When you have a plan set, it is like having a map in your hands before starting out your journey to an unknown destination.
So, you can imagine how important it is for you to have a plan.
However, what is even more important is how well you are able to make your plan work for you.
Everything might be looking great to you right now, but what can you do to ensure that your plan is just a workable with real money.
This post introduces you to a few principles of successful trading.
These principles must be used for evaluation of your strategy regardless of whether you have planned it out yourself or hired someone else to do the job for you.
You can expect your chances of success to improve dramatically once it has been tested against the principles explained in this chapter.
Always Keep It Simple
Surprisingly, the more complicated your trading strategy is, the lesser effective you can expect it to be.
In fact, the best trading strategies ever used are known to have lesser than 10 rules in them.
The reason behind this assertion is that the number of rules associated with a trading strategy increase mainly when you have curve-fitted your strategy using data from the past.
This leads to an over-optimization of the system, which is lesser likely to yield positive results for you as against a regularly optimized system.
In addition, it is equally important to keep the rules as simple and uncomplicated as possible.
Markets are ever-changing environments and more often than not, these environments will change so swiftly that you will be required to make really quick decisions.
So, if your rules make use of complicated formulae and expect you to make extensive calculations, then you are in for a tough time.
If you have had the opportunity to see some successful traders at work, you will observe that all that they sit with is a simple calculator.
Trade Electronic And Liquid Markets
Like any other book on trading, I’ll also recommend you to trade electronic markets for the simple reason that you are expected to pay much lower commissions and the fills you receive are almost instant.
Your exit is plainly based on whether your order has been filled and at what price.
Unless you have this information handy with you, you must never make an exit.
However, in non-electronic markets, waiting for the fills may be tricky as by the time you receive the required information, the markets may have turned again and the data may no longer be valid.
So, what could have been a profitable proposition may turn into an unexpected loss.
Trading in electronic markets allows you to bridge this time lag significantly, reducing the losses that you may incur as a result, completely.
On the other hand, trading in a liquid market allows you to avoid slippage by a considerable degree.
This will help you save a good amount of money.
Don’t Expect Unrealistically
Business and losses go hand in hand.
This is more so when you are in the trading business.
So, if you come across a trading system that shows all sunshine, then it is not what it does seem to be.
On an average basis, you can expect your trading system to work on the following statistics:
- You can hope to witness a maximum winning percentage between 60-80%.
- The profit factor value will typically range between 1.3 and 2.5.
- You can expect a maximum drawdown equivalent to 10-20% of year profit.
You can use the three guidelines given above as a rough reference.
Moreover, they also give you a good view of how your market must look.
So, if you notice anything that is way better than this, then it is probably a curve-fitted system.
Learn To Strike A Balance Between Rewards And Risks
If you were in a casino and you decide to put all of your money on red, what will be your chances of winning? 51% – of a win and 49% – of a loss!
The same logic applies to the trading system. Certainly, the more money you are willing to risk, the higher will be your rewards.
However, what is potentially damaging is that the reverse of this statement is equally true.
The more money you risk, the more money you can potentially lose.
This is one trade off, which is the most difficult to strike.
So, if you are able to strike a balance between risks and rewards, you are set as a trader.
In view of this principle, the strategy illustrated in this book is a good fit.
Look To Hit At Least 5 Trades A Week
Assume that you have a winning percentage of 70%.
However, you only get one trade per month.
Now, the high winning percentage will be of little value in view of the fact that a single losing trade is enough to lose you the complete month.
However, if you get higher number of trades, say 1 per day, which is the number that our strategy promises to give, your chances of making good profits are rather high.
Grow And Evolve
You must have heard a famous saying that states that anything that rises quickly falls quickly.
So, if you start small, grow gradually and evolve your own self as you grow, you can expect to have a more lasting and sustainable position in the trading system.
This requires you to have a trading strategy that can allow you to start small and grow big with time.
Two commonest causes of mistakes in trading are human errors and emotional errors.
These errors usually result from the fast-paced environment and the high speed of decision making that the same demand.
Expectedly, panic sets in and all the planning falls flat on the ground.
Making decisions that stem from the emotional turmoil involved in going through panic and stressful situations may end you up with many more losses than what you would have planned for.
The easiest way to address this problem is to ensure that your exit points can be determined easily, without much thinking or calculation.
There must be straightforward rules to be followed and this is exactly what our strategy gives to a trader.
Simple and straightforward exit rules, leaving little room for confusion.
Keep the Winning Trades Percentage High
Regardless of the strategy you use, be sure to ensure that your winning percentage is greater than 50%.
Although, there may be trading strategies that have a rather low winning percentage and still manage to yield pretty good results with the same, the pressure they tend to put on you is enormous and for many of us, working under pressure invites failure like nothing else.
Simply put, when you see 7 trades of the total 10 trades that you have losing, you will need to have a hell lot of discipline to come out as a winner.
There are no practical reasons that can hold you back.
However, for most traders, the pressure is too much to take.
So, if you see that your sixth trade is losing, realize that it is time you need to redo your strategy and not trade.
In addition to the above-mentioned reason, having a high percentage of winning to start with is a good way to build up your confidence.
When you enter the game with lost of confidence, half your battle is won.
Test Your Strategy Well
Remember the back-testing stage from our article What to Expect from A Good Trading Strategy in the Stock Market?
Like we said before, you need to test your trading strategy on at least 200 trades before you can assume that the strategy will work well for you.
In other words, the higher number of trades you test, the lesser will be the error probability and greater will be your probability of making profit.
While you will be able to create a performance report with a mere 40 trades, you cannot assume the viability of a strategy until at least 200 trades have been tested with it.
With this said, it is also important to mention here that ‘200’ is not a magic number that you cannot exceed.
You can further test your strategy and for every additional 100 trades tested, you will be able to increase your probability of success by 2%.
Conclusion – Choose Back-testing Period Carefully
One of the biggest things that you need to worry about when you back-test your strategy is the contract period.
While choosing the back-testing period, always remember that not all markets are same.
Moreover, not all markets remain the same as well.
So, keep the changing nature of the markets in view while you make a decision.
Next week, we’ll looking at the Do’s and Dont’s for Day Trading. So, stay tuned and read on at : http://stockmarketsignals.com/blog