I would like to explore the process of designing a trading system. Please note that this is all based solely on my opinions and experience only. This does not mean these are the only ways and methods, there are literally hundreds of good trading systems out there, but I can only write about my own experiences as this is what I have learn t.
I will explore two systems which I think encompass a very large portion of trading systems generally. The first of these would be trend following and the second I will just call swing trading but would include methods like scalping, day trading and the like. I will try and define the two for simplicities sake.
Trend Following
- This method can be traded on any time frame
- The idea is to firstly identify a trend
- Secondly find a low risk entry point
- Thirdly add multiple positions to this trend
- Stay with the trend as long as possible
- Positions are generally held for much longer than day trading methods and also generally on higher time frames say the hourly and higher
- The other thing to note when trend following is they generally have low win percentages, often in the range of 35-50 percent and high risk to reward rates. By this I mean they don’t win very often but when a trend is found and captured with a good method, one can expect huge returns. These returns far out weigh the large amount of small losses gained while identifying these trends.
Swing Trading
- This method can also be traded on various time frames but generally the four hourly and lower with a definite higher percentage of traders leaning towards the one hour time frame and below.
- The Idea is to define a particular entry point or method
- Ideally again looking for the lowest amount of risk
- Have a predetermined exit strategy or exit point
- This type of method generally has a higher win rate and a lower risk to reward rate, by this I mean that it would be looking at winning 60-80 percent of the time and rewards generally being in the vicinity of between 1:1 and 2:1.
Both these methods have there pros and cons and I will definitely explore these as we go, but for now I will look at how we can built our own system. This is necessary I feel, for if you make your own system, it is more likely to match your personality and therefore more likely that you will stick with it and continue to implement it. A lot of traders systems are just variations of someone Else’s system. This is fine and does save some leg work. They generally adapt the things they like and change the things they don’t. This is the bit where these changes are made to suit your own personality.
Making a trading system is not that difficult, what can be challenging though is sticking with it when it’s not performing so well. Unfortunately, most methods don’t always work in all market conditions and market conditions never persist forever. What happens is that the minute you become discouraged with a particular methodology and abandon it, market conditions change and the system begins to work again. You end up exiting every methodology at its low draw down on its equity curve so you are always one step out of sync. If you are always switching, you are probably just leaving the one that is ready to kick in.
Does this sound familiar ? How many times have you left a good trading system to trade another because it’s not working. I think it would be fare to say that every trader has done this in the past. How many times have you taken 3, 4 or 5 losing trades in a row and become that disheartened with your system that you just can’t bear the pain anymore. You don’t take the next trade, just to watch this next one go to the moon and you just watch in disbelief as you can’t believe you missed the one trade that would have covered all the previous losses and some. This is quite common in trading and one reason why so many fail.
This is why so many people recommend to only trade money you can afford to lose and stay detached from your trading etc. Not because you will lose your money but because if that emotional attachment is not there, there is more chance that you will keep placing your trades and trade through these rough times.
I have added a few charts below just showing graphic examples of the two different trading styles.
The above is a 4 hour chart of the GBP/JPY and is a period that would have most trend followers seeing some increased profits in their accounts. In this particular market both trading styles can potentially capture profits. The trend trader would try and capture a large percentage of the whole move and most likely be adding position size the whole way. The swing trader on the other hand would be in and out many times capturing small pieces of the move.
The shaded area in this chart though would not be very profitable for a trend follower. A Swing trader on the other hand could still capture plenty of profits in a choppy market like this.
Perry
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