Systematic trading

Systematic trading (also known as mechanical trading) is a way of defining trade goals, risk controls and rules that can execute trade orders in a methodical way.[1]

Other authors characterizes Systematic Trading with the usage of computer models, mainly based on technical analysis of market data or fundamental economic data, to identify and make trades, with limited manager intervention[2]

Although it needn't include the use of computers, it is almost impossible to achieve trading goals without using a computer and a systematic trading system in which rules are programmed.

The opposite is discretionary trading. Compared to systematic trading, due to the direct involvement of humans, discretionary trading may be influenced by emotions, with no easy possibilities of backtesting and a limited risk control.[3]

Similar ideas are algorithmic trading and quantitative trading. But Algorithmic trading is more related to how to trade an order or a set of orders, using a set of well-known algorithms. Quantitative trading includes all those kinds of trading (systematic, discretionary, algorithmic, HFT...) which uses quantitative techniques to decide trading options and executions.

Example

Suppose we need to replicate an index with futures and stocks from other markets with higher liquidity level. An example of systematic approach would be:

  1. Identify, using Fundamental analysis, which stocks and futures should be used for replication.
  2. Analyze correlations between targeted index and selected stocks and futures, looking for the strategy which provides a better approximation to index.
  3. Define a coherent strategy to combine dynamically stocks and futures according to market data.
  4. Simulate the strategy including transaction costs, rollovers, stop-loss orders and all other wanted risk controls.
  5. Apply the strategy in the real world using algorithmic trading for signal generation and trying to optimize the P&L, controlling continuously the risks.

Elements of Systematic Trading

Following the ideas of Irene Aldridge's,[4] who describes a specific HFT system, a more general systematic trading system should include these elements:

  1. Data management (in real time and for backtesting purposes)
  2. A signal generation system (to create, buy and sell signals according to predefined strategies using quantitative methods)
  3. A portfolio and P&L tracking system
  4. A quantitative risk management system (defining exposure per market, group, or portfolio)
  5. A routing and execution subsystem (usually containing execution trading algorithms, like TWAP, VWAP...)

Backtesting

The key point in systematic trading is the use of backtests to verify (at least partially[5]) strategies and alternatives. It's a basic point in backtesting the easy and robust access to trading data.

Systematic trading and risk management

Systematic trading should take into account the importance of a risk management, using a systematic approach to quantify risk, consistent limits and techniques to define how to close too risky positions.

Systematic trading, in fact, lends itself to risk control precisely because it allows money managers to define profit targets, loss points, trade size, and system shutdown points objectively and in advance of entering each trade.[6]

Several strategies living together

A systematic trading approach should be able to take benefit from the existence of several strategies living together, reducing transaction costs and the total amount of assumed risk.

References

  1. ↑ Managed Futures Today, Systematic Trading, Systematic Risk Control
  2. ↑ Definition of Systematic Trading
  3. ↑ Systematic trading, benefits and risks
  4. ↑ Aldridge, Irene (2010). High Frequency Trading, A Practical Guide to Algorithmic Strategies and Trading Systems. Wiley Trading. ISBN 978-0-470-56376-2.
  5. ↑ Canals, L.F. "Why HFT cannot be tested".
  6. ↑ "Managed Futures Today, Systematic Trading, Systematic Risk Control".

See also