Robert Carver’s Systematic Trading isn’t your typical get-rich-quick trading book. It’s a pragmatic, down-to-earth guide for anyone interested in building robust, profitable trading systems using a quantitative approach. Carver, a former quantitative hedge fund manager, emphasizes the importance of rigorous testing, diversification, and, perhaps most crucially, psychological discipline. This book is for aspiring traders, finance professionals, and anyone willing to put in the work to understand that successful trading is about managing risk, not chasing elusive profits.
Key Concepts
The Importance of a Systematic Approach
Carver argues vehemently against discretionary trading, where decisions are based on gut feeling or perceived market “expertise.” He champions a systematic approach, where trading decisions are based on predefined rules and backtested strategies. “Rules protect you from your own worst instincts,” he writes. For example, a systematic rule might be to exit a trade if it drops 5% below the purchase price, regardless of your feeling about the stock’s future potential. This systematic approach helps eliminate emotional biases and ensures consistency in decision-making. In the book, Carver presents a case study where a discretionary trader lost a significant portion of their portfolio due to impulsive decisions driven by fear and greed, highlighting the dangers of relying on intuition.
In the book, Carver shares his experience at AHL, a systematic hedge fund, where their rule-based trading systems consistently outperformed discretionary traders during the 2008 financial crisis, demonstrating the value of removing emotions from trading decisions.
Building a Trading System from the Ground Up
The book meticulously guides readers through the process of building a trading system. It covers everything from generating trading ideas and formulating rules to backtesting and optimizing these rules. Carver provides practical advice on using various data sources, indicators, and software tools. He emphasizes the importance of keeping the system simple and avoiding over-optimization, which can lead to curve-fitting and poor out-of-sample performance. He uses the analogy of building a house, explaining that a solid foundation (data and rules) is crucial before adding complex features (advanced indicators). One example he provides is a simple trend-following system using moving averages, demonstrating how a straightforward approach can be surprisingly effective.
Forecasting and Signal Generation
Carver explains different forecasting methods, emphasizing the importance of understanding their limitations. He introduces the concept of “forecasting combinations,” where multiple uncorrelated forecasts are combined to improve prediction accuracy. “Don’t rely on a single magic bullet,” he advises. “Diversification is key, even in your forecasting methods.” He provides examples of how to create simple yet effective trading signals using moving averages, momentum indicators, and other readily available data. For instance, combining a short-term moving average with a long-term moving average can generate buy/sell signals when the short-term average crosses above or below the long-term average. He shows how combining different indicators, such as a momentum indicator with a volatility indicator, can lead to more robust signals.
Position Sizing and Risk Management
Perhaps the most crucial aspect of Carver’s approach is risk management. He dedicates a significant portion of the book to position sizing, explaining various methods for determining the optimal amount to invest in each trade. He introduces the concept of the “Kelly criterion,” a mathematical formula for maximizing long-term growth, and demonstrates how to adapt it for practical trading. “Controlling your risk is paramount,” Carver emphasizes. “It’s not about maximizing profits, it’s about surviving long enough to reap the rewards of a well-designed system.” He provides specific examples of how to calculate position sizes based on different risk tolerances and volatility levels. He mentions that consistently risking more than 2% of your portfolio on any single trade can lead to devastating drawdowns.
Backtesting and Optimization
Carver stresses the importance of thorough backtesting to evaluate the performance of a trading system before deploying it with real money. He explains how to avoid common backtesting pitfalls, such as look-ahead bias and over-optimization. He also discusses the importance of out-of-sample testing to ensure the system’s robustness. He illustrates the concept of look-ahead bias with an example of using future information (like tomorrow’s price) when making trading decisions in a backtest, which would lead to unrealistically positive results. He advises using a portion of historical data for “out-of-sample” testing to simulate real-world performance.
Psychological Discipline and Dealing with Losing Streaks
Even with a robust trading system, psychological discipline is crucial for long-term success. Carver acknowledges the emotional challenges of trading and offers practical advice on dealing with losing streaks and avoiding impulsive decisions. “Trading is a marathon, not a sprint,” he reminds readers. “Maintaining discipline and sticking to your system is essential for weathering market volatility.” He shares personal anecdotes of how he dealt with significant losses and the importance of having a pre-defined plan to manage emotional responses to market fluctuations. He emphasizes the importance of journaling trades and emotions to identify patterns and improve self-awareness.
Practical Implementation and Automation
The book provides practical guidance on implementing and automating a trading system. Carver discusses various trading platforms and software tools that can be used for automated trading. He also emphasizes the importance of monitoring and regularly reviewing the performance of the system. He cites the benefits of automated trading in eliminating emotional biases and executing trades consistently. He provides examples of how to use APIs to connect to brokerage platforms and execute trades automatically.
Conclusion
Systematic Trading provides a comprehensive and practical framework for developing and implementing a quantitative trading system. It’s not a get-rich-quick scheme, but a guide for those willing to put in the effort to build a robust, risk-managed approach to trading. The book’s emphasis on psychological discipline and the importance of managing risk sets it apart from many other trading books. Its relevance remains strong today, as the principles of systematic trading are timeless and applicable across different markets and asset classes.
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- “Following the Trend: Diversified Managed Futures Trading” by Andreas F. Clenow: Explores trend following strategies in detail, complementing Carver’s systematic approach with practical examples from managed futures trading.
- “Machine Learning for Asset Managers” by Marcos López de Prado: Offers advanced quantitative techniques for portfolio management, building on the systematic foundations laid out in Carver’s book.
Different but Interesting:
- "Thinking, Fast and Slow" by Daniel Kahneman : This book explores the cognitive biases that can affect decision-making, offering valuable insights into the psychological aspects of trading. Understanding these biases can help traders make more rational decisions and avoid emotional pitfalls.
- "The Psychology of Money" by Morgan Housel : This book explores the behavioral side of investing and personal finance, providing valuable insights into how our emotions and biases influence our financial decisions. It complements Systematic Trading by emphasizing the importance of mindset and discipline in achieving financial success.