide what size bet is right for your account...and your psyche.

good luck my friend

[BoneFishGA]

I did read in one of your other posts you mentioned using LEAPS, something I had not thought about.

...........the purpose of this thread is to show people how to construct a trading system...........

Its working, I'm trying to create my own now.
Or maybe more like put together a stategy from different parts of other peoples strategies.

[charlesK]

that's very good. yes, options can be used as surrogates for stock positions as long as you choose the right ones. for longer term plays, I would definetly go with LEAPS and stay away from shorter expirations

[Leth]

you got it bonefish.
everyone should put something together that works best with thier psychology.
LEAPS are great instruments as pointed out by both you and charlesk. I personally implement them in 2 of my 3 systems. I use 6 month options on my shorter term trend following system...and 1 and 2 year leaps on my longer term trend following systems; this is because some of my clientel like higher risk higher reward (shorter) and others like a bit lower risk lower reward (longer term). all traders are different, all clients are different.