Analysis: Trading Systems Buy Or Build?

JAMES T. HOLTER

In the world of trading, two approaches stand out as distinct camps: systematic and discretionary. A systematic approach involves conceptualizing, defining, writing, and testing rules for entering and exiting trades based on a defined set of parameters, whereas a discretionary approach relies heavily on personal judgment in individual trading decisions.

One of the most compelling arguments for systematic trading is that it allows traders to account for the underlying logic and principles that govern market behavior. By developing a trading system based on empirical evidence and rigorous testing, traders can minimize their reliance on emotions and make more informed decisions. According to Rick Thachuk, president of the WLF Futures, Options, and Forex Education Network, "The buy or sell signal of a trading system follows automatically from the enabling of a set of rules that is independent of the varying discretion and emotion of the trader."

However, developing a trading system can be a daunting task, especially for new traders. As Michael Gutmann, an independent systems trader, notes, "A mechanical system executes without the immediate emotion that accompanies discretionary trading." To overcome this hurdle, building one's own trading system is often considered the most viable option. By having full knowledge of when, why, and how a system trades, traders can make more informed decisions and minimize their reliance on emotions.

Moreover, building a trading system allows traders to test its performance under different market conditions, which can lead to better risk management and increased confidence in the system's efficacy. As Paul King, owner of PMK Trading LLC, notes, "A trading system will also follow obediently the established rules for risk management and limiting loss, rules that can be difficult to adhere to when trading by discretion, especially for beginners."

If you agree and wish to take advantage of the consistency and emotional control that trading systems offer, then you have at least two choices: developing your own trading system or buying one from a third-party developer. The benefits of building a trading system are multifaceted. First, it provides traders with full knowledge of when, why, and how their system trades, which can lead to increased confidence in the system's efficacy. Second, it allows for historical testing of performance under different market conditions, which can help identify areas for improvement.

Building a trading system also enables traders to develop and refine rules based on empirical evidence, rather than relying on intuition or emotions. According to Thachuk, "A trading system will also follow obediently the established rules for risk management and limiting loss, rules that can be difficult to adhere to when trading by discretion, especially for beginners." This level of control over one's own decision-making process is particularly valuable for new traders who lack experience in market moves and reactions.

However, building a trading system is not without its drawbacks. First, it requires significant time and effort to develop and refine the rules. Second, it can be mentally draining, as traders may experience frustration or disappointment when their system fails to execute as expected. As Gutmann notes, "When a trader builds his own system, he knows why it performs as it does and can make adjustments — and adjustments are always needed."

Ultimately, the choice between building one's own trading system or buying a third-party developer depends on individual preferences and circumstances. For traders who value the control and flexibility that comes with developing their own rules, building a system is a viable option. However, for those who prefer to rely on the expertise of others, purchasing a developed system can be a more attractive choice.

In conclusion, trading systems offer a unique combination of consistency, emotional control, and historical data that can enhance an investor's ability to make informed decisions. While building one's own system is not without its challenges, it provides traders with unparalleled knowledge and flexibility. As Thachuk so aptly puts it, "Trading with discretionary logic is simply another way of saying 'trading inconsistently,' and this will produce volatile results." By adopting a systematic approach to trading, investors can minimize their reliance on emotions and make more informed decisions.

1. Full knowledge of when, why, and how the system trades 2. Ability to test performance under different market conditions * 3. Increased confidence in the system's efficacy

Drawbacks of Building:

Time-consuming and effort-intensive process Mentally draining due to frustration or disappointment with failed systems

Benefits of Buying:

Easy access to pre-existing systems with built-in rules and features Potential for reduced emotional stress and increased consistency in trading decisions

Drawbacks of Buying:

Limited control over the system's parameters and decision-making process Dependence on third-party developers may lead to lack of customization and flexibility