The most important reason to use a trading system is to gain a "statistical edge." This often-used term simply means that you have tested the system, and the profit of the average trade—including all losing and winning trades—is a positive number. This average trade profit is large enough to make this system worth trading—it covers trading costs, slippage, and is, on average, likely to perform better than competing systems. Later in the book, I discuss all of these criteria in greater detail.
The statistical edge is relevant to another statistical quantity called the probability of ruin. The smaller this number, the more likely you are, on paper, to survive and prosper. For example, if you have a probability of ruin less than, say, 1 percent, your risk control measures and other measures of system performance are typically sufficient to prevent instant destruction of your account equity.
6 Developing and Implementing Trading Systems
My biggest source of concern about these statistical numbers is they assume you will trade the system exactly as you have tested it, with not one deviation. This is difficult to achieve in practice. Thus, your risk of ruin—and it is only a risk until it becomes a fact—could be higher than your calculations. Despite this concern, you should develop systems that meet sound statistical criteria, for that greatly enhances your odds of success. As usual, there are no guarantees, but at least the odds, if not the gods, will be on your side.
Another reason to use a trading system is to gain objectivity. If you are steadfastly objective, you can resist the siren call of news events, hot tips, gossip, or boredom. Suppose you are a chart trader and you enjoy some flexibility in interpreting a given chart formation. It is very easy to identify a pattern after the fact, but it is rather difficult to do so as the pattern evolves in real time. Hence, analysis can paralyze you, and you may never make an executable trading decision. Being objective frees you to follow the dictates of your analysis.
Consistency is another vital reason to use a trading system. Since the few rules in a trading system are applied in precisely the same way each time, you are assured of a rare consistency in your trading. In many ways, objectivity and consistency go together. Although consistency is known as the hobgoblin of little minds, it is certainly a useful trait when you are not quite a champion trader.
A trading system gives another crucial advantage: diversification, particularly across trading models, markets, and time frames. No one can be certain when the markets will have their big move, and diversification is another way to increase your odds of being in the right place at the right time.
In summary, you can use a trading system to gain a statistical edge, objectivity, consistency, and diversification across models and markets. A key assumption underlying this section is that the system you are using is well designed and robust. The next section discusses examples of a robust trading system.