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Mechanical trading systems - Weissman R.L.

Weissman R.L. Mechanical trading systems - Wiley publishing , 2005 . - 240 p.
ISBN 0-471-65435-3
Download (direct link): mechanicaltradingsystems2005.pdf
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182
MECHANICAL TRADING SYSTEMS
signal. Subsequently I have found that the simplest and preferred solution to this problem of conflicting signals for the same asset is the maintenance of two (or more) separate trading accounts—one for each distinct trading methodology (e.g., trend-following, intermediate-term mean reversion, short-term).
PSYCHOLOGY OF TRADING SYSTEM DIVERSIFICATION

Years of empirical observation have led me to firmly believe that there are at least three distinct trading personalities: trend-following, mean reversion, and short-term (e.g., swing trading, day trading) trading. Yet nothing prevents us from expanding beyond our natural center of gravity (see Chapter 6 to determine the innate trading personality) and adopting the trading strategies of the other basic personality types. Although I feel adoption of intermediate-term mean reversion trading systems is easier for either the trend-trading or short-term trading personalities, I believe that, with practice, a person can adapt and master any of these personalities (although each person’s natural center of gravity probably will continue to feel the most comfortable).
I believe that traders should incorporate a different trading style only after they achieve long-standing success with their natural center of gravity. We must master the type of trading system that addresses our psychological strengths (e.g., quick mindedness, patience, contrarianism, etc.) to build confidence and strengthen discipline. We nurture the good trading habits necessary for success in the easiest environment possible, and then, and only then, do we apply the universal rules of discipline and money management to the type of trading that seems foreign.
Although at first glance it seems simple enough merely to add another style of trading to our arsenal, with the exception of the transition from undisciplined gambling to consistently disciplined, rule-based speculation, this idea of combining noncorrelated trading systems is the greatest challenge most traders will ever face.
Imagine that you are a successful trend trader who has made a good living in the markets for several years. You have had several years of positive reinforcement for buying recent highs and/or selling lows, for taking numerous small losses and letting profits run. Now you attempt to add intermediate-term mean reversion trading to your core trend-following strategy.
Typically here is what happens: Your trend trading strategy has you selling the euro against the U.S. dollar, and you do so with the utmost confidence. The trend unfolds nicely and profits start to accumulate. Then the mean reversion system signals a buy of the euro currency against the Japanese yen. For the last three years you have never deviated from a signal gen-
Improving the Rate of Return
183
erated by your system(s), but suddenly you hesitate. You are already making money with your trend-following system by selling euros, so even though you have tested the mean reversion system and intellectually know that the combination of negatively and/or uncorrelated systems improves overall performance, you decide not to take the mean reversion system’s signal.
This single inaction in the face of a trading signal subverts years of disciplined trading. Suddenly all of the old psychological problems that haunted your early career as a trader reemerge because you are fighting the basic premises that have led to your recent success.
If that story sounds familiar, do not despair. It may take a few missed signals and much review of backtested results before you gain the confidence and discipline necessary to simultaneously take trend-following, mean reversion, and/or short-term signals of highly correlated assets. At the outset, participating in and fading a trend simultaneously is a highly unnatural and uncomfortable endeavor. In fact, many traders find the practice so foreign and stressful that they simply abandon system diversification and revert to what is comfortable and has worked for them in the past.
Although there is absolutely nothing wrong with adhering to a single successful trading methodology, personal growth and heightened success in trading comes from psychological flexibility and ability to behave consistently in an uncomfortable and unnatural manner. One of the best tools to help us in modifying our behavior is a thorough review of the backtested results from system diversification, including risk/reward quantification and other comparative analyses similar to those shown in Tables 9.3 to 9.5.
In addition, it is also helpful to remember that our initial success as a trader stemmed from our ability to do the unnatural, uncomfortable thing. Incorporation of trading systems that are antithetical to our innate trading personality is merely the natural extension of the same skill set that led to our initial success as traders.
Finally, by expanding their trading vocabulary to include systems that specifically target weaknesses in their psychological makeup, short-term traders learn patience, while longer-term traders master quick-mindedness. The ability to transcend our innate center of gravity by adopting trading systems that are antithetical to our personalities challenges not only habit-based behaviors but also core belief systems. Such challenges can have profound and lasting consequences to our lives both within and beyond the markets.
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