GTD, Trading Systems and Trust

I'm a fan of David Allen's "Getting Things Done" system. I don't actually follow it very well, but at least I like the theory. Yesterday I was listening to some podcasts from the 43folders website. David was talking about patching leaks in the GTD system. The whole point of GTD is to get everything out of your head and into folders or lists or whatever you're comfortable with. You process all the stuff in your life into a manageable system. He said many people will do most of it, but for whatever reason they won't completely trust the system. They're afraid they'll miss something so they leave a piece in their inbox rather than process it. Then they'll do the same for one more thing and one more until the system falls apart. It's not because the system is broken, they just didn't follow it.

So what does this have to do with trading? I was trading the emini Dow futures (YM) intraday today. As I explained in an earlier post, I don't have these trades automated. I have rules for them, but there's a good amount of discretion there as well. I only took one trade today even though there were at least three setups that I could see. The one I took didn't work out so great, the two I didn't take did. All three setups were pretty good, but "something" told me not to take the two that did well. It may have been the TICK readings or the advance/decline line...I couldn't really tell you for sure. It doesn't really matter. The setups were there, I just didn't trust the system. One trader I know used to say that the most unreliable part of any system is the pink blob that drives the mouse.

So how does one trust a system? Do you trust it because some author said such and such pattern usually works? Or someone said some indicator predicts price movement (just a hint..if anyone says something predicts price, run away)? I do believe there are some really good discretionary traders out there - guys that just have a really good feel for market movement. Unfortunately, I'm not one of them. I need something that has concretely defined rules that I can backtest. Then I can see what percentage of trades were winners, how big the average winning and losing trades were. And whether or not I can expect to make money over time.

I've seen some traders debate the usefulness of backtesting. Their argument is they aren't concerened with what happened in the past because they do not believe history will repeat itself. In the "Way of the Turtle", Curtis Faith addresses this very issue. To those traders Curtis asks these questions: "What is the alternative? How do you arrive at any strategy without knowledge of the past? How do you determine when to buy or sell? Do you guess?" I am firmly convinced that some form of testing is essential to the success of any system. It does not have to be completely computerized, although if it isn't, be prepared to spend quite a bit of time in the process. Computerized testing also has the advantage of not introducing bias into the results. If you do it manually, be sure you aren't cherry picking trades.

If you know what 'normal' is for a system, it's much easier to trust it. If you've had 3 losing trades in a row but you know that in the past there have been as many as 10 losing trades in a row yet overall the system is profitable, it's a lot easier to take that next trade.

All that was a lengthy way to say I really need to code up my intraday system.

How I Trade

I've mentioned I have several different systems I trade. I also mentioned The Trading Digest as helping me not only with those systems, but also in allocating funds across to them. Yes, I do mention their site a lot. You should visit it.

I have six systems I currently trade. By system, I don't necessarily mean entirely mechanical, but some are. I'll list them here in order of capital allocation:

Option Spreads
Dip Buyer
Trend Following
Another Dip Buyer
Discretionary Options
Intraday Futures system

Currently, I'll allocate about 40% of my capital to the Option Spreads. I usually don't tie up anywhere close to this during a given month, so I'll also use that for any discretionary trades. 50% gets spread across the dip buyers and trend following. That leaves 10% for futures.

The option spread strategy is not mechanical. I don't think I can make it that way. Since the volume of trades is relatively low, I don't think I will spend a lot of energy trying to mechanize it. I primarily trade the RUT and occasionally the IWM if I need a little more granularity in my adjustments.

The Dip Buyers and Trend Following are entirely mechanical. I'm just an order taker for those. I will adjust my allocation to each as I see fit depending on the market conditions.

The Discresionary system is just that, discretionary. This is where I take the occasional speculative bet. I'll usually use options for this and it's usually a straight call or put or a vertical spread. Nothing more fancy than that.

Lastly, I have my Futures system. This one is not entirely mechanical, but I am striving to make it so. It's a little trickier to code because there are more variables (like different TICK readings, Advancing / Declining volume, sector ETFs, etc.). I only trade futures intraday because I don't want to comb through a zillion stocks and I can use a relatively small amount of capital. The capital I use is generally what's left over from the other systems. If I'm loaded up on my other systems, I'm not trading any futures. However, if things are relatively slow on the others, I'll add that capital to my futures capital and maybe trade a little bigger.

So, that's how I trade in a nutshell. The reason I trade multiple systems is because each has it's inherent strengths and weaknesses. The dip buyers do well in higher volatility markets regardless of trend, but not as well in strongly trending markets. The trend following model obviously does well when things are trending. They kind of complement each other.

I know this wasn't the most coherent ramble. I'll try to detail these a little more in future posts.