Fully Mechanical System : Trading System

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The simplest answer to why a system must be mechanical is that you cannot test a discretionary system over historical data. It is impossible to forecast what market conditions you will face in future and how you will react to those conditions. Therefore, in this book, we will restrict ourselves to fully mechanical systems.

If you can define how you make discretionary decisions, then these rules could be formalized and tested. The process of formalization could itself provide many interesting ideas for further testing. Hence you are encouraged to move toward mechanical systems.

You are more likely to make consistent trading decisions if you use mechanical systems. The manner in which a mechanical system will process price data is predictable, and hence assures that you will make consistent trading decisions. However, there is no assurance that these logically consistent decisions will also be consistently profitable. Nor is there any assurance that these trading decisions will be implemented without modification by the trader.

Summary

This chapter developed a checklist for narrowing your trading beliefs. You should narrow your beliefs down to five or less to build effective trading systems around them.
This chapter also reviewed six major rules of the system design. A trading system with a positive expectation is likely to be profitable in the future. The number of rules in a system should be limited because increasing complexity often hurts performance. Relatively simple systems are likely to fare better in the future. The rules should be robust, so they will be profitable over long periods and over many markets. You should trade multiple contracts if possible because they allow you to make more profits when you are right. Risk control, money management, and portfolio design give you a smoother equity curve and are the keys to profitability. Lastly, a system should be mechanical to provide consistent, objective decision making. You should follow the six major rules to build superior systems that are consistent with your trading beliefs.

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