The lack of a clear trading strategy is one of a few key features that separates out the successful traders from the unsuccessful traders.
Traders/investors without clear strategies have a tendency to commit the following "crimes":
- Buy high and sell low
- Over sizing their trades
- Not managing their risk
While points 1 and 2 on that list are important, the most important point for developing any profitable trading strategy is point 3 - professionals say that what separates out institutional investors from retail investors is invariable the managing of risk rather than the investments they make.
Building a strategy:
While the idea of "building a trading strategy" tends to conjure the image of a technical trader or quant, the reality of the situation is that anyone who takes the time to write down even some trading rules that they then have by their computer will outperform traders who don't.
Even if these rules are as crude as "Place a stop" or "split your order", as long as they're not fundamentally stupid rules they will help your performance.
In addition to this, the markets that you trade will also be an important factor in building a strategy. Traders of larger capped equities, ETFs, commodities and currencies will all benefit from strategies that link their position entrance to market movements - limit orders placed in the market ready to be executed.
Even if these rules are as crude as "Place a stop" or "split your order", as long as they're not fundamentally stupid rules they will help your performance.
In addition to this, the markets that you trade will also be an important factor in building a strategy. Traders of larger capped equities, ETFs, commodities and currencies will all benefit from strategies that link their position entrance to market movements - limit orders placed in the market ready to be executed.
This has a couple of added benefits to traditional market orders:
- There is a tendency amongst traders to jump the gun and enter too early with market orders before their trade pattern/reason has been confirmed as valid by the market.
- This acts as a further risk management tool, as the market only takes you into trades that are validated by your signal.
It's worth noting that in the trading of smaller capped equities this style of trading will only likely cause risk management issues, as the heightened volatility caused by wider spreads and lower order book weighing on each side of the book means that your chances of being entered into the market on a mis-signal are raised.
Signal Generation:
After you have developed your risk management system, the next step will be to develop your signal generator.
Signal generation can be highly complicated or it could be as simple as a moving average crossover, or a P/E ratio.
I am a fan of the backtesting of strategies to prove that they have some form of historical bias towards making you money, so if you are a good programmer or know someone who is, test out your strategy first!
The Yahoo Finance API should be available for gathering daily closing data and ranges so this could be a good place to start if you want to technically test a strategy. For guys in the US, Quantopian is a pretty handy tool too for testing strategies.
As and when I think of more to add here, I will update this page.
Cheers,
The Masked Stock Trader
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