What is Systematic Trading?

Definition of Systematic Trading
Wikipedia defined Systematic trading (also known as mechanical trading) as a style of trading that defines trade goals, risk controls and rules to make investment and trading decisions in a methodical way. It essentially means trading based on a predefined set of rules. This set of rules governs (either fully or partially) the trade entry conditions, management and exits. They could be based on technical, fundamental or quantitative strategies or a mix of any. Hence systematic trading is not only meant for technical traders or quants as most commonly known. A fundamental investor could be systematic too. In addition, systematic trading could be executed manually as well as automatically as long as it follows a predefined set of rules.



Trend following in a systematic way
Many strategy can be implemented in a systematic way as long as it can be quantified, which means it can be written down as a set of rules (possibly without any ambiguity). One such strategy is trend following. A significant part of my trading algorithm is based on trend following (Check out my post on trend following at https://diyquantfund.blogspot.com/2018/01/diyquant-trend-following-keep-winners.html). Trend following is a trading strategy that attempts to capture gains through the analysis of an asset's momentum in a particular direction. Trend following can be executed in a discretionary or systematic way. In the systematic approach, a set of rules are predefined to identify a trend, determine the entry point as well as the exit point.

A famous example of systematic trend following is the turtle breakout system. In 1983, legendary commodity traders Richard Dennis and William Eckhardt held the turtle experiment to prove that anyone could be taught to trade. The 'turtles' (referring to their disciples) were taught how to implement a trend-following strategy. A very specific set of rules were imparted to them and they were instructed to follow them closely in their trading. This is a characteristic of systematic trading.

Rules are NOT meant to be broken
I attribute a great part of my success in trading so far to the fact that I was able to consistently follow a set of rules in making my trading decisions (Check out my results on the main page at https://diyquantfund.blogspot.com). This set of rules governs my entry, risk management and exit of trades irregardless of the current market condition. Even if it does not make sense at times. I do have people ridicule my trading decision once in a while. Take the recent case of market downturn in Feb 2018. On 21st Jan 2018, based on the result from the data analysed by my system, I made the call about the high risk of correction. I was met with skepticism as many still believed that the bull run will persist. Well you already know what happened next, I shall not repeat that again here but you can check out my prediction at https://diyquantfund.blogspot.com/2018/03/how-my-system-predicted-recent-downturn.html. These set of rules that my trading based upon has been back-tested and forward-tested to have an edge. Breaking the rules is as good as going back to square one, which is not having a system in the first place. To change the rules would require rigorous testing to determine its usefulness if possible in all kinds of market conditions.

More trades brings out the edge
Systematic traders tend to trade more frequently. One of the reasons is because in order to 'realize' the edge in their strategy (assuming the strategy has an edge in the first place), they need to have many trades to reach a big enough sample size in order to properly measure the expected return. Profiting by just having a few trades are considered lucky win (or beginner's luck). On the other hand, discarding a system after having a losing streak of a few trades is not wise.

Easier to Automate
As systematic trading rules can be very specific and quantifiable, it makes it easier to automate.
Automating the execution of trading rules brings one's trading potential to an even greater level due to the ability of computers to process large amount of information and make objective decisions at lightning speed. I shall leave automatic trading to another future post.

From the above write-up, I hope you get an idea what is systematic trading all about. In the next post, I am going to share with you what are the advantages and disadvantages of systematic trading and how it has benefited me so far. One of the greatest benefits is it removes emotions from my trading decisions. Stay tuned. And do give me a in my Facebook page if you find this article helpful.

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