Develop Your Own Trading Strategy in 5 Easy Steps
Many people try their hand at trading, but only a few will go on to become successful at the game. One of the things that will be essential on that road is the development of your own unique trading strategy.
Step 1. Form a trading concept
Any trading strategy has to start with an idea or concept. To start this need be little more than a notion of the characteristics that your system will have. Will it be technical or fundamental? Will it be a trend follower? Will it be holding positions for the long term or short term?
These questions will hinge on on the type of market you’re planning to trade. The character of the foreign exchange market for example, is very different to the stock market. Futures markets have different characteristics to the spot markets.
A basic understanding of your chosen market is of course essential to the success of your strategy. That’s why most traders already gain some exposure to their chosen market before they decide to automate their efforts.
However automation is not the only goal. It is not even a necessity. A well-formulated strategy has many other benefits.
- It forces discipline
- It can be systematically tested
- It eliminates emotional biases
- It lends itself to iterative improvement
A haphazard approach to trading supports none of the above.
One part that needs the prime consideration is of course what cues your system will use to enter and exit the market.
These cues will usually be from chart analysis, indicator output, or other such triggers.
Step 2. Write down a set of rules
With an idea in mind you can begin to think about a “mechanical” set of rules that your system should obey. The purpose of this is to solidify your trade concept into a simple flow of conditions and actions.
Rules: If this happens, then take this step. If this condition and that condition happen together, then do this step.
The simplest concrete example is a candlestick trade. A rule could be something like this: If a certain bullish candlestick pattern appears, trigger a buy order.
Another example is an oscillator trade. If the RSI is above 70, trigger a sell order. If the RSI is below 30, trigger a buy order.
In a real strategy, the rules will be more complex and will likely have several conditional steps. As an illustration, with the candlestick rule, you might want to include a second condition that says there must be a confirmed uptrend, defined by a moving average, before the buy order triggers.
Step 3. Test and refine your rules
The above step sounds a lot like a software specification. However turning your idea into software at this stage might prove costly and even a waste of time. There’s also no guarantee that it will produce results.
An alternative is to use a strategy tester like Tradoso. With this tool you can test your rules without writing any software.
The advantage of Tradoso opposed to code generators is that you can build your own rule set easily, and include any conditions, or inputs as needed. Access to base functions is through a simple graphical panel. This works something like a pocket calculator.
It lets you structure your rules and feed outputs from one layer to the next allowing you to create trade logic with any number of conditions and inputs.
Each block has inputs and outputs. These can take values from chart data (OHLC) or a combination of logical, mathematical or standard chart indicators.
Once you have put your rules into the editor panel, the test button lets you apply your procedure to real chart data.
As well as showing you where your rules are triggering trade entries, it also shows you the success rate of those data points. That tells you how reliable your rules were at picking market rises or market falls.
When you get instant results in this way you can fine-tune your rule set until it works in an optimum way for the markets you want to trade.
Step 4. Paper trade for a while
Once you have worked on your rule set, tested it and refined it, the next step is to test it on a practice trading account.
A practice trade account, also known as a paper trading account, lets you trade without the risk of losing real money. This is the preferred way to test a new strategy.
With Tradoso, you can switch your trading strategy on to live mode, and it will run against live market data. You’ll be able to track the profit and loss and keep tabs on the trade timings like openings, and closings.
If you want to script the strategy yourself, or find a developer to do it, you’ll need to choose a platform and programming language. Platforms like TradingView, MetaTrader and TradeStation all have their own scripting languages.
Step 5. Live trade
When you’re confident that your strategy produces the results you are looking for you can switch to live trading. At first, this will be with very small positions sizes to reduce the chance of large losses.
Testing and refining your strategy doesn’t stop after paper trading. Real trading can sometimes reveal problems with your rule set that won’t appear in paper trading. This is why you’ll want to examine your trading results carefully before ramping up on position sizing.
The last three steps are ongoing and involve iterative improvement until the strategy runs reliably and consistently in the way it was intended.