Whenever I talk to people about what a trading system is and what its function is they are often confused by my view. My view is that a trading system is designed to keep you ut of suboptimal positions not necessarily find you massive winners.
As an explanation consider the table below which appeared on my X (Twitter) feed. If you have Koyfin which is free you can open the original at this link.
This table shows you a series of stocks drawn from US and European markets that in the past decade have generated a return of over 1,000%. There are a few points to note about this table.
- Every other listed share in the US and Europe did not generate these sorts of returns. The pool of candidates that underperformed this population would probably number in excess of 10,000.
- This is how survivor bias works.
- The universe of non-performing entities is vast – it is known that the vast majority of gain within a market comes from a handful of stocks.
With these points in mind consider what the role of a trading system is.
My view is that it is not to find those stocks that return more than 1,000% although that is a downstream aim but rather it is to as much as possible to keep you out of the pool of non-performing stocks. It is to tell you what not to trade. By sheer dent of numbers, there are more dud potential trades out there than potential large winners. A trading system keeps you away from the duds via a series of carefully crafted rules.
