Defining a trading strategy
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Definition of trading strategy
A trading strategy is an action plan for all your trades in the financial markets. It is important for every trader, from the novice to the most experienced to have one. If you do not use a trading strategy, you will certainly lose all your capital. Contrary to what many novice traders may think, trading leaves no room for improvisation, it must be structured.
A trading strategy is a course of action that you must strive to follow. It therefore requires rigour and discipline. Forget trading by feelings!
What is the purpose of a trading strategy?
A trading strategy gives traders a lot of advantages:
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Risk management
: This is also called money management. This lets you know in advance how much a trade can cost you. Novice traders often tend to consider their gains but they forget the potential losses. This is the basis of trading, you must consider all possible scenarios. Each trader must impose his own risk management rules. For example, never risk more than x% of the portfolio on one trade, stop trading if a certain level of loss is reached.-
Define your entry and exit points
: On what technical elements do you base your positions? On technical indicators, on chart patterns, etc.? When do you consider a bullish/bearish signal valid? At the close of the candlestick where do you place a buy/sell stop order, etc.? How do you determine your price objectives? Do you cut your position once the objective is reached or hold your trades? How to place a stop loss.A trading strategy encompasses all these elements and allows you to frame your positions.
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Don't give in to your emotions
: A trading strategy helps to combat your emotions, one of the main factors of loss in the financial markets. Psychology is the trader's enemy. The more precisely you define each point of your trading strategy, the more you consider the different possible scenariosin advance, the less you will give in to your emotions.Without a clearly defined action plan, you cannot win in the long-term on the financial markets.
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Evaluate your trading
: A trading strategy lets you evaluate your long-term performance. It is a way to draw conclusions about your past trades by studying your trading history. For example, you may find that you regularly lose on one asset, that you perform better on a particular unit of time.If you do not have a trading strategy, it is impossible for you to set goals, you are constantly wading through fog, you could lose everything overnight.
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Acquire rigour and discipline
: Having a trading strategy and respecting it means learning rigour and discipline. It is better to learn on a demo account, no need to risk your money from your first steps in trading. If you can't follow a clearly defined trading strategy to the letter, there's no point in trading live.The different elements of a trading strategy
The type of trading
A trading strategy can be based on scalping or swing trading. Scalping often seems easier but actually requires some experience of the financial markets. Scalping requires more technical knowledge and very good reactivity. Scalping does not engage emotions to such a great extent.
Swing trading gives traders the possibility of analysing and detecting bullish/bearish signals, but risk management is often the key to success. Psychological is a greater factor because of the trade’s longer duration.
Your choice will be made according to your preferences but also your psychology. You must determine what type of trader you are.
Your trading time unit
The time unit of your trades is what determines your investment’s duration. If you trade on daily charts, you keep your trades for several days, even weeks. If you trade on 15 minute charts, the duration of your trade will not exceed a few hours.
No time unit is better than the others. Some trading strategies perform very well in the short term and badly in the long term. You must therefore test your trading strategy on several time units to determine the one that generates the most performance.
It is also better to feel comfortable with the time unit. It is firstly important to feel that you have time to make the right decisions, to properly analyse your products to properly react to the signals given by your trading strategy. You should also choose the unit of time that gives you the least stress.
Choosing your products or markets
Firstly you need to determine in which market you wish to invest. This can be on stocks, forex, indices or commodities. Once you know what you are interested in, you then need to look for products that interest you the most in that market.
For example, if you decide to process stocks, you could choose to only trade in CAC40 stocks. You could also decide to trade only European indices.
Each market and product has its own characteristics. It is important to study them to know what best suits your strategy, your preferences and your psychology.
Trading signals
These are all the technical elements that will enable you to open a position on the financial markets. I can only give you one piece of advice, keep your trading strategy simple. Novice traders often tend to use little-known indicators or look for a complex strategy (thinking that their strategy will perform better).
First study chart patterns, Japanese candlesticks (the bases for detecting reversals), resistances and supports and the best-known technical indicators. This is more than enough to establish a winning trading strategy.
Searching for complicated combinations wastes your time and it is likely that you will lose yourself whilst trying to learn trading.
The goal is to find a strategy that maximizes your chances of winning each position. Trying to findmartingales in trading is doomed to failure. All trading strategies generate losing trades. It's no big deal. The important thing isn’t having as many winning trades as possible, but having positive performance at the end of the month.
Earnings management
You must determine your action plan by anticipating each possible scenario. Understand that financial markets are unpredictable. You can only exploit probabilities but in the end it's the market that decides. The market is made up of irrational players.
If your position is profitable, you should plan in advance what you are going to do. Will you carry the trade up until you reach your objective, until the movement is exhausted or will you cut at the first signs of a correction? All this is planned before the trade. Experienced traders can afford to improvise during trading but novice traders are not able to do so.
Never forget one thing: the only time you are fully rational is before a trade. During the trade, your emotions come into play because your money is at stake. Therefore, it is better to determine your action plan before opening a position
Loss management
This is probably the most important point in trading. If you manage your losses well, even with more than 50% losing trades, your trading strategy can generate money.
A trading strategy is a winner only if the gains generated by the winning trades cover the losing trades. You must therefore attempt to minimize your losses on losing trades.
Minimizing your losses is accepting that you will have losses. Put your pride aside and realise, as soon as possible, that the market is going to prove you wrong. Either you move your stop regularly to monitor the price and gradually reduce your risk, or you must be able to cut your trade, at a loss, before your stop is reached.
If your trading strategy gives you a false signal, cut your position. Don't wait for a stroke of luck. The market rarely gives presents. It is better to take a lot of small losing trades than to persist in wanting to be right on a trade (by placing a distant stop or no stop at all).
Cutting a losing trade well, counts as much as cutting a winning trade well! At the end of the month, it pays the same, added performance!
