NOW YOU HAVE SOME THEORY AND PERHAPS A FEW QUANTITATIVE tools at your disposal you are ready to begin creating trading systems. In part three of this book I am going to describe a framework which will provide you with a template for the creation of almost any kind of strategy.
Why a modular framework?
Remember that I drew an analogy between cars and trading systems in the introduction of this book. Trading rules are the engine of the system. These give you a forecast for instrument prices; whether they are expected to go up or down and by how much. In a car the chassis, drive train and gearbox translate the power the engine is producing into forward movement. Similarly, you will have a position risk management framework wrapped around your trading rules. This translates forecasts into the actual positions you need to hold.
The most obvious benefit of a modular design is flexibility. Cars really can be any colour you like, including black. Similarly my framework can be adapted for almost any trading rule, including the discretionary forecasts used by semi-automatic traders and the very simple rule used by asset allocating investors. If you don’t like the position sizing component, or any other part of the framework, you can replace it with your own.
Getting the boring bit right
The part of the trading system wrapped around the trading rules, the framework, is something that’s easily ignored. Creating it is a boring task compared with developing new and exciting trading rules, or making your own discretionary forecasts. But it’s incredibly important. By creating a standard framework I’ve done this dull but vital work for you.
The framework will work correctly for any trading rule that produces forecasts in a consistent way with the right interface. So it won’t need to be radically redesigned for any new rules. Also by using the framework asset allocating investors and semi-automatic traders can get much of the benefits of systematic trading without using trading rules to forecast prices.
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