Creating a trading strategy? Use these 41 tips!
Create your own trading strategy or trading system based on the tips in this article.
Trading Tip # 1: Look for an edge
An edge is something that gives you an advantage over the rest. This will allow you to win more than you lose in the long run. An edge may be a little different for everyone. For example, a combination of two specific technical indicators can be an edge. You can also have an edge in the form of a trading system, a good analyst, astrology, intuition, knowledge, et cetera. In general, an edge is something that leads to an improvement in entry and/or exit timing of your trades. Read more about this on: Trading with an edge
Trading Tip # 2: Trade something that suits you
There are thousands of ways to play the financial markets. Find something that suits you and what matches with both your strengths, your time constraints and your beliefs. Do not be tempted to follow the methodology of someone else if this method does not suit you, because you probably never will get the desired results. Read more about the personal characteristics of a good trader.
Trading Tip # 3: Specialize
Today there are thousands of markets and products to trade. Stocks, indices, mutual funds, bonds, forex, options, CFDs, futures, turbos, ETFs, you name it. Specialize in one or more markets / products and get to know all the ins and outs.
Trading Tip # 4: Consider trading as a business
Consider trading as a business that requires a lot of time and energy in order to keep improving. The threshold to taking part in this business is very low. Nowadays, anyone can open an investment account within a few days through the internet, deposit some money and go to work. You do not have to prove that you’re an experienced trade or that you have a college degree, and most brokers do not even require you to pass a theoretical and practical test. Anyone can become a trader. That might well be the reason that only a small percentage of traders actually are successful in this business.
The percentage of successful people in just about every other profession is many times higher. The threshold to taking part is also much higher. People did a study, wrote a business plan for the bank to obtain financing, did market research and so on. This causes many to give up before they have even started. If you want to succeed as a trader then you need to take the profession of trading seriously.
Trading Tip # 5: Make a trading plan
Trading is a skill and like almost all successful entrepreneurs had to write a business plan, all successful traders have put their ideas on paper. A trading plan contains at least the following: trading style, entry rules, exit rules, risk parameters and objectives.
Your trading plan should be able to respond to any situation, only then can you avoid emotional decisions as much as possible. Read your trading plan regularly, as this helps to become a more consistent trader.
Trading Tip # 6: Focus on long-term results
Focus on a steady growth of your trading capital and do not focus on a few mega winning trades that should make you rich quick. The chances to “become rich quick” in the financial markets is a lot smaller than the chance to become poor quick arm. But those who handle it well can “become rich slowly”…
Trading Tip # 7: Set goals
As long as you do not set any goals you have nothing to work to. Do you have daily or weekly goals? What do you want to have achieved by the end of the year? Objectives do not solely have to be focussed on performance, you can also create targets in designing a second strategy or in the field of education and development.
Trading Tip # 8: Avoid the herd
Following the herd gives a feeling of safety. If you a wrong at least you’re not alone. But when you consider that the vast majority of traders lose money in the stock market, it is not wise to follow the herd.
Trading Tip # 9: The majority loses
Trading Tip # 10: Take your own decisions
Do you know someone who has become rich from the tip of the neighbour?? Neither do I… Do your own work, make your own analysis and take your own decisions based on what you perceive, and not based on the opinions of others. Or, as professional traders say it: “Tips are for waiters”. Apart from the tips from this article, of course ;-).
If another trader gives his opinion on a particular market make sure that you always know on what time frame this trader is trading. If this does not correspond to the time frame you are trading on his or her opinion could be totally irrelevant.
Trading Tip # 11: Always think one step ahead
Trading is thinking ahead. Determine in advance under what conditions you want to get in or out of the market. If, in the heat of battle, you still have to figure out what the next step will be, it is likely that you will be influenced in your decisions by emotions.
Trading Tip # 12: Define different scenarios
The market can only move in three directions: up, down or sideways. Defining different scenarios can help to achieve a more objective decision-making. You can use a decision-making table for this purpose. In the table, write down why you would want to go long, why you would want to go short and why you would want to remain out of the market. For each scenario you describe the potential rewards and risks. Then you can use these answers to formulate an approach.
Trading Tip # 13: Be prepared
Go prepared to work. Do your homework and you keep developing itself continuously. For example, start your day with some mental exercises. Analyze your previous trading day, what went well, what went wrong and what lessons can you draw? Make an analysis of the previous day (s), where are the support and resistance areas and decide how you would like to act if the market follows your vision.
Trading Tip # 14: Bull, Bear and Trading Range
Markets can rise (bull), fall (bear) or move sideways (trading range). Each type of market offers opportunities, but often requires a different approach. A strategy that does well in a bull market will probably perform less in a trading range. Therefore it is important to recognize the current market type and anticipate on it.
Trading Tip # 15: Take volatility into consideration
In addition to the three different market types, you also have to take into account the volatility of the market. We often make a distinction between high and low volatility. During high volatility, for example, it is wise to set the stops a little wider than during low volatility.
Trading Tip # 16: 6 different market conditions
If you combine the direction and volatility of the market you get up to 6 different market conditions:
- Bull – high volatility (rapidly rising prices)
- Bull – low volatile (slowly rising prices)
- Bear – high volatility (rapidly falling prices)
- Bear – low volatile (slowly falling prices)
- Trading Range – high volatility (quick rising and falling prices within a horizontal band)
- Trading Range – low volatility (slow rising and falling prices within a horizontal band)
No strategy performs equally well in all market conditions. It is therefore important to recognize the current market conditions and adjust your strategy accordingly.
Trading Tip # 17: Filter the information overload
Today there is a plethora of information available over the internet, television, newspapers, radio and other media. This creates the risk that you cannot see the wood for the trees. A good trader simply focuses on the issues that are important to him and ignores everything else. Consider what information is really important in making decisions. Implement this information in your trading rules and leave the other things for what they are.
Trading Tip # 18: Predictions are worthless
Gurus seem to make a sport out of it and take every opportunity to give their predictions for the upcoming week, month or year. Perhaps interesting for long-term investors, but for traders and active investors these predictions are worthless.
Trading Tip # 19: Test, test, and test again
Before you put your first Euros, Dollars, or Pounds at stake you want to have tested you method or strategy extensively. There are different ways to do so; testing on a demo account, using back-test software, or manually navigate through a number of graphs and charts. The latter we call “eating charts”. Just print 50 charts or so, apply your methodology to them and test whether you can come up with something useful. You will start to trade with real money once you have developed a strategy with an edge.
Trading Tip # 20: Practice with real money
Trading on a demo account can be useful to become familiar with a platform or a particular financial product. It also has a number of disadvantages however. The trades on a demo account are almost always executed immediately, against the currently most favourable price, while in reality the order execution often goes a little slower and you cannot always get the best price from the broker. The advantage of practicing with real money is that you often experience other emotions, because real money is at stake.
If you are unfamiliar with the platform or the financial product it is highly recommended to start with a demo, but be aware that results on a demo account often cannot be translated one on one into a real money account.
Trading Tip # 21: Start small
First open 50 to 100 trades at the lowest possible risk. Evaluate these trades and analyse what went right and what went wrong. Keep trading in small amount until you are confident that you have got an edge which you can statistically support. If you fail to make a profit while there are just cents at stake, then you won’t be making money with hundreds or thousands of euros.
Trading Tip # 22: Trade like a casino
A casino knows that it always has the odds in its favour in the long term, and that it always earns money over long ranges. They don’t worry about what one round of roulette costs or benefits them, because they know that if 1000 rounds are played they always earned money. Traders should have the same mind-set. Once you have a strategy with a positive expectation value the result of a single trade is no longer important, only the result of all trades combined is what really counts.
Trading Tip # 23: Trade what you see, not what you think you see
That sounds simple but in reality it often is not. You can compare it to reacting versus anticipating. Do you see the market is breaking its previous high and do you react on that? Or do you expect the market to break its previous high and do you anticipate on that? By the way, reacting is not necessarily better than anticipating. With reacting you wait for confirmation and you will be in the trade later; you pay for additional security. With anticipation it is just the other way around, you will be in a trade much earlier, but you will also be frequently stopped out.
Trading Tip # 24: Let the trades come towards you
Trading can ask a lot of your patience. Depending on the strategy you follow, it can sometimes take hours before a new setup occurs. At such times it is tempting to go to look for setups. Be alert that you do not start looking for opportunities, instead, patiently wait for the opportunities (the setups of your trading plan).
Trading Tip # 25: Span of control
The span of control of a trader tells you how many open trades he or she can effectively manage, without compromising the final result. That is different for every trader. One trader will focus his full attention on one trade, while the other trader can manage 8 trades at the same time. The span of control is also closely linked with the experience of the trader, the time frame which is traded and how many screens a trader has at his disposal. It is important to consider your own span of control, since exceeding this will directly affect your final performance.
Trading Tip # 26: Focus on what works
Perfectionism can come in handy in many aspects of life, but with respect to trading it can also be an obstruction. As a trader you will have to accept that many things will fail. Focus on what works and focus on a near perfect execution of your trading plan, instead of trying to make everything perfect.
Trading Tip # 27: Do what needs to be done, but no more than that
Many traders do everything to increase their “edge” and eventually develop strategies that are so complex that they are actually impossible to trade consistently over the long term. Successful traders instead spend a lot of time simplifying their strategies in order to accelerate the decision making process and minimize the margin of error.
Trading Tip # 28: K.I.S.S. (Keep It Simple Stupid)
The K.I.S.S. principle also applies to trading. Complex does not necessarily mean better, in fact, it’s often the other way around. If you cannot describe the operation of a strategy in a few sentences it is probably too complex. Of course there are also very complex algorithmic systems that do very well, but they are mostly used by institutional investors. Contrary to what many think, complexity is not a requirement for a profitable strategy.
Trading Tip # 29: The Holy Grail is you
Every day investors start looking for the holy grail in trading. A strategy that always makes a profit and with which one can acquire enormous wealth. In my belief, there are no holy grail strategies. The holy grail of trading is you. Give a profitable strategy to 100 traders and none of them will achieve the same results. A good example of this is the turtle trader experiment by Richard Dennis. Read more: The Turtle Trader experiment
Trading Tip # 30: Use multiple time frames
Whatever kind of trader you are, it never hurts to regularly watch a longer and shorter time frame to see what is happening. Imagine you trade on the 1-hour chart, then it is wise to also monitor the 15-minute chart and the 4-hour chart. The more time frames showing the same picture, the stronger the setup and the probability of a successful trade.
Trading Tip # 31: Add to profitable positions
Add to your the trades that are on a nice profit and thus prove themselves. This is exactly the opposite of what most traders do(they instead add to their losing positions). Adding to your position is also called scaling in. Please note, this strategy gives a probability of greater profits, but on the other hand, the volatility of your account also grows.
Trading Tip # 32: The market does not take into account anyone
The market doesn’t know you and doesn’t take into account anyone. The market does what it wants and listens to nobody. The market is merciless, both to novice and seasoned traders. It makes no sense to fight the market, because the market owes you nothing.
Trading Tip # 33: Stay alert for big news moments
Every month there are some fixed news moments in which key figures are published with regard to the global economy. Many day traders remain out of the market around these kind of news events since the publication of these figures often leads to additional volatility and abnormal behaviour. Using an economic calendar you can see what figures will be published on a particular day.
And then there are the really massive events that can cause big shocks on the stock markets, like the Brexit on June 24th, 2016.
Trading Tip # 34: Dare to pull the trigger
How often it happens that you see an opportunity and afterwards think: “I wish I had done it, I would have earned so much by now.” For trading, it is not only necessary to see opportunities, but also to pull the trigger as soon as you see them. If you find yourself incapable of pulling the trigger consistently, it might be an idea to work with conditional orders.
Trading Tip # 35: Beware of overtrading
Do not trade just to trade, but be picky in the trades you make and try to act on your best setups. Read more: How to prevent overtrading
Trading Tip # 36: Winning strategy vs. winning trades
Novice traders often make the mistake of finding a strategy that makes maximum winning trades instead of searching for a strategy with a positive expectation. The number of winning trades will not affect the profitability of a strategy. Ultimately it’s all about the expectancy of a strategy, or how much you will earn on average for every risked euros.
Trading Tip # 37: Know the characteristics of your strategy
Once you have developed a strategy is also important to know the characteristics of your strategy. Important to know is, for example, the expected value, the maximum losing streak (consecutive series of unprofitable trades), the percentage of winners, the standard deviation in trading results, the maximum drawdown, et cetera.
Trading Tip # 38: Do not be tempted by a high win ratio
The win ratio indicates how many winning trades were made in comparison to the total number of trades. Suppose you make 100 trades with 45 winners then you have a win ratio of 45%. However, the win ratio says nothing about the profitability of a strategy. Strategy A can have 80% winners and still lose money, while strategy B has 30% winners and is making money. Only when you combine your win ratio with the average profit per trade and the average loss per trade you can say something about the profitability of a strategy.
Trading Tip # 39: Range of results
There are a number of factors that determine the stability of a strategy. One of these factors in the spreading of your trading results. When a strategy makes 50 trades in a month with 49 trades broadly in balance and one mega winner, you do actually have a profitable strategy, but the strategy is not exactly stable. When your strategy is based on the principle of “cut your losses and ride your winners” then you’re looking at what we call in technical terms a “positively skewed distribution”.
Trading Tip # 40: Evaluate your trades
Dare to look critically at your results, the trades you’ve made and the trades you didn’t make. Learn from your mistakes, but also look at the things that have gone well. At the end of the trading session evaluate what went right and wrong and make notes of it in your trading diary, so that you can learn from it.
Trading Tip # 41: Optimize your strategy
After the evaluation comes the optimization. You’re going to examine what you could optimize to achieve an even better performance. Try to avoid curve fitting (adjusting the trade rules so that it would have led to a much better result in the past) when optimizing your strategy.
To reduce the effect of curve fitting can you divide backtest data into two pieces: in-sample data and out-of-sample data. You first test your strategy by considering the in-sample data which allows you to optimize some things. Once you are satisfied with the results you test the optimized system for the out-of-sample data. In this second test, it becomes clear if the optimizations also lead to similar results in a period to which the rules of the system are not optimized. If this is not the case, then there is likely to be a curve-fitting.
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