Creating Trading Rules & Trading SystemsThis is an article I posted on the INVESTools site last week. It helps an entry level trader know what to take into consideration when deciding on what your "rules" or "apporach" will be. Take a look!
Creating a Trading System & Trading Rules
By Jeff Kohler
PHD Coach / Master Talk & Trading Rooms Instructor**www.irich.com.cn交易之路收集整理**
In this weeks article I want to tackle the topic of developing trading systems and trading rules. Before we start this journey, I want to remind everyone that if you have not had success trading the initial system you purchased from INVESTools, you might want to review all of its rules and signals to make sure there were no misunderstandings along the way, and keep practicing with it until you get positive results. If you were not able to follow a system successfully, should you be trying to create one? Many of you have benefited from the INVESTools method, and based on your experiences, you have ideas of how to optimize its performance and produce better results. This is where the process of building a system and personalizing trading rules begins. You must arrive at an idea or a concept to get started. Through this article, I want to use a few examples and create a set of “mock rules” to give you an idea of how the process works.
General Principles
When coming up with a system or trading rules some of the elements you need to consider are…
A simple yet robust system- Come up with something easy to follow that generates good results.
Risk- understanding how risk plays a role in this, and determining how much you will risk per trade.
Longevity- Find something that will work no matter what the market encounters over the years.
Stock Selection/Diversification- Create a system that can apply to any stock, or only the specific stocks you trade.
Entry & Exit Signals- Create specifics to enter & exit. Test these methods to ensure their results.
Stop placement- Have exits planned for any scenario.
Record Keeping- Keep records of what you trade and why. This will also help create new rules and modify existing rules when needed.
Depending on how far you want to take this, you can add on as many topics to the list above that you wish. The more thorough your list is, the more systematic your trading becomes, and the more reliable your results can be.
What do you want to risk?
Most traders will confess that this concept is more important than the system itself. You need to develop an easy to use method for managing your risk in your trading. If you are not applying risk management now in your trading, do not delay this any further. Let me give you an example you might have read in your materials.**www.irich.com.cn交易之路收集整理**
We teach our students to use a fixed percent of risk when they trade. Most will agree that 1-2% is an acceptable range to use. Let’s assume we have a $100,000 account value to trade with. Using a fixed percentage of risk would mean putting 1% ($1000) at risk per trade. This means that even if the trade goes completely against me, I would only lose $1000 per loss. (This does not mean I spend only $1000, this can mean I spend $5000, but set my stop so that I only lose $1000.) If you keep your losses small, you will give your winners a chance to outpace those losing trades.
Let’s translate this into a trading rule! Determine your risk management plan and follow it. Here are some examples. These might not apply to you, so when creating your own, make sure your rules follow your personal risk management plan.
Only put 1% of my account value at risk in an entire trade.
Only use 10% of my account to trade riskier investments such as options.
What types of stocks do you want to trade?
To some this is a very vague question, however a very important one. You need to establish guidelines of the quality of stocks you will select to hopefully lower your risk in a trade. This encompasses the fundamental quality of the stock, the industry group quality, the trend, etc. Some of the categories may or may not be important in your eyes, but focus on the ones that are. Here is a sample of items you might want to consider when answering this question.
Fundamental quality- Does the fundamental quality of the company matter to me? How do the scores look, do they meet my minimum criteria? (Ex. MG-Zacks of 3.25 or higher)
Technical quality- Is this stock in the right trend? Where does the price fall in relation to support & resistance?
Industry group quality- How does the stock measure to the industry? How does the industry measure against the market?
News & upcoming events- Are there any upcoming earnings announcements or news events that might affect the trade?
Diversification- How do I diversify myself? Do I trade similar stocks? Should I have trades in multiple groups? Should I consider ETF’s? Can I be both bullish & bearish in my account at the same time?