While it appears I rehash this topic several times, it’s important to continually learn and expose oneself to new perspectives when one is involved in trading system development. For quants, this typically involves reading new research that seems to be coming out all the time. For fundamental traders, it involves learning about new ways to value companies and examining the strengths and weaknesses of the classical models. My systems are based on technical analysis, but I take ideas from the quant side and the fundamental side wherever I can to test on my own systems. More often than not, I find that these ideas either directly improve my systems or give me ideas for how to develop new filters or techniques on my own.
Now, back to the topic at hand. Neil Rosenthal at Futures Magazine has been running a series on trading system development, broken into three articles.
- Developing the market model and the basic automated system
- Risk management and profit management
- Money management (position sizing) and monte carlo analysis (test of system robustness)
I find it interesting that he struggles with the risk management and profit management side (aka managing stops and profit targets), as I have never been able to successfully implement these techniques without eviscerating my systems and dramatically degrading their risk/reward characteristics. I do not trade with stops or profit targets, and let the technical analysis tell me when to close a trade or reverse–this comes at the cost of volatility, but it also seems to make my systems more survivable across market conditions. That said, I continue to search for effective ways of implementing risk and profit management, as intuitively, successfully managing risk and profit would appear to be the definition of mastery of the market. That said, Rosenthal’s money management techniques yielded great results, so keep in mind that there are several ways to approach the risk management question.