On uses and abuses of e-mini trading systems - uses

In the first part, we discussed the abuses of the idea of the trading system. And while we were mostly interested in e-mini futures trading systems, the problem of abuses is pretty much common also when it comes to stock and Forex trading systems.

The uses of trading systems seem much more straightforward to address. One can easily distinguish two major ways in which trading systems can be used.

The first one is a direct use. You simply follow the calls generated by the trading system and place your trades based on them. This is a mechanical way of trading that can easily be mastered by virtually everyone out there. It is important to keep in mind that you need to follow all calls. Choosing only some of them and disregarding other is not what mechanical trading is about. It is pretty much what discretionary trading is about for you choose to rely also on your personal judgment when executing the system calls and not exclusively on the calls themselves.

That does not mean that you cannot or should not use your discretion, but unless you trust your discretion more than a system and have a very good reason to trust it more than the system, employing it for a mechanical trading system can be a risky proposition. It may and very often does make more sense to simply religiously follow the mechanical system to the "t." After all, what was the point to design and test it in the first place, if you prefer to override it with your discretion? This also seems to suggest that you don't particularly trust your system and so perhaps it is not such a good idea to trade it at all.

It often makes more sense to use the ideas the trading system is based on to infer the market bias and apply your discretion right at this point instead of waiting for the system call in order to decide whether to take it or not. This kind of use has much more in common with other class of proper uses of trading systems.

The other use is the indirect use. Here is one popular way to do it. You follow the system, but don't act on it. In fact, you act only when the system did not issue a call, but came close to it. You interpret this as a weakness of the market to advance in the direction that would have been indicated by the system had it issued a call. Because of this, you go in the opposite direction. For example, had the trading system came close to calling putting on a long position, but ultimately failed to generate this call, you would have gone short. In trading parlance this is sometimes called "fading the system."

These two ways of using trading systems, including e-mini futures systems, the direct and indirect one are most common and make most sense. Using discretion, which some do when trading mechanical systems, is more advisable when it comes to the indirect use. Otherwise, more often than not, it is more of an abuse of a properly designed trading system that it is its kosher use.