Ten Steps to a Coherent, Organized and Methodical Trading Strategy


trading strategy

A foundational step in evolving into a successful trader is the ability to develop a trading strategy that finds the perfect liaison between your trading personality and a consistent edge in the markets. This article will be all about developing such a strategy from scratch.

Why Bother with a Trading Strategy?

Often a major pitfall for new traders is the eagerness to begin executing trades. That’s where the gains are after all right? Well yes, and no. You can’t make any money if you don’t execute trades, but you also don’t make any money if you start gunning trades without a well-crafted, tested and proven strategy. The challenge here is to get over the temptation to pull spontaneous trades and instead invest your time and resources to develop your own strategy.

This article is designed as a potential blueprint to help you achieve just that!

Here are ten steps to a potentially sound trading strategy:

Risk Consideration

The art of trading revolves around being able to manage your risk effectively. And sound risk management stems directly from a careful observation of your risk tolerance. You will need a comprehensive analysis of your risk appetite. How much capital will you be bringing into your trading business? How often will you be revising your strategy to adjust it to new market conditions?

How much are you willing to risk and gain on a particular trade? Does the potential loss vary with the strength of the trade setups or does it stay constant?

It is a common mistake for traders to skip answering these difficult questions and leaving them for the moment. They might even be disguising this procrastination as flexibility and adaptability to a given situation. While seasoned traders will often be quick to make ad-hoc decisions and alter their trading plans as the trade transpires, newer traders are too much at the mercy of their emotions to be able to think clearly under crunch situations. Beginner traders should know their risk consideration up front.

Technical vs Fundamental

At the heart of any trading strategy is a trading “signal”. That is a moment or action in the markets that will make you consider entering the market or exiting the market. What will these signals be based on? Will they be based on news and fundamental developments? Or technical signals on the charts like candlestick or chart patterns, trend lines and moving averages? Or maybe a combination of the two?

There are countless trading strategies out there that are built entirely on trading important news announcements or other fundamental developments. There are also, in our opinion, quite a few successful traders who just trade the charts and believe all fundamental developments tend to get priced in the charts and is thus reflected in one of the technical signals they are looking for. You can also alternatively build a trading strategy that uses components of both; technical and fundamental factors.

Whether you choose a technical strategy, a fundamental one or a hybrid strategy, the choice is ultimately yours and will depend on what you are comfortable with rather than relying on “superior” merit.

Market Consideration

One of the most brutal truths about the market is its fickle nature! The markets can be smooth and trend for a period of time and then without warning, run into a volatile sideways and choppy movement that can make trading very difficult – well at least for trend traders. Another group of traders might just be waiting for that sideways movement. And that’s exactly the point we are trying to make.

Always know the market you are going to be trading in! And no, we don’t mean the instrument, but rather the market conditions. A trading system will often define the market it is best suited for. For example, you could be relying on a trend trading system that calls for entering on minor pullbacks within a dominant trend. Or you could be scalper who benefits from short brisk price movements within a wide range. Maybe you try and catch reversals which means you’re looking out for larger swing trades.

The point is, even as the markets are constantly moving, understand that they are not always presenting high probability and low-risk opportunities. There are going to be phases when you will be ‘enjoying’ the action from the sidelines. Make sure your trading strategy allows that. A good way of ensuring that is knowing the market conditions that usually present you with reliable trading signals, and also having a strict entry criterion that allows you to stick to certain market conditions for the most part. As a trend trader, for example, your entry criteria must define the existence of a strong trend as a pre-requisite so you stay away from choppy price action.

Time Frame Consideration

No discussion of a trading strategy will ever be complete without tackling the frequency question. How frequently will you be trading? Will you be trading the lower time frames that call for a larger volume of short-term trades or the higher time frames that call for a lower volume of longer-term trades? Usually, the time frames you decide to trade on will determine your frequency of trades – which is a crucial factor of your trading strategy.

Make sure you determine if you are more suited to lower or higher time frame trading. The most important difference between a high and low-frequency trading strategy is the availability of time in between trading decisions. Shorter-term trading calls for quicker decision making with regards to entering, managing or exiting a trade. On the contrary, lower frequency trading will usually allow you more time to think – a luxury that comes in very handy for newer traders.

Regardless of your choice of trading frequency, your trading strategy must reflect some criteria for consistency in this regard. For a high-frequency strategy, for example, it helps to have rigid trading plans with little room for subjectivity to aid quicker decision making – and maybe even consider automating the trading strategy.

Entry Criteria

Now let’s tackle the actual trading decision: when to initiate a trade! Whether you are a technical trader or a fundamental one, risk-averse or an aggressive one, Scalper or a swing trader – you will need concrete trade entry criteria. Period!

You will need to know the exact set of conditions you need to pull the trigger on the trade. Without these rules, your trading strategy is simply incomplete and can quickly erode your capital base.

A potentially good trading strategy will signal for a trade usually based on some needed conditions and perhaps a few optional conditions that, if present, would add to the strength of the setup. For a trend trading strategy, for example, having a dominant trend in place would be a MUST in our opinion, while optional factors like a 50% Fibonacci retracement or the confluence with a trend line or a moving average could be optional factors to look out for to add to the strength of the setup.

The crucial part of sound entry criteria is knowing which combination of factors will result in good quality trades, average trades, and false signals. This judgment will take some time, practice and of course having other aspects of your trading strategy nailed down such as knowing your risk tolerance and frequency of trading.

Exit Criteria

Besides concrete entry criteria, you also need solid exit criteria. Again, depending on factors like your experience, risk tolerance and your frequency of trading, you can either have a rigid constant plan or one that allows for some ad-hoc decision making. When it comes to exiting a trade you have options ranging from using a tight constant stop loss, or a trailing one. You can also choose to pre-determine or apply as needed, take profit levels to take part or all off the table at some point during the trade.

Stop-Loss Risk Disclaimer: The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.

There is really a lot of subjectivity that goes into developing a solid exit plan, but make sure you do devise one to ensure a complete trading strategy. There is no point in knowing exactly when must enter but then depending on how the trade transpires, scratching your head wondering what to do with your moving equity as price swings away from your entry point – either in the red or green. Traders often struggle more with the exit part then the entry part. After all, there is much to regret when you pull off a losing trade-off and seeing price move back in your direction, or “killing” a profitable trade only to see it travel farther in your direction.

Even if you achieve trading success, you need to understand that nailing down exits 100% of the times is impossible. The point of a good trading strategy is not to allow you to make the most out of every single trade, but make the most out of the majority of your trades to allow you to be profitable long-term.

Now that you have the basics of your trading strategy laid out, it’s time to put it to the test!

Back Testing

This is perhaps the most ignored aspect of a trading strategy for beginners. Who wants to sit for hours scrolling back charts and identifying trade setups and their results when there is so much live action to be making money off of? Well apparently, YOU do if you want to stand a chance in this business!

One of the important ways to prove your system is to backtest it. That is, apply the trading principles (Entry and exit criteria) on past price action to determine if the strategy holds a consistent edge. It is not uncommon for serious traders to go back sometimes years back on their favorite markets testing their strategies. Prepare to do the same if you want a fool-proof trading strategy.

A quick tip here: Avoid just casually scrolling your charts to the left eyeballing points of interest. You will almost definitely miss some of the setups! That is because your eyes are subconsciously drawn to the larger more clearer moves in the market resulting in a skewed set of backtesting results. A more formidable approach is to scroll back rapidly to your desired starting point (the further back the better) without giving any attention to the price action you see. From that point start revealing small bits of price action at a time to simulate real-time conditions. Alternatively, you can use commercial software out there that allows you to simulate past price action with real-time data feeds.

Forward Testing

This process involves actually testing your strategy with real-time data and real execution. In our opinion, only real-time trading allows you to see the merits of trading.  We have seen examples of people who demo, paper trade for years thinking it will give them an edge. It does not. In fact, it does just the opposite: It conditions them to unrealistic execution and euphoric psychology.

Real-time trading allows you to tweak, fix or eliminate a trading strategy. It also gives you signals and clues on whether you trade a time frame that is too fast or too slow for your risk temperament.

One final thought: In our opinion, going back and forth between demo and live does not help in particular either.  While the transition from a model to a real live account can be quite challenging, we recommend reducing the frequency of trading if the model is not working out and alter it in real time. The reduction of frequency will still allow you to stay in real market conditions, without drastically changing methods because there is “something better” out there.

Stay methodical, disciplined and never stop learning and observing your trades!

There is a substantial risk of loss in Futures trading. Past performance is not indicative of future results.

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