Invest in Stocks and Secure Your Future

WrittenBy:Shaun Connell
In my previous article entitled The 3 Critical Elements to being a SuccessfulTrader we defined trading (as opposed to investing) and looked at the 3 Golden rules to being a successfultrader, namely:

1. Finding a System to Trade;
2. Riskand Money Management and;
3. Psychology.

In this article we willdiscuss finding a System to trade in detail. Whenwe talk about finding a System to Trade, what we are really referring to is trading with an edge in a consistent and repeatable manner to allow usto profit overthe longer term.

To use the common coin flip analogy, if you flipped acoin 100 times, because the flip of a coin in random, youwould expect thecoin to land on heads and tails approximately 50 times each. The more flips you make, the closer to 50% the distribution of headsand tails will be.

A trading edge then, using the coin flip example, would be where wecan turn the flip of a coin to 51 out of 100 (or greater) in our favour.

It is important to note that in trading, an edgedoes not necessarily mean we have more winning than losing trades (although this is thecommon perception).

What a trading edge actually means is that wewill be profitable over the longer term. Often thiswill mean we will have more winning than losing trades (and this is certainly true where our risk and reward are the same). In some cases however,our winning tradepercentage can be less than 50% and yet we can still have atrading edge.

As an example, let's assume we place 100 tradesover a period of time, and we win on 40 trades and lose on 60 trades. Thislooks like we are losing money, but what if each winner was twiceas profitable as each loser? Assuming we risked 1% per trade the non-compounded outcome would look asfollows:

Losers:60 losing trades at 1% risk = -60%

Winners:40Winning trades at 2% reward =+80%

Net Result: =+20%

As you can see, all things being equal, the above system would remain profitable at around 20% return per 100 trades as long as our win percentage stays around 40%, and as long as our winners are approximately twice the size ofour losers. Commonly, we would refer to the winners being twice the size ofthe losers as having a Risk to Reward Ratio of 2:1.

So, how doyou find a systematic way to trade?

System trading is almost limitless inits application. To find the bestsystem to trade you need to consider the following factors:

1. What financial instruments are you interested in trading?

2. What timeframedo you wish to trade, or areavailable to trade?

3. How frequently do you wish to trade?

4. What win/loss ratio is acceptable to you?

5. How about Risk to Reward Ratio?

6. What is the maximum Drawdown you are comfortable with?

7. Does the system fit in with your longer term trading goals?

8. Does the nature of the system mean that Back Testing becomes important?

9. Is the system fully automated like an Expert Advisor (EA), semi-automated (like a signal service) or a full manual system?

10. Isthe system mechanical or does it require subjective decision making or discretion?

11. Is the system a simple trading system?

On the face of it, people newer to trading assumes findinga ProfitableandsuccessfulSystemtotrade is the beall andendall. This is notactuallythecase.

Asanexample, I found asystem a few years ago trading tick charts on S&P E-Minis. It was very successful and consistently profitable. Problem was, to trade it I had to be awake all night as the time to trade it was during the U.S. Equities markets being open, which happens to be the middle of the night where I am from. I tried to trade it for a few weeks, but it burnt me out and I stopped trading it. The lesson here is that finding a System to Trade also needs to fit in with your lifestyle to be successful in the long term.

The other observation I would make that goes against convention is that you should specialise when finding a System to Trade. Don't try and trade a system on 100 different financial instruments. Pick 1 or 2 and stick with them. You will be amazed how much you learn about how a financial instruments moves, you get to know its personality and heartbeat. As an example I have done this with Google and Gold (2 different systems), and I only trade 1 financial instrument per system. I am convinced that you will be a better and more successful trader if you take this approach.