this picture was gotten from pixabay
About two weeks ago, a friend came to me excited, telling me about a new trading strategy that he got from a friend. He was like he has tried it and it works well. I asked him how he verified the strategy and he was confused as he did not understand what I meant.
This post will be centered around trading strategy and how to develop a trading strategy.
What is a trading strategy?
According to Investopedia, A trading strategy is the method of buying and selling in markets that is based on predefined rules used to make trading decisions.
Wikipedia defines a trading strategy as a fixed plan that is designed to achieve a profitable return by going long or short in markets.
Dr Alexander Elder, the author of new trading for a living defines a trading system as a set of rules for finding, entering, and exiting trades.
To me, a trading strategy are sets of objectively structured plans that a trader follows to ensure more profit. The most important aspect of my definition is the objectivity of a trading strategy. A trading strategy should fulfil its purpose which is to bring profit. This therefore goes to say that a good trading strategy must have gone through verification.
There is this common saying in trading
History tends to repeat itself most times
This singular quote is the basis behind the creation of a trading strategy. Therefore for a trading strategy to be verified, you have to go back in history and check its potential to make your account green in the long run. There are two steps that must be taken for a good trading strategy to be verified; backtesting and demo trading also known as forward testing.
Back testing
Back testing is the process of going back in history to find out if a strategy works. Back testing is the first step in the verification process of a trading strategy. This process has to be done without bias. If the strategy fails in one trade, you record it as a fail, you don't try to alter the outcome.
Back testing helps in objectively determining your win loss ratio. Back testing can be done by using previous chart which can be gotten from your trading applications like metatrader4 and trading view. Being bias is a very common problem as people tend to always want a trade to be a winner. This is especially true if the created the strategy is a personal one. If you create your strategy by yourself, always resist the urge to be bias.
On a final note,
A trading strategy may have worked perfectly when you back tested it based on past market data, but always remember that past performance does not always guarantee future success in real time markets.
Even if history tends to repeat itself, once you put this quote at the back of your mind, you will be able to detect when your strategy is failing.
Demo trading
Demo trading refers to forward testing with virtual money. Demo trading is usually done when you have back tested your strategy. Once the result of ypur back testing is good, the next thing to do is demo trading. Many amateurs and beginners skip this process and go on to start trading live. The next thing that happens within the next couple of days is a blown account. While starting my trading journey, I made this mistake and I paid dearly for it. However necause of my knowledge of risk management, I didn’t blow any any account. But I lost a huge part of my capital
You should never start live trading without trading.
What should your trading strategy address?
1. Finding a trade:
Your trading strategy must be able to help you find high probability trades. It should be able to help you sort good trades. If your strategy does not fit into the trade set up, you shouldn’t enter the trade. Some beginners are tempted to force a trade on their strategy. This mistake should never be made by any trader who wants to accumulate equity
2. Entry point:
Finding the exact point when entering a trade can be challenging. When I was developing my strategy, at times I would enter the trade to early , other times too late. When developing a strategy make sure you are able to objectively ascertain your entry point.
3. Exit point:
One important quality of a good trader is knowing when to leave a trade. You should have a plan at every point that ensures you leave the trade with a profit. Its either you trail your stop loss or you put a take profit target. Personally , when a trade goes 50% in my direction, I take my stop loss to my entry point, Making my trade free of risk. When the trade goes 75% toward the direction of my trade I set my stop loss in a way that if I am kicked out of the trade I still get 25% profit. This is another thing your strategy has to show you.
4. Risk Management Strategy:
A good strategy should contain your risk management protocol. Every trader should aim at reducing his risk anytime he is trading in the market.
Final Tips on Developing a Trading strategy
- Know your type of person and which type of trader you are. Are you a mechanical trader or a discretionary trader
- Take time and discipline to develop your strategy
- When demo trading act like it is a live account.
- If your strategy does not agree with the market set up, step aside.
- Stick to risk management principles
- Never let a winning trade turn to a losing trade.
- Always look for high probability trades
- know when your strategy is failing and stop trading and re analyse your strategy.
References
- Investopedia
- Wikipedia
- The new trading for a living by Dr Alexander Elder
- Pixabay