Building a Trading System: Where to Start

CryptoCred
Mar 19 · 14 min read

The aim of this article is to outline the author’s view on what a trading system is and to guide novice traders towards systematising their approach to trading.

I will note from the outset that this is a very broad topic. Trading systems exist on a spectrum; from the rigid and automated to the loose and discretionary. This outline is by no means prescriptive.

The idea is to help novice traders be more organised in how they approach their trading and to set the framework for developing a set of rules or principles to guide them in this endeavour.

Note that this is also aimed at discretionary traders.

This will likely be a multi-part series.

Most of the material I’ve found on Twitter regarding trading rules/systems has been generic “Don’t FOMO/trade the trend/buy low sell high” shit.

I think I can shed some more light than that on this topic.

Let’s have a crack, shall we?

Part 1: Trading Systems: What & Why

I suppose since I’m outlining how one might go about systematising their trading, it would be helpful not to assume the premise and instead to make a case for a rules-based approach to trading.

What is a trading system?

In essence, a trading system is a set of rules or principles that governs a trader’s overall approach to trading financial markets.

A trading system will therefore outline what types of trades a trader can take, the markets they may engage in, specific setups/structures that trades may be premised on, risk management, rules around times of day or trading sessions, trade management, and so on. This list is by no means exhaustive.

As mentioned earlier, there’s certainly a spectrum when it comes to how much discretion a trader allows in their approach. Some trading systems will simply give loose guidance regarding setups and risk, and leave the rest to discretion. Others will encompass much more than that. Where one lies on the spectrum largely comes down to preference and experience. This will be covered in some detail later on.

Why bother with a trading system?

A good trading system defines the conditions under which a trader is most likely to emerge profitable and outlines how to engage those conditions.

Good technical trading, in my style of trading at least, is about finding asymmetrical risk:reward opportunities at high probability technical structures that allow for clear risk definition.

A trading system, once complete, can outline what those structures look like, when and where they form, and how to trade around them (as well as when to avoid them).

The basic premise is this: trading is hard but falling prey to ad hoc shitty pseudo-gut-instinct punt trading is easy.

Without a trading system, how can a trader even know if what they are doing is working or has a chance of being profitable? It becomes very difficult to derive any meaningful data or make adjustments if a trader’s ‘plan’ is to take a punt at what looks good.

Put simply: a disorganised trader is unlikely to be a profitable trader. Think of creating a trading system as getting serious and organised about trading.

Part 2: Building a Foundation

I’ll preface this section by stating that keeping a meticulous record of your trading and your trading system is of paramount importance. This should be self-explanatory.

Contrary to what an unsettling amount of late 2018 crypto Twitter entrants might suggest, you need not reinvent the trading wheel in order to form the base for a good trading system.

I would actually suggest the very opposite — build on the hard work and sound foundations set by experienced and profitable traders whose approach resonates with you, and tailor their principles to your preferences.

Read my article on trading mentors for more on this topic.

There’s a sort of chicken-or-egg scenario at play when it comes to building a foundation.

You can take whatever you’re doing now, start keeping a record, and begin essentially codifying your approach into a set of rules that outline your existing approach (when you’re trading well).

This is the riskier option. It assumes that your approach is a good one, and more importantly, one with an edge/offering a positive expectancy. If it isn’t, which is likely or at the very least unknown if you don’t track your trading, then you risk codifying a shitty trading system. However, if you’ve been trading for a fair bit, have worked on and refined your approach, and have a profitable track record over a decent period of time then this approach is the logical one. It’s simply organising and outlining what’s already ‘proven’ to work.

You can build a template or skeleton trading system derived from what you’ve learnt from other traders and, by keeping a trading record, gradually make amendments and personalise it to your own needs and preferences.

This is usually what I recommend to novice traders who have no idea where to start, as well as to intermediate traders who have wasted a lot of time on junk that doesn’t work. The benefit is that you don’t have to (re)invent anything and, if you choose the right sources, you’re building on a sound foundation of trading principles. The risk, of course, is that you choose shitty mentors and base your rules around the garbage they teach. That’s a topic for another Medium article, but any decent critical thinking skills will usually lead you in the right direction. Look for credible individuals not trying to sell you sports cars whose method works in your own testing and resonate with your intellect.

Let’s summarise:

  1. A trading system outlines aspects of a trader’s approach to trading with varying scope and rigidity.
  2. Having a trading system is beneficial because a systematic and organised approach to trading is likely to lead to better outcomes.
  3. Trading systems can be based on one’s personal experience and existing approach to trading assuming it’s profitable (with the aim of systematising and organising said approach) or based on principles derived from the teachings of other traders (with the aim of refinement and personalisation over time).

Clear?

Let’s talk about what a trading system is substantively.

Part 3: The Meat of a Trading System

So what is a trading system?

In other words, what does one look like and what kind of trading parameters does it encompass?

Here’s my personal take.

Bear in mind this is aimed at beginners, and this list is by no means exhaustive. This is designed to give you a solid foundation and, more importantly, a general framework.

How rigid/loose you want to be, how to frame it, and so on is all down to personal preference. It’s your system, after all.

One thing I’ll note is that a lot of the excellent traders I talk to tend to start with quite strict rules and gradually give themselves more discretion as their experience grows. This is a sensible approach and one I followed myself.

What kind of trader am I/what is my style?

This doesn’t need to be some scientific description for a government census. Nor must you classify yourself using some rigid and mutually exclusive category like scalper/swing trader/position trader, et cetera.

The idea is to roughly describe what kind of trading appeals (or works) to you, the time frames and trade durations you’re comfortable with, and so on.

For example: I am primarily an intraday swing-ish directional trader. I trade using support/resistance. I enter at turning points with tightly-defined risk. I trade from one level to another. I trade setups that usually quickly tell me whether I am right or wrong. I don’t like to hold positions for more than a couple of days at the very most.

That’s what works for me! You might be completely different. You may be a trend trader who’s not terribly concerned with exact entry points and you might use an indicator suite to tell you when to enter/exit. You might not care about turning points and may just want to catch the meat of the move; happily holding a position for weeks/months doing so.

Here are some points you may want to consider when describing yourself and your style:

  1. Which time frames work best for you?
  2. Are you able to build and hold positions for extended periods of time?
  3. Can you handle being in an underwater trade for days/weeks in the expectation of catching a larger trend? Or do you prefer jumping in/out of the market more frequently based on specific intraday structures?
  4. How many trades can you take without going full wannabe scalper degenerate mode? Can you be disciplined with intraday trading or need you restrict yourself to higher time frames?

I’m sure you get the drift.

Three additional points:

First, you can only know what works for you if you give it a chance. You might think you’re a scalper if all you’ve ever done is stare at low time frame charts, but there’s a (good) chance that your strengths lie elsewhere.

Even this basic step of outlining your style is a useful part of your trading system. For example, if you know you’re a high time frame trend trader and the chart of a market you’re looking at shows nothing but weeks of chopping, you don’t need to go much further into your trading system to ascertain whether there’s a trade to be taken there.

Second, there can be more than one answer to these questions. Your trading style needn’t be 100% fixed (though it would probably help, at least at the beginning). For example, plenty of swing traders can also scalp effectively using the same techniques simply applied on lower time frames. Despite this crossover, as mentioned, it’s best to start with your strongest suit and expand your arsenal later on.

Third, one of the benefits of a clearly-articulated Entry & Exit section is that you also know when not to trade. A lot of money is lost trading shitty trading conditions that you have no business getting involved in from the beginning.

Risk

Risk is a massive topic. I recommend starting by watching my risk management video and reading the section on risk management in my study guide.

Risk is also one one of the most important topics. There’s little point in fretting about entry techniques, trade management, and so on if a single trade or several trades blow up your account.

It’s important to get this right.

Here are some factors that a Risk section of a trading system might consider:

  1. How much capital are you comfortable allocating to active trading? Would you be able to stomach, financially and psychologically, losing (nearly) all of it?
  2. What’s your baseline risk per trade (in nominal or % of trading balance terms)? What factors, if any, adjust this number up/down e.g. setup quality, winning streaks, losing streaks, et cetera?
  3. How do you respond to drawdown? How about consecutive losing trades? Do you adjust your risk per trade? The types of trades you take? Do nothing at all?
  4. Are you a higher win rate/lower R:R trader or lower win rate/higher R:R trader? (Not prescriptive categories, think of it more as a spectrum). Can your win rate handle the R:R of the setups you’re taking on average/vice versa?
  5. What’re your risk limits across different time spans? What’s your session risk limit? What’s your daily/weekly/monthly risk limit?

This should help you build a solid foundation.

One thing I’ll add is that if you’re just starting out, it’s worth erring on the conservative side of things.

0.5–1% risk per trade on high quality setups offering at least 2:1 Reward:Risk under reasonable conditions (i.e. entry/stop/target not arbitrarily chosen but based on logical technical structures) provide a decent starting point.

Entry & Exit

Trade entry is an equally important section — it dictates the conditions under which to put your (hopefully) hard-earned money at risk for a trade.

This is also one of the most personalisable sections. Some traders prefer really rigid and objective entry techniques whereas others just need a few factors to look right before stepping in. There’s no ‘right’ way per se, but as mentioned, most of the good traders I talk to started on the strict side and loosened up over time.

Here are some factors that an Entry section of a trading system might consider:

  1. What do you have to see in your analysis to take a trade/consider a setup? Examples: S/R level, cluster/consolidation, chart pattern, price closing above/below a certain Moving Average or other value, and so on. It’s worth being strict and selective with this element. Nowadays, if a setup or at least structure doesn’t jump out at me within a couple of minutes of scanning the price chart by eye, I pass on the trade. There’s absolutely nothing wrong with looking at a chart and coming to the conclusion that there’s no trade to be taken, as will often be the case! Quality setups are worth waiting for.
  2. What are the defining characteristics of the structures that you trade? Could you sketch out your ideal setup in Paint and identify it on a price chart? This is crucial! I recommend having both drawings and chart examples (really high quality ones at that) for your reference. You know you’re trading like an idiot if you take a setup that looks nothing like what you’ve got outlined in your sketchbook.
Quick sketch example of a Cluster setup.

3. What time frames will you use to identify (and further refine) the structures you trade? Is every setup tradable across all time frames? Does a structure need to be visible on a certain (high) time frame in order to be tradable?

4. What’s the entry trigger once/if price arrives at the structure you want to trade? Is it a limit order or market order? If the former, which specific part of the structure do you use to place your order? Do you scale your entries or go for one specific price level? If the latter, what does price need to do at the structure in order to warrant a market entry e.g. H1 close through the resistance boundary to buy/H4 wick and close below resistance boundary to sell, et cetera.

5. How do you ascertain where to exit the trade? Is the exit ‘built-in’ to your entry structure e.g. from one side of the range to the other, or is it discretionary? Which structures do you typically target for exits e.g. nearest S/R, liquidity in the form of deep swing points in the market, specific price levels, certain retracement/extension levels, et cetera. Is your exit fixed based on a specific structure/price level or is it adjustable based on indicators/certain price formations, and so forth?

I could extend this section ad infinitum. There are dozens of nuances that a good trading system can account for. It’s best that you don’t overwhelm yourself at this stage — the basics are covered.

In essence, in terms of building a foundation, your Entry section should tell you what to trade, what it looks like, and how to open a position, and where to get out.

The vitally important (I know the ‘important’ is somewhat redundant since I’ve used the adverb ‘vitally’ but I’m really trying to drive this home) thing is that these parameters are predetermined based on criteria clearly laid out within your system.

Trade Management

Contrary to what the Twitter box-drawing legends might (inadvertently) insinuate, trade management is where a lot of excellent trade entries go to die.

In other words, one of the hardest parts of trading is managing the position once it’s open and before it has hit either your stop loss or take profit. Overtrading, getting out early right before price goes to target without you, lazily moving your stop to break-even only to be taken out before price moves to target, giving back countless R to the market, and so on are all hallmarks of shitty trade management that’ll cost your account.

Here are some factors that a Trade Management section of a trading system might consider:

  1. Do you manage trades at all or do you leave your setup to play out according to predetermined parameters? Do certain setups require more active management e.g. big swing trade positions compared to others e.g. level-to-level from entry to trouble area?
  2. What time frame do you use to manage trades? How does it correspond to the time frame of the setup you’re trading? For example, would you manage a Weekly setup on the H1 (I hope not)? I generally recommend managing positions on the time frame of the setup itself e.g. H1 setup managed on an H1 basis/D1 setups managed on a D1 basis, et cetera.
  3. Under what conditions, if any, do you move your stop? Can you move your stop to increase your risk as well as to reduce it? What does the market need to do/how must price behave in relation to your entry to justify moving your stop to break even or in profit? Examples: impulse candle in the direction of your trade, up a certain amount of R, ‘paying’ for the trade, et cetera.
  4. Under what conditions, if any, do you move your take profit for the trade? What does the market need to do/how must price behave for you to cut the trade early or to let it run further than originally planned?
  5. Are you allowed to either pyramid or average down entries? What needs to happen to warrant such an action?
  6. Does a HTF bias affect how you manage a position on an intraday basis? If so, a) how is your HTF bias formed; b) under what conditions is it invalidated; c) how does it affect your management?

This is another one of those sections where I could go on for ages.

The important thing is that you’re meticulous in how you record your trades; the best hints about management will be derived from your trading journal.

If you constantly meddle with otherwise good trades that, if left to play out, would succeed then you need a less active management strategy. If, on the other hand, you constantly let winning trades turn into losers/break even trades, that would warrant a more interventionist management strategy (or more realistic targets, a better profit-taking strategy, and so on).

Appendix A: Journaling & Tracking Nuances

One thing that should be very clear is that a good trading system cannot come to exist without good journaling habits.

By journaling I simply mean keeping a record of your trades.

If you want something on the heavy side but that’ll yield excellent data, I recommend Edgewonk.

If you’re just starting out and want something lighter and more manageable to build a habit of record-keeping, just use this quick template:

Trade Journal Template for Beginners 📓

Time & Date
Screenshot of Setup
Direction
Risk %
Size (Risk Amount)
Setup Name/Reason for Entry
Risk:Reward
Entry Price
Stop Loss Price
Take Profit Price:
Did I Trade my Plan: (Yes/No)
Trade Management Notes: (e.g. moving stop, cutting some before target)
Results: (Equity % and R)
Emotions when taking the trade:
Feedback/notes to self:

What you’ll notice over time are subtle nuances in your trading.

You might perform better on certain days of the week compared to others. You might excel in certain sessions compared to others. You may discover seasonal tendencies i.e. longer time spans where you trade well/trade poorly. You may discover that certain setups form more frequently and play out more often in certain instruments/session times/days of the week than others. You may discover that certain setups have a much higher expectancy and can justify a higher risk per trade compared to others. You may discover specific events/news risk under which you either flourish or should stay far away from the markets.

The possibilities are endless and can, cumulatively, make a big difference to your equity curve.

Your only hope of discovering them is by meticulous record-keeping and careful study of those records.

I’ll cover this in far more depth in the next article.

Conclusion

Well done if you made it this far!

As mentioned, this is a huge topic with great scope for personal preference.

What’s universal is that being at least somewhat organised in your trading will make you a better trader.

I’ve only scratched the surface but I am confident that this is more than enough to get started.

Systematising your trading and being organised will make a very significant and positive difference to how you trade, at least it did for me!

Happy trading.

Cred

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