Systematic Trading –
What Does That Mean for You?
by D.R. Barton, Jr.
This past weekend, I had the chance to meet some incredible new folks and also spend some time with old friends at the workshops in Raleigh,NC
And, we certainly had some very interesting discussions. One theme that kept re-appearing on the radar screen was the topic of systematic trading. It was clear from the heated debate that BELIEFS play a huge role in our understanding and implementation of systematic trading.
So I thought it would be helpful to share some useful beliefs about systematic trading that might guide expectations and actions as folks design and implement their trading strategies.
First of all – we need a working definition of systematic trading. My belief is that systematic trading is any trading strategy that follows a defined a set of rules. I can hear the cringes out there now, so bear with me while we explore some of the subsets of systematic trading.
Purely computerized trading. By way of definition, this is any strategy that can be programmed and executed via computer. For some diehard adherents, this is the only “true” systematic approach. But this is a very constrictive and less useful belief about systematic trading.
Mechanical trading. In this subset of systematic trading, the rules are completely mechanical (all decisions are either “yes or no”). But some of the rules may be difficult or impossible to program. In this style one may ask a question like, “Is there news on this stock?” or "Has Market Profile shown time/price contraction or a similar rule that is tough to program?" However, those questions can have a binary “yes or no” answer, making the system purely mechanical in both design and application.
Now we need to stop and add a definition -- one that makes mechanical traders wince. A rule can be a decision that requires trader input. And to be honest I know many more traders who have rule-based systems that aren’t purely mechanical than those that are (more on this next week).
What’s an example of a rule that isn’t mechanical? There are plenty. What is the current market sentiment? How is this sector doing compared to three others? How does this pattern compare to the last time I saw it?
Hybrid mechanical / rule-based trading. I added this category, which is a combination of mechanical rules and rules that require a trader’s input, because lots of traders use this style of systematic trading – more than any of the others.
Rule-based, non-mechanical trading. Here is the style where a trader follows rules, and follows them every time, but those rules aren’t a mechanical set. My belief is that most successful intuitive traders fit into this category. They have rules that they follow, but they just haven’t formalized them in a way that a linear/logical thinker would understand.
Next week, we’ll look at the pros and cons for each of these styles of systematic trading. Until then…