Developing a Trading Strategy
It is important to decide the timeframe that we are going to work towards in our system. This really comes down to how much time we are prepared to spend trading and how active we require the system to be in terms of the number of trades. Broadly speaking there are four main timeframes:
|Timeframe||Length of trade||Data used|
|Long-term||Months||End of day|
|Medium-term||Weeks||End of day|
|Day-trade||Up to 1 day||Intra day|
Long Term trading systems will save on commission costs and have larger profits per trade. Shorter term trading systems will rack up the commission costs and generally make less per trade but the frequency of trading opportunities will make up for this. For example:
System 1 makes an average of 250 points per trade but only trades 4 times a year.
System 2 only makes an average of 10 points per trade but trades 200 times a year.
System 1 makes 1,000 pts a year but system 2 makes 2,000 points a year. However if we allow 5 pts per trade for commission and slippage then system 1 costs 20 pts/year whereas system 2 costs 1,000 pts/year.
Both systems make a similar net profit over the course of a year however there are a number of points to bear in mind:
With only 4 trades per year for system 1 every trade is important and must be taken. It is likely that the bulk of the profits will come from only one of the trades so this must not be missed. With system 2 producing a new signal every day it is not so reliant on individual trades.
- System 1 will require a larger capital base to trade as the trades will have to ride wider swings.
- System 2 will require a lot more work to trade as intra day data will have to be monitored.
- System 2 will be psychologically easier to trade as the equity draw down periods will be shorter. Well designed and robust day trading systems will rarely have losing months.
The frequency of trading is an essential element of any trading system and our choice of timeframe will help to determine it. There is no right answer; it is very much a case of what suits the individual trader. For the purpose of this article we will look at developing a day trading system.