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Am I telling you, therefore, that you ought not to trade according to a system? Am I saying that there are no trading systems which are worth trading? Am I saying that trading systems should not be tested or develВэoped? Or do I wish to lead you in an entirely different direction? Frankly, I'm telling you that your time is more efficiently spent on developing your own methods of risk management and trading style as opposed to optimizing trading systems. You will find within this book few examples of trading system results, no outrageous claims, and furВэthermore, repeated warnings about the limitations of trading systems. This book will not present you with a stable of optimized, perfected, and curve-fitting trading systems which look great on paper but which will not perform well for you in the future. System development and system testing are illusory. Do not depend upon them too muchтАФthey will lead you astray.

Accordingly, I feel that serious day traders and in fact serious traders regardless of their time-frame orientation should devote their energies to the following:

1. Research and develop timing tools which have shown relatively high accuracy as opposed to trading systems per se.

2. Focus on methods of risk management including limitation of losses, maximization of profits, and such important issues as the use of trailВэing stop losses.

3. Focus on improving your relationship with the markets and develop your skills as a trader, skills which will serve you well regardless of whether you are using a trading system which has been thoroughly back-tested or not.

Markets ChangeтАФMarket Participants Change

Another very important consideration in the use of trading systems and in trading system development is the fact that the characteristics of marВэkets change. The markets of today are distinctly different from the marВэkets of the 1950s, the 1960s, the 1970s, and the 1980s. Each era of market activity has had its own characteristic issues, and each market has expeВэrienced significant fundamental developments which have changed its tone and underlying response styles.

Furthermore, the nature of the players has changed. Whereas instituВэtions were involved only marginally in futures trading until the early 1980s, they now constitute a major force in the markets; their collective buying and selling can produce significant market volatility. A trading system, therefore, which would have worked well in the 1970s may not work well in the 1990s. This is why trading systems show regression to the mean the farther back they are tested. You may wish to try a little experiment on your own. Develop a trading system based on the last 5 years' worth of price data. Once it has been developed, test that same trading system on the last 10 years' worth of data. In all probability, you'll find that the system has diminished in its performance. Now, test the last 15 years of data. Result? You'll find in a vast majority of cases that the system was even less effective. This is a classic example of regression to the mean. It shows that markets change their characterisВэtics and that the players in a market change as well. This in turn affects the ability of trading systems to show consistent performance over time.

Striving for Solutions

What are the answers to the significant questions and limitations I've posed regarding trading system development and back testing? There are several potentially valid answers. First and foremost, trading system research should be given less attention rather than more attention. I do not believe that the ultimate trading system using conventional methВэods of research will ever be uncovered or revealed. I feel very strongly that the emphasis must be the development of simple but repetitive and reliable market relationships as opposed to systems per se. Second, the day trader must develop specific methods for implementing consistent intraday market relationships within the context of effective risk manВэagement. And third, the day trader (in fact, all traders) must be sensitive to changing market conditions. Monitor your performance closely in order to determine when conditions are changing and when you ought to respond by changing your trading style and methods. This book is about these solutions.