Trading System and Trading Strategy

Trading System and Trading Strategy

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What is the difference between a trading system and a trading strategy?

This is the curious story of how government regulation, over a decade ago, changed the use and meaning or the words trading systems and trading strategies.

On the Google search engine nearly 1,000 people per month type in the words Automated Trading Strategies.   For me this phrase brings a smile to my face because I do not believe you can automate a strategy..  Let me tell you why.

You see the way I look at it the words “automated” and “strategies” really do not go together in the lexicon of a knowledgeable trader.  When a trader thinks of a trading strategy he is thinking more in general terms such as:

Example of Trading Strategy

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“I will focus on newly issued NASDAQ stocks trading under two dollars and I will buy them on the first pull back after an initial price surge.”

In this example the word strategy is more general and global in its meaning with respect to actual market prices.
A strategy however cannot be automated unless it is precise as opposed to being general.  For a trading approach to be automated it must be based on specific market prices and   trading strategies are too general to lend themselves well to automation.

I will try to explain better.

Taking the above example, I will focus on newly issued NASDAQ stocks trading under two dollars and I will buy them on the first pull back after an initial price surge, I can convert the statement into a more precise trading statement by saying:

Example of Trading System

“If this is a NASDAQ market and if  the average close of the past 10 days is less than $2 THEN if there is a price expansion on a daily bar AND where the daily range of that expansion bar is three times the average range of the previous 10 daily bars AND the high of  the expansion bar is higher than the lowest low of the past 10 bars PLUS three times the average range of those 10 bars THEN I will BUY IF AND WHEN price comes back to the expansion bar’s high minus one half of the average range of the past 10 bars.”

The second statement is a mouthful, but it is precise, it is programmable and its validity can be tested in any market.  In theory, using a computer and the right software, you could test this idea using one thousand years of daily bar data.

But the second statement is really no longer a STRATEGY.  It is more like a TRADING SYSTEM. (For an expanded discussion of these ideas please see my article TRADING SIGNALS)

The words trading strategy is not generally applied to buying at a specific price and therefore it CANNOT BE AUTOMATED.  So I really do not understand what people are searching for when they type into Google the words “automated trading strategy”.

If a trading approach has specific predetermined rules that dictate the exact price at which a market is to be bought or sold it is called a TRADING SYSTEM not a TRADING STRATEGY.

So how did the phrase TRADING SYSTEM ever become TRADING STRATEGY?

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In this case government rules changed the English language just a little.   Starting in the early 1990s government regulators and agencies sought to extend their power and influence by forcing anybody who gave market advice to register with the government, take tests, pay fees and submit to government reviews and audits.  And obviously this process implied censorship of ideas.
I did not register with the government and around 1999 I got hauled in for publishing articles about trading on the Internet.  I had to travel to Los Angeles, testify under oath for several hours and pay my attorney $25,000 to escape the tentacles of government registration, regulation and censorship.

Originally the government tried to regulate the Internet, software and even Newsletters that contained information about trading and markets.  But because of legal challenges by free speech advocates the government backed off and soon it was implied that market advice, as defined by the government, only meant giving precise and specific recommendations regarding the price at which a market should be bought or sold.

So everybody started using the phrase TRADING STRATEGY rather than TRADING SYSTEM in order to avoid the appearance of giving specific market advice that might subject them to government registration and regulation.  Probably the largest trading software developer at the time, Omega Research in Miami, launched their first system development software circa 1985 which was appropriately called

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SYSTEM WRITER.  But after the government started witch hunting Omega promptly eliminated any mention of SYSTEM from any of its software and substituted the word STRATEGY.

And so Trading System became Trading Strategy

And after that everybody started using the phrase TRADING STRATEGY when they really were talking about TRADING SYSTEMS.  In fact I believe that the phrase trading strategy was invented, for very practical reasons, by the now defunct Omega Research organization as a convenient euphemism for trading system.

But it has been a euphemism that has stuck and one that is now used frequently by traders.

But in my view it is an improper use of the word particularly when combined with the word automated.   You cannot automate a trading strategy; you can only automate a trading system.

Our country is great and for the most part so is its government, but I think this story remains a cautionary tale, albeit slightly humorous, of how the power of government regulation can change how we use the English language and in fact how the government can force the IMPROPER use of the English language.

And I insist again, Trading System and Trading Strategy are different, but government regulation made them, in the minds of many, synonymous

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I am a trading system pro and have been trading markets and have been involved with trading system development and the programming of trading system software for 25 years. “Today Stock Market” is my opportunity to share with you some of my trading experience while discussing stock market news and giving my daily stock market update.