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Creating a Trading System

This article could be entitled, “How to Steal a System for Fun and Profit.” I may be kidding a bit, but not much. There are several reasons to start construction of your own trading system by stealing or borrowing another trading system's ideas and concepts.

First, it is easy. There are some pretty good trading systems out there. Some are free and some are very expensive. The cost of these systems is not an indication of the value of the system. The problem with some trading systems is that they might not work for you. Now I am not talking about out right dishonesty, which is a big problem when trading. Rather, I am talking about your ability to effectively trade with the system that you are using or buying.

You need to use a system that matches your life style and personality. If you have a day job (not trading), do not use a system that requires you to stare at a screen all day. You will be distracted at work and miss the opportunities to make money or worse you will not close a trade effectively and will lose money.

Some systems have a potential to lose 20, 30 or 40% of you money before they are profitable. Can you handle a system that can drop your trading capital to half before making money? Or, are you prepared to have a string of 8 to 10 loses in a row before you have a winning trade? Some of the best traders in the world lose money on more than 50% of their trades. An excellent trading method made famous by Richard Dennis and William Eckhardt (Schwager) and sometimes referred to as Turtle Trading, is one of the best trading system that I know. They get returns in excess of 20 to 100% per year. Would I ever trade their exact system? Not a chance! Dennis and Eckhardt also get losses on over 60% of their trades. I am not emotionally capable of handling that many losses, even if I can get large returns. Their system is great, but I would not follow it and therefore, I would get into trouble and lose money. However, I would and did use some of their concepts in other trading systems that I developed. More on that idea, latter.

Second, don’t reinvent the wheel. Let’s face it, if you are a new or even a fairly serious trader, what is the possibility that you will come up with a totally new concept? There are some very smart and wealthy traders out there. Why not use their ideas? Remember Dennis and Eckhardt in the above paragraph. Basically, their system is based on a “breakout” method. I know that I can not trade with their method but I use breakouts to validate or confirm my moving average cross-over system.

Third, use other systems to give you the basics of what is necessary in a system to make money. All great systems have three basics:

  • Price – What price do you enter and exit the trade
  • Money Management -  How many shares do you place in a trade
  • Risk Control: You need to preserve capital until a favorable price trends appears

Study and learn from other systems and make sure that you incorporate all the above in your system.

Last, use other trading systems is to give you new ideas and concepts. Use other trading systems’ ideas and add them to other or new systems. Use other trading systems’ concepts and add them to your own method.

Be creative and combine systems and methods. Add an ADX indicator to a trending system. This might prevent whipsaws when the market goes flat. Perhaps you use a 3 day breakout as a close to an oscillator system to indicate that the stock is no longer trending.

No matter how you construct your system, remember that the key to success and profit is sound money management and risk control. It is not having the fanciest system or the latest indicator that will make you money. It is how you use cash management, risk control and trading discipline that will make the difference between success and failure.

Keep in mind that not all trades can be successful. A losing trade does not mean the system is a failure. In fact, several losing trades do not mean that you have a poor system. Read about expectancy. Although you want to be right on every trade, profits come from having a system with a positive expectancy. Loses are just the cost of doing business.
 

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