Building a profitable trading strategy – Complete guide
If you go to the internet, you will often find trading to be represented as the “9-5 escape” or something “you can do from anywhere in the world”.
This makes many people jump into financial markets, thinking the path to fortune is very easy, but this could not be further from the truth.
Trading financial markets is extremely hard, time demanding and complex.
If you decide to go this path, you will soon realize that instead of working 9-5, you spend 12 hours a day in front of the screens trying to extract a little bit of money from the markets.
To make a living, you need to be well-capitalized and be your 100% every single time, as markets don’t care about how you feel, what time it is, or what your opinion is.
In this article, I will do my best to lay down what I think every profitable strategy should look like and give you some of my personal tips to be able to make well-educated decisions in the markets.
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Choosing trading style
Before you do anything, you should decide what type of trader you want to be.
There are essentially two options: day trade or swing trade.
For most people starting out, this is mostly dictated by other aspects of your life, if you are still working, you might be limited to only being able to watch markets for a few hours a day, but some jobs might allow active trading on a second screen, for example.
There are advantages and disadvantages to both styles of trading.
As a day trader, you will most likely focus on only 1-2 markets compared to swing trading, where you will be taking positions in more markets at the same time.
Of course, you can only swing trade one market, but you will need to be very well capitalized for it.
As you can see on the screenshot above, we have an equity simulation with a 2 to 1 risk-to-reward ratio over 100 trades with a 50% win rate on a 10,000 Euro account.
The average PnL in this situation is around 15,000 Euro, but how quickly this will happen solely based on your trading style.
If you take four trades every week, this can be achieved in around half a year, but if you only take one trade a week, you are looking at two years of time.
As you are not allowed to withdraw anything from the account during this time, you can definitely see that you really need to be well-capitalized to make trading worth it.
This often creates a problem for both sides of the camp, people that don’t have money and people that have a lot of money.
Those that don’t have much capital, to begin with, often try to increase the risks on each trade to fasten the journey, which will more often than not end up liquidating the account.
New traders that have enough capital and just start to trade have a hard time risking smaller amounts as the money feels insignificant but are often not prepared to trade with large sizes as they don’t have a track record to back their decision-making up.
This very often leads to a lot of mistakes.
There are other aspects you need to consider when you are choosing your trading style.
Daytrading tends to be more straightforward as you only focus on one or two markets, and your trading tends to be very technical. You just need to ensure that you follow your system and don’t make mistakes that are actually very easy to make in the heat of the moment, as markets are moving very fast.
Daytrading is extremely hard. You need to be able to focus 100% and be able to make a quick decision, as every mistake can be very quick and costly.
Swing trading, on the other hand, can be more forgiving.
You will work with wider stops, and you will often have hours to place your trade or get out from positions that don’t work out your way.
What makes swing trading hard is understanding market correlations and also the fact that you are more exposed to the market and the fundamental events.
If you are trading solely crypto and you trade ten coins at the same time, you are essentially trading one market with different liquidity.
People tend not to understand this, and if things don’t work out, they realise much bigger losses than anticipated.
On top of that, you have plenty of events throughout the week that will cause volatility spikes that can affect your positions.
This is not so hard to fix. You just need to be aware of these things.
If you are taking more positions in correlated markets, either pick one that meets your criteria the best or split your risk across different markets.
When it comes to new, you should know the exact time of releases and manage your existing positions according to that.
You can implement the rule of pulling all existing orders a few minutes before the release and making sure your existing trades are protected with stop loss and accounted for possible slippage.
There are more nuances when it comes to choosing a trading style you should consider, and I covered them previously in this article.
Markets to trade
There are plenty of options of stuff you can trade.
Crypto, forex, indices, commodities, and stocks are the most popular.
No matter what you decide to trade, you should know your market in and out.
- What are the most volatile hours?
- What news influence the given markets?
- Are the markets open 24 hours, or do they close for a certain period of time?
- What market participants mainly move the markets?
- What are the main correlations for the market?
- How liquid the market is?
These are some questions you should ask yourself when picking up the markets to trade.
For day trading, this choice is rather simple, as you will most likely end up with one market.
Trading only one market will give you an advantage as every market has unique characteristics, and after some time, you will start to know your market really well.
One of the things to consider is if you are looking for a slower, more liquid market like S&P500 or if you looking for something fast, thinner like Nasdaq or Bitcoin.
If you swing trade, you might end up with a handful of markets, as correlations are quite high. You need to introduce rules so you won’t end up over-exposing yourself.
For example, I tend to trade a lot of correlated markets at once, but I have introduced a lot of systematic rules to my strategy, so in most cases, only one or two markets will meet all my criteria for the actual entry.
My exact process is covered in Tradingriot Bootcamp.
When I ask people what markets they trade, their answer is often: “I trade futures.” or “I trade CFDs”.
These are not markets but derivatives from the underlying assets.
They derive from markets such as Crypto, Commodities, Indices and so on.
Assuming you are not looking to be a “long-only” investor, you will be trading a derivatives market that will allow you to speculate on the market’s downfall by shorting. In that case, you are most likely going to trade Futures, Options or CFDs.
What is important here is to know 100% all the details about the derivatives of your choice, what leverage is, what margin is, how different order types work and so on.
By taking your time to dig deep into different derivate mechanics, you won’t end up making mistakes in execution.
I covered different derivatives in this article, so if you have any doubts, make sure to read it.
This is the part where most traders jump straight in, thinking the strategy is the most important thing ever, and there is some sort of holy grail in the market.
This is certainly true as, without a working edge in the market, you won’t be able to make money, but there is certainly no holy grail in the markets, and any trading strategy will fail short if you aren’t able to execute and manage your trades properly.
Your strategy should be simple. The more things you decide to add to your system, the more confusion it can bring.
If your charts look like children drawing books with dozens of indicators and lines, you will have a hard time taking trades as you will be stressing over every single detail.
Over the years, I have met a lot of profitable traders, and their systems were often very simple.
When it comes to my trading, I also like to keep things simple. Everything I do in the markets boils down to two things.
- I take trades in areas others are forced to exit, and I am happy to take the opposite side.
- I take trades in areas where large amounts of buying/selling stepped in, and I bet on continuation as these large players will defend their positions.
For this, I use price action, volume and orderflow.
Of course, there are more nuances I developed over time to know how exactly I want to structure to look like, what timeframes are important for me and so on, as my goal is to really take the high-quality trades and filter out the lower quality ones.
As mentioned, this is especially important when trading more markets at once so you won’t end up over-exposed in the same direction.
The idea of backtesting is extremely popular in the trading world.
In theory, you go back in historical data and look for all the samples where you would be executing trades and collecting data on how profitable your decision would be.
This can work, but your strategy has to be 100% systematic.
In other words, there should be zero room for any discretionary decisions.
Personally, I am not the biggest fan of backtesting. Although I have a lot of systematic aspects in my trading, it is always going to be different when the real money is put in line.
What I would rather recommend is to start small, deposit a small amount of money to your account (it doesn’t matter if you are sitting at 6-7 figures ready to trade with) and just trade your system for a couple of months.
Accept the fact that you won’t be making any significant money, and just journal your trades to see how your setups perform in different markets under different conditions.
Don’t try to over-risk or find any shortcut, as you are only hurting yourself by doing that.
After the sample size of around a hundred trades, you will quickly see if things you are doing work or not.
During the process, you should not only look at trades and if they were executed according to your strategy but also how you could probably cut losers quicker or hold winners longer.
Try to bring as many systematic rules as possible to cut your emotions and decision-making, and by the end of the sample size, you might find out setups that have a stellar performance in some markets and some markets that might not be worth trading at all.
This will allow you to use more dynamic risk parameters for your trading going forward.
People will tell you that risk management is the most important thing in trading, but it is not.
You can be excellent at managing risk, but if you are trading without edge, you will never make money.
Proper risk management is something that should go without saying. You should never bet the amount that can ruin you in one single trade, no matter how good the trade looks.
You are speculating in the markets, in most cases using simple things such as technical analysis in some shape or form.
No matter how you think sophisticated your system is, the outcome of every single trade is always random.
Even if you take a setup with a 90% win rate over the long run and you will go all in, that 10% chance of loss can hit, and you will lose everything.
You need to embrace the unknown in the markets. Every time I take a trade, I make sure I come prepared, following my trading plan and the rest is just a probability game over the long run.
Risk management is complex and what makes it hard is that with trading by itself being complex and challenging enough, there is no room for mistakes in managing risk.
A while ago, I published long-form articles about Risk Management and Trade Management, if you are lacking in this area, make sure to read them.
Trading is hard, and if someone tells you otherwise, they are either lying to you or trying to sell you something.
Trading can be daunting and messy sometimes, but you must embrace it. Same as with starting any business, which trading essentially is, put together your trading plan, covering all the things you will be doing.
Include trade examples, risk parameters, markets you will trade, and how exactly you will manage each trade from entry to exit.
Once you write everything down, you can come back to it anytime and quickly refresh your memory on things you should be doing.
Journal all your trades, as that is the only way for you to see what you are doing and if it is worth doing in the long run. Even with a smaller sample size of just a few months of trading, you can run simulations that will tell you if you have a chance in the long run.
I hope this article was helpful in building your profitable trading strategy.