The Best Trading Systems Have These Two Characteristics

Have you ever found yourself struggling to develop a new trading system or find a new trading system that has a consistent, stable edge that holds up over decades of backtesting? My name is Adrian Reid, and I’m from Enlightened Stock Trading. And this week I was developing a brand new trading system for the trading system collection. And this system looks amazing. It has a consistent, stable, profitable edge and the equity curve is really nice and smooth, it has a high win rate, so the equity curve is strong, and there’s very low drawdowns.

But what struck me when I was developing this system, is that there’s two reasons why most traders fail when it comes to developing trading systems. And the first reason is that good trading systems are psychologically hard to follow. You see, I’ve tested hundreds of systems and I’ve taken thousands of systematic trades, and without doubt I can say that some of the most profitable trades that I’ve ever taken have been psychologically the most difficult; the signals that my system generated that I least wanted to take are very often the most profitable.

Now, why is that? Well, my theory is because if you look at a chart and you don’t wanna take that trade then most other traders out there won’t wanna take that trade. I mean, psychologically we’re all wired the same. So, that trade is not gonna be a crowded trade: It’s not overloaded, there’s not lots of people already in the move: assuming you’re following your system, you’re getting in at a moment where you’ve got the maximum edge, you’ve got the minimum competition. And so, the psychological challenges of system trading are always that you’ve gotta follow the system, you’ve gotta take every single signal regardless of whether it feels good or not. Now, if you take that concept and extrapolate it out to the system wide level, sometimes, almost always, the best systems are the ones that are psychologically difficult to trade. So, Why is that? That’s because those systems, as well, are not crowded.

If something was psychologically easy, everyone would do it, and if everyone was doing it in the market, then it wouldn’t make money. This is one of the reasons why trend following works: year after year, you know, sometimes there’s drawdowns and sometimes there’s dips, but over decades the strategy keeps coming back and it keeps working because the vast majority of people don’t have the psychological makeup, the intestinal fortitude to follow that system, to buy something that is going up and hold it and hold it and hold it regardless of the market dips and gyrations until the trend obviously changes and starts going down. That is psychologically difficult and that’s why it keeps working. And take mean reversion, for instance, now if you’re buying a stock after a sudden dip waiting for the spring back: when you look at a chart the sudden dip, the really aggressive full inch in the share price is not a place where, psychologically, we would, naturally, want to enter, and so if it’s psychologically difficult to wanna enter there, most traders won’t be able to do that consistently, and that will give that system a stability because you’re in a system that is not crowded. There’s thousands of other people doing that because it’s psychologically hard.

Most traders do the easy thing. They take the obvious trade, but I’m here to share with you that the obvious trade doesn’t work, the obvious systems don’t work either, okay? So, the first reason why most traders struggle developing a trading system that works and holds up over decades in backtesting is because the good systems are psychologically challenging. So, that thing that you don’t wanna do in trading, that’s the thing that you should be investigating. Sometimes when you develop a system, you don’t tend to test the things that you’re naturally uncomfortable doing, but sometimes that’s where the gold lies. So, if you’re testing and designing and playing with different system ideas: stop and take a step back and have a think about what you haven’t tested, what haven’t you analyzed thoroughly? Because you don’t feel like, it’s a good idea because sometimes there’s some golden there. So, you go back and you journal about that, you find some ideas: chances are you’ll find some profitable trading systems.

The second reason why most traders struggle to develop systems that are good, that have a solid edge, that holds up over decades in backtesting, is it that the best systems are counterintuitive, and it’s very closely related to this issue of the psychological ease of trading that we talked about just before, because if a system is counterintuitive, you wouldn’t think that it would naturally work. And again, we don’t tend to test or analyze things that we assume, naturally, won’t work because it’s a waste of time and energy, right? But if you have a think about all of the things that you assume don’t work in the market and write them down and look at them and you’re really honest with yourself, chances are you haven’t tested those things thoroughly, and if you haven’t tested them thoroughly, then they could be some little nuggets of gold waiting for you. Because I’ve found in my backtesting that sometimes the most counterintuitive idea gives the biggest edge because people aren’t looking there.

Traders move and investors move in a herd: they bundle into the favorite sector, they take the same trade, they have the same emotional reaction to different moves in the stock market. Investment markets move in psychological herds, and if you can bring yourself to step back from that and have a look and find counter intuitive ideas: ideas that you have, naturally, assumed wouldn’t work because of all of your experience in the outside world, they’re the things you need to test in the stock market. Because when you test the counterintuitive things, you’re gonna find some edges that other people have not found, and that’s how you make it big in the stock market: trading systematically with a system that is psychologically challenging to trade and that is counterintuitive because if you got those two things, that system, chances are that’s gonna last for decades because most people won’t be able to follow it.

But if you, as a system trader, can design that system and do the testing to build the confidence in that system then you could end up with a trading system that has a sustainable edge that will make you money for decades to come. That’s what it takes to be a successful as a systematic stock trader. You need a stable, robust system that you’ve got confidence in, that is psychologically difficult for the masses to follow and that is somewhat counterintuitive because other people are looking there to find that idea: that way it’s not gonna be a crowded trade, it’s not gonna be a crowded system.

So, if you can do that and build the confidence: the confidence is the key because the confidence that you get from testing the system properly is what’s gonna get you past those two things: the psychological difficulty and the counterintuitiveness of that system. So, in order to build confidence in your trading system: how do you do that? Well, click the link on this post and download my trading system confidence cheat sheet which gives you the exact steps that I follow every single time I develop a new trading system, and I’m following those steps today while I finalize this trading system that I talked about earlier.

Download the trading system confidence cheat sheet and start looking for trading ideas where other traders aren’t looking, and chances are you’ll find some nuggets of gold that’ll make you a ton of money in the future. My name is Adrian Reid. This is Enlightened Stock Trading. Click the link and make sure you download your trading system confidence cheat sheet. That’s all for this video, see you on the next one. Bye for now.