The Alchemist: Rules For A Trading System

Posted in Money Matters on September 11, 2003

The following is this week’s installment of The Alchemist, a column by Mensan Al Thomas, author of If It Doesn’t Go Up, Don’t Buy It. Click ‘Read More’ below for this week’s article, “Rules For A Trading System.”

The Alchemist: Rules For A Trading System

by Al Thomas



Before you buy or create any trading system there are
certain things you should know and the first one is about yourself. Can
you withstand pain? I mean the pain of losing money in a trade. Any good
trading system will have losses. Just because you paid big bucks for it
doesn’t mean you will profit all the time.


There isn’t any good system I have ever seen that makes more
than 50% winners, but the best systems always have an exit strategy that
will keep losses to a minimum. That is the first question you should
consider before you pay for it.


Before you start you must have enough capital to be able to
follow the buy signals as they develop. How much is that? Depending upon
the method you have chosen either one you have created or one you will
buy you must determine the worst case drawdown of funds. What is the
hypothetical biggest amount of money you will lose during a losing
period of several trades? If a worst case drawdown might be $5,000 you
had better start with $10,000.


There are systems you can buy for $99 and others that cost
more than $3,000 and many require a very sophisticated computer with
real-time data input. This is not cheap. Computers have taken over most
of the grunt work. Many of the cheapest systems will out perform the
expensive ones. I have looked at hundreds of trading methods over the
years and in my opinion the more complex the formulas the less chance it
will work. Also a good system will work in all markets without
optimization. I would avoid any system that says it must be optimized as
you will not know when to optimize until it is too late.


Don’t buy 2 systems and try to make them work together.
Stick with one and give it a fair trial by exactly following its rules
for at least 15 trades. Review each trade by going over the rules so you
will know why you made or lost money. You must keep scrupulous records
in the beginning until you understand the method completely. It is a
good idea to always review any losses.


You decide what percentage of your funds you will commit to
each trade. It might be 1%, 5% or 10%, whatever will fit the parameters
of the system.


There is no Holy Grail of trading. When I was a floor trader
on the exchange there were a thousand guys all trying to make money and
no two traded the same way. If the perfect system had been found they
would know about it.


The biggest monkey wrench in any system is you. Your ego
will do more damage to your trading than anything. There will be times
when you will know that the trade specified by the computer is wrong so
you won’t execute it and it will turn out to be a big winner. Other
times you will deviate and buy or sell something you shouldn’t. Another
loser.


Over time you will probably modify the method, but to be
successful you must stay with your basic rules.


Copyright Albert W. Thomas. All rights reserved. Author of “If It Doesn’t Go Up, Don’t Buy It!” www.mutualfundmagic.com. Comments to al@mutualfundmagic.com.