42 CHAPTER ◆ 3 Overview of the Trading/Investment System Development Methodology
purpose of probationary trading is to allow the trader or money manager time to use the
trading tools and determine what additional reporting tools need to be built to properly
manage the embedded risks. Management tools should contain, for instance, displays of
underlying data for calculations and trade reports. At this point, the performance of the
trading/investment system will be similar to those of the final product.3.12. Gate 3 (Chapter 24)
As with Gates 1 and 2, Gate 3 has several questions the product team must answer before
proceeding to Stage 4. If the questions are answered to the satisfaction of the customer,
development will be allowed to proceed.
This gate will prevent development of the trading/investment system from moving
to the final stage until the required activities and deliverables have been completed in a
quality manner. Furthermore, at the gate meeting, management will chart the path ahead
by ensuring that plans and budgets have been made for the next stage. Approval at this
gate permits full investment and trading of the system.3.13. Manage Portfolio and Risk (Chapter 25)
Portfolios of securities and derivatives require constant monitoring and so successful
implementation of a trading/investment system necessitates that periodic reports be gen-
erated to show the performance of the working system. These reports will present the
portfolio statistics and performance metrics, risk calculations, and provide documenta-
tion of the attribution of gains and losses. Traders are notorious for turning off systems
right before they become profitable and leveraging up after positive statistical anomalies
with strong mean reversion, which is why SPC is a critical tool. Reports should present
a proper determination of the root causes of variation from the expected results, that
is, nonconformance, and an action plan to deal with those variations, that is, corrective
actions.3.13.1. Plan Performance and Risk Processes (Chapter 26)
Markets are stochastic and trading/investment system performance will be stochastic as
well. Stochastic processes should be measured and monitored by tools built for the pur-
pose. The product team, with risk management, must plan for a system of monitoring and
reporting portfolio statistics, performance metrics, and risk factors. Essentially, these risk
control techniques will help the team understand whether or not the system is working
within specifications and in conformance with the backtest and/or a benchmark.3.13.2. Define Performance Controls (Chapter 27)
To monitor a working system, automated processes should keep track of the system ’ s per-
formance metrics. These will be valuable when reevaluating the underlying premise for
the system relative to the performance experienced during backtesting.