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Find God and the Devil in Trading Systems

by Ren Richardson

Curtis Faith, one of the original members of Richard Dennis’ famous Turtle traders, noted a quote from the prominent architect Mies van der Rohe when talking about the profitability of trading systems: “God is in the details.”When it comes to designing sound trading systems, God is in the details but his presence there does not preclude the devil from residing there as well. Many trading systems are created with a great deal of imagination, elegance, and theoretical grace but the only way to tell whether the details are divine or diabolical is through extensive and rigorous testing. In meticulous forward testing the grace of one’s trading system gets put to the test. The most creative plans become mere grist for the mill of the market. Whether theory translates into dependable performance is almost always a matter of details and the only way to cull God or the devil out of their hiding place is through experimentation.

Theoretical Trading vs. Empirical Trading

We have seen many situations in which the difference between stellar performance and steady bleeding literally came down to one line of code; where a fine system that performed beautifully in backtesting got annihilated in real trading while an ad hoc, cobbled-together system showed steady and consistent results; where systems that work superbly in one market get dismantled when applied to a similar but distinct market or when applied to a different time frame.That is part of the reason why we are suspicious of trading systems that are sold under the premise that they apply to all stocks, all markets, or all pairs. To be blunt, that kind of sales pitch can be nothing short of an admission that no real testing has been done on that system. It may be the most stylish and well-dressed system out there but even the best systems have their Achilles’ heels. For every great performing system, there is a market or a time frame that tends to pick it apart. Even if I have the Michael Jordan of trading systems, why force it to play in Madison Square Garden if I don’t have to? Each dollar used there is a dollar I could use in another arena that produces better results. So what does it tell us when a system is marketed for any instrument on any time frame? It should tell us that it is simply an academic system and is useful only for thinking about trading, not actual trading. It should tell us that it hasn’t been tested for trading, it has simply been designed for selling.Theoretical Trading: Exhibits conceptual returns and many idealized “what-if” scenarios (“you could realistically do 3% per month with a simple covered call strategy; imagine what 3% compounded over 10 years would do to your portfolio”).

Empirical Trading: Exhibits actual results from real market data. In order of increasing importance, results come from backtesting (strategy applied to historical data), forward testing (demo results in live market environment), and actual results (performance of strategy in live accounts).

Theoretical Trading: Assumes that uncertainty and ambiguity can be removed from the market by trading by its rules. Treats uncertainty as an enemy and feeds into the craven natural tendency to eschew all things unknown. Results are too clean, too mathematical.Empirical Trading: The unexpected regularly occurs, sometimes in your favor, sometimes against you. Results reveal the consequences of both. Good systems weigh the pros and cons of different methods of trading the randomness of the market. In the end, nothing is certain and nothing lasts forever. Great strategies will eventually wear out. But there will always be a place for innovation and new ideas. Embrace the sfumato. With most humans, ambiguity leads to anxiety. The market, however, is entirely ambiguous. Good traders embrace the ambiguity rather than running from it. Anxiety is the enemy.

Encyclopedic Training vs. Pragmatic Training

Even good training companies tend not to produce good traders. They have great training, just not great results. Why? Because they throw the book at you; actually, the whole series of them. You pay handsomely for tons of information and all of that information makes you a very knowledgeable freshman. You could pass all kinds of tests but you are still not a trader. The only way you are likely going to make money with all of that information is if there happened to be an appropriate category on Jeopardy! (“I’ll take ‘Markets and Economics’ for $400 Alex...”).Contrast the typical training programs out there with the successful programs that actually produce profitable traders. Both programs have drop outs. There is absolutely nothing wrong or shameful about not making it as a trader (and it may help you to see that there are far more useful and productive ways to employ your talents than by gaming the markets). What is shameful is having it in you to be a successful trader but going through the wrong training program. This is what we see happen to most promising traders. While any training program will have drop outs, the difference between the right kind of training and the wrong kind is simply in the end results of how they define success.

An encyclopedic training program will call you a graduate once you have passed certain levels in their program and you can show that you know how to do iron condors, that you understand descending wedge patterns, that you know what the ex-dividend date is, and can even talk a bit of trader lingo (“I saw the Cable go 6 wide so I knew something was coming and just hit the bid”). They consider you successful because you passed their program. You may know more than 99% of everyone else out there when it comes to the market. Congratulations.A real training program doesn’t consider you successful until you start making money consistently.

Almost every real training program trains you in specific strategies, sometimes just one strategy (like the Turtles). They teach you specific rules. They walk you through the details like trading platforms, execution issues, and so forth (there is a lot more of God and the devil in just those two issues than any guru-based training program would know to admit). They show you what markets are ideal for the strategies you will be trading. And, of course, they have a vested interest in your success. They put their best resources into your training and divulge years’ worth of strategy development and secrets so that you make money – because they will make money when you do.The business of a trader is to make money, not to know all there is to know about the market. If you want to become an encyclopedia of market knowledge, become an analyst, a commentator, or an economist. There you get paid to know more. Trading won’t pay you for knowing sundry facts and figures. Trading pays you for trading well.

In sum, training should be utilitarian. It should align the interests of the teacher and student. Education that merely accumulates knowledge is trivial. Good education should be transformational.