Technical Analysis of Financial Markets

The Holy Grail Of Any Trading System

It is common for the novice trader or investor to begin their quest for financial freedom by searching far and wide for the “holy grail” trading system. Oftentimes, the novice scours the internet looking for a self-proclaimed guru’s advice or they shell out their hard earned cash for a trading indicator that holds the keys to the castle, or in this case the bank vault. Once burned a time or two, they may seek more professional help. Perhaps they are mentored by someone with a specific skill set such as Elliott Wave Theory, Market Profile, Harmonic Patterns. Perhaps they find some success, but they can’t expect any level of real consistency. They bounce around from time frame to time frame, from scalping to swing trading.

When I first began lifting weights more seriously, I bought my fair share of Muscle & Fitness Magazines, and visited the website T-Nation daily. One week I was confident that the 5 x 5 (Five sets of Five reps) was the way to go due to an article I read. By the end of the week after lifting too heavy, my muscles and nervous system were fried from overtraining. I went back to the website or magazine and decided since I didn’t look any different in the mirror I’d be best served to switch it up. The next Monday I was back in the gym doing high rep low weight and using drop sets, reverse pyramid training, and any other fancy technique I read about.I was doing nothing more than spinning my wheels, never giving any program enough of a chance to work for me. I saw the pictures of the bodybuilders and wondered why after doing the same program for a week or two, I didn’t start to look like them. Young and naïve, I was unaware that 100% of them were on anabolic steroids while pushing protein powder and BCAAs along with “holy grail” programs that claimed to pack on muscle faster than humanly possible.

Much like a young man’s initiation to bodybuilding, a trader’s path in the early going is riddled with hurdles, missteps, and blunders. We fall victim to traps and work our way out of them, learning with each failed attempt. Finally in the case of bodybuilding you learn that the holy grail is eating right (a surplus of calories with plenty of dense protein), good form, and consistency. Pretty boring, but effective. What eluded you turned out to be right under your nose.

As it turns out, the holy grail to any successful trading system is also pretty boring. Without it however, you are almost certainly doomed to failure. So what is it? Like bodybuilding, it was also right under your nose: Actually HAVING a successful system. I don’t mean a system of picking stocks / options. I mean a system with proper position sizing, risk management, and defined objectives. I’m always surprised when I hear from people that have been around this industry so long and they still can’t explain in simple detail their system of money management.

What do you risk per trade?

What beliefs do you hold internally that may affect your decision making? Do your political views play into your strategy?

What do know about statistics?

How disciplined are you in trading, and in life? Are you compulsive?

What do expect to make trading based on your account size?

What is the largest peak to trough drawdown in your account are you willing to accept?

What is your risk tolerance?

Are your objectives even attainable?

Those questions right there once answered honestly will do more for you than the next hot stock pick. You could be a great stock picker or have an unusual string of good luck, but if you don’t understand the necessity of cutting losses quickly and letting winners run, it’s all for not. If you don’t understand the statistics behind W/L rate and position sizing you will fail. And most of all, if you don’t understand yourself and your own psychological strengths and weaknesses, turn off your charts and let’s work on that.

I can’t stress this enough. Your plan for picking stocks, trading futures and options, entry and exit is not a sufficient trading system. These are only part of the overall plan and not anywhere near the most crucial aspects. Anyone can buy lotto tickets and hit a big winner once in a while. Few understand the proper setup and mechanics of a system with proper risk management and position sizing to reach a desired objective.

As I am in the midst of putting together a couple new plans for portfolio strategies I am building, I am reminded that individual stock selection is nowhere near a top priority. In fact, it’s much closer to the bottom.

If you have questions about setting up a proper trading system, feel free to shoot me an email and I will get you started in the right direction.

Trent. J. Smalley. CMT