Trading systems: Buy or build?

December 31, 2009 06:00 PM

However, the same experts who wouldn’t recommend a black-box system say that there are times an open-logic commercial system may make sense.

John Hill, president of Futures Truth Inc. in Hendersonville, N.C., has been independently testing and developing trading systems for decades. His company is best known for periodically publishing a table of independently tested third-party commercial trading systems (see “Futures Truth’s Top 10” ).

While Hill says there are caveats to buying a third-party trading system — he says he’s seen his share of suspect approaches — occasionally a viable commercial system does become available. He also says the question to buy or build doesn’t have to be an either/or decision.

“There’s nothing wrong with trying both approaches,” Hill says. “But if you’re going to buy one, you’ve got to be extremely careful that you deal with reputable vendors. There’s a lot of trash out there.

“We had a couple of those come through here last week,” he adds. “One was a guy who based the success of his system on the results of trading crude during the Gulf war (a one-off scenario that has little relevance going forward). And I had a guy present what we call the Will Rogers system: only buy stocks that go up. If they don’t go up, don’t buy them. What this cat was doing was looking at the close of the market, and if the stock went up, he had the system buy earlier in the day.”

However, there are lot of reputable vendors, Hill says. And many of them have developed solid trading systems that can form the core logic of a viable program.

“Some of these guys know what they’re doing,” Hill says. “If somebody has already invented the wheel, why reinvent it?”

One reason, some traders say, is because that wheel may not stand up to the road ahead, and if you don’t understand what you’ve gotten yourself into, then you can’t hope to fix it.

“What does the user do when the purchased system generates losing trades right out of the box?” Gutmann says. “Often, the new user gives up quickly, disgusted that they spent hard-earned money on something so opaque as an automated system whose inner workings they took for granted.”

Others see no value whatsoever in purchasing a third-party system, open or closed.

“There is no benefit that I can see,” King says. “If you have the skills to evaluate a ready-made system, then you have the skills to develop your own. Alternatively, just give your money to someone who already knows what they’re doing to manage.”


One of the most common arguments against commercial trading systems questions the rationale of the seller.

“It is difficult to understand why a developer would sell a system that generates profit rather than use it personally and exclusively,” Thachuck says.

Hill says that one reason to sell a trading system is something all traders should understand: to make money. It’s extremely unlikely that a commercially sold trading system could become so popular and widespread that it would invalidate the logic used in the system.

“If a small vendor sells his system, it’s not going to affect his trading one iota,” Hill says. “First of all, the effect on the market will be irrelevant. Second, most buyers will follow it for three months then get distracted and quit. Also, a lot of vendors simply don’t trade. There’s a tremendous knowledge gap between the ability to build a good trading system and make money in the market. Even the best developers can’t follow a system because of the emotions of fear and greed involved.”

Whether you have the discipline to stick to a defined set of rules is an important consideration if you are going to trade systematically, whether you buy or build. Trading systems require following all rules religiously. Successful system traders avoid the temptation of bypassing the rules, whether that comes in the form of holding a loser too long or being too quick to take profits. The beauty of trading systematically is that you have made those exit decisions beforehand based on strong research and statistical evidence, not in the heat of a fast market.

Some argue that the most important factor in how, or if, you trade systematically is you.

“If a person is going to build a system,” Hill says, “That person needs to be mathematically strong. They should be an entrepreneur type [who has] built their own business. A type-A personality [but also] patient.”

In addition, some market expertise is necessary, and that takes time to acquire. “The system developer should have good experience actually trading his or her target markets,” Gutmann says. “I don’t believe in development of trading systems by smart but inexperienced traders. The developer needs to have a good background in technical analysis, and this includes knowing what technical methods have been tried in the past so that previous systems are not simply recreated.”

King agrees: “If you just make it up as you go along, then you’re going to lose money competing against traders who have a complete, tested, and positive expectation trading method. If you can’t or don’t want to put the effort in to design, develop, and test your own trading system, then you can’t expect to be successful.”

James T. Holter works as technical editor and contributor at Futures.

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