Systems Trading (part 9) By: Jake Bernstein www.trade-futures.com

A Rational Approach to System Development
I favor a rational approach to system development.  My rule of thumb is simple: your trading system should have no more than four to six variables.  You should search for the best combination of entry and exit variables as well as a reasonable combination of stop loss and trailing stop loss amounts.  But this is where optimization should end.  The more variables you build into the system, the less likely will be the future performance of the parameters.

Another aspect of system development relates to market personality; a topic that has received little attention by most traders and market analysts.  Rather than heavily optimizing a system, I recommend tailoring your system to the personality characteristics of the individual markets, provided that such characteristics exist and that they are sufficiently stable.  This is what I have done in developing WT.

Market Personalities and Indicator Lengths

We know from considerable experience that markets have their distinct personalities.  The “personality” of a market is a function of numerous variables which include the following:

•    The type of commodity
•    Weather factors that affect the commodity
•    Margin and tick value
•    Size of the contract
•    Market participants
•    Sensitivity to political events (domestic and internationally)
•    Perishability or storability of the commodity
•    Cash settlement or actual delivery
•    Warehouse procedures of the contract specifications and
•    Exchange at which the commodity is traded

Traders know, for example, that coffee futures have always been volatile.  The primary factors affecting this market have almost always been weather and politics.  Hence, coffee has been a volatile market, making some very large and wild swings over the years.  Coffee is a market that is known for its bad price fills on market orders.

Compare coffee futures to EuroDollar futures.  While coffee makes wide swings and trades only a moderate amount of volume (i.e., number of contracts), Euro Dollar futures trade a large amount of volume and are very stable, making only relatively small moves each day.  Hence, the technical indicator lengths used in developing a trading strategy for coffee must be necessarily different than the strategy and indicator length for Euro Dollar futures.

My systems taken the different market personalities into account in developing its methodology.  Every market was analyzed on several variables as follows:

•    Volatility
•    Consistency of moves
•    Speed of moves
•    Tick size relative to market swings
•    Margin and drawdown

A specific strategy was designed to maximize efficacy based on the above factors.  In other words, I found that the best way to trade gold is for longer term moves, while TBonds are best traded for shorter term moves and S & P for very short term moves.  These findings are reflected in the parameters for every market in the WT portfolios.

Part One, Part Two, Part Three, Part Four, Part Five, Part Six, Part Seven, Part Eight