Building & Backtesting Trading Systems

Way of the Turtle

One of the books that had a powerful impact on my thoughts on trading and markets early in my career was Michael Covel’s Trend Following. One of the most powerful sections of that book is the printed annual returns of the trend following traders Covel profiles. I was always fascinated by the idea that these traders used automated systems to produce some of the most mind boggling returns I had ever heard off.

Covel’s Trend Following¬†was also my introduction to the legendary story of The Turtles, which he told the expanded version of in his book The Complete Turtle Trader. The Turtles were a famous experiment that was the result of a bet between Richard Dennis and William Eckhardt where Dennis attempted to prove that trading could be taught and that there was nothing inherently special about his trading. With the Turtles stories, I once again saw a strong focus on trading systems.

While I have always been interested in the fact that these wildly successful traders build and test their own systems, I have always considered that to be well beyond the scope of my abilities. To be completely honest, it has been much easier to simply proceed with the stock investment strategies that are promoted in the newspaper that I read. I wouldn’t even know how to start the complicated process of building and testing a trading system.

Here’s The Problem:

By strictly (sometimes) following the rules of someone else’s stock trading system, I have gone almost an entire year now without buying a stock that increased in price following my buy. Since I bought PCLN on February 14, 2012, I have lost money on ten straight trades.

I could argue that 2012 was a very choppy market that was very difficult to make money in. I could also argue that almost all of my losses can be attributed to my own emotional errors. I can (and have) very easily argue that the experience I gained from my 2012 trading will pay enormous dividends if I just stick to the system.

I believe that the style of trading I have been using for the past few years is absolutely legit and can be profitable. I know a number of traders who were very profitable in 2012 using very similar systems. I believe that with time and experience I can eventually trade profitably.

The Nagging Idea Of A System:

I just can’t seem to shake the idea of building and testing trading systems. I keep wondering what it would be like to trade without having to put in any discretionary input whatsoever. If emotions have been one of my biggest problems, why not check them at the door and try a completely systematic strategy?

With this nagging idea in my head and my disgust with my current track record, I decided to get curious. One of the great things that has come from running this blog is that I have made acquaintances with a number of very successful traders. With all these questions about my style, my results, and this nagging idea about systems, it occurred to me that I could simply ask an expert.

So I Did:

As simple as it sounds, this was revolutionary to me. I simply sent a message to a respected systems traders that asked “Where should I look to get started learnings about systems?” He recommended that I read Stan Weinstein’s Secrets For Profiting in Bull and Bear Markets and Curtis Faith’s Way Of The Turtle. Ironically, both of these books were already sitting on my bookshelf.

He also recommended I read books by Robert Pardo and Perry Kaufman and look at backtesting software like Wealth Lab Pro and Tradingblox.

Here it was. I have a starting point.

Evolution Or Timesuck?

The big question for me now is whether this curiosity is my evolution to the next level of trading or if I’m just wasting time that could be spent analyzing charts and breaking down my emotional decisions. I guess only time will tell.

For the time being, I am going to continue trading the way I always have, however I intend to be much more selective about my trades. Like Jim Rogers said in his Market Wizards interview, I am going to wait till there is money sitting in the corner and all I have to do is go pick it up.

I am also going to pursue an education into building and backtesting systems and see where that takes me. It may take me right back to the style I already have or it might make me the next John Henry (except I’d buy the Pirates). Either way it should make for an interesting blog.

I am also very curious as to what my readers think about trading systems. Is this worth exploring or am I just wasting all of our time?