Getting StartedTrading Systems

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.

Principle #5:  Find a system that produces at least five trades per week

The higher the trading frequency the smaller the chance of having a losing month. If you have a trading system that has a winning percentage of 70%, but only produces 1 trade per month, then 1 loser is enough to have a losing month. In this example you could have several losing months in a row before you finally start making profits. In the meantime, how do you pay your bills?

If your trading system produces five trades per week, then you have in average 20 trades per month. Having a winning percentage of 70% – your chances of a winning month are extremely high.

That’s the goal of all traders: Having as many winning months as possible.

Principle #6: Start small – grow big

Your trading system should allow you to start small and grow big. A good trading system allows you to start with one or two contracts, and then increases your position as your trading account grows. This is in contrast to many "martingale" trading systems that require increasing position sizes when you are in a losing streak.

You probably heard about this strategy: Double your contracts every time you lose, and one winner will win back all the money you previously lost. It’s not unusual to have 4-5 losing trades in a row, and this would already require you to trade 16 contracts after just 4 loss! Trading the e-mini S&P you would then need an account size of at least $63,200 just to meet the margin requirement. That’s why martingale systems don’t work.

Principle #7: Automate your trading

Emotions and human errors are the most common mistakes traders make.  Clearly, they are to be avoided by any means possible. Especially during fast markets, it is crucial that you determine the entry and exit points fast and accurately; otherwise, you might miss a trade or find yourself in a losing position. For that reason you should automate your trading and look for a trading system that either already is or can be automated. Automating your trading makes it free of human emotion. The buy and sell operations are all automatic, hands-free, with no manual interventions and you can be sure that you make profits when you should, according to your plan.

Principle #8: Have a high percentage of winning trades

Your trading strategy should produce more than 50% winners. There’s no doubt that trading systems with smaller winning percentages can be profitable, too, but the psychological pressure is enormous. Taking 7 losers out of 10 trades and not doubting the system takes great discipline, and many traders can’t stand the pressure. After the sixth loser they start "improving" the system or stop trading it completely.

Especially for beginners it is a big help to gain confidence in your trading and your system if you have a high winning percentage of more than 65%.

Principle #9: Look for a system that is tested on at least 200 trades

The more trades you use in your backtesting (without curve-fitting), the higher the probability that your trading system will succeed in the future. Look at the following table:

The more trades you have in your
backtesting, the smaller the margin of error, and the higher the probability of producing profits in the future.

Principle #10: Chose a valid backtesting period

I recently saw the following ad: "Since 1994 I’ve taught thousands of traders worldwide a Simple and Reliable E-Mini trading methodology".

That’s very interesting, because the e-mini S&P was introduced in September 1997, and the e-mini
Nasdaq in June 1999, therefore none of these contracts existed before 1997. What kind of e-mini trading did this vendor teach from 1994-1997???

The same applies to your backtesting: If you developed an e-mini S&P trading strategy, then you should backtest it only for the past 2-4 years, because even though the contract has existed since 1997, there was practically no one trading it (see chart below):

Now you should have working method for separating the good trading system from the poor one. By applying this checklist you will easily identify trading systems that work and those that will never make it.

As CEO at Rockwell Trading Inc, Markus has taught hundreds of investors how to make consistent profits in the US and European markets.  Markus started trading 19 years ago. At that time he was mainly trading stocks using point and figure charts from published numbers in the morning newspaper. In 1996 he started developing trading systems using SuperCharts (which is now TradeStation), MetaStock, OmniTrader and other software. In 2002, Markus decided to quit his regular day time job as a director at IBM to become a professional trader. At that time he moved from Germany to the USA. In his trading career, Markus has traded EVERYTHING that’s out there: stocks, options, futures, commodities, spreads, Forex, foreign markets, interest rates, … Whatever is out there, he probably traded it. And he traded on all different time frames: ticks, 1-, 3-, 5-minute, hourly, daily and even weekly. In the past 5 years, Markus has been teaching thousands of traders all over the world, offering educational webinars for the CME (Chicago Mercantile Exchange), Eurex, FxStreet, Strategy Runner and other financial companies. He has published articles on over 500 websites and has become an expert contributor on ezinearticles.com, Yahoo Answers and FAQTs.com.  Markus holds the German equivalent to an MBA in Business Administration and Computer Science.

As CEO at Rockwell Trading Inc, Markus has taught hundreds of investors how to make consistent profits in the US and European markets.  Markus starte...

Rhody Trader

Senior member
2,620 264
Markus's guide to evaluating trading systems may not be suitable for all, and it is bound to spark debate on some points. That said, however, it does make a number of very valid points for anyone reviewing a system that they have or are thinking of purchasing.
 

FetteredChinos

Veteren member
3,897 40
facile.

point 8 is valid and important. the others failry obvious.

9 is a bit spurious. lets have some more than 200 trades

10 is excellent, but misleading:- if you have a strategy that worked since 1997 then great. if you have one that worked on other, similar markets before then as well, then even better.

fc
 

dbphoenix

Legendary member
6,952 1,242
GammaJammer said:
FC - imho I think describing the article as facile is perhaps a tad harsh. Sure, none of the individual points are exactly rocket science, but surely this is the whole point.
True.

Many novices read this sort of thing hoping for the "Aha, so that's it" moment, but there really is nothing new under the sun. This article provides a nice overview, but, as you say, the trick is to actually do it.
 

ale

Active member
108 1
As a newcomer to this very complex arena I agree with GJ - it is useful to have all these points together even if some of them are so basic that if you need to be told you really shouldn't be considering trading.
The ability to take the points and write them into your own trading plan in a way that makes sense to you is great. If all this article does is to provide a checklist for newcomers then it's still valuable.
IMHO it does more than this by emphasising the reality of trading. I can see myself rereading this several times whilst fine tuning my system.
 

dbphoenix

Legendary member
6,952 1,242
ale said:
As a newcomer to this very complex arena I agree with GJ - it is useful to have all these points together even if some of them are so basic that if you need to be told you really shouldn't be considering trading.
The ability to take the points and write them into your own trading plan in a way that makes sense to you is great. If all this article does is to provide a checklist for newcomers then it's still valuable.
IMHO it does more than this by emphasising the reality of trading. I can see myself rereading this several times whilst fine tuning my system.
It's also a nice companion for Tim's article posted a couple of days ago:

http://www.trade2win.com/knowledge/articles/general articles/trading-plan-template
 

jmreeve

Well-known member
432 13
Disagree with point 5 and would add a point 11 that you should trade lots of different systems at the same time.

This is another company selling a the idea of trading a single system that they, "the experts" have created. Ultimately, if anyone has anything really good they keep quiet about it and make money from trading it and not by selling it with hands free software for $600.
 

FetteredChinos

Veteren member
3,897 40
ok, sorry for the slightly rude tone.. i didnt mean it in an aggressive sense..

yes i agree it is good for the points to be grouped together for a newbie. and for that it is useful.

i just misread the target audience.

no personal offence intended, and i agreed with the bulk of the article. thanks for taking the time to write it.

not enough jokes though..


"whats half a pear" ?

FC
 

JumpOff

1
702 14
At Rockwell Trading we develop and test up to 25 trading systems a month.
Why?

I'm confused. The basic premise of this article is that is possible to design a hands off automated system that consistently makes money. That they have done it at least once. If this were so, wouldn't these folks be sitting on a beach in the Riviera, compounding their gains until the size of their system ran into liquidity issues? Wouldn't a series of successful automatic trading systems eventually mean the end of all the electronic markets ? Theoretically, it would consolidate all the market capital the hands of the system owners......

It is not my intention to be rude or ungrateful, and I hope that someone will be able to point out the error in my logic..

Thanks,
JO
 

dbphoenix

Legendary member
6,952 1,242
jmreeve said:
Disagree with point 5 and would add a point 11 that you should trade lots of different systems at the same time.

This is another company selling a the idea of trading a single system that they, "the experts" have created. Ultimately, if anyone has anything really good they keep quiet about it and make money from trading it and not by selling it with hands free software for $600.
Where did you get that idea? He says they test up to 25 systems a month, and that the point of the article is to know what to look for, and that a system created by oneself can be just as good as one bought.

Trading lots of systems at the same time won't save someone who can't make a consistent profit off of one..
 

Rhody Trader

Senior member
2,620 264
jmreeve said:
Disagree with point 5 and would add a point 11 that you should trade lots of different systems at the same time. .
Why do you disagree with #5?

And for that matter, why should someone trade lots of different systems?

It was understood when this article was being prepared for publication that it wouldn't fit with everyone. The hope was to generate discussion and healthy debate so that traders with different views could share and exchange them for the benefit of everyone.

It's not that I disagree with you in either of your comments, it's just that you present no reasoning. As has been noted, the primary target for this piece is less experienced folks. I'm sure they would like to get your point of view.
 

dbphoenix

Legendary member
6,952 1,242
JumpOff said:
Why?

I'm confused. The basic premise of this article is that is possible to design a hands off automated system that consistently makes money. That they have done it at least once. If this were so, wouldn't these folks be sitting on a beach in the Riviera, compounding their gains until the size of their system ran into liquidity issues? Wouldn't a series of successful automatic trading systems eventually mean the end of all the electronic markets ? Theoretically, it would consolidate all the market capital the hands of the system owners......

It is not my intention to be rude or ungrateful, and I hope that someone will be able to point out the error in my logic..

Thanks,
JO
If logic applied, then your propositions would be true. But markets aren't governed by logic. Therefore, even automated systems must be adaptable.