As experienced traders know, markets are subject to drastic changes. I have seen industry mentors generally encouraging new traders to use technical analysis for over twenty years. However, in my opinion, this leads first-timers to think this is all you need to learn to trade profitably. Technical analysis alone has severe limitations.
Yes, you use graphical indicators to analyze price charts and make assumptions and hypotheses about future movements. And this analysis is key to having a foundation of knowledge about what the markets might do. But even with this data, you still need to make decisions about how you trade based on what you believe will happen. In this way, technical analysis is still subjective and should be approached cautiously.
So how do traders produce consistent results over time?
Numbers and Statistical Data Provide a Base of Knowledge
Instead of just analyzing the charts and making decisions based on what you think will happen, you can start to analyze the past historical data of markets and figure out how they behave statistically. In this way, we use numbers and objective data to make decisions rather than depending on the trader’s talent or feelings. This will enable you to identify the specific characteristics of each market more easily.
This method is referred to as systematic trading, and it entails trading efficiently by programming computer systems to place and manage trades. It is based on developing strategies by identifying and exploiting the specific characteristics of each market. Studying the past data can be done through backtesting, which is the core of the systematic trading approach.
Diversification is Key in Systematic Trading
Many investors build a collection of investments in different industries, countries, and markets to reduce risks. Having a diversified portfolio, nonetheless, is pointless without proper management. Simultaneously, handing over a hundred investment strategies, each having its specificities, is so challenging that slight mistakes can lead to severe losses.
A systematic trader can diversify and manage their strategies in a more efficient way because they are able to simulate and evaluate different scenarios in just a few minutes, which will indicate the potential results of a certain money management or risk profile before implementing it.
3 Reasons Systematic Traders Have an Advantage Over Other Traders
Now that we’ve covered the features and main characters of systematic trading, let’s explore three reasons why it’s a preferred way to trade.
- Traders Rely on Numbers and Statistical Data
Successful systematic traders have data covering over ten years, encapsulating all the various potential market phases including bearish, bullish, sideways, choppy, wild crashes, and others. Since strategies obviously behave differently in different market conditions, the best way to evaluate the efficacy of a strategy before live trading it is to test it in as many market phases as possible.
To do this, you need to gather a vast amount of reliable historic data in addition to making sure it covers many different phases so you can effectively evaluate the strategy in different scenarios.
- Traders Use Integrated Management Systems
Without appropriate software, the systematic trader cannot be successful. In my eyes, what constitutes the perfect software is an integrated management system that can include data feed with a broker in a single tool. The software must use an easy programming language with affordable monthly fees for real-time and historical data.
Since I have about 300 systems in my portfolio, I’ve developed proprietary software to manage them effectively and figure out which ones should be active and which ones should be paused or stopped. This allows me to analyze the performance of all my systems. The software automatically tells me, at regular intervals, which systems to activate and which ones to turn off.
- The Right Mindset
Most traders have what is called a discretionary approach. This means deciding what to invest in based on guesses or hypotheses deriving from chart analysis. The success of their decisions depends on their intuition, and oftentimes, just sheer luck. In contrast, a systematic trader pursues his goals by using a rational method, exploring all possible scenarios, and making decisions based on statistical data.
Systematic Trading is Measurable and Replicable
Another reason systematic traders find success in the long-term is that in addition to the historical data, they have their own method, which is measurable and replicable. Studying market behaviors and simulating different scenarios lets you identify not only the characteristics of a market (trend following, mean reverting) but also if there are certain times of the day or days of the week or periods of the year in which the prices have been affected.
All these elements can be explored and optimized using the trading software before live trading a strategy, so you can identify the most effective sets of rules. Remember, the less rules you use, and the simpler those rules are, the more stable your system will be. These are the methods I’ve used as a 4-time World Trading Cup Champion, and they are the reason I’ve been successful with an average yearly return of 20-30% in real life trading.
Written by Andrea Unger.
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