The Secret of Systems Trading

'The REAL Secret of Systems Trading' - Part 2

The Evolution of Systems Trading

- a Short History

Systems Trading is the method used by the winning traders. It has evolved over the last century to the point where today nearly all the profit made in the futures markets is taken by systems traders. These are professionals and amount to only a small percentage of those who trade the commodity markets.

With hindsight, it's easy to see why this small minority would turn out to be the sole beneficiaries of the progress made in systems trading. After all, they have done the work to get systems trading where it is, so they have reaped the rewards.

That does not mean things will remain as they are.

It will help anyone wishing to become a successful systems trader to take a look at the major landmarks in its evolution.

Way back when …

Delving into trading history and the beginnings of systems trading in the 1920s, Jesse Livermore’s most important advice in the classic book, ‘Reminiscences of a Stock Operator’ was to use a system and stick to it. Thus the First Commandment of successful commodity trading was identified.

But was he really a systems trader? The definition of a systems trader is one who fully delegates his trading system for running on a machine without interference. So clearly Jesse Livermore was not even close to being what would be regarded as a system trader these days.

But things were different then. Nobody was a system trader because there were no machines that could have been used to live up to what was needed for that ‘non-interfering’ method to be possible.

Even so Jesse Livermore was well ahead of the rest in recognizing the ‘First Commandment’.

In the 1920s communication was slow and markets were not as reactive as they are these days. Opportunities for arbitrage were greater since it took much longer for information to permeate so that markets could adjust. It was perhaps even harder then for the majority to ‘keep up with the play’ because individual opportunities were more uneven and those in privileged positions could exploit this.

Compared to today, everything was slow and easy and computers were a very long way off.

Traders had their ideas for trying to outwit the markets, which were usually not too successful. Economic forecasts and weather forecasts were painted into the reckoning of what the markets were expected to do. Rumour and superstition held sway. In these circumstances, folklore grows and voodoo becomes respectable. Information and misinformation thrive alongside each other.

You can imagine that in those times every trader would swear to having a system and to sticking to it but you could also be pretty certain that none of them had or did anything of the sort. The possibility of ‘following a system’ in the manner it is meant today was out of the question.

Just like today, there were those private individuals who wanted to trade some of their capital but did not want to trade for a living.

Not a great deal would change until after World War II.

The computers are here …

The landmark of the 1950s was the arrival of the electronic computer on the commercial scene. That did begin to wake things up. The effect was slow at first because computers were such expensive and fearsomely difficult beasts to use but in time they became somewhat less difficult to manage and a lot less expensive.

During the 1960s, new pioneer system traders began to appear. These were people who could appreciate the power being delivered by computers and the implications of their speed and accuracy when applied to trading. The speed of the early computers was phenomenal compared to anything seen previously, although now you would laugh at the figures in comparison with those of a modern laptop.

To be fair, the old computer set-ups delivered a much greater proportion of their power to the user than today’s machines do – but this was in exchange for the almost total lack of software and the viciously unfriendly human interface.

Pioneer system traders …

There will always be pioneers prepared to sacrifice their time and resources working on projects that fire their enthusiasm but might not come to fruition. These people are entitled to extra reward if their ideas work out. Ed Seykota was not someone to be put off by having to cope with hole punched cards and the like.

As the transition to systems trading progressed throughout the 1970s, many professional traders would elect to remain in their cosy circle of discretionary traders but most would grasp the opportunities offered by these new machines and form the new circle of system traders. We are not talking of desk top computers but monsters needing space of ‘conference room’ dimensions plus considerable extra area for air conditioning equipment.

Exploited …

The commodities markets in this 1970s era were no place for the private individual to be trading and he would have been well advised to put his money elsewhere. But oblivious to his disadvantages against the professionals, he was taken in by stories circulating about commodity trading and the large sums of money that could be made – by some.

These stories were spread by opportunists on the ‘fringes’ of the trading business. They were not traders and knew nothing about trading. They were clever at selling rules for curve fitted systems that would have made large gains in this or that market if you had only done this or that. Keen newcomers bought these systems, lost their money and moved away, to be replaced by another stream of enthusiasts.

Now there are Turtles! …

While all this was going on and the years were ticking by, systems trading was establishing itself more firmly. In 1978, the great Richard Dennis moved out of the trading pit to become a desk trader. While developing new ideas for systematic trading, he formed the opinion that his method of trading (a highly successful one if results are anything to go by!) could be taught.

You may know the story of how he proved this point to his dissenting partner by recruiting the ‘Original Turtles’ in 1984. These were a bunch of bright trainees who were given a crash course in trading ‘a la Richard Dennis’ and let loose to see what they could achieve. They did frighteningly well. Richard Dennis proved beyond all doubt the falsity of the argument that traders are born not made. Yes, he could teach successful system trading without a doubt.

The ‘rules’ that the Turtles used as a basis for their trading became very well known, although these were by no means the only rules that were used - and Richard Dennis’s own preferences were more varied. The major point was that systems trading was being performed – methodical trading plus the First Commandment that Jesse Livermore had cottoned onto all those years previously.

Interestingly, markets change over time and adjust to systems being traded on them. There are some Original Turtles who believe they would not be able to make money these days with those old Turtle rules.

Miniaturization and the PC …

Other things that would prove to be immensely important to system trading were also happening as the years slid by. Moore ’s law was being confirmed in practice. This law states that the number of transistors that can be got onto a computer chip will double about every 18 months.

So when IBM released their first PC ‘as we know it’ in 1984 a lot of progress had been made with computers in terms of size, power and cost. The little PC sat on your desk and did not need an air conditioning room the size of a garage to keep it cool. Since 1970, using Moore ’s Law, the number of transistors that would fit on a chip had been increased by 2 to the power 9 which is 512 times. That multiple explains how a tiny computer could be produced with such low heat output and low cost. But compared with today’s PCs it was enormously expensive - $4,000 was a lot of money in 1984.

The Turtles were doing well in 1984 and continued to do so afterwards. Systems trading was being put on an ever firmer knowledge and experience base. But the individual trader was not part of the show. Would he ever be?

As the decade wore on, the PC developed rapidly on all fronts – there was even some software coming along! By 1990 Microsoft Office Products appeared. Referring back to Moore ’s law we could now get 8,192 times as many transistors on a chip as we could in 1970.

Where would systems trading go from here? One thing was certain – things were getting much easier for the professional systems traders. Fast computers were wanted to test their ideas and help them develop not only more sophisticated methods but simpler methods too.

Still on the sidelines? …

The private individual wishing to trade commodities was still where he had always been – and better advised not to trade against the professionals. By this time there is even more bad material being offered to these traders. Curve fitted system results are still being peddled and outright nonsense material is plentiful.

In the absence of professional quality software, otherwise respectable products suitable for price charting, are misapplied as substitutes for trading software. This can lead nowhere good. It is as if, in desperation, some private individuals are telling themselves “even if I’m not trading the right way, at least I can look as if I am.”

Was that a revolution? …

The wonderful pace of technological progress can only be fully appreciated retrospectively. We now understand how important the World Wide Web was, invented by Tim Berners Lee in 1991. We also realize how vital was the ‘on-line’ revolution that was completed with the arrival of fast modems the following year, 1992. Then there was the advent of the Great Search Engines culminating with Google in 1998.

All of these developments make it easy for traders to obtain price information and deal on-line.

By now, our good old Moore’s law multiple has grown to 2 to the power 19 which means we can get 524,288 times as many transistors on a chip as we could in 1970! The systems traders are delighted because they can develop even better methods and software with this ever expanding ‘cost free’ improvement.

The professional system traders are now taking all the profits from the futures markets.

At last – a glimmer of hope …

In 2003 there is a landmark occurrence, when the VeriTrader trading and testing harness is released for public sale. This is software of the highest professional quality. Private traders can obtain software suitable for commodity trading – at last!

Moore ’s Law is going wild, we now have a multiple of over 4 million on the increase in chip power and small computers are phenomenally potent. Massive performance improvements are just what systems traders need. VeriTrader can perform tests of staggering size in seconds.

Here it is - the last link in the chain …

2003 Curtis Faith and David Bromley introduce the Advantage-YOU Trading Workshop.

Perhaps surprisingly, some professional traders welcome the idea that those who do not trade for a living should be able to trade the commodities markets with the same tools and the same opportunities as the professionals.

Through this hands-on event, eager private individuals are exposed to how professional system traders generate ideas for trading systems and evaluate them for profit potential and robustness. The workshop format is well received but limited in its scope to disseminate its message to more than a few keen traders at a time.

Tomorrow I’ll explain how you can use
what you've learned about the winning traders to
launch your trading career with a head-start

Please feel free to comment on any trading issue, I'll be pleased to hear from you.

Sincerely,

David Bromley.

P.S. – If you're in a hurry, you can see what I'm about to explain tomorrow by clicking How to Profit From What the Trading Pioneers Discovered.

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'The Secret of Systems Trading' - Part 1
'The Secret of Systems Trading' - Part 2
'The Secret of Systems Trading' - Part 3

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