Defining your trading strategy
All markets go through the same set of cycles. Like we discussed earlier, knowing that ever-persistent market cycles is step one. The next thing to do is defining the key parts of a strategy that will help you enter and exit while making sure that you manage your risk correctly.
Building your strategy
While making a strategy, we aim to define
- Asset and time frame: identify if an asset is in the appropriate phase of a market cycle
- Entry point: conditions that need to be met to trigger a buy
- Exit point: conditions that need to be met to trigger a sell
- Take profit /Expected reward: the amount of profit you are looking to take on the trade
- Stop loss /Loss prevention: the point where you decide to bear the loss and move to your next opportunity
Traders use different kinds of indicators to define these points. Different indicators help identify separate kinds of market scenarios. There is no one size fits all here.
Eg: A moving average is best used to identify trends and fails during consolidations; oscillating indicators are used while an asset is moving in a range and not during trends; momentum indicators can be used during trends and reversals but fail during consolidations and pullbacks.
Using a combination of indicators you can create an optimum strategy that suits your risk appetite, the asset you are interested in and the timeframe you are looking at.
Testing your strategy
One of the biggest reason for early failures is the lack of testing your strategy in different conditions. Testing helps you cover for any lack in understanding of markets or hypothesis.
Before you put your strategy out there in the wild, you should
- get quality data over a large enough period of time
- run backtests across various time ranges to check for fidelity of results
- tweak stop losses to minimize failure
- paper trade your strategy i.e. run a live simulation and monitor returns without putting in money
You should invest in the strategy only once you are satisfied with the results should.
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Originally published at blog.mudrex.com on November 5, 2018.