eToro

What is a trading system?

This website’s name starts with trading systems.

So I thought I would make a short post about what is meant by a trading system if you are new to this type of idea.

I went to dictionary.com and there are 16 definitions for system. The closest one as far as trading systems are concerned is the fifth one:

5. any formulated, regular, or special method or plan of procedure: a system of marking, numbering, or measuring; a winning system at bridge.

It is interesting that the example that they took is a winning system at bridge, because this is exactly what trading systems are all about, winning.

The point is that a system is formulated, so composed of formulas. It is regular, which here means “characterized by fixed principle”. It is a method or plan of procedure or procedures. A trading system is exactly that, i.e. a system applied to making trading decisions.

In the trading world there are three approaches for trading:

  1. Discretionary trading: this is the main form of trading which relies on the belief of the trader; he has the discretion to buy or sell depending on what he thinks; he can base his decision on the news, macro-economic analysis, chart patterns, rumors, etc.
  2. Systematic trading: this form of trading uses trading systems to decide between buying and selling; the computer program is totally in charge of the decision process; such software can be the results of years of research.
  3. Semi-discretionary trading: this type of trading uses a trading system but the human trader can override the system and ultimately make the final decision.

Trading systems were developed to cope with the complexity of modern financial markets and to eliminate emotionality from trading. There are many biases ingrained in human traders, and these have been documented in depth by behavioral finance researchers.

One example is that humans tend to take their profits faster then they take their trading losses. This habit is unconscious but overwhelming in us humans. It is clear that over the long term this bias will be costly. On the other hand, it is possible to program a forex robot trading without this bias. And this is true for all kinds of other biases or traits.

Other reasons for using trading systems (trading bot or trading robots just means that the process is at or near 100% automated) is the speed of our markets; their width as some bots trading the stock market may review thousands of stocks simultaneously; and the repetitive nature of the required analysis.

Last but no least, the main reason for using trading systems is that it is possible to back-test them, i.e. to test their “simulated” performance in the past. So unlike discretionary traders who use their best guess of what the market will do, systematic traders believe in their ability to discover patterns with statistical robustness.

While researching for this post, I came across a similar concept which is a sports betting system. This system in particular has incredible accuracy in specific sports bets applied to NBA basketball and MLB baseball.

3 Responses to “What is a trading system?”

  1. Bertrand says:

    It is good to have a definition of a trading system for a newbie. Or even for more experienced people.
    I mean people throw names all over the place, and often they do not know what they are talking about. Thank you for the definition.

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