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Designing a trading strategy is one of the most important things you will do as you trying to get your career as a traitor off the ground. Much like determining your goals, if you do not have a trading strategy you are simply swinging wildly and a market that is dominated by professional traders who have access to an almost unlimited amount of knowledge and capital. After all, some of the people in this market to you are jumping into are trading for large banks and hedge funds, and therefore have massive amounts of support, well beyond what the individual trader will have. With that being the case, it’s very important that you decide how you want to trade by developing a strategy BEFORE you start trading with real money. In other words, you are going to need a demo account, which is easily found at most brokerages. You need to figure out what indicators, position size, trend following mechanisms, or anything else that you feel comfortable with in order to make money. While there are a multitude of trading strategies freely available on the Internet, the most important thing is to be able to trust your strategy. The only way you can do that is if you will build up some type of history with that particular strategy, via the demo account. For example, you can have a strategy that’s proven to work overtime, but if you are not comfortable trading it, you WILL mess it up. But by having a history with this particular strategy, you know that over the longer term you were going to make money all things being equal. Most strategies can work overtime, it really comes down to the trader and whether or not they have the ability to follow that strategy. Most do not, and that is one of the biggest reasons why people lose money in the markets. If you have a strategy that averages a 15% return every year, you truly can make money like that, but you have to be able to trust and follow your trading strategy. By far, that is the biggest challenge the traders tend to face.

Systematic trading involves a trading system that says wind certain conditions are met, you place a trade in one direction or the other. It leaves very little to the imagination, and simply gives you a “buy, hold, or sell signal.” Most traders use some type of system, as it gives them a framework from which to trade the markets. By contrast, discretionary trading involves simply making a decision on a spur of the moment type of calculation. An example of systematic trading might be using something like a moving average crossover system. In this chart, I use a classic 10/20 moving average crossover system. You can see on the chart that it worked really well on one particular trade, but on the other hand you get quite a bit of chopped that would’ve cost you a few pips here and there. Ultimately, we are in a move now that looks proper one the opposite direction. That’s an example of how a system works, you get the signal and you simply do what it tells you. Discretionary trading could keep you out of this trade because it involves your best educated guess in a sense. For example, there might have been an economic announcement coming out that might have kept you out of all of the choppiness. On the other hand, when you look at the weekly chart of the AUD/JPY pair in this chart, you can see that we have been in a downtrend for some time. Discretionary trader may just simply sell this market occasionally, expecting to eventually make money based upon the overall trend. The reality is that most traders use discretion even if they are systematic trader, simply because it involves a lot of common sense. For example, Nonfarm Payroll numbers could be coming out shortly, and if you get a signal to start buying or selling, you may stay out of the market simply because you know how volatile that can be. With fact, you are using discretion along with a system. Truthfully, it’s very rare to be a systematic trader with no discretion, which in a sense tends to lend itself to people who use expert advisors, or what are known as trading robots. Most traders will try to be a systematic as possible, but you have to use some discretion so that you don’t make really dumb choices. As an example, entering a CFD market for the S&P 500 right before the Nonfarm Payroll announcement is simply gambling, and as a result you would more than likely step away. Discretionary trading can involve simply selling in a downtrend in stepping away. They may not even have put on a stop loss at that point in time, which could be very dangerous. Having said that, some traders will buy options to offer put any significant moves while they sleep. Truthfully though, most people, and most successful traders I know, will use a little bit of discretion with their systems.

One of the most important things you can do as a trader is to determine your goals. Quite frankly, if you do not have some type of idea of what you are trying to accomplish, you will simply find yourself trading blindly, and probably impulsive. Simply put, the easiest goal to come up with is to be profitable. Obviously, you are not looking to lose money, but there are many nuances about trading that you need to think about before throwing money into the market. One of the biggest mistakes traders make is that they come up with unrealistic goals. For example, there are a lot of products out there that will tout the idea of making a ridiculous amount of money. Recently, I have seen a black box system suggests that 50% returns per week were common. If you do the math, a 50% return is absolutely outrageous, as the compounding interest will turn $100 into over $1 million in just 23 weeks. This is not realistic, and anybody telling you anything different is obviously trying to sell you something. Not all goals have to be based on returns. After all, you want to perhaps have a goal of sticking to your trading strategy. Or perhaps you have a goal of being able to trade just one particular hour out of the day. You can also find yourself trying to trade only long-term trades, more or less like an investor and as a passive type of business. There is a multitude of different things that you can think of in order to determine goals, as some people will simply do it for entertainment, while others will try to make a living off of a larger account. Other people will use the account to grow money while adding money into it every paycheck, so that they can speed up the rate of compounding. Either way, you need to know where you’re going first in order to have some of the most important things that a professional trader can have: a trading strategy, a risk management system, a set of rules from which to operate, and quite frankly some organization to your trading day.

The Sharpe Ratio that is referred to in the financial world is named after William F. Sharpe, a Nobel laureate in economics. It’s simply a measure of calculation for a risk-adjusted return and is the industry standard when it comes to doing such things. That’s the average return earned in excess of what is considered to be risk free assets. In general, this normally is suggested as US Treasury bills, which is considered to be “risk free.” The Sharpe Ratio works as follows: the average rate of return for your portfolio is subtracted by the best available rate of return of a risk-free security. Then, you divide that number by a standard deviation of the portfolio’s return. Essentially, a return of “zero” is the same as a treasury bill. A number of 1.0 or above is attractive, a return of 2.0 is even better, and one of 3.0 is excellent. These numbers are used to compare one portfolio to another, in order to see whether you are getting acceptable returns for holding risky assets over risk-free assets. Essentially, it’s a way to compare 2 portfolios in an even playing field.

Paper trading, or using a demo account, is the first step in learning how to trade. After all, you have to be able to know whether or not your even capable of making money in the markets before you can risk any significant amount. By using the demo account, you have the ability to take risk without actually risking any money. This of course is a big deal, as it gives you the opportunity to trade various systems or methodologies and see how they work out. Most professional traders have paper trading accounts most of their lives. They are constantly looking to improve their returns, and as a result they are normally trying new methodologies for indicators or other such things. A demo account is the perfect place to do this because you have absolutely no real risk. Most brokerages offer demo accounts, and it’s very rare that you will find one who doesn’t. In fact, as a general rule you should probably avoid the shops, as it’s a very basic thing to ask. Quite often, traders will use a live account simultaneously to trading a demo account, as the one great thing about trading is you will never know everything. There is always something new to learn.