Wednesday, December 12, 2012

Creating a trading system IV - The basics

What are the absolute minimum needed to create a trading system?

The answer is:

  • Trade management methodology
  • Risk management system
  • A methodical way to enter the market (even if its a coin toss)
My system of trade management is fairly mechanical. I prefer fixed stops and a fixed scalp exit that is twice the stop size. Some discretion may be applied for any additional contracts. They may be held until a price target is hit such as high or low of today or prior day, or the trend terminates (by breaking a trendline), or a climax bar or simply when the profits are too large to be left on the table. The first step in creating a trading system therefore is to determine an acceptable stop size. If the stop size is too small, you will probably be stopped out before reaching twice the risk. If your stop size is too large, it may never reach twice your risk. Somewhere in between is a band where stop size is acceptable.

Risk management is also pretty simple. I have maximum loss limits per trade (stop size), and per day (maximum number of failed trades) and in case I run into unexpected price action, I will also have amortized loss limits per month. I have posted extensively on risk management and those rules are universal regardless of what you trade.

There is a broad choice of ways to enter the market based on indicators, price action, support and resistance levels and possibly countless others that I haven't even heard of. I have the strongest confidence in price action, having tried many others which resulted in utter failure and bafflement. 

However, for the purposes of stop size determination, I may choose a mix of random entries and price action. Once stop size is determined, I'll only trade price action.


  1. Hi,

    Am coming to this site after a while now. Have found useful stuff here, having read what Brooks wrote. Am based in India and I have tried price action trading on Index futures and also on EURUSD. The results however have not been very encouraging. Small winners and rare 2R or higher wins.
    I was also thinking of trading Crude as it is known to give more opportunities when it comes to R:R of 1.7 or higher. Will be keenly watching your new experiment.
    Thanks for your write ups. All the best.


  2. I'm with you big-time on having confidence in price action. Price action is truly the only thing that matters when it all boils down. I'm kind of new to the 1:2 risk/reward ratio school of thought, having managed risk poorly in the past, but it's making more sense to me every day. Cheers.