10 Steps to build a great stock market trading system

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10 Steps to a Professional Stock Market System

After you have undergone stock market education in fundamental and technical analysis you will be ready to start to create your Stock Market Trading System. Of course any good educational service in the equities/security space should help you to create this system yourself.

Developing a stock trading system is about combining logic, knowledge, experience, art and science. Your system will need to perform well (higher than 6% on average per year) both historically and be expected to perform well in the future at least for the time-frame in which you expect to use it. The “Nirvana” of a trading system is that it would need to perform well and need little “user interpretation” for it to function. This would mean using  “trading robots” or a mechanical method. I do not recommend a trading robot that would place your trades for you as this will essentially take any on the fly decision making out of your hands.  However you should use a mechanical method (computer) to help you test your systems and create the buy and sell signals for you.

In this context your systems would have the following requirements.

  • A good stock trading system will need to be back-tested to prove that it worked in the past. This would give us an element of proof that the logic upon which we base our assumptions are functional.
  • A good system allows us to trade with less emotion providing a market advantage. Emotion is known to be the culprit of many trading errors and losses.
  • Automation of the fundamental screening for the stocks will save us a lot of time.
  • Automation of the Technical Indicators Scan will also narrow the list further to enable us to focus only on our preferred candidates.

Step 1 – Get educated

Take a high quality stock market training course.  This site has a FREE 10 module Stock Market Training Course, covering fundamental and technical analysis.  For help on choosing a quality stock market education read this Stock Market Training Review.

Step 2 – Choose your favorite time-frame for trading / investing

If you have the time to fully immerse yourself in the Stock Market you might want to trade shorter time-frames (days to weeks).  If you have a full-time job and less free time available you may want to trade longer time-frames and only monitor your stocks on a weekly basis.

Step 3 – Choose your favorite Markets

As an active trader you should choose your Stock Markets wisely.  If you want to be active (checking your stocks intra-day or on a daily basis) then is may be wise to trade a stock market that is not in your time-zone.  For example, Mr. Smith has a busy day job and only has time free in the evening.  Mr. Smith is based in India.  Normally he would want to trade the Indian Stock Market.  But actually the European Markets might be a good choice as they open close to the end of his working day.  Therefore he can dedicate and focus his spare time on the stock market in question.

If you are a less active trader, then it might be wise to trade the stock market in your own time-zone as you may have the advantage of being able to spot successful companies in your country and investigate them further using your “Local Knowledge”.

Step 4 – Understand what your profit target is

What is your target?  Active traders should expect higher returns/profits as they will be spending more time trading the market.  Less active traders might expect a slightly lower return as the trade off for not being as focused. But what is a good target.  Do not believe the scam artists of “Penny Stocks Newsletters” and  peddlers of “Microcap Stocks” ; in the real world 100% or 1000% profits are not realistic, in fact it is irresponsible that they would promote their services in this way.

Warren Buffet has averaged just over 24% annual return over his entire career.  That is just 2% per month.  Realistically you should choose this as a viable upper target.

Step 5 – Select your favorite Fundamental Screens

Capitalization, Earnings Per Share, Earnings Acceleration, 5 year revenue % increase, Price Earnings Ratio.  If these terms are simply vague notions to your, please go back to step 1.

Step 6 – Select your preferred Stock Market Indicators using technical analysis

What Charts should you use?

What indicators should you use?

  • Price Indicators – the study of price based chart indicators or Oscillators know as Stochastics,”Relative Strength” (RSI), “Rate of Change” (ROC), “Moving Averages” (MA), “Moving Average Convergence Divergence” (MACD), Parabolic SAR, ADX Average Direction Movement Index.
  • Study of Volume – understanding how the level of volume has a relationship with price – and how price has a relationship with volume.
  • Study of Price Volume Indicators – “On Balance Volume” (OBV), Chaikins Money Flow, “Time Segmented Volume” (TSV), MoneyStream.

Step 7 – Turn your previous choices into specific  rules

Quantify your choices of the fundamental screens and technical analysis screens.

At what point would you by?

  • When the 10 day Moving Average crosses the 20 day moving average and holds above price for 2 days?
  • When RSI holds above the RSI 5 days Moving Average for 2 days?

At what point do you sell?

  • When MACD turns negative?
  • When you see a negative divergence in Money Flow?

Step 8 – Run your rules and back test

Using back-testing software you can start to implement your rules and see if they actually work historically. This is a fascinating and immersing topic.

Most Stock Market Analysis Software allow you to back-test your theories to see if they work historically and some even allow you to do forecasting forward.  One of the easiest to use is Telechart 2000 and one excellent choice for forecasting forward is MetaStock

If the systems produces the targets you expect, move to step 9.

Step 9 – Let your rules run

Let your rules run for a week or two to see if it continues to perform.

Step 10 – Go or No Go

If successful – Implement the system – If unsuccessful – tweak the system and start again from step 5.

If your rule are working then implement your system, start to trade it.  If not you may need to refine the system.  The best systems have been refined over and over again to remove logical errors and improve the percentage of winning trades and the % of the profit per trade.

The results of a great stock trading system

Building and running a trading system takes time, a logical mind and patience.  Many successful traders have started to make losses because through boredom they have deviated from their winning system or strategy.  Try not to make the same mistake.

The results will be profits and plenty of them.

Good luck and may the trade be with you.

 

7 COMMENTS

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