The neuro-behavioral science trading edge
Before automating your day trading systems
- Vijay L Bhambwani Jan 12, 2016
Day traders are a unique kind of people - they go into a trading session with a near open (blank slate) state of mind, quickly form directional opinions in the first few minutes of trade by watching the screen, and jump into the trading pit. They put in multitudes of trades and hope to make more than they lose during the session, and go home after being "flat out" (zero exposure) on their prop trading book. Many trading styles exist and all have their pros and cons. Some are discretionary and some are mechanical. Some are gray boxes (mixture of both) and then again, some are statistical programs, some pure chartical, some are sheer screen reading regimens and so on and so forth. The first question is - should you automate ? My answer would be - yes ! My suggestions -
a) Automating a trading style takes the emotional aspect out of trading. The trader has a lesser probability of "chickening out" of a trade or "kill" the trade prematurely.
b) Mechanical systems once put in place, save tremendous time, effort and emotional energy on a daily basis as the trader is almost totally relieved from the onerous task of selecting the counter to trade
c) The entry and exit are pre-determined, the contingencies of premature exits are well defined, should something go wrong (it invariably happens)
d) Traders often react to the same scenario in different manners, depending on the prevalent circumstances. If you are broke, you tend to pass off many high probability trades. If you are flush with funds, you tend to overtrade. With a mechanical system, risk management and trade size is automated.
e) Mechanical systems are a tremendous psychological help as they "flag" the markets at turning points more reliably than discretionary style manual trading.
Having decided to go for a mechanical trading system (I assume you will program a system yourself, like I do), do keep in mind a few things -
a) KISS - keep it simple stupid. Veteran traders know this. Rookies think complicated is sexy, its profound and "with it." But most of those rookies arent even traders. They are everything but traders !
b) Your system must be all encompassing - entries, exits, stoplosses, trade sizing, financial management, capital control and layoffs (periodic forced trading holidays after big gains or drawdowns). Only non participating experts feel you can get away with leaving a few chinks uncovered in your armour. As a doer of deeds, you know the chain is as strong as the weakest link in the chain.
c) The system should perform reasonably well in bull & bear markets with an acceptable variation in performance
d) The system should not let a trader remain in an adverse position at market turning points, evolution from trending to ranging markets or vice versa
e) The system should catch atleast 35% of the trending price move (if not higher) once the trade is initiated. A lower percentage would result in a skewed risk / reward ratio
f) The return on capital vis-a-vis traded turnover for the day should ideally be 0.2% or higher. For every crore Rupees in daily turnover, your profit should be Rs 20,000 or higher.
g) You should ideally be "flat out" (zero open trades) at the end of the session. If a residual trade does remain open, it should be initiated into the direction of the prevalent trend and the trend in a higher time frame of atleast 1 magnitude (hourly / daily)
h) Professional traders dont take reckless risks, that is for rookies. Your system should be based on sound trading maxims and zero leeway should be allowed to get into a trade because you "havent traded for x period of time"
i) You programmed your system, your values, passion to trade and commitment to the trading game is not negotiable. Neither should your system be. Dont bypass your system once implemented
j) Avoid the pitfall of over simplifying your systems using linear extrapolation - 7 out of 10 years, markets are bullish in December. Let a statistician have fun with such analysis. You cannot bet your risk capital unless all technical parameters and weight of recent evidence (not historical alone) support a buy or sell decision. When you climb the stairs of a high rise building, the climb is easier initially, but laboured as you get higher. Markets labor similarly after a sustained uni-directional move.
k) Volatility tends to move in clusters. Seldom does a price spike up / down and return to equilibrium like the spike never occurred. Prices have a "memory" too. Your system should be able to factor in these clusters
l) Dont let your system go "live" unless it's tried and tested over 1 bull phase and bear. It must complete one full cycle before winning your trust. Your trading capital is not your own, it belongs to your entire family, it is not worth risking your capital.
Have a profitable day !
Vijay L Bhambwani

Disclosure - I in my individual capacity or our investment company as a legal entity do not provide any advisory, PMS, broking, distribution or any allied services.