Designing and Implementing a Trading System

The Three Key Decisions of Any Trade

A typical trading strategy or system is based on three crucial decisions regarding any given trade:

  1. The precise entry point into the market (when the trader decides to open a position).
  2. The precise level or levels to take profit (when a profitable position is closed).
  3. The precise level or levels to exit or close a losing position.

Traders base their ideas around these three key decisions, but many fail to formulate a clear blueprint in order to realize them fully.

Five-Point Blueprint for Designing Your Trading System

Here is a suggested list of five points to follow when designing your own trading system:

  1. Decide on the Trading Style: Determine the style you are most comfortable with.
    • Are you a trend follower?
    • Are you a contrarian (someone who goes against prevailing trends)?
    • Are you an intraday trader (someone who opens and closes positions within a single day)?
    • Or are you a long-term trader?
  2. Formulate the Rules of the System: Set clear rules based around the three key decisions (entry, profit-taking, and exit).
    • What are the conditions required to enter a buy?
    • What are the conditions required to sell?
    • What happens when the market moves in an expected direction?
    • What will you do if the market moves against you?
  3. Test the System (Visual Inspection): The first step in testing your system is through visual inspection. Scroll back and forth on the price chart to check whether the system appears profitable. If so, then you can test more thoroughly with larger amounts of data and on various financial instruments.
  4. Backtest the System: For those with programming knowledge, backtesting the system using trading bots can be very handy. Reports generated can reveal information about profit factors, average losses, wins, and so forth.
  5. Forward Testing: Once you have a clear system with its own set of rules in place, forward test it before investing your money. A popular way to do this is by trading on a demo account. This allows you to see how the system behaves in a real trading environment by testing with live prices, enabling you to make any necessary final adjustments.

Detailed Summary

Designing a successful trading system requires making three fundamental decisions for every trade: determining the entry point, setting profit-taking levels, and establishing exit levels for losing positions. The text outlines a five-point blueprint for formulating a trading system, which includes deciding on a trading style (e.g., trend following, contrarian, intraday), formulating clear rules around the three key decisions, and rigorously testing the system through visual inspection, automated backtesting, and real-time forward testing using a demo account before committing actual capital.

Key Takeaways

  • Every trading strategy is built around three crucial decisions: entry point, profit-taking level(s), and exit level(s) for losses.
  • The first step in designing a system is deciding on the trading style (e.g., trend follower, contrarian, intraday, long-term).
  • The system must have clear, formulated rules addressing the conditions for buying, selling, and managing movement both in favor of and against the position.
  • System testing begins with visual inspection of price charts to gauge apparent profitability.
  • Programmers can use backtesting with trading bots to analyze performance metrics like profit factors and average wins/losses.
  • The final testing phase is forward testing (live testing with a demo account) to evaluate system behavior in a real trading environment before investing money.