 Trading
Systems and Trading
Strategies
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Definitions:
Trading Strategy:
A trading strategy is a plan to achieve a long term aim or goal. The
Plan may incorporate a mix of processes to achieve short term
objectives on the way to the aim or goal.
Trading Systems:
A trading system is a mechanistic set of rules that guide a trader in
his trading decisions in a logical and unemotional way.
Before you adopt any particular Trading System or Trading Strategy you
should:
- determine what you goals are
- evaluate what your personal risk
profile is
- decide whether you are:
- an Investor,
- a Trader,
- a Day Trader.
In the coin tossing game of heads and tails you will be wrong 50% of
the time and right 50% of the time in the long term. The trading game
is
to learn how to improve your decision making and risk taking strategies
to weight the odds in your favour. It is NOT
possible to be right 100% of the time. You WILL
make losses in the process.
To increase your wealth you need to learn how to manage RISK
consistently and be correct in your decision making better than 50% of
the time.
Very skilful Traders can even succeed at making a profit with less than
50% correct decisions by CUTTING LOSSES EARLY and LETTING
PROFITS RUN.
This is a skill that comes from experience and learning to read the
patterns in the information presented to them.
If your mental attitude cannot handle being wrong, and the monetary
losses that will accrue from incorrect decisions, then you would be
best advised to choose the longer time frame. Losses can be offset in
the longer term because of growth in the value of the investment. You
can still make some losses as all investments can be subject to
extraordinary events that can cause a total loss of that investment.
The probability of this occurring is lower in a diversified portfolio.
Remember the old proverb:
"Never put all your eggs in one basket."
Your peronal attitude, and where you are on the learning curve when you
start share trading, will influence your decisions.
Achieving success builds your confidence and is a major factor whether
you continue with this form of wealth creation. A string of failures
may well deter
you.
But persistence, determination, and the
ability to stand back and look at what you are doing (usually when you
are making mistakes) are the most fundamental characteristics you will
need to master the skills of surfing the stockmarket waves.
Everyone wants to improve their financial position, and
some will wish to do this aggressively, and take risks (high
ones) to achieve their objectives quickly. In the
process they may well "crash and burn", perhaps more than once, before
they develop their skills.
Others will be content to start slowly and
cautiously (taking little risk) until they have developed confidence in
their skills before investing larger sums of money. This is
my personal approach because, as a retiree, protecting my assets is
more important to me than making a million in as short as time as
possible.
Whichever approach you decide to take is
quite OK if it suits YOU.
There are many different trading systems and
strategies available and you can select whichever one you like
most. So what are you?
Evaluate your profile by looking at the criteria below and
decide for yourself what appproach best suits you at this stage of your
learning.
» Investor?
» A Medium
Term Investor/Trader?
» Day Trader?
» Leveraged
Trading?
» Options Trading?
» CFD's?
» Forex?
» Trading
Systems?
Share Trading and Investment
An
Investor
Briefly an Investor buys shares and holds them for the long term,
accepting the rise and fall in share
prices over time, collecting the dividends that are paid, perhaps
reinvesting the dividends, and seeking the long term growth in price
over time. This is simply "Time in the Market", which is a
strategy advocated by some fund managers. You may still want to take
action if there is news of events which are going to affect your
particular shares and sell them. Often the decision to buy is based on
Fundamental Analysis.
Risk Profile: Investors usually do not like losing money and
avoid selling, even at a loss, preferring to hold until the price
recovers. Stop Losses may or may not be used depending on the
individual investor. When assessing a long term situation and they can
see opportunities of greater profit in other investments they may
choose to take the loss and reivest elsewhere. Often they are put "in
the bottom drawer" and forgotten about.
A
Medium Term Investor/Trader
This type of Investor/Trader can take a more active role in buying and
selling stocks/shares. The period for which they are held may vary from
weeks to months, perhaps years in a long growth trend. Decisions to
enter or exit a trade may be made based on both Fundamental and
Technical Analysis. The objective is to pick up the shorter
term capital gains but to exit from stocks that are going sideways to
make more effective use of the available capital. It is
usually done on an End of Day, or End of Week charting basis using
Technical Analysis to determine entry and exit points.
Risk Profile: Cutting losses and letting profits run is more the style
of this type of investor/trader. They are less emotionally attached to
money and are more concerned with keeping their capital earning at the
best rate of return. Returns of 5% to 15% are not of high interest to
them. They are looking to achieve returns of 30% plus, on
their capital and are prepared to take calculated risks to achieve it.
The courses I have done and recommend that
relate to this form of
trading are those offered by David Schirmer. His Home Study course
provides the basic introduction to charting techniques and risk
management, and provides a back tested system for beginners to follow.
The Professional Trader's Worshop is a more advanced course that
intoduces leveraged trading using CFD's and additional trading methods
for the advanced trader.
There are many other courses provided by other educators that I have
not done, although I have attended a number of introductory meetings to
promote the courses.
These include Gryphon Learning, Home Trader, Safety in the Market, and
Stock Course. My purpose was to learn what was being offered and assess
whether the additional investment would be worthwhile. Each offer their
own particular system or strategy to trade, often linked to a
proprietary software package. Prices vary with each course and
marketing specials are usually made on the day.
Learning to use the tools is one part of the investment/trading
process, but a good software package is essential. I have purchased two
software packages becuase the second one provided access to fundamental
information not available in the first package. It does provide a more
diverse range of graphics facilities and analytical tools. These are
Market Analyst and IC - Investor. See the Software page for more
information.
My present focus is to supplement my learning with specific skills and
knowledge and improve my trading performance. This includes Risk
Management and the Psychology of Trading. It is far more important than
most people realise.
A Day
Trader
Day Trading is probably the most challenging form of trading because
you are seeking to make profits from small movements in the stock price
and use technical analysis to determine the probability of the
direction and magnitude of the movement.Those that master this form of
trading usually trade derivatives, such as E-minis and the SPI to
give them the leverage needed to make it profitable. Stop losses are
essential with this trading methodology as part of your risk management
strategies to protect your capital.
The successful Day Traders can make significant profits very quickly,
and this is why Trading can be the way to your FINANCIAL
FREEDOM.
Risk Profile: They are seeking the large returns on Capital and are
prepared to take higher risks to achieve this. They are more
likely to "crash and burn" in the early stages of their learning until
they master their risk management strategies. Many Day Traders lose
their capital within six months, if statistics are correct, and either
leave trading or learn from their mistakes. I am currently
testing my
skills in this form of trading with a small portion of my capital.
It is highly volatile in results, but it is a challenge to master. This
is
my goal.
Leveraged
Trading
To make money quickly on the Sharemarket/Stockmarket it is
essential to learn how to trade leveraged products, and the two
available to me in Australia were Options and CFD’s. They
have different characteristics which give them particular advantages
and disadvantages, but both enable the trader to take a leveraged
position in buying and selling shares.
The benefits of a leveraged position is that you can make much larger
profits with the funds you have available to invest, but you do need to
thoroughly understand the risks and manage them correctly, or the
benefits can turn negative and magnify your
losses, if the proper risk management steps are not taken.
The oldest form is Options Trading and this allows
you to buy or sell contracts that give the purchaser the OPTION to buy
or sell a parcel of shares at a stated price. The largest Option Market
is the US market and it is more highly developed than other markets and
you can trade smaller parcels of shares in contracts than you can on
the Australian
Market.
CFD's, or more correctly Contracts for Difference, are a product that
has been available in the Australian
market for the last few years, after being conceived and used
in the UK previously. They are not currently available on the US market
for legal reasons. They also enable the trader to
gain leverage on a larger parcel of shares through margin lending which
enables larger profits to be made.
Interest charges are made on the margin borrowings.
Options
Trading
For quality education in Options
Trading on
the US market I recommend Options University Courses and programs.
Options are the lowest cost derivative
product available for leveraged
trades. This is their prime advantage. Their disadvantage is that they
are subject to "Time Decay" and "Volatility" which makes them more
complex to understand.
Basic Options Theory is available to people on the ASX, and I worked my
way through their course. However, I did not feel I understood the
intricacies of the processes, and began to search the Internet for
other sources of information.
Understanding options requires understanding all the characteristics of
the product, including time decay and volatility. This information is
represented in what is called “The Greeks, Delta, Gamma,
Theta, and Vega”, and when I first encountered it, it was all
Greek to me. My understanding is now much improved but it is not
automatic as yet.
What I like about options is the ability to limit risk with the correct
strategy.
Most beginners lose when trading options, because they fail to
understand the
difference in risk by buying the cheaper option. When the cheaper
option expires they have lost their money for no gain, because they
were too far from the “Strike Price”.
The best options market available is the US market, and recent
announcements about Options being introduced on the NASDAQ indicate
that it is going to become bigger. Anyone who is
interested in trading Options on the US market needs to understand them
thoroughly, and not simply learn set strategies, which is what is
offered in most options courses.
In the research that I have done on the
Internet in the last two years the training provided by Ron
Ianieri at the Options University has impressed me the most.
I bought the first basic course offered by
them and found it very good. Since then I have been privileged to tune
into Webinars and other material they have provided. I have now
completed the Mastery Series II course and I have found them
most professional in their approach and passionate about the quality of
education they provide for those interested in learning options. Ron's
objective with this program is to provide option education to a
professional level so that you can assess the opportunities available
in the market and use the right strategy for the particular situation,
rather than apply a strategy that is not appropriate. I like his
approach because it focusses on educating the prospective trader to
understand the situation, and then select the most appropriate strategy.
Besides teaching Options they have provided excellent supporting
information on Technical Analysis and trading platforms. In March 2007
Options University put on a free webinar to demonstrate the ThinkorSwim
trading platform. I managed to book into this platform demo and was
very impressed with it. Think or
Swim were ranked No. 1 by Barrons.
The more I see of this group of professionals the more impressed I am
with their passion for their subject and commitment to providing good
education on Options Trading. For those who want to know more about
Options University follow these links: Options University and
Who is Options University
For more information on Options
University and the courses they offer go to their Home page.
Options University - HOME PAGE
Australian Traders may be interested in Australian Educators in Options
Trading. There are two I have encountered that offer educational
courses in
Options Trading and they are:
Daniel Kertcher, who runs Platinum Pursuits,
Paul Wise, who runs Options 21.
Both provide reputable training in Options Trading.
CFD Trading
CFD’s have the advantage of no time decay, which is what
makes them simpler to grasp. They have the disadvantage in that you pay
interest at a daily rate on your margin borrowing, and can be subject
to margin calls if your trade goes the wrong way. If you are going
Long, then they are suitable for short term trades; but holding a long
trade over the long term can be less profitable or even not profitable,
if the stock is going sideways, because of the interest charges. You
need to monitor your positions and exit the trade if necessary.
You can lose more than your initial trade if you do not manage your
risk correctly.
You should ensure you have protected your trade with a stop loss, but
there is the potential for a major loss if the price gaps down, or up,
on the following day and does not trigger your stop loss.
Some CFD providers offer a guaranteed stop loss, but this requires a
special premium to protect you from these moves.
There is a lot more that will be added on this strategy later. Used the
right way CFD's can be a very profitable trading strategy.
Foreign
Exchange Trading
The Forex - Foreign Exchange market runs 24/7 six days week. It turns
over trillions of dollars a day and the liquidity of this market is
suited to trading systems. It is now an option for smaller traders
since the development of software and other tools available on the
internet. The charting techniques used for share and option trading are
applicable to trade Forex. This is another
market you can consider.
Trading
Systems
A trading system is a set of rules that guide a trader in
his trading decisions.
It is usually written down in a procedural form with a checklist.
Individual traders have to develop the discipline to
ensure that they stick with the system. This is easier said than done,
as it is too easy to slip into the pattern of making adjustments to the
system. As soon as you do this it is no longer a backtested
mechanical system with emotion removed.
The best explanation of Trading systems I have found is on
Investopedia and rather than reinvent the wheel the link is Investopedia
- Trading Systems
This defines them and tells you how do design, construct and test them.
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