How to design your very own trading system
Making a long term profitable automated trading system is very time consuming, testing and difficult feat to accomplish. If it was easy everyone would do it right? When you look online at the people and companies who attempt to design a profitable automated trading system, you will find that most of them don’t have a mechanical, well-thought approach to system design.
The final product is usually based on an initial “thought” based on repetitive and almost constant modifications to eliminate short term draw down periods which are natural to long term profitable systems. They also hold extremely unrealistic expectations of their automated trading system. These people never make it and usually give up with their trading system before they had the chance to make a return.
In the end, the result is a set of dangerous systems, usually without even accurate simulations abilities that will put their account equity at very high risk of a long term total loss.
Today I want to focus briefly on the steps to designing your very own automated trading system. You may think I am crazy for doing this considering this is what we do for a living; however I know some of you are wondering how we go about designing our automated trading strategies so it’s only fair I give some valuable information.
Our automated trading is designed around sound principles and the ability to profit long term. Our trading systems are not your make a million on 6 days auto robots you see advertised all over the internet, which usually always end in disaster. Our automated trading systems make consistent long term profits, and a realistic percentage return on your trading capital with small realistic drawdown figures.
So where do we start?
To begin there are many ways in which designing a successful trading system can be approached. I am going to discuss the way we go about ours, because it has worked for us. Our approach has led to the generation of many long term profitable automated trading systems. You can model the basics of our development process to make your very own trading system. By no means are we perfect and we are always learning new ways to improve, however this gives you a solid base and a starting point.
What are the necessary steps to successful automated trading system development?
Firstly we look at the entry logic. Over time and experience in trading will show you certain patterns in the market that are very repetitive. Professional day traders know this and exploit these trading patterns every single day. We begin by coding these repetitious patterns and look at our mathematical back testing expectancy. We look to see without adding anything on the exit criteria side of things if the automated trading system has potential. We also look to determine the correct time frame during this stage of development.
If the particular entry criteria has merit and looks from back testing and visual confirmation as if it can produce a long term profit, we will then look to add our exit criteria coding around this. The reason we do this is we don’t want to form fit or over optimize our trading approach around several settings. At this point we want to keep it as minimal as possible. If during this step we cannot produce positive results we will either look at other entry criteria or modify slightly the one we have. At this point also we may experiment with different time frames and other tradeable markets.
Most people would be surprised at how little importance the entry logic actually has on developing an automated trading system. The problem with most to try to develop their own automated trading system is they put nearly all their effort into finding the perfect entry with no drawdown on their position. This will never give the system the ability to actually be profitable in the long term.
After we have determined an entry that shows potential we will now move onto the exit criteria and money management. Money management is truly the most important part of developing an automated trading system. If we were to break it down I would put 20% on the entry and 80% on the exit. It really is that important. We look for which time frame and which exit method is going to work best with our market of choice. We adjust trailing stop losses and profit targets being very careful not to over optimize settings to “fit” past data. We want to allow our automated trading system to profit effectively without a great deal of drawdown.
At this stage we may look to add filters to complement our money management. These filters will tell our trading system when to stay out of the market and when not to take a trade. They will also confirm when to take a trade. We only use very basic filters, mainly volume and trading various levels.
We then step up the intensity of our back testing. There are several areas we look at from the back testing. We want our automated trading system to have a favourable profit potential for the trading account size we want to trade. Most importantly to achieve this we look at the drawdown over a long period of time. A trading system that shows 10 thousand in profit is useless if at some point the drawdown is 12 thousand. The number we like to see is drawdown should not reflect more than 20% of the profit potential. This is the figure we feel comfortable with.
Once we are at this step we commence forward testing. We let the automated trading system trade in the real market, in simulation. Our main focus during this testing time is to see that our entries and exits reflect closely to our back testing results. If they don’t back to the drawing board and we make some adjustments. If they do reflect back testing we will look to run a large sample of simulation trades to have confirmation of our results.
If all the above is positive we then trade a small account with our automated trading system to confirm that simulation trades now reflect live trades with real money.
At the end of the day designing an automated trading system is extremely difficult and takes hours of hard work, number crunching, testing and looking through trade by trade of many weeks of figures. If you have the time and willing to put in some hard yards designing your own automated trading system is achievable. Alternatively you could look at our systems which have been proven by hundreds of clients as being effective, long term strategies. We focus on long term success and not short term excitement. You should also.