Mechanical Trading Systems: Pairing Trader Psychology with Technical Analysis

TRADING SYSTEM PHILOSOPHY STATEMENTS

Most asset allocation firms and many institutional investors will ask traders for a trading methodology philosophy statement along with hypothetical and real-time trading results. I encourage traders and system developers to write a philosophy statement for each of their trading systems (and for their combined portfolio of systems, if applicable), irrespective of whether they are currently attempting to secure outside allocations of capital. By formulating a trading philosophy statement, we concretize trading strategies and/or mechanics and sometimes can identify flaws in logic or price risk management prior to committing capital in the markets. In addition, this document serves as an ideological benchmark of performance expectations through which we can compare our real-time results. The philosophy statement should include these items.

• Overall trading philosophy. The philosophy statement should outline explicitly the principles on which the strategy is based, what type of market behavior the methodology is attempting to capitalize on (e.g., trend-following or mean reversion), and why it is robust enough for similar results to be achieved in the future.
• Length of performance (and/or backtested) history. This section should explain to potential investors the length of performance (and/or backtested) history. The explanation should prove that the data history is robust enough to include all types of market environments (bullish, bearish, trending, ...