This is going to be a thread on Systematic Trading from whatever I have experienced. @madan_kumar and a friend of mine (who's a HNI system trader managing about 70Cr of his own money) have been huge inspirations for me to take up the systematic way of trading.
This thread is a beginner (1-3 years in market) view of systematic trading and the merits/de-merits.
If you're starting out in trading, you're better off as a systematic trader than as a discretionary trader. Reasons below.
1. The most successful discretionary traders I know - have all blown up their accounts atleast once, some twice thrice. Their discretion comes from market experience. And even the Prop Trading firms I know where there are discretionary traders, have a specific gestation period.
2. The gestation period from all the successful discretionary traders I have spoken to, and interviews I have seen - is at least 5 years. And this is for "successful" discretionary traders. 95% of all traders fail, and I think this is more pronounced in the discretionary space.
3. Within those 5 years, if you persist, you'd have either blown up once or twice, and if that doesn't deter you, you'd be psychologically wrecked too. Discretionary trading makes you take a hard look into your spirit and exposes you for who you are.
4. Discretionary trading may sound like it requires a lot of discretion. But the most successful discretionary traders I have come across, trade a set of rules/setups that they have gathered in their experience.
5. Discretionary trading is NOT throwing darts in the dark, trading whatever you feel like. It may start off like that for amateurs, but the ones who eventually become successful become the type of people in no.4.
6. The methods of discretionary traders may differ, but they all eventually resort to following a set of rules, and in that way, they are also systematic traders only. Just that only part of their system can be codified in an algorithmic format, and part of it is dynamic.
7. The dynamic part - may involve monitoring the DOM, price ladder, Open interest, news inputs, market sentiment, correlation between different markets/indices/stocks, etc., these things require advanced deep learning level machinery capacity that normal people don't have.
8. That is the wonder of human brain. When you are persistent and have traded for years, whatever huge machinery can't accomplish - your brain accomplishes, by establishing neural pathways for you to subliminally understand what only best data scientists can do with huge machines
9. Why is it not prudent for beginners to start off with discretionary trading? I'll first discuss this and then go to why systematic trading.
10. The first obvious reason is because of the dynamic part i mentioned in 7 & 8. Even the best deep learning algorithms take days to train and some take weeks to have higher level of accuracy - whatever the task may be.
11. Without training on such huge volumes of properly cleaned up data, it's impossible for machine learning to render itself useful for any task. So, if you think you can trade at your discretion from the get go, you have the highest odds stacked against you.
12. Unlike machines, it takes atleast 5000-7000 hours of exposure to charts, dynamic market movement, watching price action, open interest, and other dynamic changes in market. 250 trading days, 6hrs per day, 1500hr/year - so atleast 4-5 years for you to develop decent discretion
13. So, you have to have the stamina to sit with your trading terminal day in and day out - for 5 years. Even then, paper trading won't help coz that would mislead you by missing the psychology part. But that's better than nothing.
14. That said, how many people do you know can spend 6hrs/day for 5 yrs, every trading day without fail, sitting at terminal, watching charts, taking the data points in, and developing discretion, and understanding of market microstructure - complementing with reading that aids?
15. The best way to go about it would be to have decent capital that you can pay market as tuition (as you'll certainly blow up) and show up every single day and put in the work. You hear 95% of traders failing, coz those 95% can't take this. It's painful, and wrecks you.
16. Why do the best prop firms give preference to people who have played sports in some competitive format? Or someone who's shone in some level of national competition? Coz it takes a lot of guts, resilience, stomach and will power to go through this journey. Not for avg Joe.
17. Market has a way of weeding out the weak ones, and giving riches to the strongest of hands. If you don't give up due to blowing up or losses, you'll give up due to the sheer inhuman effort it takes to become successful at discretionary trading.
18. To say that discretionary trading in your formative years as trader will break you psychologically, emotionally, mentally, and spiritually - is an understatement.
19. The most impt psychological aspect that hinders your progress as a disc., trader is how you were brought up. Remember this rule always.
Rich get richer. Poor get poorer. Middle class almost always stays middle class.
Rich get richer. Poor get poorer. Middle class almost always stays middle class.
20. Reason for this is: The rich have abundance and growth mentality. The poor have poverty and lack mentality. The middle class have conservation mentality. This is why people who are already rich - when they enter trading - they are better off psychologically and see gains.
21. The reason they see gains initially (and continue to, if they acquire discipline) is because they attract what they believe in. They believe in abundance and growth, they attract the same for their account also.
22. Someone who grew up with poverty/lack mentality will most likely quickly blow up his/her account. This is because they attract their belief of not having enough or the belief of having lack of money. The universe gives them that lack that they believe in by blowing up.
23. People from middle class - either grow up with a lack mentality or a conservation mentality depending on their upbringing. If they always grew up being told to be safe/secure, be grateful for what they have, and don't desire too much, that's what will happen to their account
24. You can often find these people trading, making profits, and then coming back to breakeven. They do this multiple times, either to get frustrated and give up, or to face their inner demons of faulty upbringing, beliefs that have to be unconditioned, to grow as traders.
25. Those from middle class, whose parents brought them up telling them there isn't money, there isn't adequate money for food/clothes or basic necessities even though they did okay, will inevitably go into losses, even if they don't blow up.
26. Some are brought up being told that rich people are evil, they are corrupt, and it's not possible to get rich without doing something morally bankrupt. Some even look down upon trading as a worthless profession adding no value to society. This reflects in their performance
27. If you believe rich people are evil/corrupt, and you have a self-image of yourself as a good person, will your beliefs let you become rich? There's a belief clash, and the dominant belief stays - you'll stay a good person, but you won't get rich.
28. Growing up, I saw few rich students being assholes in my school, and that thought stayed in my head, and I found myself losing in trading, until i sat and thought why is this happening and found that I believe rich people are assholes and have been attracting such people.
29. As you believe in something, the belief gets stronger as it attracts further incidents, experiences that will strengthen your belief. So, discretionary traders often get messed up between the desire for money and the attitude they have about getting rich/being rich.
30. And then there's a classic mental mess ups while trading. Most traders go bust taking small profits and keeping losses extending in hopes they will come back. This is also tied to your beliefs about money.
31. Most people who take small profits are also those who haven't seen much money in their life growing up. These are also the same people who when their trade starts going in opp direction, freeze and pray.
32. The only way to break these psychological barriers is also then breaking everything down that's you and rebuilding yourself back up. That takes daily practice, introspection, meditation, and self-evaluation - for atleast similar amount of time.
33. Now that we have discussed the difficulties with discretionary trading, let's come to systematic trading and its benefits for someone who is just starting off.
34. As @madan_kumar says, systematic trading is beneficial in such a way that, you can immediately start seeing benefits, and even profits from the get go - if you trade a decent system 100% mechanically with discipline.
35. The only impediment to successful systematic trading is your psychology and requires a lot of self-restraint. Most people can't stomach being a systematic trader coz it's utterly boring, no dynamic decisions to be taken, and this exposes ppl coming into trading for thrill.
36. I am a huge proponent of what @madan_kumar advocates - MANUAL BACKTESTING. Find a system (plenty available if you can google) and test it for 6 months. If it looks profitable, test for atleast 10 years (one full market cycle) and only then you can trade it.
37. The reason for this is, sans the price ladder changes, DOM changes, OI changes - it gives you a feel for the market, looking at the chart - backtesting bar by bar. It also gives you a feel for the price-action and how your setup works in different market.
38. The first year you backtest, you may not see much. You'll just be noting down entry/exits, looking at how system has performed. As you get to your fourth/fifth year of testing, you will start seeing patterns, some ways to optimise your SL or ways to identify certain things.
39. Like, without even doing statistical calculations, you'll get a feel for each and every trade, and the following trades, and whether a big profitable trade will be followed by a losing trade or not, etc.
40. As you finish your 10th year of backtesting on the system, you'd know how to identify what part of the market cycle we are in, based on how historically your trades have played out, when you're actually starting to trade and recording trades.
41. If you have tested the system thoroughly for 10 years, manually, it takes about 3-4 months if you spend 3-5 hours with discipline - which also sets the precedent for preliminary level of discipline required.
42. If you can sit through 10 years worth data's manual backtesting, that helps you build discipline and patience for actual 100% mechanical trading, coz backtesting like that is excruciating and 1000% boring. If you can do that successfully, you have setup a base for trading.
41. If you now have a historically successful, properly backtested system, odds are high that if you trade it 100% with discipline - you will be successful over a series of at least 50 trades. @madan_kumar's followers, his workshop attendees, are examples.
43. If you can trade the system 100% mechanically with discipline, and the system has been historically successful, maximum odds in your favor to be profitable within months of starting trading. @madan_kumar and his followers/workshop attendees have done it before. You can too.
44. The impediments you face during system trading are multifold, not as excruciating as the journey you go through during discretionary trading. The pitfalls you face in systematic trading are as follows.
45. First and foremost, your psychology and ego will mess with system trading. Taking the wrong trades and profiting is much worse and taking the right trades and losing. When the former happens, you try to outsmart the system, avoid/take certain trades system gives/avoids resp.
46. When you try to outsmart the system, you will most likely miss the right trades which would have given superb profits, and take the wrong trades, which result in losses.
47. This then leads to a vicious cycle of avoiding trades coz of prior losses, those trades going right, and then resetting belief in system, starting trading, to find that those trades are losing trades and you fear and stop trading, the cycle repeats again.
48. Some people try and get out of this system saying systematic trading doesn't work and try their hand at discretionary trading, revenge trading, ego trading, news trading, before they lose substantial money and then take a look at their system to see it has performed superbly.
49. The only way to get out of this cycle is stop being an egoistic maniac and stop trying to outsmart a thoroughly tested system - and submit yourself to the system. This is a form of spiritual submission, with total faith in the system and submitting with humility.
50. People who manage to do this, start trading. Then, the next challenge to manage is trying to sneak in discretion into trading with their biases. The system will say one thing, their read of market says another thing. So they try to interfere with stop loss and targets.
51. If the system is based on trailing SL-profits, people try to take profits prematurely by thinking it can't go much further, or extending/messing with SL in one way or another (widening the SL when market is turning in opposite direction or getting the SL to breakeven faster)
52. When you do this, you take profits prematurely and find that the trade goes on for some more bigger % points. You'd want to strictly follow the system after that, you follow it, and losses happen. The actual profit of original system followed trade could have covered these
losses and kept some profit and account in positive. But, because of your interference, your account goes into loss and you'll be negative. This brings up that vicious cycle again in the second innings, and this goes on, until you finally realize you gotta be dumb.
53. Meaning, you have to stop trying to outsmart your system or adjust your system or interfere with your system once you have thoroughly backtested. And once you start trading, let it do its work, and be its humble servant. This is why I prefer full automation.
48. When full automation is not possible, before you sit in front of system every day to execute, you leave outside your home all your ego, swallow and poop your pride out, all your thoughts of how smart you are, etc and come with a humble, clean slate of a mind during mkt open.
54. If you do this, you get to the next stage - objectively, without any emotions, intellectually - knowing your system is smart, and letting the smart one be smart. This way, you will be able to tell when mkt changes and system stops working in an emotionally detached manner.
55. These things with systematic trading requires a couple of years to get set - removing ego, becoming humble, etc., and if you are half as smart, you'd have no chance of blowing up with simple systematic trading.
56. Then, once you're set, you see the account growing, watch the magic of compounding, and profits coming in. Then people usually work on few many systems alongside, and deploy additional cash into systems, phase in and phase out systems accordingly.
57. Systematic trading is not easy mind you. It's not as hard as discretionary trading though. If you can bite your teeth through the first 50 trades with discipline, you'll then get the trust and patience to stick with the system and then iterate the process as you go.
58. To sum up, if you are beginning as a trader, you want to get rich, you're better off learning the basics of market, market microstructure, and then start researching about simple systems, test them for 6 months data, and then go further if the results are promising.
59. I will do a separate thread for how to go about the process researching/backtesting and trading when it comes to systematic trading - from whatever I learned from Madan and others here and applied in my own journey.
60. One of the major advantages of systematic trading is that if you bite through with patience and without interfering with system, your beliefs won't affect your trading. Your beliefs about money may affect your cashflow through things outside of trading, but that's for later.
