How to Design Stock Market Trading Systems

Design Stock Market Trading Systems

Stock market trading systems are often touted by slick sales spruikers at expos and in the media. These spruikers are selling a dream, a “get rich quick” scheme via their stock market trading systems that are apparently so simple that anyone can make millions and sit back on a beach with their laptop trading the markets – yes, even you! However, the reality is that these trading systems were designed for someone else, not you. The system may not suit your personality, risk appetite (to achieve the amazing results they spruik generally requires massive levels of risk) or lifestyle (do you have the time to sit in front of a computer all day punting?) So let’s get real. Stock market trading systems can be designed by anyone. Let’s start at the beginning and see how it’s done. Many beginners, when learning to trade, are told to create or develop a trading plan.

This plan gives them a course of action to follow throughout the life of the trade and generally includes entry criteria, the exit mechanism and some money management. A complete set of rules is termed a stock market trading system. Technical analysis is the use of price, volume and chart patterns to make trading and investment decisions. The term ‘mechanical’ is used when these trading rules are programmed into trading software that will generate the buy and sell signals for you. Being able to program your trading rules enables 5 key benefits to improve your profitability. These are:

  1. The ability to test the trading rules on past data to analyze profitability and efficiency
  2. To ensure the consistency of the approach
  3. The elimination of emotion from the decision making process
  4. To enable risk and money management techniques to be adhered to
  5. To test ways to increase the overall returns

Whilst many traders or investors baulk at a mechanical stock market trading system, feeling they are not competent to do such programming, it is common practice amongst professional traders. A mechanical stock market trading system allows you to understand what will occur in the future based on what has happened in the past. This is termed ‘backtesting’ and is what gives the professional trader his or her confidence to execute trades with little effort or further thought. When designing stock market trading systems, the most important consideration is your own personality. You must be completely at ease when you participate in the market or it will be very difficult to follow the trading plan thus switching techniques, redesigning the system (the Beginner’s Cycle) and causing losses. Personal considerations to take into account include:

  • Time needed each day to trade
  • Your need for action or interaction
  • Stress and anxiety levels
  • Capital restrictions
  • Natural tendencies (i.e. contrarian)
  • The need to be right or wrong

Whilst your best friend may be a successful day trader, your emotional make up may not allow you to be a ‘fly by the seat of your pants’ trader. You may feel more at home taking your time and assessing more strategic opportunities, using technical analysis to visualize a trade. In order to assess your make-up, it’s important to know the nuances of various stock market trading systems. Most systems will fall into either the short term trading or long term trading categories and as a result similarities start to appear within each grouping. These tend to be:

Short Term Trading Systems (< 10 days) Long Term Trading Systems (> 10 days)
High percentage win rate (60% – 80%) Low percentage win rate (30% – 50%)
Average $$ win < average $$ loss Average $$ win > average $$ loss
Captures most profit Leaves some profit on the table
Tight stops Wide stops
High maintenance Low maintenance
High commissions Low commissions
High stress Low stress
Less capital required More capital required
Slippage is a cost Slippage almost irrelevant


Once the length of the stock market trading system is chosen, it’s then a matter of selecting the variables that generate the signals and dictate the money management techniques. Here is a simple flow chart that may represent an example of such variables. It’s best to work backwards and define the output first. New traders should aim to simply make money as an output as opposed to attempting to make a specific amount of money or return in any year. When designing stock market trading systems there is no need to reinvent the wheel. Many books and trading forums have creative ideas.

Once you are familiar with your trading software be on the lookout for new ideas to test and run through the trading software. Most ideas don’t register any startling results but occasionally you will come across a gem. If you decide to purchase stock market trading systems from a vendor, be aware of several tricks that are used to suck you in. Firstly, are the results true or have they been ‘optimized’ to show profits that perhaps could not be achieved in real time trading. Many systems have been designed with hindsight and will not work in the future. Always ask the system seller if they themselves trade it, if not why not, if yes, ask to see their trading statements. (If their advertising includes a beach, laptop, water, sunshine, etc. ask yourself “what exactly are they selling me?”)

The second issue is matching your personality to the system. Usually stock market trading systems are built around the vendors’ personality, not yours. An example would be a trend following system that, although very profitable, may leave large profits on the table. If you felt uncomfortable about this, you may be tempted to over-ride the system rules to ‘enhance’ the results. This is a recipe for disaster and is generally why such “black box” systems get a bad name. If the vendor is credible, trades the system, publishes their results and it fits your personality then it may well be worth the money.

Lastly, be cautious when stock market trading systems generate amazing results. Always try to disprove the final results and find a flaw. Do not get overly focused on great profits, look for problems. Has it only been profitable because of a recent bull market? Has it only been profitable because of one large profitable trade? Has it been optimized, that is fitted to past data with no reflection of what the future can hold? We tend to overlook various parts of our historical testing. In real time we tend to succumb to our emotions however a mechanical stock market trading system can only tell the truth. A back-tested trading system that shows robust returns can easily be traded in real time and with relative comfort, especially when it has been designed from the ground up with your own input. A small investment into systems software can make a huge difference to your future as a trader.

Once you have learnt to use your trading software (we recommend Amibroker as it is relatively cheap yet powerful and simple to use) read Unholy Grails by Nick Radge. In this book, Nick discusses 8 stock market trading systems in depth and tests the results showing you that if you tweak the system slightly you can find an edge. The trading systems that Nick tests in the book are available to purchase as turnkey systems – i.e. all the coding has been done for you and is ready to plug straight into Amibroker.