Strategies vs. Systems (Part VI)

In Part V of this series (http://www.optionfanatic.com/2012/06/05/strategies-vs-systems-part-v/), I concluded some commentary on discretionary trading.  Today I want to provide some argument for algorithmic (also known as “rules-based” or “systematic”) trading.

Rules-based trading systems may be tested for statistical reliability.  Robust systems have proven themselves over extended periods of time and different market environments.  This leaves us confident about trading them into an unknown future.

Systematic trading eliminates decision making.  An oft-cited quote is “prepare for war in a time of peace.”  In the heat of battle, adrenaline kicks in.  Decisions are then motivated by survival rather than profit.  These are the times when psychic pain causes us to realize huge losses if only to sleep restfully at night.  This is not the road to consistent profits over time.

Systematic trading ensures consistent application of trading rules.  Rules without enforcement are trades without rules.  No longer are we then trading systematically and no longer does our historical backtesting apply.  Based on nothing concrete we are now gambling, not trading.

Systematic trading eliminates emotion.  We program entries and exits to ensure they occur reliably and according to plan.  One of the largest uncertainties of discretionary trading is our emotional reactions to pleasant or unpleasant situations.  Systematic trading removes this.

Finally, systematic trading provides continuous risk control.  Profit targets and stop-losses were determined through the rigorous system development process yielding potential results with which we feel comfortable.  Gone will be the days of “I’ll hold on just a little longer because I think this market is about to reverse.”  The trading platform will exit our trades automatically.

In my next post, I will address some potential downside to systematic trading.