You can trade only what you believe; therefore, your beliefs about price action must be at the core of your trading system. This will allow the trading system to reflect your personality, and you are more likely to succeed with such a system over the long run. If you hold many beliefs about price action, you can develop many systems, each reflecting one particular belief. As we will see later, trading multiple systems is one form of diversification that can reduce fluctuations in account equity.
The simplest way to understand your trading beliefs is to list them. Table 2.1 presents a brief checklist to help you get started.
You can expand the items in Table 2.1 to include many other items. For example, you can include beliefs about breakout systems, moving-average methods, or volatility systems. Your trading beliefs are also influenced by what you do. For example, you may be a market marker, with a very short term trading horizon. Or, you may be a proprietary trader for a big bank, trading currencies. You may wish to keep an eye on economic data as one ingredient in your decision process. As a former floor trader, you may like to read the commitment of traders report. Perhaps you were once a buyer of coffee beans for a major manufacturer, and you like to look at crop yield data as you trade coffee. The range of possible beliefs is as varied as individual traders.
You must ensure that your beliefs are consistent. For example, if you like fast action, you probably will not use weekly data, nor hold positions as long as necessary. Nor are you likely to use fundamental data in your analysis. Hence, a need for fast action is more consistent with day trading, and using cycles, patterns, and oscillators with intraday data. Similarly, if you like a trend-following approach, you are more likely to use daily and weekly data, hold positions for more than five days, trade a variable number of contracts, and trade a diversified portfolio. If you hold multiple beliefs, ensure that they are a consistent set and develop models that fit those beliefs. A set of consistent beliefs that can be used to build trading systems is listed below as an example.
- I like to trade with the trend (5 to 50 days).
- I like to trade with a system.
- I like to hold positions as long as necessary (1 to 100 days).
- I like to trade a variable number of shares or contracts.
- I like to use stop orders to control my risk.
Pare down your list to just your top five beliefs. You can review and update this list periodically. When you design trading systems, check that they reflect your five most strongly held beliefs. The next section presents other rules your system must also follow.