Trading Systems Pros and Cons

Trading Systems Pros and Cons

Even God cannot change the past.

AGATHON

In my years of trading, I have met essentially four types of traders: the purely technical trader, the purely fundamental trader, the techno-fundamental trader, and the intuitive, seat-of-the-pants, guts-and-glory trader.

The Purely Technical Trader

Although there are relatively few traders who are pure market technicians, there is much to be said in favor of such an approach. But being a pure technician should not be taken as synonymous with being a disciplined trader. Yet the technical approach, as long as it is not subject to interpretation, can be very helpful in the formula for successful trading.

The purely technical trader is more concerned with analysis and the realities of his or her technical indicators than in the news backdrop, the ramifications of politics on the markets, or the emotion of traders (unless these can all be quantified and expressed as indicators). While many traders fancy themselves to be pure technicians, they are, in fact, not as pure as they may imagine themselves to be.

They allow subtle external influences to creep into their decision-making process in spite of their supposedly technical bent.

The good news for market technicians is that they are apt to be more disciplined and less subject to the emotional reactions that are often associated with losses in trading. By remaining focused on their indicators, they will be less apt to respond to situations emotionally and, therefore, more likely to trade mechanical systems with strict discipline. Hence, the benefits of being a pure technician are as follows:

• Clearly defined rules for market entry and exit
• Specific rules for exiting losing trades
• Less likelihood of riding losses beyond their dictated exit points
• Greater likelihood of maximizing profits by not exiting too soon

Are there any cons to the use of a purely technical approach? Some traders would have us believe that being a purely technical trader ignores the realities of the marketplace. They claim that international and domestic events can, and do, have a major impact on price trends and patterns. Hence, they claim that the technical trader is like an ostrich with its head in the sand. The technical trader would retort by stating that a good technical system will anticipate major events, allowing the trader to enter before they occur or, at the worst, shortly after they begin. On the other hand, the retort to this claim is that some events, such as catastrophic weather or assassinations, cannot be predicted. The technician would reply that in such cases, which are few and far between, the system would protect the trader by taking a loss. Hence, risk management "saves" the system trader when the trading method is surprised by unexpected events.

The Purely Fundamental Trader

This type of trader is a rarer breed than the purely technical trader. Why is this so? The simple fact is that fundamentals are much more difficult to understand and to find than are technical. Frequently, only a few insiders who are able to act on their knowledge well before the majority of traders have the news know the fundamental changes and conditions that precede or cause major market moves.

Furthermore, once a trader has the relevant fundamentals, they must be interpreted. Interpretation of fundamentals varies from one individual to the next. A given set of statistics might mean one thing to one trader but an entirely different thing to another trader. All too often the interpretation of fundamentals is a function of one's position. A fundamental trader with a long position will, therefore, be more apt to interpret a bearish report as bullish, while a fundamental trader with a short position will be more apt to interpret a bullish report as bearish. "Talking one's position," as this is called, is not unique to fundamental traders, but it is more common, since fundamentals are subject to considerably more interpretation than are technical.

The benefits of being a purely fundamental trader are as follows:

• You will always have a reason or justification for your trade.
• Your trades will always make sense.
• If your analysis of the fundamentals is correct, then you'll catch the major moves.
• When the fundamentals change, you will be able to change your position.

Of course, all of the above are predicated on the availability of fundamental information and on its correct interpretation once it has become available.

The Techno-Fundamental Trader

This group of market participants is larger than either the pure technician or the pure fundamentalist groups. As its name indicates, those who follow this method either knowingly or by accident tend to combine technical timing and trend factors with fundamentals. Hence, when the fundamentals are bullish, the trader would be on the lookout for technical indicators that correlate with the fundamentals in order to fine-tune market entry. The justification for this approach (and it's a reasonable justification) is that markets do not always respond to fundamental changes immediately. At times there is a delay in the amount of time it takes for the fundamentals to sink in or to be assimilated by traders. Hence, timing in the form of technical signals will help the fundamental trader fine-time entry. Theoretically, when both methods are in conjunction, the odds of success will be greater.

The benefits of being a techno-fundamental trader are as follows:

• Timing will ideally complement fundamentals, causing them to work better.
• Timing and fundamentals together comprise the best of both methods in trading.
• Trades can be justified and understood on two different levels.
• Your trading will be responsive to world events, as well as to technical signals.

The Intuitive Seat-of-the-Pants, Guts-and-Glory Trader

No matter what term you apply to this type of trader, the fact is that they rarely follow any trading system, method, or indicator for more than a few days or weeks. One day they'll be singing the praises of triple moving averages, and then next day they'll extol the virtues of the Elliott Wave. Let their pet system of the day or week take a loss, and the love comes to a crashing end.

Such traders are rarely systematic in anything, tend not to follow a plan, tend to act on an emotional or gut level, and tend to be consistent losers in the markets. But why?

Summary

Trading systems are not the panacea to resolving the many limiting factors that are part and parcel of futures trading. The good news is that a trading system will give you strict rules to follow. The bad news is that most traders will not follow their rules. And finally, there can be more bad news if the system you are using has been overly optimized.