Trading system, why trade with one
Trading commodities can be approached in two ways. Like a trip to a casino or as a regular business. Approaching it as a trip to a casino, will end like a casual trip to a casino, without cash. The only way to approach it is to look at it as a business. It needs discipline, planning and dedication. For those who are interested, here is a fully functional trading system
One of the things that every trader needs to have is a system to work with. Everyone is his own enemy when it comes to trading. The psychological biases that are contained within every individual will ultimately destroy him as a trader, unless he finds a way to control them. In essence it does not matter the system, just that it exists and that the trader is dedicated to follow it. A trading system can be as simple as buying if the price goes up two ticks and selling if it goes down two ticks, or it can be a system based on combination's of indicators and formational signals. The most important thing is that the trader has faith in the system and the stamina to follow it.
Even though the nature of the system can vary in many ways, there are few things that need to be considered if the system is to work properly.
Market picking
What to buy is one of the basic things that need to be present in the system. Without an idea of what to trade, one is not going very far. When picking a market or an individual commodity, one has to look at different factors. What is the volume or open interest of the commodity or market, hence the liquidity of it. Is it volatile, is it possible to survive in it for the long run or is this a short term market. There are some markets a trader can not trade and others that he should not trade. The volatility and liquidity of some markets is such that large funds are necessary to trade them. A futures contract that swings several thousand of dollars in any given day, is only open for those traders that have sufficient funds. Other markets are to illiquid to trade, for example lumber is a very illiquid market to trade which means that if a trader opens a position in the market, there’s no guaranty that he’ll be able to close out his position, thus increasing the possibility that he’ll be loosing more money than hey expected, even more money than he has in his account. Some might even loose more than they own, including house and savings. It’s therefore vital that the trader recognizes the conditions of the market he wants to trade.
Entry signals
When asked, most people would say entries are the single most important factor in any trading endeavor. This is not true. Entries are important, but they’re not the most important factor. Entries tell you when to get into a trade, nothing else. It’s supposed to be used as a signal that forms a whole in combination of other parts of the trading system. Everyone dreams about buying at the bottom and selling at the top. As truly as this is the heavenly way to place ones trades, it’s also the most exceptional way to do it. An exception that has more to do with luck than with anything else. How entry signals are set, depends on the trader. Typical entry signal would be when a price crosses a Moving Average value or if two or more Moving Average lines cross in a certain way. Entry can also be a combination of signals based on indicators, formations or time frames. In its simplicity, entry signals are to be used as indicators as to when the market has began to behave in a certain way, a way that the trader believes that the market could be traded with a profit. But there is no certainty when trading commodity futures or options contracts. That’s why every trader should be ready to exit his trade, even if it means that he’ll loose money on his trades. Which brings us to the exits.
Exit signals
It’s possible to put exit signals in two groups. The exit when a trade has run its course and the exit that is activated if the trade goes against the trader. Before any trade is initiated, the trader has to decide when he’s supposed to get out of the trade. Exiting the trade is no less important than knowing when to initiate it. As with entries, exits can come in many shapes and sizes, but most of the time they’re based on the same fundamental ideas entries are based on. A very common way to place trades is to enter when a price crosses a certain level or a Moving Average line or when one or more Moving Average lines cross. For the exit, similar crossings of Moving Average lines, and prices would indicate an exit out of a position when showing the reversed move. Every trader is going to loose on one trade or more, there’s no escaping that. Of course, some people could be lucky and trade for a long duration of time without a losing trade, but that’s a winning streak based on luck, more than anything else, no matter how good the trader is. This brings us to the second exit signal, a signal that is most often skipped, mainly because the trader believes he’s unable to make mistakes. This exit signal indicates when the trader is supposed to exit a bad trade, a trade that goes against him. Even though most traders seldom place enough emphasis on this exit signal, this is possible the single most important item in a trading plan and the one that should be thought about before anything else. This signal is the essence of the survivability of the trader. A result of a good asset management or position sizing.
Position sizing
When traders look at a potential trade, they always look at it from the point of view of the potential profit they’ll be making. Few begin by setting them self a loss limit. This is in many ways the completely opposite behaviour too what they should be doing. Instead of saying “how much will I profit from this trade”, a more healthy way of looking at it would be by saying “what am I willing to loose on this trade”. Setting the loss limit right at the beginning of the trade, fixes a certain border for the trader. The worst thing is for a trader to hold on to loosing trades, as it limits his possibilities of making other more profitable ones. An error that has kept many traders from big profits, is when they close a profiting trade to maintain a loosing trade, in the hope it’ll turn and give back some of the losses. A losing trade is a losing trade and should never be held in the hope that it’ll turn.
Position sizing is the magic to setting barriers on the losing trades. By following a stable asset management system, a trader has the potential to stay in the business. In essence an asset management system is the rule where the trader decides how much of his account he places or risks on each trade. We believe a trader should not place more than 1 to 5 percent of his capital on each trade. Otherwise he’ll have great difficulties in winning back the amount that he has lost.
Discipline
No matter how good the trading system is, without discipline, it will never work. Not even if it’s the mother of all trading systems, a holy grail. Without discipline you can forget it.
