Wednesday, July 11, 2012

The three critical areas of a trading system

There are three aspects to using any trading system, that you must be able to stick to. I have likened  these three areas to the legs of a bar stool - if one of the 'legs' is deficient or missing, then the stool (and your trading system) will fall over. These are:

  • The ability to identify and act upon entry and exit signals - having a set of rules that allows you to identify entry points giving you the best potential reward:risk ratio, as well as giving you and exit signal at the appropriate time. Just as important is the ability to stay out of the market if your entry signals have not yet been given.
  • The ability to use appropriate risk management - with regard to your overall exposure, your risk per trade, whether you have the ability to avoid slippage (by using guaranteed stops if spreadbetting, for example). A system that gives good entry and exit signals will fail if poor risk management is used (i.e. trading too large relative to your equity), as a relatively small run of losses will either seriously erode your trading capital or even wipe you out.
  • The ability to follow the rules as set out above - this is where trading psychology comes in. Its no good having a proven system if you can't follow the entry and exit signals, or even 'second guess' the market and enter or exit positions before getting the appropriate signal. Similarly, it's no good if you override the risk parameters you have set (as for example, if you have incurred some losses and start trading larger in an attempt to recoup those losses). The ability to stick to the rules means that you are fully 'compatible' with your system, as you are able to resist the urge to override the system parameters.
The inherent rules and parameters you need to set in a robust trend following system will cover the first two points, giving you the best opportunity to be able to have the ability to apply with the psychology side.

Trend following is a superb tool in trading the markets - the system tells you when to get in and when to get out, based on your criteria. Risk management in a critical and inherent part of the system - all systems, no matter how good, suffer periods or drawdowns or losses. Good risk management keeps you in the game, allowing you to maximise your returns in the future. It also allows you to approach the markets in a practical, unemotional fashion.

In addition, trend following can be used with or without fundamental analysis as a 'filter' to your trades. I don't use fundamental analysis at all, but that is my personal preference. Other people swear by it. Trend following allows those who DO use fundamental analysis to time their entries and exits to maximise their profits, as well as keep the majority of them when prices start to reverse.

These three aspects are covered in in my e-book or via my webinars or 1-2-1 training and mentoring, giving you a complete trend following system, complete with the codes for my stock scans and chart set ups that I use to trade, as well as ongoing support. Go to my Services page for more details.

Trading is simple, but not easy. Following these basic thoughts above will help you in your quest to make money.

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