A complete systematic-trading project on paper

What you will learn

• The ten steps of a systematic-trading project in the right order
• How to set pass or fail criteria before seeing the results
• How to combine out-of-sample results, cost drag and drawdown into one decision
• How to write a live plan with size, monitoring and stop rules

Explanation

This lesson does not introduce new tools. It connects the course into one workflow that you can repeat for any idea.

The ten steps

1. Hypothesis: one sentence explaining why the idea might work, for example "trends in broad share indices tend to persist for months".
2. Rules: exact entry, exit, universe (the list of instruments) and timing, written so that two people would trade identically.
3. Data: source, period, adjustments for dividends and splits, survivorship check.
4. Split: in-sample and out-of-sample periods, or walk-forward windows, fixed in advance.
5. Pass criteria: written before testing (see below).
6. In-sample test: develop with as few parameters as possible.
7. Costs: cost per round trip, cost drag, doubled-cost test.
8. Out-of-sample test: run once.
9. Sizing and portfolio fit: sizing rule, caps, correlation with other systems.
10. Live plan: staged start, monitoring, pause and stop rules.

Typical pass criteria

• Net out-of-sample CAGR (compound annual growth rate) at least 50% of net in-sample CAGR.
• Out-of-sample maximum drawdown no more than 1.5 × in-sample maximum drawdown.
• At least 30 out-of-sample trades.
• Still positive with doubled costs.

These thresholds are a personal discipline, not industry standards. Choose yours, write them down and do not change them after seeing results.

A quick cost-drag estimate

For a portfolio of equal sleeves (sub-portfolios), the yearly cost drag in percentage points is approximately:

drag ≈ total round trips per year (all sleeves) × sleeve weight × cost per round trip

Subtracting this from a gross CAGR is an approximation, good enough for a first decision.

Worked example

Hypothetical example: hypothesis: trends in broad share indices persist. Rules: four index ETFs (exchange-traded funds), each a 25% sleeve. At the weekly close, hold an ETF if its price is above its 40-week simple moving average, otherwise hold that sleeve in cash (assumed to earn 0%). Orders are executed at the next week's open. Data: 12 years, hypothetical; in-sample years 1–8, out-of-sample years 9–12. Taxes are excluded.

Step 1, trade count: about 3 round trips per ETF per year × 4 ETFs = 12 per year, so about 96 in-sample and 48 out-of-sample trades.

Step 2, cost drag: estimated cost 0.20% per round trip (commission, spread, slippage). Drag ≈ 12 × 0.25 × 0.20% = 0.6 percentage points per year.

Step 3, check the criteria:

• CAGR ratio: 4.5 ÷ 6.8 ≈ 66%, above 50%. Pass.
• Drawdown ratio: 19 ÷ 15 ≈ 1.27, below 1.5. Pass.
• 48 out-of-sample trades, at least 30. Pass.
• Doubled costs: drag 1.2 points, net OOS ≈ 3.9%, still positive. Pass.

Step 4, live plan: capital €20,000, so €5,000 per sleeve. Three months of paper trading, then half size, then full size. Pause rule: drawdown above 1.5 × 19% = 28.5%, which is a loss of €5,700 from a €20,000 peak (equity €14,300). Review implementation shortfall monthly.

Decision: go to paper trading. A pass is not a promise of profit; it means the idea survived the tests you defined.

Common mistake

Practice activity

On paper: a variant uses five ETFs (20% sleeves) and makes 20 round trips per year in total. Cost per round trip is 0.30%. Net in-sample CAGR is 6.0%; gross out-of-sample CAGR is 3.8% over 4 years. Use the pass criteria above. (a) Calculate the cost drag. (b) Calculate net OOS CAGR and the CAGR ratio. (c) Count OOS trades. (d) Decide go or no-go, and say what to do next.

Key takeaways

• Follow the same ten steps for every idea, from hypothesis to live plan.
• Write pass criteria before testing and do not move them afterwards.
• Judge net out-of-sample results, drawdown ratio, trade count and doubled costs together.
• A pass leads to staged live testing, not to a guarantee.

Next step

Continue with the course "Order Books, Liquidity & How Orders Are Filled" to understand exactly how your system's orders meet the market and where fills and costs come from.