How to Create a Profitable System

I was reminiscing just the other day, thinking about the first robot portfolio I ever put together.

It was 2012, and I had decided that trading robots might be the greatest thing ever invented.

So you're telling me I get all the benefits of trading and none of the drudgery of sitting and looking at screens all day? The robot does all the work and I get to keep all the money?

I was all the way in and twice on Sundays.

The problem then became: How do I make my robot?

Since I didn't know how to code, the first big obstacle was finding a programmer. Luckily my friend Rob Booker helped me find a good guy, so I was ready to go.

But ready to go with what? What was I going to build?

This is a crucial step in any trader's journey. What is it exactly we want to trade?

If we're mathematical researchers, then we can dive deep into the numbers and come out with something. Patterns exist everywhere in the world, even if they're random luck.

So we can easily crunch numbers and come out with a system. For example, after going over several thousand trades, we can discover that on the second Tuesday of the month between 10-11 am EST, the price on AAPL goes up 2% if the S&P 500 index has a volume 3% over its 14-day average and the NASDAQ has gone up 3 of the previous 4 days.

That's a whole lot of data and would sound impressive if you explained it to a stranger. And there's no doubt the numbers would back it up. But will it actually make money? In short, would you put all your savings into something like that and start trading tomorrow?

Then there's the other end of the spectrum.

Instead of blindly crunching numbers, you could build a system based on sound philosophy and universal truths.

For example, billions have been made using one simple common sense thought: what goes down must come up.

For example, in 1939, Sir John Templeton bought $100 worth of every stock below $1 on the New York & American stock exchanges. In four years, he sold those shares for nearly four times the money he had invested.

Templeton believed in a philosophical truth: when times are bad, stock prices drop, and when times are good, stock prices rise. If you buy something that's dropped, it's bound to rise. There weren't any hard numbers for Sir John to look at, only a rational belief. That being said, would you put all your savings into something like that and start trading tomorrow?

Back in 2012, I chose the latter. I was a value investor at heart and had been studying the concept of Fair Value for quite a while (and had done a Bossilator course with Rob using these principles). To me, it made sense that everything comes back to Fair Value at some point. That's inarguable.

But what happens then? What happens when it finally does get back to Fair Value?

It has to go somewhere, right?

That was the basis of my robots. After price gets back to Fair Value, it has to break in one direction or the other. To my mind, that is how every big trend in history has started. Price gets back to equilibrium, and then it breaks out to a massive winner. Not every time, of course, but it happens.

So that's how I built those robots. The rules were initially overly complicated and I kept adding on special features for no good reason (it cost me a lot of money).

And I had no idea how to put together a portfolio. What instruments should I use? How many? I didn't have the faintest idea.

Somehow I settled on the number eight. I should have eight currency pairs in my portfolio. Hooray! (I still don't know why I chose that number.)

How did I pick my eight? Randomly, of course! I thought it would be good to have a bunch of different currency pair names in the roster. That would make me diversified! Thus, my choices were EURUSD, GBPUSD, USDCHF, GBPCHF, AUDJPY, CADJPY, NZDUSD, and GBPJPY. See all the different names in there? Brilliant!

Would you be willing to put all your savings into this idea? I was, and I did. At least for a while. Eventually I came to the conclusion that I didn't like how it traded, so I switched my focus to something else.

But looking back, how did that portfolio turn out? How has it performed since I took it live back in 2012?

It's produced an average of $1,534 per year on a hypothetical $10k account (15.34%). The worst month-end drawdown came out to about 37%. Out of curiosity, how does that compare with the best Index funds in the world?

The cream-of-the-crop Vanguard Index Fund (VFIAX) has returned 14.59% a year for the past five years with a historical max drawdown of 36.9%. The two are very similar (but edge to robots).

And if you go back to when Index Funds did terribly (2007-2010), my portfolio would have kicked Vanguard's rear end. If you had $10,000 in a Vanguard Index Fund at the beginning of 2007, by 2010 you would only have $9,300. That's four years of trading and less money at the end.

If you traded the common-sense based robot portfolio, $10,000 would become $19,300 by 2010. That's a huge difference.

The point is, creating a trading system is tricky. You can look at the numbers until you find a possible, intricate pattern, or you can trust a basic truth and build from there. Or you can hope for beginner's luck.

Looking back at my own portfolio, it looks like the second option is the smarter one. With a little of the third one, too.

But if this ignorant robot portfolio is pretty good, is there a way to make it even better?

You bet. And we'll talk about that tomorrow in the Thursday webinar.

Get the Heron Course here

Note: The summer session of Thursday webinars start this week. Register here: https://attendee.gotowebinar.com/register/586982361387971587

My new website is here: https://www.scottwelsh.me/

My new eBook, The Inevitability of Becoming Rich: An Interview with a Master, is available on Amazon, and you can get it here.

For information on all my trading courses, go here: https://www.scottwelsh.me/courses/

The recordings of the Thursday webinars go on my YouTube channel. You can Subscribe by going here:  https://www.youtube.com/channel/UCxAWDDaTLVy_diMVJCkGl3A

If you'd like a copy of my free eBook, go to https://www.scottwelsh.me/free-ebook/ and just fill out the form.

Follow me on Twitter @swelsh66.