What is systematic trading?

Systematic trading is a style of trading that relies purely on predefined rules.

Rules:

• When to be in the markets and when to stay away

• What to trade

• When to buy

• How much to buy

• When to sell

You might ask what is the other style of trading.

The other style is discretionary trading. As the name says, this style relies on the intuition and judgement of the trader/investor.

Intuition, judgement and discretion are all things that work against us. Human brain works in weird ways when there is money involved.

Like Selling winners too quickly - due to fear of losing paper profits.

Holding on to losing trader - hoping for a turnaround to sell it at breakeven.

In behavioural finance, this is called as system 1 thinking ( decision making mode based on intuition and emotion).

System 2 is the rational mind that helps us in taking rational decisions.

When money is involved, system 1 (intuition and emotions) takes over the rational mode.

Why Systematic Trading?

We saw that humans behave in irrational ways when money is involved. Systematic trading addresses this by removing emotions and subjectivity from the decision-making process completely.

Systematic trading aims to minimize human error and achieve consistent results.

In systematic trading, the rules are based on a well-defined system that has been backtested using historical data. This also gives us the confidence to deploy our capital and stay consistent with our system.

By being consistent, we are letting the law of large numbers work in our favour.

In the next article we will look at the key components of putting together a systematic trading system.