Kevin Davey is one of the best people to talk about automated system trading. He's won several high-profile trading competitions and is open and frank about what it takes to make money with automated trading. In this interview, we talk with Kevin about how he recommends beginners think about programming their own system ideas, things all traders need to keep in mind when doing so, and how he evaluates systems when deciding to put real money in them. We also discuss the pros and cons of buying off-the-shelf automated trading systems.

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Tim Bourquin: Hello, everybody, and welcome to another interview. My guest today is Kevin Davey, and we're talking about systems trading and discretionary trading and the combination of both and what he's doing these days and maybe some ideas for you to add to your own trading repertoire in 2013.

So Kevin, first of all, thanks for joining me on the phone today.

Kevin Davey: Well, thanks, Tim. Thanks for having me.

Tim Bourquin: Alright. So what are you up to these days in terms of systems trading? You've been doing this about as long as anybody, and what's working for you these days?

Kevin Davey: Well, you know, just a constant reinvention of new systems and trying to plug in new systems to a portfolio and remove ones that are no longer performing as well as I'd like. What seemed to really be working good now lately in the past couple of years is I've done a lot more diversified type portfolio. So instead of, for example, trading one system with the euro, for example, I might trade five systems with the euro and gold and crude oil and a couple of other markets. And that seems to work a lot better because it smoothes the equity curve a lot of times.

Tim Bourquin: Alright, so you're running these systems simultaneously, then, in different markets?

Kevin Davey: Yes, yes. It's usually where I've had the most success is running different strategies, completely different strategies, so different entry types, different exit types and then different markets and then also a lot of times different timeframes. So I might be running a few systems on shorter time period bars and some of them on daily bars all the way out to, I think, the highest they go is weekly bars.

Tim Bourquin: All right. So how do you initially come up with systems? I mean, I don’t know a lot of discretionary traders out there that have an idea and they're just not sure where to start. Where's a good place to get going?

Kevin Davey: Where I get most of my ideas, at least the start of them, is just by keeping in tune with what's going on in the industry by reading any new trading books that come out or some of the trading magazines. Now a lot of them will give systems out or at least give ideas for systems or indicators and that type of thing, and typically once it goes out in the public domain there's a reason for that and it's usually because the author doesn’t think it works as well anymore because I guess the old saying or the old thinking there is if he thought it was so good, why reveal it to anybody?

So that will be the start. So I'll look at just about anywhere I can for trading ideas and some of these ideas actually come from different fields. So for example, I think it was in the last year or so I was looking at game theory, which has some applicability to futures markets, but it got me thinking. And I actually created a system that uses some of the aspects of game theory, which is kind of a little off the wall type approach.

Tim Bourquin: And when you've come up with a new idea for a system, how far back tested do you take it to decide whether or not you want to try it with real money going forward?

Kevin Davey: Well, usually, what I'll do is I'll try to go as far back as I possibly can. So let's just take the mini S&P, for example. I'll go back to '97, which is when that contract started. I won't go back further when they were still doing the pit trading, but I will go back to the start of electronic contract. Now, on some other markets, it really depends on the timeframe.

So for example, if you're going to be using one-minute bars or two-minute bars there are certain markets where maybe five years ago there really wasn’t a lot of volume in them and you'll end up getting a lot of minutes or two minutes, let's say, where no trading takes place and that can mess up if you're using any kind of indicators. It can also mess up any kind of patterns that you might be using. So a lot of times it's not set in stone what I'll do, but in general it's the more dated, the better.

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