Business, Career

What Are the Elements of Good Trading Systems?

So you are looking to get into the markets or you have just started getting into the markets? So what is your opinion on how to invest? Do you like the sound of day-trading with it’s manic buying and selling or perhaps you really like the idea of buying a bargain to see it’s true value emerge later? Do you devour the words of Warren Buffet with zeal or are you more into reading tomes on Technical Analysis like Candlestick Patterns and Donchian Breakouts? Or perhaps every word I have just said is all mumbo jumbo and you just want to know what you should be buying right now?

This article is designed as an overview of the elements you need to develop a trading system that will allow you to become a successful 70trades login, and to point out some common misconceptions and mistakes people make along the way.

OK, so which style is the best for trading? Well that really depends, there are people out there making money from short term trading and from mid-term trading and from long term trading and every increment in between. However, the thing to remember is there are far more people losing money regardless of the investing style.

So, what separates the winners from the losers? That is quite simply that the good traders are the ones that have a trading system or style with an edge and are disciplined enough to exploit it. Now just to make sure we are all on the same page, for the purposes of this article an edge is the amount you will make on each trade on average allowing for expense such as the cost of executing your trade and tax. This edge is what your trading system is built around so you need to understand exactly how your edge works to design your trading system.

However, when most people start trading they only consider the entry. I cannot remember how many times I have been asked for stock tips, but unless the person understands how much to invest, when to sell etc. this is useless information. In fact in the excellent book Trade Your Way To Financial Freedom there is a trading system that makes money based on randomly picking a stock and buying it but due to the exit criteria and position sizing, over the long term it will make money. You need to remember it is the entire trading system that gives you your edge and must describe what will happen at every point of your trade – how you enter a trade, how much you put at stake and under what conditions you exit the trade.

As an analogy lets do a comparison between a supermarket and a jeweller. Supermarkets have very low margins, usually only a few percent on each item, whereas a jeweller can have margins of 100% and more. So, if that is true how do supermarkets survive when their margins are so much smaller than those of a jeweller? You’ve guessed it, supermarkets sell many more items in the same time that the jeweller sells one.

So let us consider two trading systems, one that makes 10% per trade and the other that makes 100% per trade. Now let us assume we can make one 10% trade per day and a 100% trade every 10 days and start both trading systems with $1000. At the end of 10 days our 100% trade has taken our account to $2000, a 100% gain. However each 10% trade will make us $100 and we can do one of these each day. This means we have made 100×10=$1000, so both accounts have $2000 at the end of the 100 days?

In fact this is not the because we have the power of compounding working for us in the second example. Compounding is the ability to use your gains as part of the investment on your next trade to increase your gains. So for example if we do our first trade we now have our initial $1000 plus the gains from the first trade, which is $100, so we now have $1100. If we now use this for the next trade we will make 10% on this, which is not $100 but $110 (10% of $1100) If we keep doing this we do not end up with $2000, but actually nearer $2600…quite an improvement! This is an example of what I meant about understanding your edge – at first glance the two trading systems appear to be equal, but we now see that the second has a distinct advantage.