Main Types of Trading Systems


We have already talked in other articles about the natural evolution of the Trader, from the beginning of his career in the markets until he obtains the knowledge and skills necessary to develop his own profitable Trading System, and now we are going to focus on the different types of trading systems that exist. Any person interested in the markets and trade successfully through a system is going to find a multitude of systems and methodologies of various types and characteristics, therefore we will present a classification as objective and simple as possible that allows the reader to know the main categories of trading systems that can be used.

The objective is merely didactic without offering any direct recommendation on a specific system, although the following information does offer advice on certain general aspects, especially when it comes to guiding the trader in the future development of systems. There are thousands of trading systems developed for all types of market conditions, and the best system is the one that each trader designs according to the strategy that gives the best results and makes him feel more comfortable. Do not expect to become a millionaire with the system that someone has sold you. Develop your own trading rules.

Definition of Trading System

Although, this term admits a multitude of definitions and segmentations, from a theoretical point of view, a trading system is nothing more than a set of rules that generate entry and exit signals in a given market, or to be more exact, trading signals to open new positions (long and short trades) and signals for closing positions (long and short trades). After this definition, we find a tool that is too simple for direct use, so it must be complemented with a strong Risk Management model (Stop loss), a good Money Management system and a good basis of trading psychology.

Classification of trading systems based on their degree of discretion

Mechanical Trading Systems

These are the systems to which I will refer in this and in subsequent articles and as the name implies, the trading signals are generated mechanically, that is, once the set of rules has been developed, the orders will be generated without the need of our intervention, so we will simply dedicate ourselves to place the trades in the market. The advantages of this type of trading systems are the disadvantages of Discretionary Systems and vice versa. Within this category we have the Automatic Trading Systems, which are characterized by the direct delivery of orders to the broker, without the need for the trader to place the orders by himself, saving time, and eliminating the main obstacle we face when we start trading, ourselves (trading psychology).

Discretionary Trading Systems

In these systems the trader bases the buy and sell trades on rules in which he also applies his intuition and criteria in each trade in the market. The great advantage of these systems is in the flexibility and adaptation to changes in the markets. The major disadvantages are the need to make decisions constantly, decisions that affect our emotional control. In addition, the verification of their results in a historical series is impossible and requires a lot of concentration and time by the trader. Its use is not advisable if we do not have extensive experience as Traders, as is the case of one of its top defenders, Joe DiNapoli, who tells us about these systems in his work “Trading with DiNapoli levels”.

Classification of trading systems by the data used and market positioning

Continuous Systems (Always-In Systems)

These are the trading systems that are always active in the market, since they move from a short position to a long position and vice versa, but never close the position. They are the ones that offer the highest returns, although they are also the ones that carry the greatest risk.

Pure Intradiary Systems

What defines an intraday system is that all positions are closed during the day, that is, at the end of each trading session we have all our trading capital as liquidity in the trading account. They are used in intraday price charts and the main attraction of these systems is that they allow avoiding the risk of the opening gap. These systems are the ones with the lowest profitability and risk.

Continuous Intradiary Systems (Overnight Systems)

These are the systems that open positions during the trading session using intraday price data, without the obligation to close the positions at the end of the market session. Due to the risk of opening gaps, they have a higher drawdown than pure intraday systems, although they also generate higher returns, so the risk/return ratio is somewhere in between between the two previous categories.

Classification of trading systems by Charlie F. Wright

Generally, there are three types of markets: trending markets, sideway markets and volatile markets. This classification is based on the market phases.

From a perfectionist perspective, the only thing we would have to do, to earn a lot of money, is to know the phase we are in and its future duration and to apply the corresponding type of trading system. It is quite simple in theory, but impossible in practice. No one or anything can predict market movements. Trending markets are always the most profitable and those that every trader should look for, the problem is that we never know when a good trend will come and once we are trending, we will never know its duration. Some authors, such as John J. Murphy, establish that markets as a general rule are only trending 1/3 of the time.

Trend Following Systems

These systems benefit from prolonged periods with continuous upward or downward movements, and some examples of these methodologies are the Breakout Trading Systems, such as the Richard Donchian 4-week rule, or the Moving Average Systems, which can be, among others, exponential moving averages (EMA), simple moving averages (SMA), triangular moving averages (TMA), volume adjusted moving average (VAMA) and other. With moving average trading systems, crosses of two, three or more moving averages are usually used. The possibilities are endless and are not the subject of this article.

Anti Tendency or Support and Resistance Trading Systems (S/R)

In a lateral period, what we will look for will be, mainly, indicators that indicate Overbought or Overbought conditions to find the market turns. Although trying to anticipate turning points in the market can lead to many false signals, in prolonged periods of laterality these systems provide a good number of winning trades, with substantial benefits.  Examples of indicators used in these systems and known to all are the Welles Wilder RSI and the George Lane Stochastic Oscillator.

Volatility Expansion Systems

The volatile markets are characterized by abrupt jumps in the price from which we can benefit, mainly through conditioned buy and sell orders, as these are usually short-term fast movements and some of the best known indicators for the construction of these systems are the ATR ( Average True Range) by Welles Wilder and Bollinger Bands

This is, from my point of view, the main classification of trading systems and our job is to develop the strategy that best suits our personality and our possibilities. In this sense, it makes no sense to develop a system that provides us with a good risk-return ratio if we are not prepared, psychologically, to trade with it. Each trader must decide for himself, since there are examples of successful traders in all three categories, although the greatest examples of success are in the use of Trend Following Systems, which are on the other hand, the most difficult to operate because they usually comply with the Pareto principle or 80/20 rule.

According to this principle, the main part of our earnings or really productive activities occurs in 20% of our trades, the rest, 80% will be unproductive activities or in our case, losing trades. The only thing we need to generate money is that 20% of the winning trades earn more than the amount we lose in the remaining 80% of the transactions.

Market Facilitation – Theory in favor of trend systems

Peter Steidlmayer is widely known in the trading industry for the Market Profile theory, however, few know his theory about Market Facilitation, which is crucial to give us the serenity that is needed in the lateral periods (Choppy Markets), since in the sideway markets a trend following trading system will lose money and we must have enough confidence in our rules, to withstand these losses and wait for the trend to arrive.

According to this theory, the only reason for the existence of the Markets is to facilitate Trading. Markets exist to attract Traders. The markets need that traders buy or sell constantly, because if this does not happen, they will die. They must move to survive. According to Steidlmayer, markets are like living organisms, which base their survival on attracting buyers and sellers.

If the markets remain long time without a clear trend, traders will lose interest in investing in them, the volume will decrease, the lack of liquidity will increase the slippage and in the end, irremediably, the market will close. This theory is essential for all traders who uses trend following systems to be confident that the lateral periods cannot last forever, sooner or later the market will have to break the price range somewhere, creating a trend that will compensate the trader for the losses caused by the previous laterality period.

Other types of trading systems

In this category, we are going to mention another group for the rest of trading systems, whose peculiarities oblige us to establish differentiated categories, these are less known systems, some are considered ‘extravagant’, and others have important entry barriers, as is the mathematical calculation and the need to develop them with good computer equipment. For these reasons, being more restricted to the general public, they have a high growth potential.

Systems based on the moon phases.

These are trading systems based on lunar cycles. We know that the gravitational force of the moon affects the tides, the movements of coral reefs and, above all, affects human behavior, affecting the number of crimes, or births that occur during periods of full moon. If the moon affects our behavior, and the market is nothing more than a mass of traders that are positioned according to their expectations, we conclude that a system based on the lunar phases can be quite logical for some traders.

Many traders have devoted time to these types of systems, from Larry Williams to Larry Pesavento. I had always believed that a trading system based on moon phases was something ridiculous and meaningless, until I saw that some important traders and investors believe in them. It is not about trading, starting tomorrow, using the full moon or the new moon, but to have a new field of activity to investigate and that can certainly give many satisfactions to any systems developer who has concerns to expand their knowledge on the markets

Systems based on Solar Activity

It may seem crazy to try to find a relationship between sunspots and market movements, but according to its followers this relationship exists and is widely documented, as can be seen in the following examples.

In moments of high solar activity, long-distance radio transmissions are affected, even the interference we see on television is sometimes caused by solar activity, as well as changes in the weather and of course, alterations in human behavior, and therefore of the financial markets. During 1987 there were only 3 days in which the number of sunspots (Index of solar activity) was greater than 100, two of these days were on October 15 and 16. The probability of correspondence between Black Monday and high solar activity is less than 1%. Probably, now you are more interested than before in this phenomenon and no longer sees it as something extravagant. From my point of view, any phenomenon that, in some way, affects human behavior and can be quantified is susceptible to research by the trader in his constant search for tools to deal with the market.

Cycle-based trading systems

The two previous models are also based on a certain type of cycles, so in this section we are going to refer to the cycles in a generic way. Cycles that are repeated periodically forming figures that we can use to generate winning trades. Anyone interested in deepening this topic will find in Walter Bressert one of the gurus in the field. Probably, the best known software on cyclic processes is the MESA (Maximum Entropy Spectral Analysis), developed by John Ehlers.

Trading Systems based on Neural Networks (AI)

Neural networks are framed within Artificial Intelligence and were developed in order to simulate the processing methodology and the decision-making process of living organisms. We will try to simulate the behavior of human brain neurons, through the help of specialized software. The research began in 1940, however, until 1989, software specialized in financial models was not developed, so we are talking about a very young and little evolved work philosophy. The main difficulty of these models lies in the training of the network, which will have an impact on its future learning, as well as the risk of over-optimization caused by the use of a large number of parameters.

Trading systems based on econometric models

Through the models based on statistical and econometric techniques we can establish price prediction systems, among these models we find the models of Auto Regression through Moving Averages (ARIMA), which try to predict future price movements, through regression of past prices. The model is likely to include numerous parameters, although in the words of its creators, Box and Jenkins, the success in prediction lies in the development of a system as simple as possible, within a logical and rational basis. This last point is applicable to the development of any Trading System, not only to ARIMA models.


As we saw in this article, there are different criteria for classifying trading systems. Because each author classifies them according to their experience and knowledge of the market, it is not easy to establish a universal classification. Four categories have been established and we have enunciated the Market Facilitation theory to highlight the trend following systems, which are those that have been used by the great traders and those that I recommend in this article.

The important thing in this article is to be able to classify our entry and exit rules, although this does not give us anything about the comparison between systems or the way to build a more adequate system, it is a necessary, but not sufficient basis in our development process of a trading system with which to generate money in the markets. In subsequent articles we will continue to define the phases in the development of good systems.


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