

TUTORIAL: Trading Systems: Introduction

The Questions
The following questions should be answered as honestly and as fully possible. Each will probe current market conditions and will require the trader's own strategies to be scrutinized. Traders should also realize that losing trades occur to everyone, and even the best trading system can experience a string of losses. Trading rules and strategies should not be questioned every time a losing trade occurs; these questions should be used when the trader is in a sustained period of unprofitability. Being aware of these questions should also keep traders on course at all times, helping to avoid "ruts" in the first place. (For additional reading, check out: Day Trading Strategies For Beginners.)

Markets continually shift from low to high volatility and back, and ranging to trending and back again. Therefore, what works in one set of conditions may not work in another. A plan may be executed perfectly, but if executed in the wrong market environment it will likely be a losing endeavor.


2. Am I trading against the trend or with it?
Many traders develop strategies to capitalize on trends. Trends occur on different time frames, and which trends are currently relevant should be noted by the trader. Trading with the trend can be subjective in that a short-term trend is going one way and a longer term trend going the other. Therefore, being aware of multiple trends and deciding which ones to trade is a crucial factor in trading success.

If a trend following strategy is being used but is not profitable, traders must consider if the market is even trending. If a trend is occurring, the entry point is possibly too late (close to a correction point) in the move, or stop levels are too close to the price. If the strategy appears as if it should be profitable (but isn't), are the rules of the strategy being adhered to? It may not be the strategy but rather the trader's lack of discipline which is the problem (which is quite often the case).

3. Do I have a set of rules for entries and exits and am I following these rules?
If a trading rut is occurring, it could be because the trader doesn't have a detailed plan for how to enter and exit positions. Are entry and exit rules written out in detail? The details should include how and when trades will be entered and exited.



4. Am I trading all my signals or only certain ones?
When systems are created, especially if it is backtested, there is an assumption that all the signals produced by the strategy will be traded. If certain traders were filtered out of the results, these same trades should be filtered out in actual trading. Therefore, the trader must ask "Am I following my plan or am I making too many, or too few, trades?"



5. Have I created money management rules and am I following them?
One of the most important aspects of trading is money management. Each trade should only expose the trader to a very small amount of risk, ideally less than 1% of the trader's capital. Therefore, if money management rules are in place, are the rules being followed?


The Bottom Line
A losing streak can happen to anyone, and likely will, if trading for a long enough time. A rut can be caused by changes in the market or in how a trader implements their rules. By scrutinizing their system, the trader can hopefully isolate the issues causing the string of losses so it can be fixed. Monitoring markets and determining if the system will even work is one way to do this. A trader should also monitor if they are trading with the trend or against it; if they have entry, exit and money management rules in place; if all signals are being traded and most importantly if all the rules in place are being followed. By examining the market and scrutinizing the trading plan (and how it is implemented), it is likely the cause of the "rut" can be found and the appropriate action taken to remedy the situation. (To know more about trading, read: Introduction To Swing Trading.)