James Clear states in his book Atomic Habits
“Prevailing wisdom claims that the best way to achieve what we want in life—getting into better shape, building a successful business, relaxing more and worrying less, spending more time with friends and family—is to set specific, actionable goals. However, I’ve found that goals are good for planning your progress and systems are good for actually making progress.
Goals can provide direction and even push you forward in the short-term, but eventually a well-designed system will always win. Having a system is what matters. Committing to the process is what makes the difference”
This applies to investing as well as life.
Think of each individual investment/trade as a “goal”. Imagine your entire trading strategy as a “system”. Long term success comes from focusing on and refining your system. Whether or not you achieve each goal (i.e. whether or not each investment is profitable) is merely a measurement for your progress.
Too many investors and traders freak out when they have a good system and they lose money a few times. It’s important to know that EVERY SINGLE system, no matter how good it is, has losses. That’s why focusing on each individual investment/trade is silly. Once again, that’s losing sight of the forest for the trees.
Your energy should be spent on improving and refining your trading system. If your system is good, then there is no way that you will not be a successful investor/trader in the long run. Sure, you will have ups and downs. But if your thought process, decision making process, and investment process is correct, you will come out ahead in the long run.
Imagine a good salesman. Does a good salesman care about whether or not he closes each individual lead? Not really. He treats each individual lead as just a number – he doesn’t get personal with it. He knows that he will have some strikeouts. He knows his conversion %. But as long as his sales process is good, he knows that over the course of e.g. 100 sales pitches, he will come out ahead.
Of course, there is also a small element of luck when it comes to whether or not you’re successful in the long run. But between luck vs. the system, the system is the only thing we can control. We cannot control luck. So that’s where we put our effort.
The system = the combined profit from all of the system’s trades. I.e. its average annual return over a long period of time.
Now this doesn’t mean that people who don’t focus on their trading system can’t get rich. Sure they can – they can get lucky. But if you don’t use a system, you will not sustain your luck over the decades. Just because something worked once or a few times, doesn’t mean that it’s the right thing to do if the strategy is non-sensical.
Here’s a simple example. I once had this person comment very angrily on the blog (and this person wasn’t even a part of the membership program, so I have no idea where this blame comes from) “how dare you say that using RSI divergences doesn’t work Troy. If you had used RSI divergences, you would have avoided the current correction!!”. I replied “factually speaking, RSI divergences have a 50-50 chance of working over the past 50 years. So what you’re saying is ‘how dare you say that I can’t toss a coin Troy, it worked this time’!”
A big name example is John Paulson. Prior to making “the trade of the century” during the 2008 financial crisis (he short mortgages), Paulson was a C-list hedge fund manager. He made a ton of money on that 2008 trade. But his trading process and system is poor. Unlike Ray Dalio, he has no systematic way of making decisions. He made $19 billion. Over the past 9 years, he has lost most of that money. That’s the problem with not having a solid trading system. If you get lucky and strike gold once, it doesn’t mean that you can repeat your success. Paulson is making bets based on random, non-systematic research.
The best thing about systems
Systems traders/investors don’t have to deal with a lot of problems that discretionary traders have to deal with. For example, discretionary traders spend a lifetime learning how to “not panic and get emotional”.
Of course it takes a life time for discretionary traders to learn the ‘discipline’ to stick to their trading strategy, when they can’t even objectively define what that strategy is! Discretionary traders waste all this time on making 1 discretionary decision at a time.
Systems traders don’t have this problem. Just run the quantitative system, and follow the model’s trades. No time wasted.
Use systems in every day life
Ideally, you could create systems and processes for everything in life.
Because humans are prone to error. We are prone to letting our emotions cloud our thinking. Making discretionary decisions is tiring, because every step of the way you need to spend energy on deciding what to do, rather than just doing it. With a system, you only spend energy on building the system and executing the system.
Making decisions based on systems takes more time in the short run because you need to spend time building these systems. But it pays off massively in the long run.
Here’s a simple non-trading example. When a lot of couples get into a fight, they just yell in circles. It’s illogical. They let their emotions cloud their thinking, and the argument goes nowhere. Instead, they should create pre-determined systems and processes on how to deal with fights.
Here’s a simple system:
- When you fight…
- Give each person 10 minutes to talk, while the other person says nothing.
- Write down each person’s arguments.
- Debate each point on that list 1 at a time.
- Come to an agreement on each point one at a time. When you come to an agreement on each point, cross it off and don’t revisit it. Don’t go in circles.
What to do if your system makes a mistake
No system is perfect. No system will work 100% of the time.
If something goes wrong, do not deviate from your system and make one off, off-the-cuff decisions.
Instead, see if your system can be improved based on this failure. If it can’t, then stick to your current system. If it can, then improve your system and apply the same rules to all future decisions.