Friday, September 10, 2010

A basic system framework

My trading system is pretty well established, and although I have looked at other methods or potential modifications, I keep returning to my tried and trusted 'rules'. Having confidence in your method (whatever it may be) and applying that method consistently are key to long term success. If you combined those two key factors, together with rigid money management, you will be better placed to achieve long-term success than the majority of traders.

My rules have performed well in bear markets and bull markets, and have placed me on the correct side of the market. Almost as important to me, my rules tell me when not to trade. My own trading experience has confirmed that, when I deviate from my rules (whether it be by trying to be 'smart' or by ignoring my money management parameters, for example), I have lost money. My method may not make me a millionaire by this time next week, but I know that if I stick to the rules, I will achieve long-term equity growth.

Having confidence in your system means that you don't exit a long trade on a short, sharp retracement, if your pre-determined stop hasn't been hit. How many times do inexperienced traders exit in a panic, at a price which is the exact low of the retracement? I've done it - I bet almost everyone has done it. The best traders learn from that, and ensure they don't do it again.

Being consistent in your method means that, if you get a signal, you act on it - no questions asked. You must ensure that you adhere to your rules. Your rules should be based on the following:
  • What market are you looking to buy or sell (what markets are in your trading portfolio?);
  • When do you buy and sell a position (what are your entry rules?);
  • How much to buy or sell (what are you risk per trade levels and your overall account risk levels?);
  • When to exit a losing position (where is your intial stop placed?); and
  • When to exit a winning position (what are your exit rules?)
On each trade, if you can answer those questions in a consistent manner, you are well on your way.

A final point, and an important one. You need to be compatible with the system you are using. You need to fully understand how the system works, when it works best and when it does not work. (For example, trend following in a range-bound market, or trading counter-trend in a strongly trending market are when you should not be trading). The timeframe used needs to be considered in this context too. Trend following systems by their nature are usually (but not always) use longer timeframes such as weekly or daily charts. This suits me fine, as I do not want to spend all day in front of a screen.

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