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System Design: Why Having a System Matters

D.R. Barton, Jr. 9 Nov 2011 9:48 PM

A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C, and has been a guest on Bloomberg Radio.

His articles have appeared on SmartMoney.com and Financial Advisor magazine We thank D.R. Barton Jr for this article, previously sent to his readers at The Van Tharp Institute.Two events jolted me with a keen insight into the trading world this past weekend. And the insight came from two very different areas—competitive sports and movies.

Thrills and Agony

We live in a small and delightful university town (the home of the University of Delaware). Their football team is ranked second in their national division right now and the town goes crazy over its team every Saturday.
The same can be said of Friday night high school football games and Sunday afternoon professional games.

There’s a simple phenomenon plainly visible on these three days: Emotions run high. The winning team and its supporters feel the “thrill of victory,” while the losing side suffers the “agony of defeat.”

In the last couple of weeks, I’ve witnessed both ends of this spectrum. This past weekend, my favorite pro team won in overtime against an opponent that was much better on paper. My college alma mater team also won, as did the team from where I earned my graduate degree.

On top of that, my kids’ high school team won as well. What a victorious weekend for sports in the Barton household! But just a few weeks ago, I felt the opposite end of the emotional spectrum when my college team suffered a heart breaking loss in the last minute. I was devastated.

These recent sporting ups and downs provided me a great insight about emotional reactions. At the time, the emotional wins felt very different from the emotional losses.

Looking back now with some objectivity, I can see that both reactions had one important similarity: both extremes made me feel alive—fully human.
Then, while watching the film The Last Samurai (for the third or fourth time) recently, I had a similar experience. At various times the film generated feelings of exhilaration, disappointment, awe, sadness, contentment, anger and joy.

We enjoy films that bring out a wide range of emotions. In fact, we pay good money to see them on the big screen or to rent them. We pay even more money to attend sporting events, not knowing the outcome, but knowing that we’ll most likely be both disappointed and thrilled by our team at some time in the game or season.I believe that this same phenomenon has a real impact on our trading and investing. Many traders seek these same emotional extremes in their trading activities, whether they realize it on a conscious level or not.

Trading Systems Help Us Manage Emotions

More than a decade ago, Van introduced me to the concept of personal “parts.” These parts, or roles, of our personality compete for attention and influence over our decision making. 

For example, we may have a safety part, a joy seeking part, a big spender part, and a pleaser part, all acting—from their perspective—in our own best interest. While perhaps this does not count as a clinically exact description of personality, it is a simple and useful model for non-academics.

In this model, it’s easy to imagine that one of our parts enjoys emotional extremes. And from there it’s not a stretch to imagine this part of us wants to feel those emotional extremes when we trade: the exhilaration of winning or the disappointment of losing.I could get philosophical here and dig into how our need to feel any emotion is not very discerning between these two extremes, but as many of you know,

I’m much more practical than that!So let’s talk for just a moment about emotions and trading at an applied psychology level. You have probably heard "experts" say that we need to trade without emotion. I believe, however, that that common recommendation is somewhat misguided.As humans, we are going to feel emotions. Besides, trying to stifle emotions would actually be counter-productive for most people.

A more useful concept for traders would be to minimize the effect emotions have on our decision-making process.If implemented properly, a systematic trading approach provides traders a decision-making process that can reduce or eliminate emotional distractions.

To make decisions in an objective manner, we need to provide a framework that covers all aspects of trading system. Here are the individual components that make up a full trading system:

  1. Beliefs about the system. This is the part of the system that tells us why the system works and has an edge in the first place.
  2. Market conditions where the system performs at its best and worst. Rather than view this as a subset of the system beliefs, it’s important enough to warrant its own heading. A system that performs well in a bull market may fail in a sideways or bear market.
  3. Set-up.This part of the system tells us that conditions are ready for a trade.
  4. Entry. The component of the system that tells us to pull the trigger now.
  5. Stop loss. The parameter specifies when to exit the trade if it moves against us.
  6. Profit-taking exit. How and when we exit profitable trades.
  7. Position sizing strategies.

Once we have all of these bases covered in a systematic plan, we can make objective decisions more easily at every point in the trading process. There’s also a bonus for trading a system: we are free to feel our emotions during the trade as long as we follow the rules of the system. Emotions can even be useful in the system design and development phase.

Trading those strategies that cause you to feel particularly good in the development stage can add to your confidence in following the rules once you are ready to trade it.Great Trading, D. R.

D.R Barton Jnr. works with Dr Van Tharp, author of 'Trade Your Way to Financial Freedom’ 



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