8 Steps To Building A Successful Trading System

Craig Celeste
Craig Celeste

August 23, 2024
8 min read
351 views

Individuals must keep their personality, lifestyle, and risk appetite at the forefront of their minds when building their trading system.

When building your unique trading system, you must consider eight components.

  • The Market will you trade
  • Your Time Frame
  • Edges
  • Setups
  • Entry Tactics
  • Rules and Risk Management
  • Journaling
  • Post Trade Analysis

Your trading system should be reflective of you. When developing your strategies, make sure it is built around your core beliefs.

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In this blog, we will break down the components of a successful trading system for consistent returns in the markets.

The Market

Each market requires a different set of knowledge, skill, experience, and know-how.

  • Equities – Shares of publicly traded companies
  • Bonds – Debt instruments issued by Governments
  • Forex – Currencies, the largest and most liquid market
  • Commodities – Raw materials like gold, oil, and agricultural products
  • Cryptocurrencies – Digital or virtual currencies like Bitcoin and Ethereum

You should be passionate about trading the markets. Make sure your trading system revolves around something you want to analyze day in and day out.

Time Frame

A Time Frame specifies the length of time a stock is held within your trading strategy. It’s determined by the entry and exit points, which are often set based on price movements within a predetermined window.

Your trading system should be within a timeframe that aligns with your personality and lifestyle.

Day Traders use a lower time frame to buy and sell in their respective market. This usually corresponds with an intraday chart (1 minute, 5 minute, 15 minute, etc) all the way up to a daily chart.

The appeal of Day Trading is that by executing all of your trades during the session, you remove any overnight risk. You may miss out on bigger moves, but it may be easier to sleep at night knowing you have no money at risk.

Swing Traders use a variety of timeframes but will primarily focus on the daily charts. Intraday charts are used for precisely entering stocks, while weekly charts are used to determine the longer-term trend.

A drawback of Swing Trading is that you must accept the overnight risk, but you will be playing for a bigger move over the span of a couple of days to a couple of weeks. You may not hold a leading stock for over a year, but you will maximize compounding your account by entering on uptrends and then exiting before a new base is formed.

Position Traders also use the daily and weekly timeframes but add in the monthly as well, and are more focused on the longer-term trend. These traders are looking to hold onto their positions for multiple weeks to months.

The benefit of Position Trading is holding onto a leading stock for many months to over a year to maximize the stock’s price movement. The obvious drawback is having to hold onto the stock during multiple basing formations.

When identifying your style in the markets, it is normal to try out different time frames to see what works best for your personality. The only thing that matters to your trading system is extracting an income over a large sample size, how you do it is up to you.

Edges

Mark Douglas states “An edge is nothing more than an indication of a higher probability of one thing happening over another.”

Edges come from studies of repetitive patterns seen in the biggest winners from the market and the timeframe that you are trading. You have to understand the common themes that each winner displayed before they run up in price.

An example of an Edge in the equity markets is the CANSLIM system created by William O’Neil. William O’Neil was able to create and build CANSLIM by looking at the Fundamentals and Technicals of the strongest winning stocks of his time.

Studying The Past leading stocks and market cycles will help you build your trading system to catch these moves.

A more notable Edge within the Traderlion community is the High Volume Edge. When a stock exhibits the highest volume in over a year, ever, or since its IPO, the stock is under accumulation and a strong uptrend is beginning.

Setups

In relation to your Edges, Setups are essentially your criteria for entering a trade. They outline what you will seek both fundamentally and from a technical perspective on a stock chart.

Remember, the trading system you are developing is for you – What are you looking for?

  • Value stocks with institutional interest
  • Positive earnings and sales growth
  • High-beta penny stocks with unusual volume
  • Technical chart patterns like a Cup and Handle

Edges, Setups, and Entry Tactics all work together. The goal of developing your trading system is consistency.

Entry Tactics

Entry Tactics are related to your edges and setups. Wherever you discover a higher probability trading edge, you must look for areas to get you into the trade.

There can be a multitude of entry tactics, but they must fit within your trading system, style of trading, and personality. Look for repeatable patterns that you can act upon when conducting Post-Trade Analysis as we will discuss later.

Look for low-risk areas to enter a trade with

  • Certain candlestick patterns
  • Positive price action into a support area after a pullback
  • Breakout into new highs with increased volume
  • Gaps with the highest volume ever
  • Market sentiment shifts

When defining your Entry Tactics you should be trying to execute at low-risk areas that provide large opportunities.

Rules and Risk Management

Rules act as guidelines to make sure your behaviors in the market are contained and repeatable. Trading is an emotional game. Rules help prevent you from damaging yourself when things may feel out of control.

When creating your trading system’s rule set, you want to make sure it is not too restrictive. We want to be able to operate in a flow state and having too many rules may prevent this from happening.

Some examples may include:

  • After three losses in a row, take a multi-day break
  • During a Market Downtrend below the 21ema, don’t add new positions
  • If you don’t see a gain by week’s end, close the position
  • Have a maximum stop per trade based on how the trade will affect your portfolio

Proper Position Sizing will ensure our exposure is large enough to make significant progress in our overall account but also small enough to keep losses in control when we are stopped out.

Traders are wrong more than they are right, so position sizing correctly is key.

There are many ways to determine your position sizing, but a simple one to make sure you don’t lose all of your account in one trade is to risk 0.5-1% of your equity per trade as a MAX stop loss. You would have to lose 10-20 trades in a row to lose 10% of your account.

A 10% drawdown sounds scary, but it is important to note that we still live to fight another day with this method. One of the major keys to super-performance is to never let your account value fall too far from all-time highs

Insist your Reward-To-Risk Ratio is always so your gains are at least 2-3x your losses. If you are risking $100 on a loser, you want to be making $200-300 on your winners. Following these parameters means you can be right only 1/3 of the time and still not lose money.

It is also important to learn when to both ramp up or scale back your exposure in response to the current market environment. This skill comes with experience but progressive exposure is an important part of super performance.

Journaling

When trading any market, it is essential for you to understand how your emotions impact your overall trading. To accurately track this and learn from your emotions, you need to write down what is going on in your mind during the trading session.

Some easy things to keep track of are:

  • Premarket feelings about the market health and your own personal thought processes
  • Trade Executions and reasoning behind each action you take based on your trading system
  • Emotional swings during the day
  • Postmarket grading of your daily performance

By continuing to build a database of these points, you will be able to connect your current state in the market to past states. This will allow you to perform better over time as your brain builds pathways, leading to better execution and decision-making.

Post-trade analysis

Post-Trade Analysis (PTA) helps you see what is working vs. what is not working – It acts as a report card. This is when we need to be the most honest with ourselves in our trading.

Think about how athletes study their best and worst games. This allows them to identify tweaks and improvements that need to be made.

It may be painful to go through past losses but sometimes looking back on your past trades is the only way to catch flaws in your decision making.

Practicing PTA:

  • Track your win rate while reflecting on your different tactics to find your strengths and weaknesses
  • Understand your average gain and loss over multiple market cycles
  • Mathematically prove your batting average (win-to-loss ratio) works in your favor
  • Copy charts with your entries, exits, and reasoning for the trade
  • List out environmental factors including the current market cycle and other psychological trends involved in your personal life

The outcome of PTA should be to improve your trading system. Begin looking for patterns, areas of strengths and weaknesses, and then adapt your strategies to become better.

Your Trading System

Building a personalized trading system is essential for long-term success in the markets. By understanding your individual personality and risk tolerances, you can create a strategy that aligns to. your unique needs.

  • Choose a Market that aligns with your interests and expertise
  • Select a Time Frame that suits your lifestyle and risk tolerance
  • Discover repeatable patterns and advantages (Edges) within your chosen market
  • Establish clear Setups to screen for trade candidates
  • Determine specific Entry Tactics for initiating trades
  • Create Rules to control emotions and Risk Management guidelines to protect capital
  • Journal your thoughts, emotions, and trading decisions
  • Evaluate your performance and identify areas for improvement through Post-Trade-Analysis

Remember, your trading system should be a reflection of you. It should be built around your core beliefs and defined to specific circumstances.

By carefully considering these components and continuously refining your trading system, you can increase your chances of achieving consistent returns in the markets.

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