Beginning traders and investors to some seasoned investors are constantly asking us “What exactly is a system?” The purpose of this article will be to give you that information as clearly as possible. First, we’ll go through some background information to help you understand what a system is outside of the context of trading. You’ll learn how different people relate to systems according to how they relate to money. The second part of this article will focus on clearly defining what a trading system is. The third part of this article will focus on the broader picture of your system—your trading plan. Finally, we’ll focus on some key elements in system development.
Business Systems
In Robert Kiyosaki’s book, Cash-Flow Quadrant, he distinguishes two types of people who work for money and two types of people who have money working for them. In each case, one of the major distinguishing characteristics is how they deal with systems.
First, let’s look at the idea of business systems. McDonald’s, as a major franchise, is basically a large set of systems that one buys. In fact, a person who buys a McDonald’s franchise must go to Hamburger University for about six months (I believe that’s the length of it) to learn the systems for operating the franchise. There are systems for food delivery, preparing food, greeting customers, serving them within a minute, cleanup, etc. And all of these systems can easily be carried out by a manager who has a college degree and employees who might even be high school dropouts. In other words, a system is something that is repeatable, simple enough to be run by a 16 year old who might not be that bright, and works well enough to keep many people returning as customers.
Now, knowing that definition of a system, let’s look at how people in the four cash flow quadrants relate to systems.
The Employee: Employees are basically motivated by security. They have a job and they do their work to get money. Employees basically run the systems. They don’t necessarily know that they are running a system, but that is their function. For example, one employee at McDonald’s will greet customers and take their order. This employee is basically running the “customer-greeting” system.
Most employees do not understand systems. Instead, they just know what their job is. And this is typical of employees who become traders or employees who work as traders. They typically ask questions such as “What stocks should I buy?” “What is the market going to do?” Or “How do I go about doing this?” We see it all the time in the questions we get. For example, a gentleman just called into CNBC, as I’m writing this, and asked the guest, “What direction do you think the market may go with respect to 'the war' and how might one profit from it?” These are typically employee questions. And they amount to saying, “I don’t really understand anything, please tell me what to do!” The financial media thrives by answering the questions of the employee investor/trader.
The Self-Employed Person: The self-employed person is basically motivated by control and doing it right. Notice that I have often talked about how these motivations constitute some of the biases that most traders have—the need to be right and the need to control the markets. The self-employed person is the entire system. They are basically running on a treadmill only they don’t know it. And the more they work, the more tired they get.
Like the employee, the self-employed are working for money. However, they like it a little better, because they are in charge. They think working harder will make them more money—and to a certain extent it does. But mostly, working harder gets them tired. Nevertheless, they continue to plough forward thinking that they are the only ones who can do it right.
As I said earlier, the self-employed person basically is the system. And quite often they cannot see the system because they are so much a part of it. They are stuck in all the details. In addition, they have a strong tendency to want to “complexify” things. They are always looking for perfectionism and they believe that the perfect system must be complex. They are always asking, “What will make my system perfect?”
A lot of people come into trading from the self-employed mentality—doctors, dentists, and other professionals who had their own small business in which they were basically all of the systems in one. This is all they tend to know and they approach trading the same way. They keep adding complexity “until it works,” even though this strategy seldom works. The self-employed person would be likely to have a discretionary system that is constantly being changed.
