Trading Systems vs Systematic Trading

In recent years, computerized trading systems have become popular. They range from very simple to very complex, from inexpensive to costly. Such systems, it is claimed, are emotion-free and therefore not subject to the destructive influences of fear and greed. Most have been back-tested over many years’ data.

Computers are an important, perhaps vital, aid to trading. But there is no black-box trading system which will produce long-term, consistent profit.

Because markets are constantly changing, systems fail sooner or later. Markets are games in which the rules of play are freely and spontaneously created by the players. As the rules change, the nature of play changes. And change is constant.

Imagine a football game undergoing gradual transformation to a game of rugby, and then to a game of soccer. Someone trying to model the game would find it necessary constantly to recalibrate his model.

To work, systems require consistent, rule-governed behavior. But from bull to bear markets, from active to dull markets, what it takes to win is constantly changing. What works today may not work as well or at all tomorrow. Any system based on fixed rules will fail because it is static, but the market is not.

The premise of system builders and users is that markets are amenable to mathematical description, as are physical phenomena such as the diffusion of a gas or the cycles of planets. But the analogy is wrong. Markets are a form of human behavior, driven by human purposes, emotions, and needs. Markets are not fixed systems, but as elusive and adaptive as the humans who create them.

Buyers of systems are searching for one or both of two benefits: 1) quick profits without the drudge and expense of study and practice; and/or 2) protection against emotional trading decisions. Any mechanical trading system is a crutch, propping the trader against his own weaknesses. Such devices foster dependence. Those who rely on systems not only hinder their educations but also postpone the time when they will stand on their own feet.

Systems may model one aspect or another of market behavior, but the only computer capable of registering and processing the nuanced, many-faceted nature of any human activity is the one that sits between your shoulders. The single best system remains the well-tutored mind.

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