Technical Trading Systems
■ (^) The trading costs associated with such an approach and whether they signifi-
cantly increase the minimum winning percentage required to maintain posi-
tive expectancy
■ (^) The kind of equity risk controls and money management style to be employed
■ (^) The type and degree of diversification intended and the amount of correlation
between markets during a collapse
■ (^) The optimization method to be employed for such a system
All of the issues listed above should be addressed effectively. One of the most
important elements to consider when designing trading systems is to account for
the various worst‐case scenarios that may unfold during a trade and the possible
solutions to help mitigate the risks associated with such occurrences.
29.2 Basic Components of a Trading System
A basic trading system consists primarily of:■ (^) Entry and exit setup rules and filters: The rules for participation should be simple
and straightforward to implement. Systems with too many complex rules for entry
and exit will make subsequent system optimizations more challenging. It would
be hard to pinpoint the issues causing a system to underperform when there are
too many rules and price filters being employed. Also, with too many filters and
rules of participation, there exists a real possibility of unintended curve fitting.
■ (^) Passive money management components: The trader should always backtest
the system to identify the most appropriate capital, risk, stop, and trade sizing
settings.
■ (^) Rules for dynamically managing a trade: The rules for managing open posi-
tions should also be objective and simple in order to allow for effective system
optimization.
■ (^) Equity risk controls: The trader may also employ various risk controls when
equity declines to specific levels within the system. For example, when equity
declines by 30 percent, the trader may simultaneously halve the position size
and double the stopsize of all subsequent trades. This will maintain the origi-
nal maximum percentage risk associated with each trade and will also allow
the trader to gauge if the system is being swamped by market noise. If equity
continues to decline by more than 50 percent, the trader may opt to halve the
position size and double the stopsize one more time. Should equity rise back
above the threshold levels, these equity controls may be abandoned with the
system resuming its original position size and stopsize. In addition, the use of
equity curve management is critical to successful trade performance.
29.3 System Testing and Optimization
One of the main objectives of the test and development process is to optimize
the trading system. Optimization simply means finding a set of conditions that