How to build a more consistent money making trading strategy

This title is an interesting one, and perhaps is the golden goose – the promised land that many traders are out there looking for, working hard to get to. Getting frustrated by and in many cases, walking away from!  So in this article, let’s look at the key steps in building a trading strategy that offers consistency of return.

Trading Mindset

One of the biggest hurdles for new and more weathered traders is their trading mindset.  In its purest form, trading is a totally mechanical process. Where the plan is executed perfectly on each and every trade.  It all sounds so easy when typed into a sentence, but how about in reality?

  • Add in the emotional attachment that many people have toward their money. And we open Pandora’s box of issues!
  • Add in the “shall I or shall I Not” take this trade, or perhaps “I will sit this one out and paper trade it. Instead” only to watch yet another profitable trade go by without you being on it!
  • How about I watch, ponder, watch, eventually get in, instead of at the entry. Well past it and miss some of the profits and increase my risk buy getting in too late!

Any of these sound familiar?  I am sure they do because these are some of the profit roadblocks that many a trader faces.  Great – so what do I do, in order to break through this roadblock?

Develop and apply a mechanical trading system?

The biggest advantage to this approach to trading is the consistency that this brings.  A mechanical approach to trading removes 100% of the emotion behind your trading decisions.  Every trade is taken (sound scary?) which is precisely what should be happening.  Take two, three, or even 4 losers in a row – if you had the choice, would you take trade 5?  Maybe – maybe not – yet trade 5 could be the one which more than recovers the previous day’s losses and gets you ahead.

By bringing the consistency of taking every trade. One of the biggest variables – you and your trading mindset – are removed from the equation.

So Robots are the answer?

No – not exactly.  Robots are mechanical and tick many of the boxes. When it comes to the Trading Mindset challenges, particularly when it comes to trade consistency.  However, Robots are less able to evolve themselves and trading successfully is all about strategy evolution.

Trading off the chart – in a technical fashion is a very objective way of seeing the market and provides a binary way of analysing things.  Black or white – entry or exit!  However, just looking at the chart for an entry and exit signal, can sometimes miss a key aspect to any decision, and that is context.

Building into your system Context

A good example of initiating context into your trading is to adjust the risk management parameters to take into account things like volatility.  Lets take an index trading strategy.  If your stop is limited – as I have seen with some “systems” to say 5 points, you have ticked an important box – consistency.  However, in operating a system like this, you have missed the big one – Context!  If the market you are trading goes through a period of increased volatility, having a restricted risk of say 5 points, will almost certainly see you stopped out early on a trade.

So how do you combat this, while still having a process and system?

In this instance, taking into account volatility when calculating your stop is key, if you want to enjoy the benefits of a robust trading system.  What’s more – if the volatility has blown out, you can still take the trade, but through a smaller position size, ensuring you are still consistently taking trades, but without the dollar risk on your position being too large – so perhaps dollar risk per trade, rather than points may be a step in the right direction.

Having this inbuilt structure provides the trader with the ability to be consistent in the face of a variety of market conditions, where as the Robot could well be struggling with this!

Managing the risk on trading is key

Failing to manage risk in an appropriate manner is akin to signing your trading death warrant.  Just having a stop/loss, which is essential, is not enough.  Your stop/loss needs to be appropriately placed, taking into account the instrument’s context and the dollar risk on the trade.  Effectively, this means a living system that offers consistency in process, and in terms of dollar risk, rather than simply points.

What are the drawdowns?

Drawdowns are the amount or swing that your trading account may go through during the tougher times in the market.  All real trading systems have drawdowns – the question is how to handle them.  Earlier, we talked about the notion of 4 losers in a row – which would represent a drawdown in your account – would you then take trade 5?  Monitoring and enhancing your strategy – not on a trade-by-trade basis, but regularly enough to be on top of its effectiveness is key.  Maintaining an equity curve and performance statistics – not just P&L are major components in this space and should form the core of any trading system.

Enhancing your Edge Ratio

The Edge Ratio is a number that effectively identifies the ratio of wins to losses, but more importantly, when you get it right, what you make, versus when you get it wrong, what you lose.  Always, your Edge Ratio goal should be positive.  Why – well if it is positive, the more trades you take, the more money you will make. Now this is a bit of a broad statement and there is a little more to it than this, but you get the idea – you need to know not just if your system works, but why it works.

Case Study

Your system is around 50/50 win/loss.  However, you continue to slowly slide backward.  In fact, you enhance it to a positive win/loss – say 60/40 and you are still going backwards.  Ready to quit trading yet?  Surely this cannot be!!  I’m right most of the time and losing money!!

Ok so in this instance, lets say that you are looking at a target 1:1 with your profits and losses.  With a positive win/loss ratio, this should still work – at least in theory – but reality, now that is something different.  But why??

In reality, you are always going to exit at your stop – meaning a full measure of loss each time you are wrong.  No this is not the problem!! – this is the good news or the positive!!

The problem is on the other side of the ledger, your winners.  Odds are, there will be a lot of trades where you do make a profit, but not the full measure.  For example, if you are a day trader, you are 80% of the way to your profit target and the market is about to close.

Your choices?? Hold the position over night and let it run (or crash) or close out on or before the bell (correct answer) to avoid any overnight risk.  Now you were right and you made profit – but not enough, as you only made 80% profit for taking on 100% risk and long terms, that wont cut the mustard.

And then come the variables!!

Let’s add another variable.  When do you move your stop up?  Your trade is up 50% for the morning – do you move your stop to break even?  Maybe, then you get stopped and it runs away and you miss your full profit.  Alternatively, you leave your stop at its initial level – the trade was in 50% profit and now 100% loss.  Ouch – how is your trading mindset holding up now??

I guess I am not painting a happy picture here, but this is the reality of trading for many people – fortunately, not for our current NT clients.

Become an expert in your market

By becoming an expert in your market, and developing your trading system to reflect that, the whole business becomes much easier.

Sliding your stop to choke (but not too tight) the trade so that the profit target can ratchet higher.  In other words, it may hit a 100% profit. And then slide the stop to the next level – say 50%, let the trade run a touch more. And lock in the full 100% profit as your minimum and then have a free swing if it moves higher – 200% if that is available – albeit with the security of your first 100% locked in.  Ratcheting like this is a skill in itself. And really reflects a traders’ strategy development and expertise in reading their market.

Then there is the scenario of late afternoon exhaustion patterns – after all, why sit up all night trading, when you could be doing so in a far more effective and lifestyle orientated way!

Having a rule where, if you are trading short and going into an afternoon exhaustion pattern. You keep your position open to capitalise on the price action, but if you are long, you close.  This is not discretionary – it is a process and is as a direct result of being an expert in your selected market.  This is how you make big inroads in your edge ratio. And have a very positive skew in your equity curve.  As an aside, this particular element. Was just one of several developments to our Nikkei Trader strategy over the past few months.

Now if all this sounds a bit too much like hard work, why not outsource it.  Hard work, good for the soul as it is, rarely sounds fun.  To give you an example, if it were down to me, the lawns at home would be like a jungle.  I get busy and other things get in the way.  More fun things or really anything that doesn’t involve gardening!

Don’t get me wrong, I love our gardens, especially sitting in them reading the papers enjoying a cuppa or glass of wine!

So instead, Jim comes over every Tuesday ensuring the Lawn and gardens always look pristine – whether I am busy or not.  What’s more, Jim has all the tools, knowledge and expertise to make the job far easier than it would be for me – multiple trips to Bunnings to buy the wrong fertiliser or etc.

What’s more, trading can be the same.  Outsource all the hard work, years of experience and time commitment needed to develop a strategy that works.

We have already done the work – and continue to, in terms of strategy enhancement and development.  So, instead of trying to re-invent the wheel and end up investing hours getting very frustrated, why not rent ours.  It is extremely cost effect and the work is done for you.

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