What are the Benefits of Systematic Trading?

Systematic trading has defined the way I trade and has brought me the great performance I enjoyed so far. The automated trading system that I developed is a product born out of my aspiration to trade systematically. In this post, I will describe some of the most significant benefits I experienced as well as some of its pitfalls.

Advantages

Takes away emotion in trading
One of the most significant advantages is that trading systematically helps remove emotion in the trading process. When real money is on the table, traders may be subjected to strong emotional bias. Emotions like fear and greed could cloud a trader's judgement in times when the market moves quickly or turns against them. This is where objective decision making in a clear state of mind is crucial. Otherwise, traders may find themselves exiting a winning position too early or holding a losing position too long.

By trading systematically, I already have the entry and exit rules clearly defined even before the trade is made. When the entry criteria is met, I will enter a position. Once the trade turns against me and hit my exit criteria, I will exit. No questions asked, no doubts, no checking on social media or newspaper to decide, even when everybody else is doing the opposite. The rules are very clear and they leave very little room for ambiguity. It allows me to approach trading in a very disciplined way. Here I use one of my previous (real) position to illustrate.

On 12th Oct 2016, I entered a position in 800 Super Holdings Limited (5TG.SI) at 0.815 when system confirmed the stock's uptrend. The rise was quite smooth sailing. The position was held for 9 months until 14th Jul 2017 when the trend started to reverse and was sold at 1.235 for a profit of 55.83% (incl dividend). This stock's bull run in fact coincided with the uncertainty period of the US 2016 election. If a trader was fearful and sold too early, he/she may have missed the full profit potential. If he/she sold too late, the price would have dropped further, reducing the profit. If he/she held on for too long, he/she would be left holding a mediocre stock which price whipsawed for the next half a year and missed out on opportunities in other stocks during the 2017Q4 bull run.

On a broader market perspective, trading systematically has protected my portfolio from the current market rout in February and March 2018. While many are calling to buy the dip, my SG portfolio is sitting on mostly cash (80-90%) throughout March 2018 and was cushioned from the market rout which was caused by the fear of trade war between US and China. In fact, the system has systematically predicted the risk of correction on 20th Jan 2018 (Check out this post https://diyquantfund.blogspot.com/2018/03/how-my-system-predicted-recent-downturn.html). As of this writing, S&P500 has dropped another 2% today, almost touching its 200MA. If I were to buy the dip as many have suggested, it would have been catching falling knives.

Can be backtested

Another great benefit of systematic trading is that it allows me to backtest my strategies to determine their potential. It allows me to try out a strategy without having real money at stake. And back testing can be done very quickly since it can be executed with a computer using a database of historical data. I am able to measure the profitability of the strategy, its risk and fine tune it according to my risk tolerance. 

Less effort to maintain

The hard work is to develop a profitable system or strategy. After that, it would be a boring daily routine of running the system to automatically analyse the market, manage risk and generate buy sell signals. Instead of spending valuable time researching the stock market, reading financial news and checking in on investment social medias, I have more free time to spend on other more important things like family, hobbies and educating my followers.

Disadvantages

Rigid
Trading systematically based on a set of rules could be seen as rigid and some may argue that it cannot adapt quickly to changes in the market environment (eg new normal). This can be rectified by updating the rules to take into consideration of the changes. However, there is also the risk of overfitting the system.

Testing Performance not guarantee of Future Performance
Performance result of a strategy based on backtesting will not be able to 100% guarantee its future performance as market environment may change, which may not be captured during the testing phase. Even so, it is still a good indication of the profitability of a system. If I find that a strategy is not giving much profit during backtest, I would not want to put it into live trading. This saves me a lot of time and money.


Above are some of the benefits and shortfalls of systematic trading. I must admit I could be a bit biased here since I am a systematic trader after all. However, the benefits that it brought me is genuine so far as reflected in my performance (https://diyquantfund.blogspot.com). In my next post, I shall talk about automatic trading and its benefits. Stay tuned.

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