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Trading system

A complete specification of entries, exits, sizing, and risk limits that can be run over data to produce a track record.

A system is more than an entry signal. To be testable it needs five parts: the universe it trades, the trading-signal that triggers, the position-sizing rule, the exit rules including stops, and the portfolio-level limits that stop it taking twenty correlated positions at once.

Most published strategies specify only the first two and leave the rest to the reader. That is why the same idea can show a 1.6 sharpe-ratio in one write-up and lose money in another: the sizing and exit rules did the work.

Example: buy the S&P 500 when it closes above its 200-day average is an idea. Buy it with 100% of equity, exit on a close below, rebalance monthly, cap at one position, is a system, and can be tested.

Related: rule-set, trading-signal, position-sizing, backtesting

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

How a position size is worked outAccount size, risk per trade and stop distance feed into one box giving the number of shares.ACCOUNT SIZE$25,000your capitalRISK PER TRADE1%of the accountSTOP DISTANCE$0.50entry to stopPOSITION SIZE500 sharesrisk budget: $25,000 × 1% = $250position size: $250 ÷ $0.50 = 500 shares
Working out a position size. Three numbers decide how big a trade is: the account, the share of it put at risk, and the distance from entry to stop. One percent of $25,000 is a $250 budget, and a $0.50 stop divides into that 500 times.

Educational only, not advice. Spotted an error? Post in Site Feedback.