May 10, 2013

How To Develop A Trading System?

How To Develop A Trading System
How to develop a trading system and what are the key “ingredients” in a trading system.  The word ingredients is interesting because I think that trading plans or systems should mimic the way we might bake a cake – meaning, it’s important that there are very specific steps involved in taking a trade  setup, and that you need to know exactly what to do when you’re right or wrong.

Here are 5 key phases of development of a trading system:

1.    Logic of the trading system
a.    Use If / Then conditional statements that turn into conditional thought process
b.    Make some of the components dynamic
c.    Price is purest form of analysis. How did the market respond the last time this happened

2.    Syntax – Setup takes place before the trading signal.
a.    What conditions are present prior to entry?
b.    What causes entry?
c.    Stop placement (know where your analysis is wrong)
d.    Profit target (reasonable expectation about where the market will go when you are right)

3.    Testing
a.    Test for 30-50 trades (minimum) historically in one or multiple markets.
b.    How did it perform when you followed the exact rules?
c.    What was the max draw-down?