The Evolution of Trading Terminology: Trading Systems Vs Trading Strategies
By Robert Buran
Unraveling the Difference Between a Trading System and a Trading Strategy
This engaging narrative takes us back to a time, more than three decades ago, when government regulation shifted the way we understand the terminologies of ‘trading systems’ and ‘trading strategies.’
Interestingly, the phrase ‘Automated Trading Strategies’ records almost 10,000 searches per month on Google. This curiosity prompts a chuckle because, from a knowledgeable trader’s perspective, automation and strategy don’t quite mesh together.
Diving Into the Concept of Trading Strategy
When considering a trading strategy, traders typically have a broad approach. For instance, a trading strategy might look something like this:
Example of Trading Strategy: “I will target newly issued NASDAQ stocks priced under two dollars, planning to purchase during the initial price drop following an initial surge.”
Such a strategy takes a global perspective concerning actual market prices. It is more of an overall plan than a defined set of actions.
The Impossibility of Automating a Strategy
An important point to note is that strategies can’t be automated unless they’re explicitly defined, rather than being broad or general. Automation in trading necessitates specific market prices, and trading strategies are typically too vague to lend themselves to such precision.
Let me elaborate further on this point. If we take the previously mentioned 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,” this can be transitioned into a more precise trading statement. Here’s how:
The Precision of a Trading System: An Example
A trading system, on the other hand, could take the following form:
Example of a Trading System: “If the market is NASDAQ, and the average closing price over the past 10 days is less than $2, then if there is a price expansion on a daily bar, where the range of the expansion bar is three times the average range of the previous 10 daily bars, and if the high of the expansion bar exceeds 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 the price comes back to the high of the expansion bar minus half of the average range of the past 10 bars.”
The latter statement, albeit dense, brings with it precision. It is programmable and testable in any market. With the right software and a computer, one could theoretically test this system using millennia of daily bar data.
Understanding the Distinction: Trading System vs. Trading Strategy
This precise statement, however, no longer remains a strategy; it evolves into a TRADING SYSTEM. (For a more detailed analysis of this concept, please refer to my article, “Trading Signals.”)
In the typical sense, the term ‘trading strategy’ doesn’t apply to purchases at a specific price, and hence, it CANNOT BE AUTOMATED. This brings us to the puzzling question of what people expect when they search for “automated trading strategy” on Google.
When a trading approach has set rules defining the exact price at which a market should be bought or sold, it is called a TRADING SYSTEM and not a TRADING STRATEGY.
The Transition from ‘Trading System’ to ‘Trading Strategy’: The Influence of Government Regulation
The evolution of the phrase ‘TRADING SYSTEM’ into ‘TRADING STRATEGY’ is an intriguing tale of how government regulations subtly altered the English language. In the early 1990s, regulatory bodies sought to expand their influence by mandating individuals offering market advice to register with the government. This process involved taking tests, paying fees, and submitting to government reviews and audits, subtly implying the censorship of ideas.
I chose not to register with the government and faced consequences around 1999 for publishing trading articles online. An arduous journey to Los Angeles, hours of testifying under oath, and $25,000 in attorney fees later, I managed to elude the grasp of government registration, regulation, and censorship.
A Shift in Terminology: Government Regulation and its Impact
Initially, government attempts at regulating the Internet, software, and newsletters containing market and trading information were noticeable. But legal challenges spearheaded by free speech advocates made the government retract and redefine ‘market advice.’ The new definition only included specific recommendations about the exact buying or selling price of a market.
To circumvent potential issues with governmental registration and regulation, the phrase TRADING STRATEGY became more prevalent than TRADING SYSTEM. Omega Research, now TradeStation Securities, one of the largest trading software developers based in Miami, played a significant role in this change. Around 1985, Omega introduced their first system development software called ‘SYSTEM WRITER.’ However, when the government began scrutinizing Omega, the company quickly removed any mention of ‘SYSTEM’ from its software, replacing it with ‘STRATEGY.’
Trading System or Trading Strategy: Understanding the Difference
Thus, ‘Trading System’ transitioned into ‘Trading Strategy.’ Most started using the term TRADING STRATEGY even when they were actually referring to TRADING SYSTEMS. I firmly believe that the phrase ‘trading strategy’ was essentially coined by Omega Research, serving as a practical euphemism for ‘trading system.’
This new terminology has stuck around and is now commonly used among traders. By 2023, the term ‘trading system’ has fallen out of common use, and many newer entrants in the field may not even grasp my critique’s essence.
In my opinion, using ‘strategy,’ especially in conjunction with ‘automated,’ is improper. You cannot automate a ‘trading strategy.’ Automation applies only to a ‘trading system.’
While our country and its government hold merit, this narrative remains a cautionary, somewhat amusing tale of the potency of government regulation. It shows how government power can not only change our language use but also enforce an improper use of language.
To reiterate, ‘Trading System’ and ‘Trading Strategy’ are distinct concepts. However, government regulation has blurred this difference in many minds, causing them to be used synonymously.