Trading systems: Buy or build?

December 31, 2009 06:00 PM

In broad terms, trading falls into one of two camps: systematic or discretionary. A discretionary approach welcomes personal judgment in individual trading decisions. Alternatively, a systematic approach involves conceptualizing, defining, writing and testing rules for entering and exiting trades, then consistently trading by those rules going forward.

Discretionary traders argue that past data were molded by unique micro- and macroeconomic forces and rigid rules based on that data ignore the fluidity of the markets. Systematic traders counter that, with care, even new traders can write rules that are robust enough to accommodate unseen market scenarios.

One of the strongest arguments for systematic trading, however, has to do with the trader, not the system — more precisely, the trader’s emotions.

“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,” says Rick Thachuk, president of the WLF Futures, Options and Forex Education Network.

Traders, particularly new traders who lack the experience of market moves and reactions, generally perform poorly when emotions come into play.

“[A] mechanical system executes without the immediate emotion that accompanies discretionary trading,” says Michael Gutmann, an independent systems trader. “That is not to say a mechanical system won’t generate lots of emotions from the trader who executes it — losing trades from a mechanical system are also difficult to swallow — but the immediate emotional reactivity of discretionary trading is eliminated.”

Once emotion is controlled, experts say, consistency can follow.

“Trading with discretionary logic is simply another way of saying ‘trading inconsistently,’ and this will produce volatile results,” says Paul King, owner of PMK Trading LLC. “Trading with a system implies one will always take the same actions under the same circumstances.”

Adds Thachuk: “A trading system will also, by construction, 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: You can develop your own trading system or you can buy one from a third-party developer.


The steps to building a viable trading system are beyond the scope of this article. However, you don’t need to understand the minutiae of systems development to consider the benefits of developing one.

The most important reason to build your own trading system is you will have full knowledge of when, why and how it trades, Thachuk says.

“Also, by developing a system yourself, you have complete control over the parameters of the system, such as the markets traded, time horizon, risk capital required, trading frequency and maximum drawdown to name a few,” he says.

King points to a number of reasons to build your own trading system:

• You can historically test performance under different market conditions.

• You know that there is no vagueness or fuzziness in your trading rules.

• With full knowledge of the system’s rules and trading tendencies, you will have the confidence to trade through the inevitable losing periods.

According to Gutmann, having built your own trading system, you also are more adept at modifying it when market conditions change.

“When a trader builds his own system, he knows why it performs as it does and can make adjustments — and adjustments are always needed,” Gutmann says. “If a system is purchased, then the adjustments may only be available at additional cost.”

Of course, building a trading system has its drawbacks as well. First, it’s not necessarily easy and can be mentally draining, often with little or no payback. Also, if you are going to build your own trading system, you do need some knowledge of how the markets work, and that takes time to learn as well.

“[A trading system you build] will be limited to your own trading knowledge,” Thachuk says. “For beginners, this could be a significant, binding constraint. [A] successful trading system will likely need to have an edge over other, competing systems. If you don’t believe that you can provide any edge, then it may be better to consider purchasing a trading system.”

Other arguments against building your own system are the cost of development software and data, as well as your own personal time and energy. Even simple systems can appear complex to the uninitiated (see “Inside systems,” right).

“Systems development can be very time consuming,” Gutmann says. “Making use of the latest software and systems can take a level of technical background that the average trader does not have.”


In general, there are two types of pre-packaged, commercially available trading systems: open systems and so-called “black-box” trading systems.

When a trader buys an open-trading system, they can see the logic behind entry and exit orders. That is, once you purchase the system, you can examine why it trades. In black-box systems, the logic is locked. These systems — or, more precisely, the developers of these systems — don’t reveal their trade-entry logic to the buyer. A black-box system will simply read current market data and report buy and sell orders as they happen.

“I would never recommend that anyone buy a black-box system,” says Murray A. Ruggiero Jr., vice president of research and development for TradersStudio and a contributing editor to Futures. “You want the logic fully discussed, so you can learn to understand it, even modify it and make it your own so you can feel good about trading it.”

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