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Trading System Development: Components of a Strategy that Works

Updated on 2012-12-15 by Guest







Most traders, especially those who are new to the game, seem to be on a lookout for the most ideal trading system – the so-called “holy grail” of trading. Sorry to be the one bursting anyone’s bubble, but such system does not exist.

Sure, there are many trading strategies and systems that work. However, such systems are the direct result of relentless testing, tweaking, optimizing, and traders’ discipline to follow through the entire rules of the trading system. Most, if not all, of these trading systems is a result of months, maybe even years, of trading system development.


How is a Trading System Developed?

Before going to the details of the main components of a solid trading system, let’s set the groundwork and discuss on the principles essential to an effective system:

      • It should be a money-maker – the system should keep its eye on the bottom line, which is, making money. To do this, it has to maximize profit potential. Very simple concept yet hard to implement.

      • It should limit risk – risk is inherent to any trading activity and that’s precisely why the system has to have a stop in place for “bad” positions. This will quantify maximum possible loss before you enter any trade; thus, making it less emotionally taxing.

      • It should have stable and feasible parameters and timeframes – herein lies the difference between trading and gambling. Trading does not depend on luck; any trader who has nothing on his side aside from luck is destined for doom. Thus, it is very important that trading systems framework must be based on parameters and timeframes that are feasible and stable on broad market condition.


Components of a Trading System

Solid trading systems mostly consist of 6 components:


Set-up conditions – this refers to the criteria you will use in screening stocks or currencies you’re going to trade using this trading system. For example, if you’re trading stocks, you can choose from over 7,000 stocks. You can reduce this number of stocks by using a specific criterion. Say, you’re only trading S&P 500 companies that are making all-time lows; or you could limit your trades to high volume penny stocks.


Entry signal – this would determine the right time for you to enter any trade in either long or short position. Entry signals are triggered by move in direction and it has to meet your initial screening for optimization.


Stop-loss Signal – consider this your worst-case scenario plan. If the trade goes against you, what’s the maximum are you willing to lose? You have to remember that the market can go either way. It can move in your favor, or against you; in which case, you need to protect your assets by taking a small loss.


Re-entry Signal and Strategy – there will be instances when you get stopped out only to have the stock move in favor of your original position, or it could move ideally for an opposite position. Because such instances could prove to recur over time and “vengeance trading” is a common pitfall in cases like this, your trading system should have a strategy to re-enter a trade.


Exit Signal and Strategy – it’s a well-known fact in trading that you don’t make or lose money when you enter a trade; you only make or lose money once you exit a trade. For this very reason, your exit signal should be well optimized.


Position Size – lastly, your system should also control how much you trade. It determines how much of your capital or how many shares of stock are invested in any given trade. Your position size should also be enough to meet your objectives.

Setting an objective is essential before you develop a trading system that suits you. You need to start by setting an expectation and designing a system that meets that specification. Some traders have it backwards and most often than not, this account for the system’s dismal failure – it fails to do what it’s supposed to do because the framework for what it’s supposed to do is not set in place first.

Some traders also have this idea that a developed trading system is like an ATM machine that’s designed to spurt out cash forever. This couldn’t be more far from the truth. Markets are dynamic and constantly changing – and so should your trading system be if you wish to stay ahead of the pack. trading systems have to be constantly evaluated, tweaked, or revised should the need arise. Traders who understand this have learned the closest thing to a “holy grail” of trading.









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Trading financial instruments, including foreign exchange on margin, carries a high level of risk and is not suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in financial instruments or foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with trading and seek advice from an independent financial advisor if you have any doubts.