How To Develop A Winning Trading System

There comes a time in the career of a professional trader where you want to develop a winning trading system of your own. It doesn’t matter if you purchase one and tweak or take one of the many from the internet and grind out your own trading system.

The reason is simple: We all trade a little differently and just because a trader does has a winning trading system in their hands, doesn’t mean it will be one in yours.


How Do You Develop Your Own Trading System

Your development process can be as simple as coming up with a theory and back testing your system or go all in and develop an automated trading strategy. I’m more of a hands on and analytical type of person so right there, I can rule out automated.

Are you going to use trading indicators or will you stick with price action trading and price structure as your method of trading?

Can you spend time day trading or will swing trading and position trading make up the bulk of your interaction with the market?

Will Forex trading be your main activity or will your trading system also be used in Futures or Stocks?

Is your trading system going to have many moving parts or will a simple approach (often more robust) fit your needs? If you read any trading books by Jack Schwager, you will see that successful trading isn’t just the system but the person using it. Think of the Turtle Traders where everybody had the same training and system.

The results between each trader were vastly different.

Take a look at the following chart. This is an example of a simple trading system using price action and trend lines. This would be a discretionary trading system because not every trader will see the same thing on their charts.

Where you see a price pattern, another trader may see random price action.

winning trading system

One thing you must keep in mind is:  how you enter a trade is not the most important variable for a winning trading system.

Money management is the most vital component of a trading system because if you drain your trading account, your trading business is over.

When we talk about money management, we want to think of risk per trade and overall risk exposure.  If you don’t understand the effects of a win rate and risk have on your trading account, look at this image:

winning trading system needs risk management

You can see the string of losing trades that are possible when related to your win rate.  Do the math and see the beating you will take when your money management is an afterthought.


Step To Developing Your Winning Trading Strategy

Putting the pieces together for your trading strategy and trading style is not difficult.  You can toss anything on the chart and see if it sticks but the best way to go about is understand the mechanics behing the market.

Start with a top level view:  will your trading system be built on momentum through breakout or will you look towards mean reversion as your main approach?

Mean reversion is the theory suggesting that prices and returns eventually move back toward the mean or average. This mean or average can be the historical average of the price or return, or another relevant average such as the growth in the economy or the average return of an industry. – Investopedia

  1. Determine the type of trader you are
  2. What will be your method of entering the market?  There are a lot of swing trading strategies on this site that you can start with as a basic approach.  In short, what trading concept will you be using and what will you be trying to exploit in the market?
  3. What will cause you to exit your trade?
  4. How much will your risk per trade and overall exposure be?
  5. What instrument and time frame will you be trading?

This is just the start.


Back Testing/Forward Testing Your Trading System

Does your system work with historical data?  How about testing your trading strategy in the markets of today?

You must test the strategy long before you risk any money!

In my experience, far too many people throw indicators on their charts and just start trading real money.  That is the behavior of a loser.  Do not do it.

So how do you back test to see if you have a winning trading strategy?

Ensure your trading plan lists out everything you are to do with your trading method, open up your charts and start testing.

Here is a great video on back testing that I think every trader should be watching:

Final Tip

All of this work will mean nothing if you are not consistent.  If you are changing your trading rules “on the fly” or do not understand the psychology at work when you trade, you simply will not be a successful trader.

The trading system must fit you.  That statement seems vague but like a great fitting glove, your trading system that has proven itself to be a winning one, just feels right.

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