Some things in trading just aren't possible.  Maybe a car analogy will help.  Imagine for a moment you are designing a car and it has to have the following characteristics:

• 0-60 miles per hour in 6 seconds
• Top speed of 180 miles per hour

So it's a fast sports car at the high end of performance.  Now you have a couple more required characteristics:

• Carry 7 passengers in comfort
• Do 40 miles on a gallon of gas

If you know anything about physics and conservation of energy you will quickly realize that these 4 characteristics would be virtually impossible to embody into one vehicle (with current technology).  You have 2 main choices - compromise on some of the requirements, or design 3 cars (a sports car, an SUV, and a compact).

What has this got to do with trading?  Well a lot of the time people are trying to design the 'Holy Grail' system that has the following characteristics:

• High win%
• High average winner size to loser size
• High frequency
• High return
• Low drawdown
• Low slippage
• Low implementation costs

Just like the car design where some of the characteristics have an inverse relationship (e.g. top speed to fuel economy) trading systems exhibit similar behavior.  High win%, for example, is usually inversely proportional to both trade frequency and average size of winners compared to losers.

When you are attempting to design a trading system it is important that you make sure you don't have an 'impossible specification' for what you want to achieve because you don't clearly understand the relationships between the various system components and characteristics.  Otherwise the only thing you'll achieve is frustration.

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There was an interesting story recently on a forum I contribute to regularly and it is worth further investigation here.  The story went something like this:

“My experiences with the markets are like a recent tag sale event where people were selling children’s tents for $10 and they sold like hot cakes and many parents went home disappointed.  I returned the next week to find the prices at $11 so I bought as many as I could only to find no buyers and having to ultimately sell them at a loss for whatever I could get”.

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Some people believe that an entry signal is the first (and only sometimes!) step in trading system development.  In my experience this is a very short-sighted approach.  For me, beliefs about yourself, the markets, and the objectives for your trading all come before any actual system design takes place.

The first 7 items in system development that I use are:

• Beliefs – your interpretation of ‘reality’ that you will base your trading on
• Objectives – what you want a trading system to achieve
• Hypothesis – an idea about how a trading system could work
• Market Selection – what market will your system be implemented in
• Instrument Filter – which instruments within the chosen market(s) you feel are ‘tradable’
• Setup – conditions that determine a trade is possible
• Entry Signal – conditions that determine it is time to enter a position

Note that 6 major items come before you even get to an entry signal!  Also note that the objectives you have for your trading system come before development not as a result of it.  If you don’t know what you are trying to achieve how can you design a system that meets you goals?

Because you need to design a system to meet specific objectives (how else can you determine if it is working or not) it is very important to make sure those objectives are realistic and can probably be achieved with enough hard work.  Expecting to double your account every month with only 10% draw-downs is never going to happen (although I have encountered ‘traders’ who wanted to achieve these kinds of results).

You may be thinking “How do I know what’s reasonable/achievable/sensible for me?” and I can’t answer that question in a blog – it depends on how much time you have to design, develop, and implement your trading system and what your level of expertise it right now.  I recommend you get professional help/advice to guide you through this process rather than “taking a shot in the dark” or “setting yourself up for a big disappointment”.