Designing a trading methodology – Part 2Tools and resources

In last week’s blog we looked at the mindset required to begin designing and building your own trading system. This week we take a look at the tools and resources required to undertake the journey.

To design your own system with an ‘edge’ over the market certain basic resources will be required. These resources include tools, skills, people, time and money:

• A minimum of two to three years’ technical analysis knowledge is essential. You need this in order to be aware of technical concepts to research. You will need to start using and understanding charting software; do technical analysis courses to familiarise yourself with all forms of technical analysis and to discover what resonates with your personality and trading style; read everything you can on technical analysis; books, journals, magazines, on line articles, etc, etc.

• A research tool such as TradeStation, Trade Navigator, Wealth-Lab Developer or AmiBroker. (MetaStock on its own may not be sufficient for system development but there are complimentary tools such as TradeSim to assist MetaStock). Note that your research and system design software or program need not be the same technical analysis software program that you use to trade.

• Computer programming capability or access to someone who can program your ideas.

• Mathematics and statistics knowledge.

• Knowledge of system robustness metrics.

• Creativity and some knowledge or experience with the creative process (right brained capability). In essence, an ability to think ‘outside the square’.

• Logical thought patterns (left brained capability and hence in contrast to the above point). These allow you to keep the concepts and ideas ‘useable’ within the confines of the trading environment.

• Problem solving capability.

• Accurate historical data.

• Plenty of time. Allow a minimum of 2000 hours (= 1 person year of effort) but more like 4000 hours to specify, create, test and complete a system that is complete with entry and exit rules, risk management and money management.

• Mentors who understand the system design process so that you can ‘bounce’ results and ideas off them. And who you are prepared to listen to for advice and constructive criticism.

• Risk capital to test the system in a live trading environment to ensure that the system is practicable and that slippage is within the bounds of the tested parameters. Live testing will also help ensure that you haven’t ‘curved fitted’ the system design ideas to suit the historical data.

• Lastly and perhaps most importantly, the unending drive and desire to continue the process when the going gets tough (it’s tough throughout the entire process!) and you are at your wits’ end.

Besides the existence of the system design paradox (as discussed last week) when you look at the necessary resources required to design a system it is no wonder that so few complete the process

If you have no prior experience with computer programming or with the creative process add more time. If you don’t have easy access to accurate data or to mentors during the process, again add more time.

You might be thinking that these are serious resource requirements. You are right; they are. This is not a trivial process. Think of it as the preparation for a business career. What business career can you prepare for in less than a few years?

It is important to realise, too, that trying to design a system while holding down a job in a non-associated industry will prove very difficult because a degree of continuity is necessary as you plough through your research. The 2000 hours should, therefore, be as contiguous as possible.

As you improve as a system designer and roll your 2nd, 3rd and more systems off the production line, each system will incrementally build on previous experience and therefore will require less time to complete.

Do not attempt to make money out of incomplete research. Most start the process of system design and are not that serious about it or find it too tough to complete. Some may start the process merely because there are available inexpensive tools or their mate had a bash and recommended they try it—usually to justify the mate’s half-hearted attempt.

Either persevere to completion or seek another path such as acquisition of a system with an ‘edge’. Don’t trade your current work-in-progress research. Only trade completed systems and don’t let your work-in-progress research slip into your live system until the research is complete.

This is extremely important because when you trade an edge you need to execute it with consistency and a disciplined approach. Achieving consistency requires self trust, confidence and objectivity. At the time of execution you must be committed to the trade as signalled according to the rules of your system. If you attempt to trade a half completed edge, any deviation from the edge will leave you in a quandary—is this ‘normal’ deviation or is it a result of the incomplete system?

This will lead to doubt, lack of trust in the system and lack of confidence in your ability to execute. That in turn will lead to inconsistency and system development ‘on the go’ manifested through subjectively letting trades go (that typically soar), doing trades that are not signalled by the system (that typically plummet), exiting early from profitable trades (that typically rocket to record highs), or exiting early from trades in loss territory (that typically turn around into handsomely profitable trades). The financial and psychological effects of this will be disastrous.

Next week we will look at how to specify the objectives of the ‘edge’ you are designing into your trading system.