Trading systems are systems that run by them self. The system decides when to enter a trade and when to exit. The main advantage of a trading system is that it is without emotion, and that it needs little attention.

A lot can be said about developping a trading system. And even more on backtesting. Most important is however that the system is robust. It should work on any market in any timeframe, and return consistant profits.

Many experts say this is not possible, however I believe it is. I have worked with and programmed many of these systems, and most of them can turn out a reasonable profit, giving enough start capital and enough time to let the system run.

Be very carefull with optimizing. Always optimize in a certain period and have another period as a control period. Never optimize over a very long period. You will be curve fitting, meaning the computer is searching for the best parameters that will make the most profit over a historic period. But do not forget a human is even better. Look at the historic data and you will be exactly able to tell where to enter and where to exit.

Some terms you will see when you study trading systems are:

Draw down
The peak to trough decline during a specific record period of an investment or fund. It is usually quoted as the percentage between the peak to the trough. The maximum drawdown is the maximum amount you can lose on a single trade. This can be considerable, especially when the trading system stays in the market overnight. In a trading system the drawdown should be as low as possible.

Risk / Reward Ratio / Accuracy
The reward/risk ratio (RRR) is the expected profit divided by the expected loss on a particular trade. How much you are risking and how much you expect to make. Accuracy is simply the percentage of trades that you are correct on.
An RRR of .5 means you loose 2 dollars on loosing trades and 1 dollar on wining trades. Higher RRR is much better. An RRR of 2 means you loose 1 dollar on loosing trades but you win 2 dollars on winning trades. Off course this plays together with your accuracy. It does not matter you loose more on losing trades when your accuracy is high.

Backtesting
Testing an algorithm on a specific historic period for maximum profit or rate of return. You can also backtest on minimum drawdown or RRR (risk reward ratio)

Optimizing
Calculating the optimum parameters of the trading system over a certain period. The idea behind this is that this will result in parameters that will also work in an other period.

Short,Long, Cash positions
A system is long when a stock or future is bought. A system is short when a stock or future is sold. A system is cash when no position in the market is taken.

Robustness
A system is defined as robust if it works on any timescale, any period and any market. So it should work on a 10 minute chart on Dax futures, But also on a intraday chart on Coffee futures or Coca Cola stock. Off course parameters of the system should be optimized for each market, but after that it should still return profits.

System Parameters
The parameters with which the algorithm works. You decide yourself what should be a parameter. For a moving average for example it is the number of bars to calculated the moving average on. Normally a system should not have to many parameters, since it are these parameters you need to optimize in an optimization algorithm.

See the example trading system for a practical example on E-mini futures. in this example all terms are explained again.