Friday, May 18, 2007

Hybrid Trading: How Discretionary Traders Can Become More Systematic in Their Decisions

I recently finished an article for SFO Magazine with Henry Carstens, the system developer who contributed a worthy best practice for the series a while back. I continue to feel that Henry's introduction to testing trading ideas is the best article on the topic I've ever read.

For that reason, I was only too happy to write the current article with Henry. This article deals with something we call hybrid trading: the blending of discretionary and system trading styles.

If you recall, Henry worked with a blog reader and successful trader to help him extend his edge. Since that time, he has extended his ideas regarding helping discretionary traders become more systematic and consistent in their trading.

The creative idea that underlies the article is that successful traders can articulate their trading ideas and approaches to a system developer (with assurances of confidentiality, of course), who also studies the actual trades placed by the trader. From the account statements and the trader's own descriptions, the system developer identifies the rules behind the discretionary trader's trading.

Once the developer has this initial set of rules, he can then test the rules and improve upon them as part of system development. The result, for the trader, is a trading system that trades the trader's way. Many trading systems don't work for traders because they involve larger risks and drawdowns and different activity levels than are right for the trader. When a system is developed around *your* trading style, however, you're most likely to be able to use it out of the box.

The beauty of this hybrid is that you can accept or override its signals as you see fit. This enables you to see exactly how much your discretionary judgment adds to the performance of your basic rules. Moreover, you can automate your system so that you will be trading, even when you're not in front of the screen. This frees you up for other tasks and priorities, including (perhaps) developing new trading methods for other markets. Eventually, you could have a dozen computers trading just like you across different markets and time frames.

My sense is that this idea will be a particular boon to proprietary trading firms, enabling them to leverage the skill sets of their traders. A profit sharing arrangement between the trader and the firm to let a computer trade the hybrid method would prove a win-win--and it would help firms make the most of their talented traders. Too, a system developed to reflect a trader's own style could serve as a mentoring tool for beginning traders who might study under the expert trader.

I come across new ideas every week, but I have to say this strikes me as one of the most promising ones in quite a while. I'll post the link when the SFO article comes out.


Blending System and Discretionary Trading

Every Trader is a Trading System