Learning How to Build a Trading System


Know Yourself

In order to learn how to build a trading system you must have a plan. Your plan should define the strategies that you are most comfortable in executing. What is good for one person may not be good for you. Are you a short or long term trader? How much time do you have to spend in front of the computer screen analyzing the markets? Here is a key question to answer….How much money do you want to risk?

If you are not a full time trader and you have a 9-5 job then it may not be possible for you to trade the minute or hourly charts. It may be more productive for you to have a daily perspective when it comes to trading, maybe even weekly. It should have a focus that does not interfere with your real job.

When you decide on a system you must determine what is right for you. Evaluate your temperament, trading account, and time allotted. Weigh each against its cost and make the best choice.

When learning how to build a trading system you should also check out the best ideas of other systems. Evaluate systems that you have used and systems that other traders have used but may have abandoned. I found some very productive and profitable ideas from tweaking systems that were thought to be useless. Trader forums are also good places to check for trading ideas.


Optimization how to build a trading system

Optimization is the activity of finding the parameters of a system that work the best. It is always exciting to “curve fit” the conditions that are most profitable on a historical chart.

It is also dangerous and misleading because as good as it looks there is no promise that the markets will behave in the same way in the future.

I find it more productive to focus on the drawdowns to see if they are survivable. Avoid spending a lot of time optimizing on historical charts and test your strategy forward by using a demonstration account to see how profitable it performs.


Simplify Your System

Simple is almost always better. Simple rules executed with discipline and money management will almost always make you money. The more elaborate the rules the more likely you end up curve fitting and optimizing your system to the data. The more optimization the more likely it will not work consistently enough to be profitable.


Know Your Biases

Are your tendencies to only take long (buy) trades or short (sell). From my experiences with the stock market I knew that I was reluctant to take short trades because I was burned so many times. If you know your biases then build it into your strategy to account for it. If you tend to exit early you know that you should counter that tendency in your plan.


Testing Your System

Always test your system. Check it’s potential using historical data but validate it’s performance “real time” by paper trading with a demonstration account at your broker. Most brokers are glad to let you trade as long as you would like to check the viability of a new system.  If you do all these things then the task of getting up to speed with how to build a trading system is not so daunting.