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Designing your own trading strategy

By Philipp Pfitzenmaier

This article will help you get started in designing your own customized trading strategy. But before we get started on that, let’s highlight why it can be very important to have a trading strategy of your own.

Trading is mostly a statistical process. Winning and losing trades will come along and we will never know for certain which will come next. So we should make sure that our trades are comparable, and that our trading process is repeatable.

Our strategy should be designed to have an edge. What this means is that over a large number of trades, the sum of the winning trades should be greater than the sum of the losing trades.

This would be the blueprint we would then follow in order to arrive at our trading decisions. When we move to the drawing board and design our strategy, we will ultimately have to define these several aspects:

Setup: Which Market?

Entry: Should you buy or sell? At which price?

Stop Loss: if the trade doesn’t work, where should you get out?

Please note that, while good risk management and position sizing are crucial, they often form part of your overall trading plan and not necessarily part of each individual trading strategy.

What are the possible components of such a setup? At Trade With Precision, we like to use small bullish or bearish candles, moving averages, MACD and RSI convergence just to name a few technical ingredients.

And it doesn’ t have to stop there. Fancy Ichimoku? Connors RSI? The latest and greatest indicator from TASC? No problem, we could add them to the mix as well.

A common mistake traders often make is to use multiple indicators that are actually delivering similar information. For example, Stochastics and RSI usually tell the same story so there is probably little value in using them both, in parallel in the same strategy.

Remember, our goal is to find an edge – anything better than a random outcome for every trade. One component is often never enough, which is why we believe that it is better to use multiple reasons to take a trade. But this is the fun part: exploring, tweaking, data mining and back testing.

What do we mean by data mining? To validate whether or not we in fact have truly developed an edge, we should analyse our technical analysis cocktail and see whether our new strategy is likely to fulfil our expectations.

The only way to check this without putting our hard-earned money on the line, is by back testing - i.e., going back in time and playing “what if”. Try to be as precise as possible: document all trades that would have been triggered based on your rules – be rigorous and honest as possible in this process.

It can be beneficial to do this back test over a range of different markets (include FX, commodities and indices) and document the outcome of every single trade. Once you are done, start the number crunching: which percentage of trades were winners, which broke even and which lost money? How many times did the winners return the initial risk of the trade? How many trades did your back test produce and are those results statistically significant?

If the results are favourable, congratulations. You have now found a trading strategy that both has an edge and matches your trading style.

Now it’s time to implement that strategy and trade it live in the markets using the smallest trade size (volume) as you possibly can. And just as with all your other trades, you should document them diligently, so that after a large sample set of trades, you should be able to ascertain whether or not your new strategy truly behaves as indicated in your back test.

While this approach involves a lot of working through, this can be a very rewarding process, and not only from a financial perspective. Your style of trading will probably reflect your personality, and there can hardly be a better way to trade the markets than by designing your own trading strategy.

All the best for your very own personal trading journey in 2018.

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