Number of Trading Systems

In my previous posts, I seem to be fixated on exactly how many different trading systems a set of rules specify.

I've talked about having the word "OR" in a system effectively creates more than one system. If you've got a system which a whole bunch of rules, but one that specifies an entry when the close is above the 20-bar moving average, OR when the 14-bar RSI is above 70, then actually you have two systems - one which enters when the close is above the 20-bar moving average, and one which enters when the 14-bar RSI is above 70.

Then, in that system with the points (where any combination of rules adding to more than 36 points signals an entry), I said that effectively those rules made X number of different systems - one for each combination of adding the rules together to get more than 36 points. In that particular case, where there were 9 rules, with respective points of 8, 8, 8, 8, 6, 8, 6, 6, and 4, I did start to work out exactly how many different combinations could add to more than 36, but I quickly realised there were going to be many. Maybe about 20 or so. 20 different trading systems.

Why is this important?

Because one day the markets going to change its "personality", and the system you've used for years isn't going to work anymore.

When that happens, you need to find out what's wrong and fix it.

Is it the close above the 20-bar moving average that doesn't work anymore, or is it the 14-bar RSI above 70? Or both? Keeping track of them as one system will not tell you.

Trying to find out the problem in that points-based system would just be a joke.

Dare I say it, but knowing when to use a trading system and when to stop using it, is probably more useful than entry rules.

We all want equity curves that start in the bottom left, and end in the top right. But what if it starts bottom left, goes to middle top, and is currently working its way to bottom right? Is this a temporary drawdown, or catastrophic failure?

Much like we need exact, written-down, objective rules for when to enter, where to set the stop loss, when and where to move the stop loss, when to exit, how much money to use, etc, we also need such rules for when to stop using a system.

Without objective rules set out for when to stop using a system that's in a drawdown, we have essentially moved our "oh, I'll stay in a bit longer - it'll come back" thoughts from the price chart to the equity curve chart.

The reason these rules would be more important than entry rules, is because these rules would stop us using a poor-performing system - it wouldn't matter what rules made up that system.

So, what might be an example of an objective "This is not just a drawdown, but rather a catastrophic failure of your trading system" rule? I'll talk more about this at the end of the series. At this rate, maybe some time in 2007 :-) But you should check back everyday just to be sure.

I hope people are finding what I say interesting, and I'd certainly appreciate comments - anything at all. Anything.