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#Post#: 5--------------------------------------------------
How to Develop a Profitable Day trading System
By: Giuelith Date: October 11, 2018, 11:34 am
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In this article I will explain to you how to develop a
profitable <a
href="
HTML http://www.rockwelltrading.com/daytradingcoach/01_dtc_moreinfo.html#STRATEGIES"><b>day<br
/>trading system</b></a> in five steps:
Step 1: Select a market and a timeframe
Step 2: Define entry rules
Step 3: Define exit rules
Step 4: Evaluate your day trading system
Step 5: Improving the day trading system
Let’s take a closer look at these steps.
Step 1: Select a market and a timeframe
Every market and every timeframe can be traded with a day
trading system. But if you want to look at 50 different futures
markets and 6 major timeframes (e.g. 5min, 10min, 15min, 30min,
60min and daily), then you need to evaluate 300 possible
options. Here are some hints on how to limit your choices:
·
you stick to the electronic markets (e.g. e-mini S&P and other
indices, Treasury Bonds and Notes, Currencies, etc). Usually
these markets are very liquid, and you won’t have a problem
entering and exiting a trade. Another advantage of electronic
markets is lower commissions: Expect to pay at least half the
commissions you pay on non-electronic markets. Sometimes the
difference can be as high as 75%.
·
average profit per trade is usually comparably low. On the other
hand you get more trading opportunities. When trading on a
larger timeframe your profits per trade will be bigger, but you
will have less trading opportunities. It’s up to you to decide
which timeframe suits you best.
·
risk, too. When you are starting with a small trading account,
then you might want to select a small timeframe to make sure
that you are not overtrading your account.
Most profitable <a
href="
HTML http://www.rockwelltrading.com/daytradingcoach/01_dtc_moreinfo.html#STRATEGIES"><b>day<br
/>trading systems</b></a> use larger timeframes like daily and
weekly. These systems work, too, but, be prepared for less
trading action and bigger drawdowns.
Step 2: Define entry rules
Let’s simplify the myths of “entry rules”:
Basically there are 2 different kinds of entry setups:
·
When prices are moving up, you buy, and when prices are going
down, you sell.
·
When prices are trading at an extreme (e.g. upper band of a
channel), you sell, and you try to catch the small move while
prices are moving back into “normalcy”. The same applies for
selling.
In my opinion swing trading is actually one of the best trading
strategies for the beginning trader to get his or her feet wet.
By contrast, trend trading offers greater profit potential if a
trader is able to catch a major market trend of weeks or months,
but few are the traders with sufficient discipline to hold a
position for that period of time without getting distracted.
Most indicators that you will find in your charting software
belong to one of these two categories: You have either
indicators for identifying trends (e.g. Moving Averages) or
indicators that define overbought or oversold situations and
therefore offer you a trade setup for a short term swing trade.
So don’t become confused by all the possibilities of entering a
trade. Just make sure that you understand why you are using a
certain indicator or what the indicator is measuring. An example
of a simple swing daytrading strategy can be found in the next
chapter.
Step 3: Define exit rules
Let’s keep it simple here, too: There are two different exit
rules you want to apply:
·
·
Both exit rules can be expressed in four ways:
·
·
·
movement) or
·
We don’t recommend using a fixed dollar amount, because markets
are too different. For example, natural gas changes an average
of a few thousand dollars per day per contract; however,
Eurodollars change an average of a few hundred dollars a day per
contract. You need to balance and normalize this difference when
developing a day trading system and testing it on different
markets. That’s why you should always use percentages for stops
and profit targets (e.g. 1% stop) or a volatility stop instead
of a fixed dollar amount.
A time stop gets you out of a trade if it is not moving in any
direction, therefore freeing your capital for other trades.
Step 4: Evaluate your day trading system
The first figure to look for is the net profit. Obviously you
want your system to generate profits. But don’t be frustrated
when during the development stage your day trading system shows
a loss; try to reverse your entry signals. On our website
www.rockwelltrading.com you already learned that trading is a
zero sum game: So if you are going long at a certain price
level, and you lose, then try to go short instead. Many times
this is the easiest way to turn a losing system into a winning
one.
The next figure you want to look at is the average profit per
trade. Make sure this number is greater than slippage and
commissions, and that it makes your day trading worthwhile. Day
trading is all about risk and reward, and you want to make sure
you get a decent reward for your risk.
Take a look at the Profit Factor (Gross Profit / Gross Loss).
This will tell you how many dollars you are likely to win for
every dollar you lose. The higher the profit factor the better
the day trading system. A system should have a profit factor of
1.5 or more, but watch out when you see profit factors above
3.0, because it might be that you over-optimized the system.
Here are some more characteristics you might want to consider
besides the net profit of a system:
·
Many profitable day trading systems achieve a nice net profit
with a rather small winning percentage, sometimes even below
30%. These systems follow the principle “Cut your losses short
and let your profits run”. However, YOU need to decide whether
you can stand 7 losers and only 3 winners in 10 trades. If you
want to be “right” most of the time, then you should pick a
system with a high winning percentage.
·
Do you need daily action? If you want to see something happening
every day, then you should pick a day trading system with a high
number of trades per month. Many profitable day trading systems
generate only 2-3 trades per month, but if you are not patient
enough to wait for it, then you should select a day trading
system with a higher trading frequency.
·
Some people get really nervous when they are in a trade. I have
heard of people who can’t even sleep at night when they have an
open position. If that’s you, then you should make sure that the
average time in a trade is as short as possible. You might want
to choose a system that does not hold any positions overnight.
·
A famous trader once said: “If you want your system to double or
triple your account, you should expect a drawdown of up to 30%
on your way to trading riches.” Not every trader can stand a 30%
drawdown. Look at the maximum drawdown the system produced so
far, and double it. If you can stand this drawdown, then you
found the right day trading system. Why doubling? Remember: your
worst drawdown is always ahead of you.
·
The amount of most consecutive losses has a huge impact on your
trading, especially when you are using certain types of money
management techniques. Five or six consecutive losses can cause
you a lot of trouble when using an aggressive money management.
In addition this number will help you to determine whether you
have enough discipline to trade the system: Will you still trade
the system after you have experienced 10 losses in a row? It’s
not unusual for a profitable trading system to have 10-12 losses
in a row.
Step 5: Improving your system
There is a difference between “improving” and “curve-fitting” a
system. You can improve your day trading system by testing
different exit methods: If you are using a fixed stop, try a
trailing stop instead. Add a time stop and evaluate the results
again. Don’t look at the net profit only; look also at the
profit factor, average profit per trade and maximum drawdown.
Many times you will see that the net profit slightly decreases
when you add different stops, but the other figures might
improve dramatically.
Don’t fall into the trap of over-optimizing: You can eliminate
almost all losers by adding enough rules. Simple example: If you
see that on Tuesdays you had more losers than on the other
weekdays, you might be tempted to add a “filter” that prevents
your day trading system from entering trades on Tuesdays. Next
you find that in January you had much worse results than in
other months, so you add a filter that enters trades only from
February – December. You add more and more filters to avoid
losses, and eventually you end up with a trading rule that I saw
recently:
IF FVE > -1 And Regression Slope (Close , 35) / Close.35 * 100 >
-.35 And Regression Slope (Close , 35) / Close.35 * 100 < .4 And
Regression Slope (Close , 70) / Close.70 * 100 > -.4 And
Regression Slope (Close , 70) / Close.70 * 100 < .4 And
Regression Slope (Close , 170) / Close.170 * 100 > -.2 And MACD
Diff (Close , 12 , 26 , 9) > -.003 And Not Tuesday And Not
DayOfMonth = 12 and not Month = August and Time > 9:30 ...
Though you eliminated all possibilities of losing (in the past)
and this trading system is now producing fantastic profits, it’s
very unlikely that it will continue to do so when it hits
reality.
Author’s name
Markus Heitkoetter
Author's Info:
Markus Heitkoetter is a 19 year veteran of the markets and the
CEO of Rockwell Trading. For more free information and tips and
trick how to make consistent profits with online daytrading,
visit his website www.rockwelltrading.com.
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