The main benefits of using a Trading System are to:
• Remove emotion from the buy/sell/hold decision.
• Remove personal ego from the buy/sell/hold equation.
• Exclude outside influences and ‘noise’ from the buy/sell/hold decision.
• Achieve objectivity & consistency, trust and confidence, in the buy/hold/sell decision process.
• Overcome personal expectations of the market.
• Overcome human biases that are detrimental to profitable active investment.
• Improve size and consistency of returns from your investment in the stock market.
With a correctly designed trading system you know exactly what your entry and exit criteria are and you can enter the market with trust and confidence that the trade will either be profitable or limited to a small loss. The word ‘you’ is highlighted above because you and you alone are responsible for all decisions that are taken in the market. Your broker, friends and the market are certainly not responsible!!!
Using a trusted, robust and consistent trading system will make you objective about your buy and sell decisions. What is meant by objective? The dictionary definition of objectivity is ‘uninfluenced by emotion, surmise or personal prejudice’ and that is precisely what you want in your trading decisions!
Making emotional trading decisions is probably the biggest reason why investors make losses, particularly large losses, in the market. The two main emotions that cause inconsistent buy and sell decisions are greed and fear – greed to make more profit and fear of making less profit, a large loss, of being proven wrong about your trading decision, or of missing out on a handsomely profitable trade.
Often traders will stay with a losing trade because they want to prove that the trading decision they made was the right one. More often than not this egotistical action will lead to losses. Being right is very important to human beings. However, active investment is about making money not about being right. Active investors have to learn that money can be made in the market even when the active investor is wrong as much as 50% to 70% of the time.
Naive investors also act on outside influences that lead to emotional illogical actions. These influences, which we call ‘noise’, include: brokers, ‘friends’, newspapers, newsletters, TV, chat forums and so called ‘experts’ who often have opposing views on the market. These outside influences will often convince the uninformed investor to take a position in the market because he/she does not have a consistent set of criteria against which to check whether the position should be taken. As a result, every position will probably be entered for a different reason.
The uninformed investor has inconsistent buy/sell criteria on which they act. If you don’t have a system then it will be easy for outside influences to impose their objectives on you. These will be different every time and will almost definitely NOT be consistent with your objectives……they will be consistent with the objectives of the outside influences. Even if the outcome of inconsistent decision-making is profitable it will unlikely be possible to repeat the positive performance in the future.
Taking action on emotions or ego and reacting to outside influences all lead to unpredictability and inconsistency in the buy and sell decisions that over time will cause sporadic large loss trades that erode or eliminate profits and that cause severe market under performance. It is these ‘outlier’ negative trades that need to be eliminated from your portfolio.