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Feature Article

System Design: Why Having a System Matters

Two events jolted me with a keen insight into the trading world this past weekend.  And the insight came from two very different areas—competitive sports and movies.

Thrills and Agony

We live in a small and delightful university town (the home of the University of Delaware).  Their football team is ranked second in their national division right now and the town goes crazy over its team every Saturday.  The same can be said of Friday night high school football games and  Sunday afternoon professional games.  There’s a simple phenomenon plainly visible on these three days: Emotions run high.

The winning team and its supporters feel the “thrill of victory,” while the losing side suffers the “agony of defeat.”

In the last couple of weeks, I’ve witnessed both ends of this spectrum.  This past weekend, my favorite pro team won in overtime against an opponent that was much better on paper.  My college alma mater team also won, as did the team from where I earned my graduate degree.  On top of that, my kids’ high school team won as well.  What a victorious weekend for sports in the Barton household!

But just a few weeks ago, I felt the opposite end of the emotional spectrum when my college team suffered a heart breaking loss in the last minute.  I was devastated. 

These recent sporting ups and downs provided me a great insight about emotional reactions. At the time, the emotional wins felt very different from the emotional losses.  Looking back now with some objectivity, I can see that both reactions had one important similarity: both extremes made me feel alive—fully human.

Then, while watching the film The Last Samurai (for the third or fourth time) recently, I had a similar experience.  At various times the film generated feelings of exhilaration, disappointment, awe, sadness, contentment, anger and joy.

We enjoy films that bring out a wide range of emotions.  In fact, we pay good money to see them on the big screen or to rent them.  We pay even more money to attend sporting events, not knowing the outcome, but knowing that we’ll most likely be both disappointed and thrilled by our team at some time in the game or season.

I believe that this same phenomenon has a real impact on our trading and investing.  Many traders seek these same emotional extremes in their trading activities, whether they realize it on a conscious level or not.

Trading Systems Help Us Manage Emotions

More than a decade ago, Van introduced me to the concept of personal “parts.”  These parts, or roles, of our personality compete for attention and influence over our decision making.  For example, we may have a safety part, a joy seeking part, a big spender part, and a pleaser part, all acting—from their perspective—in our own best interest.  While perhaps this does not count as a clinically exact description of personality, it is a simple and useful model for non-academics.

In this model, it’s easy to imagine that one of our parts enjoys emotional extremes.  And from there it’s not a stretch to imagine this part of us wants to feel those emotional extremes when we trade: the exhilaration of winning or the disappointment of losing.  I could get philosophical here and dig into how our need to feel any emotion is not very discerning between these two extremes, but as many of you know, I’m much more practical than that!

So let’s talk for just a moment about emotions and trading at an applied psychology level.  You have probably heard “experts” say that we need to trade without emotion.  I believe, however, that that common recommendation is somewhat misguided.  As humans, we are going to feel emotions. Besides, trying to stifle emotions would actually be counter-productive for most people.  A more useful concept for traders would be to minimize the effect emotions have on our decision-making process.

If implemented properly, a systematic trading approach provides traders a decision-making process that can reduce or eliminate emotional distractions.  To make decisions in an objective manner, we need to provide a framework that covers all aspects of trading system. 

Here are the individual components that make up a full trading system:

  • Beliefs about the system.  This is the part of the system that tells us why the system works and has an edge in the first place.
  • Market conditions where the system performs at its best and worst.  Rather than view this as a subset of the system beliefs, it’s important enough to warrant its own heading.  A system that performs well in a bull market may fail in a sideways or bear market.    
  • Set-up.  This part of the system tells us that conditions are ready for a trade.
  • Entry.  The component of the system that tells us to pull the trigger now.
  • Stop loss.  The parameter specifies when to exit the trade if it moves against us.
  • Profit-taking exit.  How and when we exit profitable trades.
  • Position sizing strategies.  This almost can be another system in itself that answers the question, “How many units to trade?” 

Once we have all of these bases covered in a systematic plan, we can make objective decisions more easily at every point in the trading process.  There’s also a bonus for trading a system: we are free to feel our emotions during the trade as long as we follow the rules of the system.  Emotions can even be useful in the system design and development phase.  Trading those strategies that cause you to feel particularly good in the development stage can add to your confidence in following the rules once you are ready to trade it.

After researching top traders for years, Van has mastered the model for trading system design that includes all of the key psychological and technical components.  That will be the focus for three days at the upcoming How to Develop a Winning Trading System That Fits You Workshop. Attendees will study the individual system components and learn the system development process through an end-to-end hands-on workshop project. 

If you have some thoughts or feedback on using systems to manage emotions or about system design, I’d love to hear them.  Drop me a note at drbarton “at”  Until next week…

Great Trading,
D. R.

About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on and Financial Advisor magazine. You may contact D.R. at "drbarton" at "".

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Trading Tip

Professionalism in Trading

What does professionalism mean?  Who can call themselves a professional and why?  These may sound like abstract questions but their answers have everyday implications for doctors, lawyers and even traders. 

The topic is also an area that a number of academics have researched and tried to understand.  James Q. Wilson, a UCLA sociologist, has written extensively about bureaucracy and professionalism. He defines professionals as groups who receive important rewards from other members of their group, and have special membership criteria usually related to formal education. In addition, that group’s defined code of conduct is different from most of the population.

This raises the question about whether or not an individual trader can be professional in their trading performance without being a member of a professional group.

It seems clear to me that an individual trader does not meet the formal definition of a professional. Nevertheless, the qualities of professionalism can be adapted and used in your trading practice. You will benefit greatly from putting in effort toward professionalism.

Benefits of Professionalism 

We can identify the qualities of professional behavior and hold ourselves to that standard without being a formal member of a professional group.

These qualities have to do with a code of conduct, and the ways of knowing and learning about the professional domain. Professional qualities such as preparation, self-discipline, attention to detail, rigorous thinking, and a commitment to excellence clearly add value to our trading practice. 

One of the members of our trading mastermind observed that professionals identify a baseline of minimum acceptable performance that is not negotiable. For example, we may experience a string of five losses in a row in a trading system that is designed, tested and reliable at a 0.55 win rate. 

The minimum acceptable professional behavior is that we have thoroughly tested and prototyped the system, we understand the reliability and expected distribution of results, and we are trading it at an appropriate level of risk given the known performance parameters. Without these baseline behaviors, we are not trading in a professional manner. 

Because trading can be such a lonely job, having a traders' mastermind to help reinforce professional behavior is a major advantage. This is why I strongly recommend a traders' mastermind for every trader regardless of experience level. The positive reinforcement of effective group norms will help you in your darkest hour and keep you humble on what you think is your best day.

Limitations of Professionalism

While conventional wisdom advises traders to become more professional in their trading practice (professional behavior will help protect you against the kinds of emotional behavior that is your enemy as you struggle to compete for profits in the market), I would not say that this advice is always sound. In some circumstances, professional behavior can actually be detrimental to your trading performance. 

Commonly, a profession defines a paradigm of beliefs, theories and behaviors that should govern their domain of action, which collectively we might call doctrine.  This frequently leads to professional doctrine taking on a life of its own and failing to adapt to a dynamic world. 

Under these conditions, the doctrine can become an end to itself and the professional may lose sight of the doctrine’s original purpose as a source of authoritative advice and, instead, give it an aura of timeless truths. 

It was precisely this insight that led me to develop what is now one of my most reliable and productive systems.  This came about as a result of following the exact opposite of what could reasonably be called conventional wisdom. 

An Unconventional Trading System

I made a list of the top dozen or so beliefs about how the market works and how you should plan to make money in it. These were beliefs that could easily be found in any best-seller on personal finance and investing. I defined a new set of beliefs that were the exact opposite of each one of these and operationalized them in terms of screening criteria, technical analysis and so forth.

I constructed a system that, on the surface, violated every professional norm you could imagine. I then tested the system using back tests and forward tests in all kinds of market conditions and discovered that I had a robust strategy for short-term trading that was effective in most market conditions.

I never would have developed this system intentionally from these anti-beliefs. This simply started out as a thought experiment that turned out to have surprisingly good results.

This is the kind of the system that professional traders in a professional group with a professional doctrine would be very unlikely to discover as a direct consequence of the constraints of their professional approach, which—under most circumstances—is a positive thing.

Choose your beliefs carefully.

About the Author: Ken Long is a retired Lieutenant Colonel in the U.S. Army with a Master's Degree in Systems Management. He is a  doctoral candidate researching the management of uncertainty and an active trader. Ken is the founder of Tortoise Capital Management,, where he conducts market research and publishes a newsletter for his trading systems' signals.  He is a proud father of 3,  a husband, teacher, student and martial artist. The above article was reprinted from Ken's blog. Read more of Ken's essays at


Disclaimer »



Defining 1R Using Pips

Q: I am eagerly working through The Definitive Guide to Position Sizing. Unfortunately, I am having difficulty calculating 1R. I am a currency trader, so it seems to be easier for me to calculate everything in pips.
I do enough intraday-charting; I manually move my stop loss in order to protect at least 15 pips as soon as the trade turns positive. How do I calculate that?

Let's say my initial stop is 90 pips away, and my initial target is 120 pips away from the entry price. In a few hours my trade looks good, so I move my stop 15 pips above the entry price (worst-case scenario = plus 15 pips). Then, I eventually decide to close for a profit of 50 pips.
Now, the profit is clear, but what shall I consider as my stop loss, the initial one or the new one (which is the actual profit)?

A: 1R for a trade is always the amount that you put at risk initially in a trade—the distance from your entry price to your initial stop price. 

If your initial stop was 90 pips away from your entry price, then 1R = 90 pips.  If your target is 120 pips away from your entry, then you are looking at a +1.3R trade if the price gets to your target.  If you exit at your initial stop, then you will have a -1R trade.

Moving your stop to reduce your loss or lock in a profit does not affect your 1R but managing the trade and evaluating its results can all be done in terms of 1R.  When you move your stop to 15 pips above your break-even point, that would be a 0.17R trade if 1R = 90 pips.  Exiting with 50 pips of profit means you had a +0.55R trade, if 1R = 90 pips. 

Evaluate the trade in terms of your initial risk amount rather than where the stop was most recently set. 

—RJ Hixson 

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October 13, 2010 - Issue 496

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