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Designing a trading methodology – Part 2Tools and resources

By February 11, 2010System Design, Uncategorized

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.


  • fastbucks says:

    I think you totally overestimate the time taken to develop a system. It is not the system which gets you the money. Its you and its your experience in the market so that you can understand what is happening and react accordingly.

    I can design a simple moving average system which works well. The trick is to get you to follow it, don’t second guess it etc etc. And also another trick is to find a style of trading you are comfortable with and are profitable in – everybody is different…

    I would suggest that the 2000 hrs is close though in terms of understanding how you react and being able to devise ways to enable you to do the right thing in trading. My current time investment would be around 2500 hrs…

  • Lew Rose says:

    I have invested in shares periodicaly since the 1980s and more seriously since 93.There is no LOCIC in the speulation of results.I have invested in Maquarie Office,stockland,Mirvac stb looking at lower returns but stability.I sure got lower returns but no stability-because the management of the Companies have borrowed from 30% to 70 % in order to get commisions.Now they are all in strife. I have bought RIO shares(CRA) in 1980s for $3 ea,when it went to $170 I did not sell because I figured they will be great value with the Chinese trade.Wrong.Since the Chinalco event they issued new shares for about $29 while on the market it was $59. I sold at $59 and received half at $29 but it did not drom to this level-it is getting close to $70. Where is the logic?

  • Gary Stone says:

    Response to Comment by “fastbucks”:

    “It is not the system which gets you the money.”

    It certainly is not the system on it’s own that gets you the money. The system provides you with the edge in which you trust and which you surrender to, so it is a necessary part of the formula for profits. But the executor needs to tune their mindset to engaging the market. I have written many blogs on both the edge and the necessary mindset to trade successfully.

    ” My current time investment would be around 2500 hrs… “

    I rest my case.


  • Bruce says:

    Good execution on your article, your ideas made good sense, along with some of the bloggs. I have built my own trading system ( 18 months work so far) as a support feature to help me with my own Trade assessments, tracking, & keeping historical details so it was with a great deal of interest to me that your article surfaced when it did. You opinion (as your opinion) was well received in this neck of the woods, thankyou.

    sincerely etc


  • Graham says:

    Would have to agree with Gary’s views. Most people who half-heartedly develop a “system” cannot have faith in it and will not follow it for long once their equity curve heads south. The whole internet-based trading culture sells the dream that trading is easy. It’s not, and that’s why a lot of people make more money selling the dream than actually trading profitably. Every successful trader has either devoted thousands of hours and energy to developing their own system, or trusts in someone else’s system.

  • P. Allan says:

    It sounds like too much hard work developing one’s own system.

    Which is why I prefer using an existing and proven trading system such as SPA3 Edge (via CBS Funds Management Ltd Intelledgence Australian Equity Fund)on the one hand and using trend following signals generated by market timers (like on the other.

    That gives me a comfortable balance between aggressive trading and conservative market timing without taking up a large chunk of my time. I’ll leave it to others to pursue the holy grail of a perfect trading or timing system since it doesn’t exist. Use what’s available to become a mechanical investor. It helps keep one’s emotions in check.

    What’s missing for most investors in not a better mouse trap, but a willingness to surrender one’s ego to an existing proven mechanical trading or timing system that will call the shots.

  • potla says:

    Good work, keep it up.

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