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Have you completed lesson 2’s action steps?
If not, complete those steps before reading on.
Designing a Winning Trading System
This is perhaps the key section of this e-book: It
is your trading methodology that will ultimately determine whether
you win or lose in the markets. While, it is vital that you
have the discipline to stick to your plan, it is equally
vital that you have one to stick to in the first place.
Sadly, I cannot develop your methodology for you. I can make suggestions
and put forth examples, but you ultimately must devise a system
that is your own. This is because you must be able to follow it.
In order to follow it, your system has to reflect who you are.
Every successful trader has a winning system and there are as many
successful systems as there are traders.
Some systems get you to buy on strength and sell on weakness; others
do the opposite. Some investors succeed as value investors, suck
as Warren Buffet; others make their millions in momentum trading.
I have even heard of an astrologist who is said to trade profitably
using the stars. Although there are a variety of methods, the point
I am trying to illustrate here is this: there are many ways to profit
from the markets.
Despite their differences, there is one common element amongst all
successful traders: they have a systematic way they approach the
market. This approach is unique. In reality, no two people have
exactly the same amount of money, tolerance for risk, personality,
time or experience. Therefore, the key to success is to design a
system that is suited for you.
Many traders fail because they do not assess how well a trading
system matches their personality. Instead, they chase fads, searching
for the "Holy Grail" of trading success; worse yet, they waste their
money on the latest investing software or buying up the tapes of
the latest self-proclaimed stock market guru.
The fact is there is no perfect system. Successful investors
succeed because they choose a system that they feel comfortable
with, not one that claims to be the cutting edge. A cool, disciplined
trader will make money with an “average” system, while a nervous,
arbitrary trader will wreck a “brilliant” system.
The key is to develop a methodology that maximizes your strengths
and minimizes your weaknesses. But how do you do that? Firstly,
you must define your objectives.
Ask yourself these questions:
- Am I designing a trading system for cash flow or capital
growth?
- Do I want to trade part time or full time?
- How much money can I work with?
- What annual rate of return do I want?
(Note: the higher the return, the higher the risk, in most cases).
Take a minute to think about and answer these questions:
Decisions such as these will have the largest impact on the
style of your trading system.
For example, if your goal is cash flow and low risk, buying or selling at
extreme levels (overbought/oversold) isn’t suited to you. If your goals center
on quick capital growth, high returns and high risk, then bottom picking strategies
and gap trading may be your style.
Styles range from aggressive day traders looking to scalp a
few point gains to investors who are looking to capitalize on
long-term macro economic trends. In between, there are a whole
host of possible combinations, including swing traders, position
traders, aggressive growth investors, value investors and contrarians.
Moreover, your style will depend on your level of commitment. Day traders
are likely to pursue an aggressive style with high activity levels. The goals
would be focused on quick trades, small profits and very tight stop-loss levels.
Intraday charts would be used to provide timely entry and exit points. A high
level of commitment, as well as focus and energy would be required.
Unlike day traders, position traders are likely to use daily
end-of-day charts and pursue 1-8 week price movements. The goal
in this case is to be focused on short to intermediate price
movements and the level of commitment, while still substantial,
would be less than a day trader.
With this in mind, be sure to define your trading objectives
as best as you can since your system must match your own criteria
or you will never make big profits. You need to complete this
simple sentence: "I am trading in the market because I want
to......" complete this and you are well on your way to setting
your portfolio objectives (see lesson 1).
What Should You Trade?
With a few portfolio objectives defined, your next step is to
decide what market you are going to trade in order to reach
your portfolio objectives.
To select the most appropriate market, I suggest you pick a
market you are familiar with or one in which you would ultimately
like to trade. There is no right or wrong answer. Unfortunately,
there is no “best” performing market…
The important decision is to select one market. Avoid the tendency
to want to trade everything and realize that there are enough
potential profits by trading just one market. Many traders fall
into the trap of thinking the more they trade, the more money
they will make. Unfortunately, this could not be further from
the truth.
Real money is made by mastering your chosen market and understanding
it is not the selection of the market that makes the money.
I personally am less concerned about the markets I trade, and
the securities I choose within those markets, than I am with
the plan I am entering those specific markets with (but more
on this later).
You can successfully trade any of the markets I have outlined
below… just be sure to choose only one:
1. STOCKS
Plain and simple, stocks are a share in the ownership of a company.
Stocks trade on a stock exchange, which is basically a venue to
buy or sell a stock. In this arena, big players such as Warren Buffet
and Merrill Lynch dominate the market. That said, don’t be scared
off because, if you’re new to trading, this is probably the best
place to start.
2. OPTIONS
Options are a leveraged instrument that derives its price from an
underlying security (stocks for example). They give the buyer of
the options contract the right, but not the obligation, to buy or
sell an underlying asset at a specific price on or before a certain
date.
So, unlike a stock, which represents equity in a company and can
be held for a long time, if not indefinitely, options contracts
have finite lives.
Basically options are the next step up from stocks in their complexity.
They introduce the opportunity to leverage your money and increase
profits.
3. COMMODITIES
Without going into too much detail, commodities trading involves
the trade of raw materials. Such as grains, livestock, precious
metals, energy, etc.
Commodities trading can be a great stepping stone for trading more
advanced markets.
4. FUTURES
In a similar vein to options, futures contracts also have finite
lives. They are primarily used for hedging commodity price fluctuation
risks; or for taking advantage of price movements, rather than for
buying or selling the actual cash commodity.
The buyer of the futures contract agrees on a fixed purchase price
to buy the underlying commodity (wheat, gold or T-bills, etc.) from
the seller at the expiration of the contract. This differs from
options, where the buyer has the right to purchase the underlying
commodity, but is not obligated to do so.
As time passes, the contract's price changes relative to the fixed
price at which the trade was initiated. This creates profits or
losses for the trader.
Futures trading is one of the more complex forms of trading, but
along with the increase in the skill level required, there are greater
rewards (in terms of return on investment (ROI).
5. FOREX
Forex - short for foreign exchange - is trading where the commodity
is currency. What makes the Forex market unique is that, unlike
other financial markets, the forex market has no physical location
or central exchange. Additionally, this market trades 24 hours and
its daily volume exceeds $1.4 trillion, making it the largest and
most liquid market in the world.
While this sounds exciting, it’s not for the faint hearted. Forex
trading can be fast and furious. If you’re just starting out, unless
you have your heart set on trading the Forex, I recommend that you
prove that your trading plan can trade profitability in other non
leveraged markets (e.g. stocks) before entering into this market.
Side Note: Remember, with trading any leveraged product,
you are faced with a double edged sword. On one hand, the leverage
will increase your winning trades, however on the other hand, it
will increase your losing trades too. The secret to successful trading
is to first learn to trade unleveraged markets profitably and then
take this system and increase the leverage gradually. In this way
you will clearly understand the risks involved and also position
yourself for the best possible chance at success.
After reviewing the markets outlined above, write down - in the
space below - which market you would like to trade in:
Alternately, if at this point you are new to the trading game and
have absolutely no idea what you would like to trade, I recommend
you purchase Bill Polous’ course “Instant
Profits”. What makes this course so invaluable to the beginner,
and even the advanced trader, is that you will learn the key principles
to trade multiple markets. With this knowledge you can then choose
the market that makes most sense to you.
Let’s get your psychology right. |
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