Here’s my simple 12-step guide to creating your own trading strategy from
scratch. Please don’t skimp on the later steps – too many traders get about
halfway through step 9, and think they’re ready to go. Steps 1–8 are the easy
bit! Steps 9–12 are where I do 90% of my work, so ensure you see it through
all the way …
Step 1: Timeframe
Work out when you can trade and how much time you have to devote to it.
If you have several hours each day and are keen to use them for trading, then you’ll be looking at shorter-term intra-day trading. If you can only look once or twice a day, then medium-term trading would be better. Or if you want to spend even less time, then you may want to trade daily or weekly charts.
Don’t worry if you don’t have much time – longer-term trading methods that use daily and weekly charts are actually, often the most profitable.
Step 2: Trigger indicator
Choose an indicator that will trigger your trade. This needs to be something that highlights a good moment to get into a trend.
You may already have ideas of indicators you want to use. Don’t get too bogged down in finding something complex.
Step 3: Confirmation indicator
Now find a second indicator that you’ll use for confirmation. The aim of this indicator is to discount many of the weaker trade signals. (You’ll never get rid of all losing trades, but this indicator should ensure that you’re trading LESS.)
Step 4: Profit taking
Decide where you’ll take profits. This may be a single place, or you could take partial profits early, leaving part of your position in play to collect more if the price keeps on trending.
Step 5: Stop levels
Decide how you’ll manage your risk. Will you use a fixed stop loss? How will you know where to position this. Will this stop level trail the price, tightening in as your trade moves into profit?
Step 6: Risk management
How much will you risk per trade? How many markets will you trade, and how will you manage risk across those markets? What will you do in the event of a drawdown?
Step 7: Brokers
Shop around brokers. Depending on what you’re trading, how often you’re trading, and at what time, the costs between different brokers can vary enormously. This is a step that many traders overlook – preferring to stick with a broker they know and are comfortable using. However, this simple step can make a big difference to your profitability, so is well worth the time.
Step 8: The rulebook
Write down your rules.
Step 9: Back test
I’m afraid that’s the fun bit over, and this is where the hard-graft really starts.
It’s possible to use back-testing methods on MT4 software, but I find these very unreliable. I’m afraid there’s no better way to back test than laboring over old charts! It’s a very time-consuming process, and you have to be very disciplined about it.
Go to your trading platform and bring up old charts in the timeframe you require. Depending on what timeframe you’re using, you may be able to go back 6 months, a year, or more. Some platforms, like IG, have more historical data than others.
Now you just slog through those charts, being super-disciplined about where you would have taken trades according to your rules, what your risk would have been, and being painfully honest with your results (you’re only cheating yourself if you fudge this bit).
While running back tests, you’re likely to come up with new ideas and adaptations you want to try out. Write these down and test them alongside your original rules to judge what works best.
At the end of backtesting, you may decide that your trading rules just don’t work and need tearing up. Or they may need adapting to make them profitable. It’s fine to change the rules – but ensure that any rules you use are thoroughly backtested, and not changed on the hoof.
Step 10: Forward test
So, you’ve got your trading rules … it’s proved profitable in backtesting … you’re ready to hit the market and make money, right?
Any backtesting that’s involved adjusting rules to ensure profitability isn’t good enough to risk real money on.
The backtesting you’ve done so far is guilty of curve-fitting.
Now it’s time for forward testing …
Using a demo account, you’ll want to forward test your system. This means following the rules you’ve set out to the letter, to check that it works with no adjustments or curve-fitting allowed.
If the performance you’ve seen in backtesting continues – then you’re onto a good thing and can consider moving into live trading.
(It is possible to split your backtesting into two parts – the first will allow for adjustments, the second will not. This way you incorporate strict testing, without curve-fitting into your backtesting.)
Step 11: Live trading
Remember that live trading accounts use different data feeds to demo accounts, so it’s not unheard for a system to work perfectly in demo mode, only to fall apart in live trading. (The main pinch point here is if you’re trading fast-moving prices, where you can’t get in at the price you want on a live account.)
For these reasons, start off cautiously with your live trading, using low stakes.
Step 12: Advancements
Meticulously record results, and be looking for issues that you can iron out and ways to improve performance.
Look for patterns that emerge in your winning trades or losing trades – is there a way you can filter out some of those losses? Is there a time of day/market that isn’t performing as well? Are you taking profits/cutting losses at the right time?
As always, any changes need to be rigorously tested before you adjust your trading rules.
Putting it all together
As I said above, putting together your trading rules is the easy bit … 90% of the graft comes with all the work of testing, adjusting, testing again … and again …
Please don’t skimp on this, or cut corners. In addition to doing my own trials, I also regularly look through testing done by other traders – and it’s rare to come across traders who don’t ‘fluff’ results to some degree …
It’s so easy to make excuses for trades ‘I wouldn’t have taken, because …’, or ‘I’d probably have closed a profit, it’s close enough …’
Remember, when you’re back testing, there’s still the cost of a spread to take into account, so if your trade would have ‘just’ hit its target – chances are, in the real world of live trading, the cost of the spread would have stopped that trade from winning.
Being 100% strict and honest with results is what makes the difference between a trading strategy that genuinely works and makes money … and one that just looks good on paper.
I wouldn’t dream of risking my own money – nor asking anyone else to put money on – anything less rigorous than this.
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