The Seykota System Blueprint: A Step-by-Step Guide to Building Your Own

The Art of the System

Ed Seykota, a master of systematic trading, has long advocated for the use of mechanical trading systems. He believes that a well-defined system is the key to removing emotion from the trading process and to achieving consistent, long-term success. While Seykota has never revealed the exact details of his own trading system, he has provided a wealth of information about the principles that underpin his approach. This article will provide a step-by-step guide to building a trend-following trading system inspired by the legendary Ed Seykota. We will cover the core components of a Seykota-inspired system, from choosing your markets and timeframes to defining your entry and exit rules, and developing a robust risk and money management plan.

The Core Components of a Seykota-Inspired System

A Seykota-inspired trading system is a trend-following system that is based on a set of mechanical rules. The core components of such a system include:

• A trend-following indicator: This is the indicator that is used to identify the direction of the trend. Seykota is a proponent of using moving averages, but other trend-following indicators, such as the Donchian Channel or the Average Directional Index (ADX), can also be used.
• A set of entry and exit rules: These are the rules that dictate when to enter and exit a trade. The rules should be clear, concise, and unambiguous.
• A risk and money management plan: This is the plan that dictates how much to risk on each trade and how to manage your overall portfolio.

Choosing Your Markets and Timeframes

The first step in building a trading system is to decide which markets and timeframes you will trade. A Seykota-inspired system can be applied to a wide variety of markets, including stocks, futures, and forex. The key is to choose markets that are liquid and that have a tendency to trend. The choice of timeframe will depend on your personal trading style and your availability. A long-term trend follower might use a weekly chart, while a short-term swing trader might use a daily or even an hourly chart.

Selecting and Configuring Your Indicators

Once you have chosen your markets and timeframes, the next step is to select and configure your indicators. As we have discussed, Seykota is a proponent of using exponential moving averages (EMAs). A common combination is a 13-period EMA and a 40-period EMA. The 13-period EMA represents the short-term trend, while the 40-period EMA represents the long-term trend. The crossover of these two EMAs is what generates the buy and sell signals. It is important to backtest different EMA combinations to find the one that works best for your chosen market and timeframe.

Defining Your Entry and Exit Rules

The entry and exit rules are the heart of your trading system. They should be based on the signals generated by your indicators. For a moving average crossover system, the entry and exit rules might be as follows:

• Entry Rule (Long): Enter a long position when the short-term EMA crosses above the long-term EMA.
• Exit Rule (Long): Exit the long position when the short-term EMA crosses back below the long-term EMA.
• Entry Rule (Short): Enter a short position when the short-term EMA crosses below the long-term EMA.
• Exit Rule (Short): Exit the short position when the short-term EMA crosses back above the long-term EMA.

It is important to note that these are just examples. You can and should experiment with different entry and exit rules to find what works best for you.

Developing a Risk and Money Management Plan

A risk and money management plan is a important component of any trading system. It is what will protect you from catastrophic losses and will allow you to stay in the game for the long run. A Seykota-inspired risk and money management plan should include the following components:

• Risk per trade: This is the maximum percentage of your trading capital that you are willing to risk on any single trade. A conservative figure of 1-2% is a good starting point.
• Position sizing: This is the process of determining how many shares or contracts to trade based on your risk per trade and the distance to your stop-loss.
• Stop-loss placement: This is the process of determining where to place your stop-loss order. The stop-loss should be placed at a level that invalidates your trade idea.
• Portfolio diversification: This is the process of spreading your risk across multiple markets and trading systems.

The Importance of Backtesting and Forward-Testing

Once you have developed your trading system, it is essential to backtest and forward-test it. Backtesting is the process of testing your system on historical data to see how it would have performed in the past. This will help you to identify any flaws in your system and to optimize its parameters. Forward-testing, also known as paper trading, is the process of trading your system in a simulated environment with real-time data. This will help you to see how your system performs in a live market and to gain the confidence to trade it with real money.

Conclusion

Building a trading system is a challenging but rewarding process. By following the steps outlined in this article, you can build a trend-following trading system that is inspired by the legendary Ed Seykota. Remember, the key to success is not to find the perfect system, but to find a system that you can follow with discipline and consistency. As Seykota himself has said, "The goal of a successful trader is to make the best trades. Money is secondary."