This week in the blog we are talking about part 2 of the system build. From the image above if you want to make it to the top of the pyramid you have to have a solid base underneath and as Qbert has taught us you need to be fleet of foot. This is also true in trading systems, you need a good base and you need to be able to adjust to get the maximum success from your system. That is where part 2 comes in, we need to decide what markets will be used for the system and what processes we need to put in place to make sure that we can execute the system in a manner that is consistent with successful principles.

In this section, I am not going to tell you what your system needs because I really have no way of knowing that information because it is not my system but what we will explore is what we need to think about in this part so that we have a complete framework for our system when we are done. This guide should help you think about your own system and whether it may be lacking something or whether some quality enhancements could be added to optimize the results of the system.

First up we need to figure out what market types are we going to trade in? You may ask yourself, “well can’t I trade my system in all markets?” I would say that this probably won’t work because of the nature of different types of markets, for example, the bond market might lend itself well to a trading system that has lengthy time in the trades taking advantage of longer-term trends but this may not lend itself well to a market like the options market where time can be a factor because of expiration issues? Another example might be your system works well in the stock market because it has minimal leverage attached to it but when it comes to the futures markets you may be risking too much because of the inherent leverage in that market? You see the parameters of the market can either fit with a system or make it virtually untradeable. This is our first task in part two, determine what markets we can use? We can ask ourselves more questions about the system itself, “does it follow trends?” or “is it a countertrend type of system?” How fast do the markets move and does this velocity help or hurt the system? An example of this might be an iron condor system where you are looking for sideways action and something that has swift large moves up and down may not work well. Once we have determined the market types we will use then we can look into the processes that we will use to transact this system.

The processes I am talking about are when the system is to be deployed? Is this a system that requires everyday attention or is it like a covered call system that requires a commitment on a less frequent basis? Does the system require frequent adjustments? How often do we require looking at the market to see if it is still in a state that works for our system? For example, if our system requires a consolidation trend then how often do we look at the trend to ensure that it is still in that trend. Also, does this system work in an environment that is not ideal and will we lose money in that environment or will the system just be less effective? We need to ask ourselves what can we do if this environment changes do we need to close trades or ride it out? Do we need to make adjustments to the trades in order to prevent big losses? Is our system designed to withstand certain deviations? For example, if we are using an iron condor type system, how wide are the wings and what to do we do if it reaches these outer points? You see the questions we are asking here is about the overall makeup of the system and not the mechanics of the system. A lot of people confuse the parameters of a system with the mechanics of the system and this can be detrimental. You see, we need to define the limits of the system and then put all the pieces together so that we can see if the system is still effective.

Once we have the markets defined and the procedures for deployment of the system then we need to look at how we keep the system running and procedures for tracking the system. We asked ourselves how often we need to look at the trend to determine if it remains viable to the system but what about tracking the system itself to make sure that is it still working and that we are still running it well and this is also an opportunity to see if improvements can be made. This is where we need to design a procedure to track the profits and losses of the system as well as the actual trades within the system so that they can be reviewed on a periodic basis to see if they will remain valid in the current market conditions.

I think you can see there are many things to think about before employing a specific trading system and this is not an exhaustive list but only a primer to get you thinking about all the aspects of the system before deciding if it is the right system. There is one other thing that I should have mentioned above when thinking about when to deploy a particular system, like a covered call or maybe a day trading system be sure to give some thought to whether this setup is congruent to your trading style. In my experience, some folks are built for the stresses of day trading and some are not and this should be considered before choosing the appropriate system for yourself.

This should give one lots to think about from a systems perspective and as I said this is not all-encompassing but it should kick start a conversation in your mind about what system is right for you and what that system will look like from a big picture standpoint. In next week’s blog, we will get down to the nitty-gritty and start looking at the mechanics of the system or you could call it the actual execution of the system. Parts two and three of a system will blend into one another and you will see more of this next week as we drill down further. We will tackle the specific steps to adjusting a system instead of the concepts of adjusting a system that we need to think about from above.

Until next week…. trade well!

Coach Holmes