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Designing a trading methodology

Over the next few weeks I would like to focus on the steps and processes involved in designing a trading system. Whilst by no means an exhaustive list, it will provide an insight into the process for those interested in designing their own trading system and for those who are weighing up whether to develop their own system or purchase an existing mechanical system with a positive edge over the market.

I will provide a practicable insight into designing, developing and building a trading system or more correctly, a trading methodology. This is a general overview rather than an exhaustive coverage of the subject but should be sufficient for a potential system designer to get a good idea of the processes involved. I trust it will assist you in either embarking on the journey or accepting that it is one that you would rather not make. For those of you who already know that designing a system is not for you then this chapter will give you a greater understanding of how to evaluate any system when you are considering a purchase. My goal is that regardless of whether you choose to pursue the development of your own trading system or purchase a proven methodology from a reputable system vendor you will be more knowledgeable about avenues for profitable trading by grasping the content of the blog over the next few weeks.

Generally the purpose of developing an edge is to trade the edge in order to make money with it. Whilst this statement may seem obvious, the majority of people who embark on the system development journey don’t complete the journey and hence don’t achieve the purpose.

The system design paradox

Before getting into any detail I must uncover a paradox that is one of the main reasons why most who start the journey of system design do not complete it.

Most people generally wish to avoid the pain associated with losing. Unfortunately this paradigm (avoiding loss) will, by default, be used to evaluate the edge the individual is attempting to design. This is a Catch 22 situation as the system designer needs to have learned to think in probabilities with a market paradigm in order to evaluate and hence complete the design of a system. I covered many of these topics in last year’s weekly blogs. You may wish to refer back to them to refresh your knowledge or to read them for the first time if you are unsure of some of these terms.

The operative word in system design is ‘complete’. If some degree of a consistent mindset has not been achieved, then the designer will not know when to stop researching and start trading. Typically the results of the research will continue to be evaluated from the paradigm of trying through analysis and further research to eliminate losing. This means that the individual will be thinking like an analyst rather than a trader.

The analyst’s mindset attempts to analyse away losing. Even though the analyst will admit (using the logical left brain) that analysing away these situations is impossible, his/her subconscious, having been trained by society to avoid these situations, will rule the roost and lead the analyst to continue research, attempting to analyse the following out of the system: losing, being wrong, missing out and leaving profits in the trade.

The trader’s mindset, achieved through reprogramming the subconscious, is to trade an edge and totally accept the losses an edge generates. Therefore, if you have an analyst’s mindset when trying to design an edge, the probability of completing the development, let alone trading it successfully, is very low. In fact, an analyst will have a difficult time trading any edge, let alone one they have developed themselves.

The successful researcher must have a degree of successful trader in him/her, and must know what a practicably profitable system looks like to know when he/she has completed the research journey and can begin the trading journey.

By definition, an edge will make money over a large sample of trades.

I know that my comments on this paradox may be contentious amongst readers but successful system designers and system traders who have completed the journey or part thereof will agree with me. In next week’s blog I will take a look at the tools and resources required to begin the journey of designing your own trading system.


  • DV says:

    Totally agree as I am currently backtesting a strategy right now, I guess the main point is that losses will occur no matter what strategy you use, that in itself is trading – you cannot win them all…
    However, a successful strategy has to have the right balance of win/loss ratio coupled with money management strategies that achieve an acceptable reward to risk ratio, this coupled with a good overiding trading and execution plan should perform well over the long term…

    A strategy can have a high win/loss ratio with a low reward to risk ratio and still theorically lose money!! (contrary to popular belief) and conversely another may have a low win/loss (~30%) ration but a very high reward to risk ratio (~3:1)… and make money.

    The key is to find the right balance that gives a good positive expectancy and acceptable drawdowns over a large number of trades.

    Nice Article…and timely for me too!!

  • DV says:

    Actually the strategy I am testing has a current win/loss of 45%, even with this low win loss ratio I still think I can make it work with a filter for entrie and a money management plan that takes advantage of the expected target range…

  • Dave says:

    Hi gary
    This is great timing as i am in the process of researching with the goal to develop my own system. I am still lacking the knowledge and skills to do this so I will be following your blog in the coming weeks. I also think that I understand the mindset paradox you talk about so helpfully that helps.


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