5 Steps to Trading System Success

06/12/2015 6:00 am EST

Focus: STRATEGIES

A veteran systems developer, Donald Pendergast of Linear Trading Systems, LLC, shares five important lessons learned over the course of a three-decade trading career to help less-experienced traders or even beginners find their way in the markets.

I made my first trade (well, actually, it was a six-week investment in half a bag of junk silver coins in August 1979) when I was 19 years old, nearly a third of a century ago, back when Jimmy Carter was wearing a sweater in the White House.

It was an era of punk rock, new wave, Van Halen, and disco set against a backdrop of 13% annual inflation and soaring interest rates. American cars were garbage and Reggie Jackson was swatting balls out of Yankee Stadium with alarming regularity.

Life was a bit simpler then, but still very fast-paced, chaotic, and scary at times...just like today. Somehow, I managed to make about 50% on that $3,500 investment (about $17,000 in today's debased dollars), even though I had no detailed plan on when to exit the trade with a profit (or a loss).

Every day the trade was open was a time of intense anxiety for me—as it should have been—because of the realization that silver might just start to go down in price just as fast as it had been going up. Having no plan meant I had to deal with plenty of pain and worry about losing a good part of my investment due to ignorance and fear, which was yet another thing for me to worry about in 1979.

Looking back, I see how foolish that behavior was. Not necessarily the worry aspect so much as the lack of a defined exit strategy that was driving all of the anxiety.

In the late 1990s (after a modest amount of success trading in the 1980s and 1990s), when I began to develop systems using OmniTrader 4.0, I decided to incorporate stop-losses into my systems along with a plan of trade (position) sizing so I wouldn't ever be in the position of risking of total loss ever again.

Suddenly trading became more fun and a lot easier on the psyche and for that I was grateful. But I soon noticed that I was placing far too much faith in my automated mechanical methods than on my personal trading psychology, with the result being that I found it hard to consistently stay with a winning system through periods of drawdown (I was trading stocks then).

While I said to myself that I believed in my systems (and they weren't bad for a new developer), in reality, during times of drawdown, I would more often than not throw in the towel and abandon the system only to start the search for the perfect trading system insanity once again.

I did this at least 20 times, probably scrapping a half dozen systems that went on to make seriously good money over a longer-term time frame. Ultimately, I had to take a break from trading and reexamine my personal belief systems, commitment issues, risk tolerances, and market biases.

NEXT: The 5 Steps to Trading System Success

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What I learned was that I was the centerpiece in my trading system and not some magic computer code designed to anticipate every twist and turn in tomorrow's trading action which will never, ever even exist in the first place. So in the interest of sparing new traders from making the same mistakes, here are a few of the things I learned.

Make of this what you will, but here are five steps to trading system success:

  1. Focus on systems that are based on repetitive market patterns that have existed since the beginning of freely traded markets.
  2. Make a realistic assessment of your ability to commit yourself to a trading system with real money for the long-term.
  3. Be honest with yourself: If you're a control freak, you aren't going to be too happy participating in an arena (the stock and commodities market) that defies control and that could care less about your needs, wants, and goals.
  4. Be willing to come to the conclusion (if the facts demand it) that trading may be not only inappropriate for you and your family, but it may also be hazardous to your financial health. You may be far better-served by deploying your time and money into furthering your education and career skills than by trying to extract profits from the markets with haphazard, ineffective, unreliable, and inconsistently deployed trading strategies.
  5. Even if you are good at earning steady profits from trading, you may realize that while you are good at making money from the silver or crude oil futures markets, trading the stock market usually leaves your monthly account statement in the red. Be willing to admit your weaknesses even as you affirm your strengths and then focus only on that segment(s) of the financial markets that regularly provide you with a harvest of profits.

If you embrace and then apply at least some of the wisdom contained in the above five points, you should notice a marked improvement in your financial situation, as well as in your emotional and spiritual health.

Take some time this week and carefully reflect on what I've written and then make changes in your life and trading strategy accordingly. It could mean the difference between success and failure when trading the financial markets.

By Donald Pendergast, trading system developer, owner of Linear Trading Systems, LLC

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