The 10 Power Principles of Successful Trading Systems
At Rockwell Trading we develop and test up to 25 trading systems a month. The 10 Power Principles for Successful Trading Systems is a set of rules we established and refined to help us effectively evaluate a trading system. Using these Power Principles you too can find solid trading systems - whether they be those you develop yourself or those you obtain from other sources. You can be assured of a high probability of success by applying these simple principles.
Principle #1: Few rules - easy to understand
It may surprise you that the best trading systems have less than 10 rules. The more rules you have, the more likely you "curve-fitted" your trading system to the past, and such an over-optimized system is very unlikely to produce profits in real markets.
It's important that your rules are easy to understand and execute. The markets can behave very wildly and move fast, and you won't necessarily have the time to calculate complicated formulas in order to make a trading decision. Think about successful floor traders: The only tool they use is a calculator, and they make thousands of dollars every day.
Principle #2: Trade electronic and liquid markets
We strongly recommend that you trade electronic markets because the commissions are lower and you receive instant fills. You need to know as fast as possible if your order is filled and at what price, because based on this information you plan your exit. You should never place an exit order before you know that your entry order is filled. When you trade open outcry markets (non-electronic) you might have to wait a few minutes before you receive your fill. By then the market might have already turned, and your profitable trade become a loss!
When trading electronic markets you receive your fills in less than one second and can immediately place your exit orders. Trading liquid markets you can avoid slippage, which will save you hundreds or even thousands of dollars.
Principle #3: Make consistent profits
You should always look for a trading system that produces a nice and smooth equity curve, even if in the long run the net profit is slightly smaller. Most professional traders prefer to take small profits every day instead of big gains every now and then. If you trade for a living, you need to pay your bills from your trading profits, and therefore you should regularly deposit profits in to your trading account.
Making consistent profits is the secret of successful traders!
Principle #4: Maintain a healthy balance between risk and reward
Let me give you an example: If you go to a casino and bet everything you have on "red", then you have a 49% chance of doubling your money and a 51% chance of losing everything. The same applies to trading: You can make a lot of money if you are risking a lot, but then risk of ruin is very high. You need to find a healthy balance between risk and reward.
Let's say you define "ruin" as losing 20% of your account, and you define "success" as making 20% profits. Having a trading system with past performance results let you calculate the "risk of ruin" and "chance of success".
Your risk of ruin should be always less than 5%, and your chance of success should be 5-10 times higher, e.g. if your risk of ruin is 4%, then your chance of success should be 40% or higher.