About 10 years ago I gave over my trading to a systematic, rules based approach. That helped turn the corner for me on trading i.e., from loser to profitable. Fear and greed yielded to zen-ish disinterest and the impact of individual trades became only mildly interesting to me as a vague concept that was somehow related to the marginal economic impact of risk/return on a continuous trading system or a perpetual trading "machine." I was reminded of the benefits of rules-based systems again today. Since I run a strategy that shorts volatility by selling options on futures -- what I call a type-2 system: probability rich but with inverted risk return -- I tend to have high probability trades that are exposed to enormous risk for any given dollar in expected profit. This week I happened to have a short put on the e-mini (ES) S&P futures Sep16 contract. The strike was 2135 and at the time the trade was opened I believe that the option strike was > 2 standard deviations from the price level prevailing at that time (depending, that is, on one's assumptions about volatility and fat tails and such) so probability was in my favor, all else being equal. All else was not equal because the market knew I was going out of town (ok, I don't really anthropomorphize the market and I take responsibility for my own trading decisions and risk...but this is a blog...) and decided to school me in risk just for the hell of it. This is what it looked like today (as of 4pm ET). Keep in mind that low-probability-of-being-reached 2135 strike:
Now, without rules this would have been agony and as it was it wasn't all that much fun to have my expectations broken but at least I didn't get taken to the cleaners and the loss didn't bother me all that much. A 2:1 or 3:1 inverted risk:return realized via a rule could have turned into something like 20:1 and ruined my trading machine which I kind of want to keep around for a while. So, the rules are the key -- and here it really doesn't matter what they are: chart based, premium based, indicators, whatever -- because they allow one to detach and dispassionately pull the safety triggers when all hell is breaking loose. If it's a system, follow the rules.
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