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Types of Trading Systems
We classify all trading/investment systems into one of three broad categories—trigger
systems, filter systems, and signal strength systems. (Our methodology is flexible so that
it can be applied to any system.) Most often, of course, trading/investment systems do
not fit neatly into one category. The lines are not black and white; they are varying shades
of gray.
For example, an index volatility dispersion trading system could be classified under
any of the three. First, trading index options against options on the constituent stocks
when the valuations are different for a basket of options versus the index is what we
call a trigger, or valuation, trade. Second, trading index options against a basket of stock
options with implied volatility in the 80th percentile and historical volatility in the 20th
percentile ahead, we call a filter trade. Third, trading the index options against an opti-
mized basket of constituent options based upon qualitative or quantitative factors, we call
a signal strength, or multifactor, trade.
The nature of any given trading/investment systems will determine the performance
metrics evaluated over the course of K | V Stages 1, 2, and 3 and performance monitoring
and risk management techniques employed in K | V Stage 4.5.1. Trigger Systems
Trigger trading systems are those where an opening position is taken upon the occurrence
of a trigger, and furthermore, that a closing trade is entered once another trigger occurs.
A good example of a trigger trading system is one built on technical indicators. In such a
system, a technical indicator signals the opening and closing trades, which are dependent
only on the instrument itself, and not on other instruments, positions, or market condi-
tions. Technical systems can range from a very simple moving average crossover sys-
tem to very complex high frequency trading systems. We also consider market making
systems to be trigger trading systems. Whatever the case, the concept is always thus, an
event occurs and a trade or position is taken.
A portfolio of instruments could consist of many independent positions, a position in
one not being influenced by a position in another. Such a portfolio may become heavily
weighted in a single direction either long or short, and traders commonly place restrictions,CHAPTER ◆ 5