Line Your Own Pockets

Michael: 00:00

Alright, everyone. Welcome to another episode of Line Your Own Pockets. We're doing one from a user question or a, you know, a Dave client question again that I think will be super interesting about moving from discretionary to systematic trading and where to get started and and started down that path, which is kinda something near and dear to my heart because it's something over the last couple years I've I've done myself. But you've got the email there, Dave. So let's go ahead.

Dave: 00:26

Yeah. It's a really good question. It comes from a guy named Maxim. This is a pretty common scenario. Somebody who's is already profitable in discretionary trading, and they're looking to either they're looking to add a systematic approach.

Dave: 00:44

So let me just read the question here. So it's in two parts. My current goal in trading is to achieve a consistent level of performance. I'm already profitable. I've only back tested visually and sporadically.

Dave: 00:59

In trading, I apply market profile, volume profiles, support and resistance lines, price action, and order flow. I attended a couple seminars to study market profile, worked with a coach on Elliot waves and trend lines. I bought a course bundle from SMB with whom I heard you coach some of their traders. To be honest, I struggle with how to describe this method as it's so much context dependent. What do you suggest on how to describe discretionary context based setups for the purpose of backtesting?

Michael: 01:34

First, can we do can we do a little little rant on visual backtesting? I I hate that it is called backtesting, that it's it's something that people equate. They oh, I went back and I looked and there's a couple examples where this worked. It just kills me.

Dave: 01:52

Yeah. I think that it's pretty common. It's it's like a difference in definitions. A lot of people think that's what we mean by backtesting, and it's not really true. So it's backtesting on some sense, but, man, it's nowhere close to what we're talking about.

Michael: 02:10

Yeah. It's yeah. We need two different words. Probably, it's part part of the problem with trading, I think, in general, is there's no, like, textbook that this is these are the definitions of certain things. It is just yeah, it's technically, I guess, backtesting.

Michael: 02:26

But alright. Sorry if there's a weird cut there. I'm oil delivered and my dogs were freaking out. But, yeah, we were talking about people that use the word backtesting to mean I went back and I looked at a handful of charts, and, you know, I noticed that when this line crosses this line, that works. And, you know, I would, and this isn't really related to this particular user, but just remove that kind of from your life the best you can, because you're not seeing all the things that aren't working, you're going to be cherry picking whether you want to or not.

Michael: 03:00

There's just tons and tons of human bias that go into that type of backtesting. I just wish there was a separate word for it entirely.

Dave: 03:07

Yeah. So I think the term we should use for that is chart review, which is still very valuable and you should be doing that, but it's not backtesting. I like what you're saying there that you're not going to have a comprehensive approach doing it, but it is valuable and But just know what you're doing and know that it's not backtesting.

Michael: 03:30

Yeah, well, it has a place for idea generation for, Oh, you know, I've noticed this thing occurs. Now let me go and backtest to see if, right, if I'm just seeing shapes and clouds or whether that's something that's actually profitable. That's just a, again, kind of unrelated rant, but you know, what I got from that, you know, volume profile and Elliot Wave and all of these, not so much volume profile, but Elliot wave are very discretionary, right? The main criticism, this is my, you know, my CMT coming out, the main criticism of Elliot wave is that there's no insane concrete rules that make it something that is purely systematizable because you could get five Elliot Wave guys in a room and give them all the same chart and they would draw the lines from different areas. So that to me, I think is more of the issue that this user is gonna come through is some of the things that they listed there are just wildly subjective and trying to nail those down, I think is gonna be the hardest part.

Michael: 04:33

So by process, I think that's probably not where you start. I don't know if you agree with that, but

Dave: 04:39

Yeah. So the way I always start with the traders I coach is if you've got something that works already, let's don't make a change directly to that. Let's create something that's additive to what you're doing. And it's just a much better transition. And you also run into a lot of situations just like what you described, where you think it might be able to be automated, but you end up going down rabbit holes and it doesn't exact, like you realize there's some discretion there.

Dave: 05:17

The thing I love about these kind of traders though is if you're profitable with a discretionary system like that, you have a lot of good experience and intuition already, and you're much, much closer to being able to turn on your idea engine to create automated strategies, but it is separate from discretionary. And it's a really good foundation that people don't even realize they have and can unlock.

Michael: 05:48

Well, and I would say, you know, systematic trading we talk about all the time exists on a spectrum, right? Just because this person might not be able to codify exactly what they do and then put that into a system and hit a button and make a bunch of money, there's no reason why they can't look at their entire end to end process and pick little bits that could be then systematized. And that would just help increase consistently, see. So, you know, some of those indicators he listed like Elliot Wave, I think are just beyond the ability to desismatize. Other ones, for example, very much could be, you know, volume profile and things like that, I think, or market profile, he said, definitely could be in a way.

Michael: 06:33

So that's kind of, I would say step one is you, you know, you write down and lay out your entire, you know, I buy a stock when this happens. And like we talked about, just make a whole SOP on it. And that will start to open your brain to, okay, this, this, and this could be systematized. Maybe, you know, these five things could be programmed into an indicator that I see on my chart that, you know, changes the color of the candle if it's something. So you could probably, there's a lot of low hanging fruit and a lot of headroom as opposed to going the full systematic route of just kind of shrinking what you do.

Michael: 07:08

And then from there, should open up time and mental space and mental capital to pursue other things.

Dave: 07:14

Yeah, think that's a great approach. Usually, as part of doing that, you're going to find that the aspects of the strategy that are more modelable, I like to say, than others. So maybe the market profile or support and resistance, maybe that is the thing that is you can build an automated strategy around, but the other thing's, well, it's going be too hard to do that. So I think it's a good application of the eightytwenty rule, like figure out the 80% of the stuff that you can automate, or maybe it's even a smaller percentage than that. But think about it in that way and you're closer than you think because you've already done the really hard part, right?

Dave: 08:02

Building the intuition, having the experience, being profitable, that's the hard part. And it's like you're at the very beginning stages of building your idea muscle, like your idea generation muscle. And it's stronger than you think it is, people in this situation. So building that and thinking about that, breaking your strategy into parts and thinking about which parts you wanna test and you think could be modellable is exactly the right way to approach this.

Michael: 08:37

Yeah. And right, just because you model this. I like what you mentioned about you have a base in which to start and, you know, we already gave some ideas in which to improve that base. So that's great. You're you're ahead of 99% of of traders in general, and especially systematic traders out there, where what you need to do is you need to carve out completely unrelated time and completely unrelated, you know, keep doing what you're doing, do the SOP, make it better.

Michael: 09:07

But if you're profitable, then okay, you're making money. Focus really, really hard on that. And then look at the systematic trading is maybe to begin with, like a side gig, right? Okay, well, I'm doing this, this is making money. Well, if I could build one system that has a non zero return on any timeframe, and I have the free capital to trade it, we'll just start thinking about that nexus as it's like a bonus.

Michael: 09:30

It's, you know, you're doing your thing and that's your salary, and then this thing's gonna bring in a bonus. And then eventually, over time, I'd say probably what would happen is the systems are gonna get good enough that you can completely forget about this other thing, So, you know, you just, you go, okay, well maybe this other thing wasn't as good as I thought, because now I have all these systems that I don't need to do all of this really robust, crazy analysis for, and they're doing as well or better, and then eventually your focus shift. That's, to be blunt, that's what happened with me is I had, you know, a process that I did and I made money from the swing trading side of things. And then I shrunk that down. So it was only taking like thirty minutes a day of work.

Michael: 10:13

I'm like, okay, this is great. Now I've got all this other time. Then I started to build some systems from that. And then I just kind of did a bake off one time. I said, well, my systems are doing X and I'm doing Y and they're close enough.

Michael: 10:25

I think I was beating it by like a nose, but like it's so much easier. You know, this is now it's instead of thirty minutes a day, my swing trading systems are like thirty minutes a week. So imagine if and I then, right? So it ends up, it's not an immediate shift. It's just slowly over time, you see your systems get better and they're doing better than you are, and then eventually it it becomes a switch.

Dave: 10:47

Yeah. I I I love that approach. Let me let me mention the wrong way to do this. The wrong way to do this there there's two basic things that I see traders do that are, I I think, like, just way harder. Mhmm.

Dave: 11:02

And that is they try to completely recreate their existing strategy, even if it is automatable, like let's say it's completely automatable, but they're just trading it manually now, even ripping that out and switching to a completely automated version is gonna be tough because at some point you're gonna have a cutover period and there's just gonna be more involved with that than you think there is. I've never seen somebody attempt this and have their P and L stay the same. There's always a period during this transition where it just drops. And that's really difficult for somebody who's trying to make this transition. And during that period, you're like, man, it's going worse now.

Dave: 11:57

Like, why am I even doing this? So that's one thing to avoid. So any thoughts on that, Michael?

Michael: 12:08

Well, and I would I I always looked at it again, from from my experience, is there is some component, especially to a user like this, there is like one component that it makes all the difference. And sometimes instead of trying to systematize your entire approach, right, try to systematize the easiest part of it and see how close that gets you. But I totally agree. You're never going to take exactly what you do and import it. And that shouldn't be the goal.

Michael: 12:40

Like, this is very much a what is good enough, I think, part of it. So say you're, you know, you're trading a moving average crossover, right? And you say, okay, I trade this moving average crossover and it's great, but I'm really good at it because I have all this like 8,000,000 things of context behind it, so I only take the best moving average crossovers, and that's great. But if you could just take the moving average crossover with some simple rules around it, and it's okay, well then it's like, okay, I think that's good enough. You've gotten most of the way there.

Michael: 13:10

I wouldn't try to replicate the whole thing, just replicate maybe enough that's important. And then, you know, what we talked about with freeing up the time and moving from there, but absolutely not. I think that's a trader's get in a big trap of they look at what the backtest would do and they go, No, I wouldn't have done that because of this, and I wouldn't have done this because of this. It's like, doesn't matter because you're not looking to copy you exactly, you're looking to get some facsimile of that's good enough that, you know, it's kind of like if you're doing a really good job, then you hire an assistant, you don't expect the assistant to do the exact same thing that you were doing. But if they're getting the job done, if it's good enough, you go, okay, that's great, because I'm not doing it.

Michael: 13:53

So I'm trading the time and energy that I'm focusing on it for some amount of return, and that'll be fine. And sometimes you might find the assistant does better when all that other stuff was useless anyway. But I think that's another topic. Yeah.

Dave: 14:08

Like the way you put that. Yeah. And it, you know, a lot of traders will get stuck on maybe they'll run a back test and their systematic strategy isn't as good as their discretionary trading. But that doesn't mean you should completely discard it because what you're doing is you're increasing your capacity. That's one strategy you've created.

Dave: 14:33

You could have 10 of these and be doing no extra work. I mean, the real reason people are drawn to a systematic approach is they realize when they're discretionary trading, it's stressful. You're making decisions during the trading day by definition. So cognitive load is really stressful, certainly compared to automated trading. So they realize, okay, there's only so much time in the day.

Dave: 15:06

There's only so much mental capacity I have. There's going be a ceiling on the number of trades I can take. There's going to be a ceiling on my anxiety level. Even if you think it's simple, you're still making decisions during the day. They just realize, okay, if I'm going to scale my business, I'm going to have to introduce some automation somehow.

Dave: 15:31

The traders that do that really well are the ones that really understand that and start from the outset, creating something that is from the ground up systematic. So it's maybe tangential to what their profitable discretionary trading is doing, but it's not So in that way, it's just a much better experience when you create something that's completely additive. So instead of having this dip in your P and L because you're cutting over, now you have this bump in your P and L, small at first, but more consistent over time and growing. Then you run into the situation like you did where, okay, why am I even doing this discretionary stuff? This automated stuff is getting better fills than me.

Dave: 16:22

It's putting orders in way faster than I ever could. I can scale that easily just by sizing up these parameters I'm putting in this code. That transition is just a lot easier and there's less cutovers, there's less stress with it.

Michael: 16:47

So let's just go to a fictional world, I guess, for the user. And what if none of these things work, right? So he writes an SOP, and again, this is I think near impossible to happen. He writes an SOP, there's no real room to budge. Everything he's doing, he kind of has to do manually.

Michael: 17:09

There's nothing that he thinks he can kind of codify. And that makes it so that he doesn't really have the time to go and work on, you know, building kind of new things very well, and, you know, stuck. And I'm thinking more of someone, you know, they've got a trading strategy that takes certain amount of time, they have a job, kids, whatever, and they're just kind of stuck there, is like, where do you pull from that to go from this? And the reason I think this is a good example for this one client is that their strategy seems really complicated. So I could see a world where maybe, you know, you could save a bit of time and a bit of energy here and there, but you can't do too much.

Michael: 17:51

Is that just suck it up, write off a couple weekends and try to get to it? Or do you have any more unique suggestions there?

Dave: 17:59

Yeah. So I would reject the premise that you're at a dead end and it's impossible. That's what I would say to the person. I think you have more ideas in there than you realize and start right now. Keep doing what you're doing, but always put yourself in a position to notice something that could be systematized about your trading.

Dave: 18:25

So that means, like we said before, chart review, not back testing, but do a chart review at the end of every day, do a chart review with the eye of, okay, what about this can I automate? Maybe it's not as great as my discretionary system that I'm trading now, but what about this am I curious about? What's something that looks unusual that I could create a back test for, see how often it happens. There's a really good book called The Art of Noticing. Has nothing to do with trading, but it's a really good book because it's like a whole bunch of examples of things this guy noticed just in everyday life and how to build your noticing muscle.

Michael: 19:17

I just wrote that down.

Dave: 19:19

Yeah. It's kind of an interesting read. Like I said, nothing to do with trading, just about life in general, but that is the kind of mindset that you need to get in. And if you set out with some intention about that, I guarantee you're gonna have ideas. I mean, there's no way you're not going to.

Dave: 19:35

And that should be your default stance going into every day. So maybe the very first step of this process is, okay, having some intention about your discretionary trading and have this process going in the back of your head that's running to be noticing for the systematizable ideas as you continue your trading. So maybe that's phase one.

Michael: 20:06

Yeah. And I was thinking too some time management, right? So I think one of the easiest things that discretionary traders can do when it comes to optimizing their trading is, you know, hopefully, again, you're journaling your trades, you're recording them somewhere, is just look at the time of day of entry, and then just set some kind of hard rules around that. So say you notice 80% of your profits come from the first thirty minutes of the day, that's great. Okay.

Michael: 20:33

So after that first thirty minutes, you're done. You're done with that. And if you found yourself watching maybe the first hour and a half of the day normally, but now you've just really whittled that in your discretionary trades take the first thirty minutes, you freed up an hour a day. So now that hour a day is to, you know, like Dave was saying, noticing or consuming content or whatever to generate those ideas and then to, you know, write a little bit. And you would be surprised how just, you know, writing off that hour a day and say, this is the period of time that I'm building this next strategy can really push forward.

Michael: 21:05

So instead of really messing with what you do, you're just saying, the best time comes from this hour to this hour, whenever that is. The rest of the time, I'm just not even looking at it, I'm not even noticing it. I know I'm gonna miss some good trades. I know I'm gonna miss some bad trades, whatever it is, but by then, freeing up that time, well, now you've got, you know, dedicated time that's focused on being a systematic trader. And then again, that will kind of encroach.

Michael: 21:31

And that this experience of what happened to me as well, where I was noticing that, you know, really for my swing trades, I just needed that last half hour of the day. That's the only thing. The rest of time, was just like staring at P and L, it's like up and down and, you know, wasting a bunch of time. So by really saying, okay, I only make decisions during this last hour, so let's just shut everything down, really focus for that last hour. And then the rest of the day I have now to create and to notice and to consume content and all of that kind of stuff.

Michael: 22:01

That is huge just by, I think they call like time blocking or something. Right? It's like, this is the time for this and this is the time for that. And then you're not kind of mixing the streams. You have your systematic time, you have your discretionary time.

Michael: 22:14

Whittling that down, I think would be a huge help.

Dave: 22:18

Yeah. It's funny you mentioned that because that's exactly the approach I took way back when. When I first started Probably

Michael: 22:27

on the other end, probably you were focused on the morning. I was focused on the

Dave: 22:32

Yeah. Yeah. So I was focused on the morning. I was focused, you know, I would I would trade from 09:30 to eleven. So what's that?

Dave: 22:40

Ninety minutes? Mhmm. I would it was almost the exact same path as you described, actually. I realized that I didn't wanna dedicate that much time. I had a full time job, know, other commitments.

Dave: 22:56

So I I looked at those trades and realized that most of the p and l is coming from the first half hour. So then sort of my first step into automation was given that fact, what I would And I realized my discretionary system was sort of optimized for the ninety minute period, but I realized I could get way more trades focusing on a smaller period because that's where all the profit was. What I did, okay, limited it to the first thirty minutes, but loosened all the filters. So now I've got actually a lot more trades from this more profitable time period. Because I found more trades, I needed automation to be able to make them happen.

Dave: 23:45

There's just so many trades in that small period. But what that allowed me to do is scale my trading even by using a smaller time window of actually trading.

Michael: 23:55

Yeah. And then when then you made back a bunch of your most valuable resource, right, which is time and, you know, when I mean you're done, I mean you're done, like close the app, close whatever analysis, whatever you do, kind of fully commit in your body that every now and then you're gonna look back, you're gonna say, oh, there was that one setup, and if I was there for it, I would have taken it, it would have made a bunch of money. And you're just sacrificing that, knowing that in the long run, it's suboptimal, and that you're replacing it with time that you can spend doing other things. Right? So that that shrinking of the time again for me was huge.

Michael: 24:30

The the liberating experience of, okay, I'm I'm swing trading and I'm using daily candles, so I only really know what the daily candle is gonna look like in the last little bit of the close. So let me just forget the rest of it. And then, you know, I got back like six hours every single day and I'm like, oh, well now that I've got tons of time to pursue this other road that I thought I just couldn't do because I was so time constrained. You know, you just get so much of it back if you just put really, really like, start a clock, a timer somewhere. Right?

Michael: 24:59

Just get really rigid about it.

Dave: 25:02

Yeah. I love that. So, there's one other mistake that I see people make when trying to make a change like this, whether exactly what we're talking about, changing from discretionary to automated trading, or whether you're just trying to come up with a profitable strategy in general. The mistake they make is they create a deadline for themselves and they think they're doing the right thing. Because, hey, I'm goal oriented.

Dave: 25:37

I need to set some boundaries for myself. I'm going to have a profitable strategy by January 1. The problem with that is just like software projects, technical projects, it's just more complicated than you imagine it is going to be. So, I think you're setting yourself up for disappointment and failure if you set this deadline, which almost all the time is going to be completely arbitrary. The traders that really make this transition well don't set a deadline for themselves.

Dave: 26:14

I'm working with one trader now, had a great 2,005. He's just starting to do '25.

Michael: 26:21

2020 Which means you're old because you're around.

Dave: 26:27

He had a great year. He's just adding systematic trade strategies to his arsenal. And his goal was, like he didn't have a deadline, he said, over the next year, I'm going to add one automated strategy to my arsenal. And over five years, he's got five strategies as his goal. So if you think about that, that's a lot of room to make mistakes, have some stop and go there.

Dave: 27:04

I So definitely think that's the right approach to take. Give yourself plenty of rope. You're going to have some false starts. You're going to make some mistakes. There's going to be some stops and goes.

Dave: 27:17

But as long as you put yourself in a position to notice the things that you can make strategies out of, to fail a few times, if you give yourself plenty of rope and you're motivated enough, it's just a matter of time before you do have success. I love that approach. Like I said, the wrong approach is to have a deadline and have an arbitrary deadline that we're, okay, I got to have it done by now. That usually ends up in failure.

Michael: 27:48

Well, and especially if you're talking so I'm gonna defend myself a bit because I think even in the last pod, I said I'm gonna be doing this with Amubroker by the end of the of the month. But I do agree with you that I'm not looking for, especially I think the keyword there is a profitable strategy. So I have no idea, you have no idea what is going to be profitable and when it's going be profitable. So, you know, set deadlines based off of achievable things. Like for me, it's, you know, getting Amibroker up and running and sending orders to my broker by certain because those are, you know, things I can control, right?

Michael: 28:24

It's not whether or not the strategy makes money or anything. It's just that, you know, that getting getting this data into this system, I'm sure we'll talk about in the future. Like things like that, like set out, and I really, I really do like that. And I really do like time blocking, which you just talked about is that, you know, I think a great goal would be I'm going to free up an hour a day, or a half hour a day, or whatever it is, to focus on that. And for that time, it is going to be completely uninterrupted deep work or deep focus or whatever you want to call it on that task.

Michael: 28:57

But you're right, at the end of the day, you could stumble upon a great strategy your first time, or it could take 10 different iterations, or it could take 20, like you never know. Your first idea could be a great one, or your first 10 ideas could suck, and you just don't know what idea is really going to take off. You know, we talk about this all the time. Most of what I do, and I'm sure it's the same with you, Dave, is you think you're onto something, and you backtest it and you realize it's crap and you move on with your day. So that, you know, expect a lot of that.

Michael: 29:30

But yeah, when it comes to the framework and everything behind it, I think it would make a lot of sense to go through and and say, yes. This is I'm going to have all of these steps in place, this process built, the software ready to go in in some period of time.

Dave: 29:48

Yeah. I call those process goals, which

Michael: 29:50

is Yeah.

Dave: 29:51

The good kind of goals. Like, as long as you have goals like that where you're working on your process, you're not results oriented, eventually, the P and L is gonna come. What's really not productive is to have a P and L goal and a deadline for that. In fact, a lot of traders will come and ask me to coach them, and I have an intro call with them. And that's one of the things that I try to suss out.

Dave: 30:17

If they have a deadline, I'm just not gonna work with them because it's it's you it usually doesn't work well. So, that's one of the things I suss out to make sure that they're not in a boat where they just have to make money by a certain date. I said, well, that's not gonna be fun.

Michael: 30:33

Well, yeah. And it's why you you see so many traders do other things as well. And one of my favorite quotes from this was from Brian Lund, who's a who's a buddy of mine. He's a professional trader for many years. And he always says, right, your your mortgage comes on a regular payment and your profits don't.

Michael: 30:49

So you have to have the freedom, you have to have the ability to say, okay, you know, whether or not this day or this week or this month is profitable is irrelevant. I know over time my strategy works. And then you have that freedom. It's this Yeah, I'm the same way when I, when I talk to and work with clients, if they're like, okay, I need to make, you know, dollars 5,000 a month to blah, blah, I'm like, you're screwed. You're just, you know, And go to the beauty of systematic trading is that you can do multiple things, right?

Michael: 31:19

Because you're not staring at the screen kind of hitting buttons all the time, you can, you know, set up a bunch of things and have them run while you're doing other, it's all gonna, you're gonna be working essentially two jobs, you're gonna be putting in a lot of hours, but you can do it because yeah, there's nothing, there's no way to screw your trading quick enough than to have a, I need to make X by Y, which is why I think we're pointing this particular gentleman to saying, don't abandon what you're doing, because what you're doing is working. And if you do that, then you're just putting yourself in that situation right away where you're saying, okay, I have to automate what I was doing to make money. By the time the money I have runs out, you can't do that. You have to continue to do what you're doing, so everything's fine, and then you have to add this systematic journey kind of on top of it in some way.

Dave: 32:05

Yeah. So I think the big takeaway here that I I'd like Maxim to take from this is, you know, I think a lot of traders assume they're gonna have to come up with a completely brand new idea that nobody's ever thought of for that first automated strategy. But you've got the seeds of it in what you're already doing. You've already done the hard part. You've got the seeds for building a garden or planting a garden of strategies that can come about.

Dave: 32:41

And you've got the foundation for that. So that's where your ideas for automated strategies are gonna come from.

Michael: 32:49

Yeah, and, you know, just what I was thinking was just find, find a way to find the time, right? Just be, you know, shrink what you're doing, whatever it is, nights, weekends, sucks, but you can do it right and then add to what you're doing. And then after you you'll find there'll be a tipping point at some point where where the systematic side is is better in probably a myriad of ways than the discretionary side. And then that will happen, but it will happen at some point over time. And, you know, don't rush it too much.

Michael: 33:20

Just have a process in place to how you're gonna kind of move that along.

Dave: 33:25

Yeah. I love that. Yeah. Thanks, Maxim, for this question and for sharing with the group. Think it was a great one.

Michael: 33:32

Absolutely. And as always, I'm Michael Noss.

Dave: 33:36

And I'm Dave May. Talk to you next week on Line Your Own Pockets.