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Trading as a Business:
Profile of a Winning Strategy
By Charlie Wright
At this point in the development of your strategy, you have a clearly defined direction in which you are heading. You've decided on the strategy type and market type you are going to trade, and you have a feel for the types of patterns on which you want to capitalize. Now is the time for a brainstorming session in which you should sit down in front of your computer with TradeStation. This is the point at which you start to develop the set of rules that actually make up your trading strategy.
Many traders at one time or another have become frustrated with strategy development. Not because they dont like it, but because they run out of new ideas to test, or havent found anything that works for them.
For example, most traders have tested the Dual Moving Average Crossover Strategy sometime in their trading career. The average trader will look at this strategy and believe that the only thing to test is the length of the two averages. New traders will experiment with many different lengths for the averages. When they dont find any that work to their satisfaction, they discard the dual moving average strategy concept entirely, and move on to something else. They keep looking for that Holy Grail indicator that they can instantly make into a strategy. We have all been there, and have all discarded many great ideas.
The discarding of an idea, more often
than not, is a mistake. I believe that for the most part, any indicator
can be made into a profitable strategy. Yes, I said any indicator.
When we discard the moving averages, it is usually a mistake because
the moving averages by themselves only represent one half of the strategy
development puzzle. I refer to this half as the Set-Up
of a strategy.
The second half of a strategy, the half
that most traders ignore completely, is what I call the Entry.
In this chapter, I will talk about exactly what these two terms mean,
and more important, how using them together can turn something as
mundane as a moving average crossover into a promising new trading
The Magic of Set-Up and Entry
My experience is that the secret to successful
strategy development is to look at a method, or indicator, in an unconventional
manner. The trick is to use it in a different and unique way. With
Set-Up and Entry, you will look at strategy development in a completely
different way. As youll soon see, it can provide you with a
whole new world of exciting possibilities and ideas to test. It will
lift you out of the rut of simply optimizing standard indicators and
give you a method of organizing your creativity.
The Set-Up is the condition or set of
conditions that are necessary prior to considering taking a position
in the market. It is the indicator or group of indicators that tell
you to get ready to buy or sell. Set-ups dont get you in the
market, they simply make you aware that a trade is in the making.
Examples of set-ups for a trend-following strategy:
Examples of set-ups for a support and resistance strategy:
Examples of set-ups for a volatility expansion strategy:
There are countless other indicators and conditions that could be used as set-ups. In the final analysis, you are limited only by your creativity. There is only one constraint that you should impose upon yourself. It is essential to recognize the type of strategy you are trying to develop and use the different indicators accordingly. You do not want to use a moving average crossover for a support and resistance strategy unless you are using it in a unique way. You would not choose to use the Stochastic Indicator for a trend-following strategy unless you had completely re-configured how it is used.
Most strategy traders do not recognize that these indicators only set up the trade. They are unaware that there are a multitude of ways to actually get in the market once the set-up has occurred. They are not aware that set-ups are only part of the equation and are not particularly profitable in and of themselves.
Beginning strategy developers get discouraged when they try to develop profitable strategies from set-ups only. They quickly run out of ideas to test, because they use up all their ideas as set-ups without trying to combine them with various complementary entries.
By trading only set-ups, you lose the
added precision, accuracy and increased profitability of a strategy
that uses both set-up and entry. If trading set-ups by themselves
worked, and was profitable, trading would be easy and all traders
would be rich.