How many system should a new trader start with?
In this episode of 2Traders Podcast, Walter and Darren unravel the “number of systems” question. How many systems should you trade? Darren talks about the “four systems and one plan” concept and why it is important to have multiple systems when learning the flow and feel of your trading systems.
According to walter, you should build your system according to these two things.
They both share interesting stories about some of the most successful traders they know and the true value of making trading mistakes. They also dig more into money management, and how to deal with losing.
Download (Duration: 21:17 / 24.3 MB)
In this episode:
01:03 – 4 systems and 1 plan
03:25 – complementary system
05:08 – add to arsenal
07:55 – reap more rewards
09:43 – no benefit
11:49 – pepper spray
14:49 – compulsive gambler
16:45 – missed opportunity
19:15 – Frankenstein it
Walter: For most traders, the biggest pain is this missing out on the opportunity, on the big one. Missing out on the big one is much more painful than getting into a loser or making mistake that turns into a loser…
Announcer: Two Traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome to the Two Traders. It’s Walter here and hello, Darren. I’ve got Darren on the line here.
Darren: Good afternoon, Walter.
Walter: So Darren, we have this question for this episode which is: How many systems when you’re first trading, how many system should you start out with?
Darren: This is the question I’ve kind of know where you’re going with this so I’m deliberately going to derail the question.
Walter: Awesome! I can count on you for that.
Darren: In my mind, when you start trading and money is on the line, you should have four systems and one plan.
Walter: What do you mean, four systems?
Darren: Well, the reason I say that is because people tend to see trading as a single system whereas in reality, what’s happening is there’s multiple systems. It’s no good just saying right, “I have a buy-sell motto system and that’s it. That’s what I’m going to trade.” because you’ll fail.
What you need is you need a Psychology system, you need a money management system, you need a buy-sell system and you need a system for the market and the market condition. You need four systems and then one plan. The plan is the important part because that’s what you’re trying to achieve and that bit should stay rock solid.
Now the other systems can vary and I know what you’re deriving at here. It’s really what you should do is, “I’m going to be a trend trader. This is a system I am going to trade” and you should stick with it for a long period of time because that’s when you’ll really learn something rather than changing.
Generally, what people will do is they change their buy-sell system all the time but they keep all the other systems the same. So they don’t really change their Psychology, they don’t look at their money management or change that or they don’t look at the element of the market.
In a way, I’m saying you should have one system and stick with it so you can learn about the flow of trading, that it is not all winning or all losing, it’s variably distributed but at the same time, you have to understand that there’s more than one system required to be a trader.
Have I completely derailed your point now?
Walter: Yeah, I think you’ve kind of got where I’m coming from. I would just say, the main points I want to make are that when you start out, yes, concentrate on something. Focus on what you believe in not what you read on a book, not on what I say or what Darren says or anyone else.
Focus on what you believe in and build your confidence up that way but in the end, you’re going to have to add multiple systems. The reason why is because you will learn over time that your system is going to work in a certain type of market and you’ll want other complementary systems that work in other types of markets.
Traders, they pity themselves into a corner I believe because they think that they’re going to get away with trading the same system by trading multiple markets. The problem with that is you don’t get the same diversification factor that you would if you’re trading a complementary system.
In other words, if you’re trader Bob and trader Bob trades a breakout trading system, he trades on a CAD/JPY, the USD/CHF, and the EUR/AUD let’s say. He’s trading these totally different pairs and he’s trading a breakout system and he thinks that it’s diversified because he’s trading these completely different pairs that are uncorrelated.
Well, he’s actually going to be much better off if he trades a swing trading system and the breakout system on the same pair. That’s actually going to be much better off for his, that’s going to blunt his drawdown and whatever more but you’re right.
I mean, I agree. In the beginning, you really to focus on one thing and get good at one thing instead of hopping around a lot. You’re right. I mean, you knew what kind of I was going to say there but I did want to make the point that, eventually you’re going to get bored.
Either you’re going to completely change the way you trade or the more healthy wa yI think to look at it is, “Okay, I’ve already sort of, I’m really comfortable with system A. I really like the way it works but now, it’s time for me to build something else that maybe works in a different market altogether as system A and I’ll call it system B and will start to build this.”
I think that’s the way that a lot of traders are able to add to their arsenal or whatever of trading systems by realizing where the short falls are in the system that they’re comfortable with. They can build something with that in mind.
I think that is a great way to do it. I think that we fall into the trap of thinking we’re diversified when we’re trading different markets. It’s really, really hard to do that. You just don’t get the same effect the you would if you have multiple system.
Darren: What do you think of this idea of achieving that same diversification just by changing the money management system? So, you’re essentially trading the same setups but one will have like a 2R exit and the other one will have at 4R trailing stop, tight exit.
When price is ranging a bit more than the 2:1 will perform as well as it always does and then when price really moves strongly than the one with the bigger targets will perform better.
Walter: Yeah. That’s great because what you’re essentially doing, the way that you explained that is you diversifying the results. So, when I was before about the systems how they work in different types of markets, those exits work in different types of markets.
Like you said, if it’s really a choppy market, the trailing exit might not do as well but you’re 2R target, that exit might do quite well. When the market completely blast off and has very shallow retracements, perhaps your trailing exit does really well and takes a huge chunk of that move whereas your 2R only took a little tiny by that move, that sort of thing.
I agree. The way I look at that with what you’ve just said is exactly that which is different exits are essentially going to take advantage of different types of markets that occur after you enter a trade.
Darren: The problem with this as well is that people are instantly going to look at different buy-sell models, different entry system rather than looking at the other elements of a strategy.
It’s really important like you are suggesting, have a different system for different market conditions. Don’t just focus on a different entry system. Like, someone who perhaps trade outside bars rules say, “Okay, I’ll look at inside bars”.
You’re not really changing your system there. You’re changing your buy-sell entry system but you’re much better to say, “Okay, I’ll look at a different way, I’ll look at different market conditions to decide which system to trade” or “I’ll look at different money management systems.” That’s going to reap more rewards than just changing the entry, in my opinion.
Walter: Yeah, absolutely. If you backwards engineer it, you say, “What kind of system will do well in a trending market? or “What kind of system will do well in a sideways market?” or “What kind of system will do well in a volatile trend that has deep retracements against a trend and what kind of system will do well in a trending market that has very shallow, weak retracement against the trend.”
You can look at those different types of markets or in a really range bound market, “What kind of system will do well in range bound markets?” You can get a lot of interesting ideas from looking at the way that traders trade in these, in like trading competitions.
If you see a whole range of different approaches like sometimes you see these guys and they’re just basically trading range bound markets. Like in the interbank market, they’ll just keep taking all these trades like that’s how they win the trading system or the trading contest.
They just keep taking all these trades in the interbank market period on the HKD or whatever. It’s like this really crazy systems can give you an idea of what kind of market should I build this system to work in. You’re right, some people don’t go far enough. They don’t go far enough, they don’t see it that way.
Darren: Yeah and what’s smart about that is they’re looking for a market conditions to exploit. They’re not looking particular candle pattern or an entry. They’re looking for market condition. If you can find market conditions to exploit, that’s going to help you much more than looking for a particular entry system.
Walter: Right, exactly.
Darren: The funny thing about this is as well, I mean, the question is aimed at people starting out trading. Really they’re going to get no benefit from this podcast at all because they’re not going to listen to us anyway, they’re going to do exactly what they want to do.
You can argue that the best way to start out trading is getting everything wrong. The danger of that is you’ll start with a lot of money and lose it all and never recover but really that whole period of making the same mistake over and over again, does have an element of luck.
Where you’ve made so many mistakes that the answer becomes obvious and when you’re just starting out, then what is obvious is usually wrong. You’re just going to flip systems, you are going to make all of the mistakes, you’re going to risk too much on your trades. You’re going to move your stop loss rather than keeping your money management system tight.
You’re going to do all of those mistakes and over time, it’ll become clear why that was a mistake. Me and you just sat here telling someone starting out, “This is going to be a mistake.” Their belief is so strong that the answer is some sort of golden egg. They’re not going to listen to us anyway.
Walter: When I think about the Market Wizard, almost all of them had a situation where they made a really serious mistake and they sort of swore themselves they’ll never do that again.
Why do you think it is that we have to make the mistake in order to know this is the right path? Why can’t somebody just learn it? I’m sure there are some people that’ll naturally say, “I don’t want to do that. That will be crazy”. They don’t actually have to make the mistake.
I mean, I’ll give you a story. I have a friend, he’s an extremely creative guy. He comes up with the most amazing ideas, he never acts on them but he has great ideas. He’ll see like these products on tv or whatever, where the military will create something like that and he thinks everything is brainer or whatever.
There was this, his girlfriend had some on her keychain — I don’t if they, you call it “Capsicum spray” or whatever. In the States, they call it “pepper spray” and she had this in her keychain.
I guess, when she was coming home late at night or whatever, she wanted to have something in case someone would try to get her. Anyway, he was like, “That stuff can’t really be that bad.” And she said, “No, it’s really bad. Don’t spray it.”
She was off at work and he took the spray and he sprayed just a little, tiny bit. Just a tiny bit on the wall in their apartment and they had to move out for a week. The thing is he should have known.
You don’t do that. You don’t take the pepper spray and spray it on your wall but yet he had to, you know what I mean? I’m not pointing fingers or anything. I’m just saying, it’s a great illustration of what we humans do. We just don’t believe unless we do it.
Darren: Yeah and I think isn’t there something called, in Psychology like an anchoring? So, he even know, you know taking a really massive losses is going to be painful. You have to experience it so that in the future, you’ve got something to anchor that belief on.
No matter how much data people brought you, that’s not going to be as powerful as you actually experience that. That’s it. So, my point before about, it might actually be beneficial to flip systems for ages because then you’ll realize that essentially, it is not going to make any difference. So, you realize the elements that are making the difference and the ones that are.
Walter: Do you think that the…So, you’ve got two traders. You’ve got one and this guy he’s, we’ll call him “Al”. Al has made the catastrophic mistake, he completely blew up his little nest egg of savings that he was going to trade because he made some bad mistake about not sticking to his stop level or whatever. He basically lost 95% of his money.
And then we’ve got this other trader, we’ll call her Helen. Helen has never made a mistake like Al has because she’s very conscientious, she doesn’t want to risk all that. She hasn’t made that mistake and she keeps taking it along and she seems doing quite well but in the end, 20, 30, 40 years out from now, which trader do you think will be in a better position to succeed?
Darren: You’d have to say that Al has slightly better probabilities but not certain.
Walter: But what if we’ll get more information about Al and say, Al is also a compulsive gambler. Like, that’s his hobby. He bets on horses.
Darren: Yeah, the probabilities are complex…
Darren: I mean, also at the same time, people do not always learn from his mistakes but you stand a better probability of learning from them if you’ve actually made them than if you haven’t.
Darren: I know Adam from the Forum, his little quote is something about, “Experts are just people that have made all the mistakes” or something.
Walter: That’s a great way to say it. That reminds me of my friend, the guy who did the pepper spray thing in his apartment. He was trying to pick me up one time — because I had this failed business and he was trying to pick me up — and he said, “You know what? I will always been on the business guy who’s got the failed business. That’s the guy I’m going to put my money into. You know what I mean? Because he’s made the mistakes. He’s gone through the troubles. He’s done blah, blah, blah.”
That was his point and I don’t think he was saying that just to give me a pick me up. I think he actually believed it. That’s the guy he would’ve invest in. It’s the guy who’s gone through the…
Darren: Slightly over simplifying it but I’ll get back to Tom Basso. I listen to one of his podcast and he said that the biggest mistake he ever made was, there was a Silver trade that he missed. That he should have taken but he missed it for some stupid reason. It was the biggest trade of the year.
He said, from that point that’s when he automated his system because he said that, he was never ever in his life going to miss a trade again. Purely because that one time that he missed a trade, it was a massive winner. So that really big lesson stuck with him and probably made him a much better trader.
Walter: Yeah. I think that gets back to what I was talking a couple podcast ago where it was, for most traders, the biggest pain is this missing out on the opportunity in the big one. Missing out on the big one is much more painful than getting into a loser or making mistake that turns into a loser. The big pain really is the one that got away.
Darren: Yeah. I see that a lot with people flipping systems. Perhaps you’ll backtest a system over the weekend and it seems really great and then you’ll start trading it and then you’ll notice that there was a really big winner on your previous system, and then you’ll flip back to previous system.
Just as you do that, that goes into a run of losing. The new system you tested too do suddenly takes off and saw your massive winner there. It’s really a bad habit. It’s really hard to turn those, is it a bias or is it emotional? It’s really hard to turn that off.
Walter: Yeah, no doubt at all. Well, I guessed we’ve hit this one pretty. From my point of view, diversification through system and thinking in terms of markets, types of markets is the way to go here but certainly in the beginning, you should just focus on what you believe.
Most traders that has seen this podcast, they’re going to believe that the best way to trade is to find a turning point in the market. So, they’re kind of like swing traders or even end of trend traders and then the minority listening to this probably are going to be trend traders.
Even though every single trading books says, “Follow the trend.” Most traders don’t actually, from what I’ve seen and from what I’ve tested and I’ve tested quite a few traders, most traders don’t like to trade that way.
They don’t like to follow the trend. It’s much more uncomfortable for them to do that but that 20% of traders who have seen this, probably are very comfortable trading with the trend.
That is something to keep in mind when you build your first system. What’s comfortable for you, what makes sense to you because you want to do something you’re going to stick with and not something that you’re going to flip over again and massage and pull things out, rip it apart and turn it into, Frankenstein it into something else. You just don’t want to do that.
Darren: I’m slightly torn on giving advice for people starting out. I think, from my point of view, I agree from what you say but if you’re starting out, have one system and make that system a really tight money management system.
If you want to flip around and make mistakes and learn by trial and error, that might actually be a really good way to go but make sure that your money management is locked down so during that process, you don’t lose all of your money or too much of it.
Walter: Right, that’s great advice. Can you explain a little bit about the money management though or maybe we should leave that for another episode? I just want to make sure that people are clear what that means.
Darren: I’d say something simple like having a defined amount of risk on every trade. It means that even if you’re going to lose your money, you’re going to lose it slowly at worst and going on from that, just start with a small amount of money because you’re going to make mistake.
You will learn from those mistakes and they’ll help you in the long run but don’t take such a catastrophic loss in that learning period that perhaps you stopped trading altogether or something worse.
Walter: Yeah, something worse. It’s amazing how it hurts even when it’s a small amount of money. It still hurts.
Darren: Yeah, when you’ve got the pain of losing and the ego side of that to deal with, you don’t want to add to that, the fact that your kids can’t leave or are going to choose to go to school next year.
Walter: Well said, Darren. We will see you in the next episode. Thanks so much.
Darren: Okay. Thanks, Walter.