Use the 3-D Process To Keep Your Trading on Track

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Use the 3-D Process To Keep Your Trading on Track

Trade long enough and you will start to notice some usually regular and potentially destructive habits in your trading. You may chase trades, entering at a later point than your strategy dictates because you fear missing a trade. You may have trouble holding through a few gyrations in the market because you are impatient in waiting for your profit. You may risk too much on each trade, always finding yourself with a severely diminished account after a string of losses. Whatever your particular habits are, once you have identified them, you can use the 3-D process to start overcoming them.

A trading issue is usually linked to some type of emotion which is compelling you to continually repeat your actions. Continually risking too much on each trade is either from lack of knowledge (see: Determining Binary Options Position Size), or impatience with letting the account grow at a slower, risk-controlled rate.

For your particular issue, work through the following three step to help discover the beliefs which are causing your issue.

  • Ask yourself what feeling you have when the issue arises? Is it fear, hope, greed, anger…?
  • What is your internal dialogue as the issue occurs? Are you afraid taking a loss? Are you afraid your profit will disappear? Are you afraid to take an opportunity, or afraid of missing one? Are you greedy and wanting more from a trade than it can offer, or your capital allows for?
  • Isolate the belief causing this internal dialogue. If you continually risk too much on trades your belief may be “I need to capitalize right now because another opportunity may not come up.” Obviously this belief is false. There are plenty of trading opportunities which means risk can spread out, and there is no need to take large risk on a single trade. But until the belief is uncovered and then logically discredited, it will continue to wreak havoc on your trading.

The next step is to determine your course of action. While most issues can logically discarded with a bit of practice, some issues may require additional attention. This may mean talking with someone, such as a mentor or asking others in forums how they overcame an issue/belief, but ultimately this is the step where you choose to do something about the issue and not just let it ruin your trading.

Once you have uncovered the belief–such as “the market will take my money” if you are afraid to take trades–the first step is to see if you can just “logic” your way into no longer listening to the belief. In this case, the market doesn’t have a motive, it is just is. If you have prepared, thoroughly tested your strategies and have a solid trading plan, then this is an illogical belief. On the other hand, if you are unprepared for trading, then this belief is possibly valid and you need to more thoroughly prepare for trading. Take action to refine your trading approach, study, personally test strategies in a demo account.

Your goal here is to take action, both internally and by way of your actions to overcome the issue.

Now you hopefully have a handle on the issue you’ve been dealing with. But the work isn’t done. While your trading may just get better, more than likely you’ll need to implement a design for how you will handle this issue should it arise in your trading again.

Say you have a tough time holding through gyrations and letting the market hit your target. You realized you have a belief that “I am always wrong and market won’t hit my target.” These may be true or untrue, so in the determination stage you decided to check out your plan, make sure you had good strategies, that the strategy works in a demo account and that targets are placed at areas which are likely to be reached. If you have done this, you now need to let go and let your strategy do its work.

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Your design may be to walk away from your screen while you are in a trade so you don’t pre-maturely exit (assuming you have a stop and target on the trade). Your design may also be force yourself to watch the trade, but you can’t make any mid-trade adjustments–either the target gets hit or the stop loss gets hit. Your design may be to keep a trade journal while you trade so you can write about your feeling instead of impulsively acting on them. In these ways, through practice you’ll get used to holding trades while the market moves back and forth.

Trading issues require serious work. We all have certain tendencies which hurt our profitability, but by discovering what they are, determining what to do about it, and then designing a plan for how we will use the new found insight, we can potentially overcome our trading problems. This process won’t happen overnight, and requires taking personal responsibility instead of blaming the market or brokers for our losses.

How to Keep Track of Your Day Trading Gains and Losses

After you put your day trading strategy to work during the trading day, it’s easy to let the energy and emotion overtake you. You get sloppy and stop keeping track of what’s happening. And that’s not good.

Day trading is not a video game; it’s a job. Keeping careful records helps you identify not only how well you follow your strategy but also ways to refine it. These records can also show you how successful your trading is, and it makes your life a lot easier when tax time comes around.

Set up your spreadsheet

The easiest way to get started tracking your trades is with a spreadsheet. Set up columns for the asset being purchased, the time of the trade, the price, the quantity purchased, and the commission. Then set up similar columns to show what happens when the position is closed out. Finally, calculate your performance based on the change in the security’s price and the dollars and percentage return on your trade.

Some brokerage firms and trading platforms automatically store your trade data for analysis. You can then download the data into your own spreadsheet or work with it in your trading software, making analysis simple. If you make too many trades to keep track of manually, then this feature will be especially important to you.

Profit and loss statement

If you look at the bottom of the trade tracking spreadsheet, you see some quick summary statistics on how the day’s trading went: trading profits net of commissions, trading profits as a percentage of trading capital, and the ratio of winning to losing transactions. This information should be transferred into another spreadsheet so that you can track your ongoing success.

At the end of the trading week, calculate your hourly wage. That number, more than any other, can help you see whether it makes sense for you to keep trading or whether you’d be better off pursuing a different line of work.

The trading diary

A trading diary gives you information to systematically assess your trading. Write down why you are making a particular trade when you make it. (If you wait until later, you’ll forget, and you’ll change your logic to suit your needs.) Was the reason because of a signal from your system? Because of a hunch? Because you saw an opportunity that was too good to pass up?

Some traders create a form and make copies of it so they can easily fill them out during the day. They even create predetermined indicators that match their strategies and that they can check off or circle. At the end of the day, they collect their diary sheets into a three-ring binder that they can refer back to when the time comes to evaluate their trading strategy and performance.

If your trading style is so fast that you don’t have time to fill it out, come up with some kind of shorthand that lets you keep a running tally of trades made based on a signal from your system, trades based on your own hunches, and trades based on other interpretations of market conditions. Then match your notes against the trader confirmations from your broker to see how you did.

Build a Profitable Trading Model In 7 Easy Steps

A trading model is a clearly defined, step-by-step rule-based structure for governing trading activities. In this article, we introduce the basic concept of trading models, explain their benefits, and provide instructions on how to build your own trading model.

The Benefits of Building a Trading Model

Using a rule-based trading model offers many benefits:

  • Models are based on a set of proven rules. This helps remove human emotions from decision making.
  • Models can be easily backtested on historical data to check their worth before taking the dive with real money.
  • Model-based backtesting allows verification of associated costs so the trader can see profit potential more realistically. A theoretical $2 profit may look attractive, but a brokerage charge of $2.50 changes the equation.
  • Models can be automated to send mobile alerts, pop-up messages, and charts. This can eliminate the need for manual monitoring and action. With a model, a trader can easily track 10 stocks for 50-day moving average (DMA) crossing over 15‑day moving average. Without such automation, manually tracking even one stock DMA can be difficult.

How to Build Your Own Trading Model

To build a trading model, you do not need advanced-level trading knowledge. However, you do need an understanding of how and why prices move (for example, due to world events), where profit opportunities exist, and how to practically capitalize on opportunities. Novices and moderately experienced traders can start by becoming familiar with a few technical indicators. These offer meaningful insights to trading patterns. Understanding technical indicators will also help traders conceptualize trends and make customized strategies and alterations to their models. In this article, we will focus on trading based on technical indicators.

Example of a Simple Trading Model Strategy

Based on the principle of trend reversal, some traders act on the assumption that what goes down will comes back up (and vice versa). Using the assumption of trend reversal as a strategy, we will build a trading model. In the steps below, we will walk through a series of steps to create a trading model and test if it is profitable.

Flowchart for Building a Trading Model

1. Conceptualize the Trading Model

In this step, the trader studies historical stock movements to identify predictive trends and create a concept. The concept may be a result of extensive data analysis or it could be a hunch based on chance observations.

For this article, we are using trend reversal to build the strategy. The initial concept is: if a stock goes down x percent compared to the previous day’s closing price, expect the trend to reverse in next few days.

From here, look at past data and ask questions to refine the concept: Is the concept true? Will this concept apply to only a few selected high-volatility stocks or will it fit any and all stocks? What is the duration of expected trend reversal (1 day, 1 week, or 1 month)? What should be set as the down level to enter a trade? What is the goal profit level?

An initial concept usually contains many unknowns. A trader needs a few deciding points or numbers to begin. These may be based on certain assumptions. For example: this strategy may apply on moderately volatile stocks having a beta value between 2 and 3. Buy if stock goes down by 3 percent and wait for next 15 days for trend reversal and expect a 4 percent return. These numbers are based on a trader’s assumptions and experience. Again, a basic understanding of technical indicators is important.

2. Identify the Opportunities

In this step, identify the right opportunities or stocks to trade. This involves verifying the concept against historical data. In the example concept, we buy on a 3 percent dip. Start by choosing high‑volatility stocks for the assessment. You can download historical data of commonly traded stocks from exchange websites or financial portals like Yahoo! Finance. Using spreadsheet formulas, calculate the percentage change from the previous day’s closing price, filter out the results matching the criteria, and observe the pattern for following days. Below is an example spreadsheet.

In this example, the stock’s closing price is going down below 3 percent on 2 days (February 4 and February 7). Careful observation of the following days will reveal if the trend reversal is visible or not. The price on February 5 shoots up to 4.59 percent change. By February 8, the change is below expected at 1.96 percent.

Are the results conclusive? No. One observation matches the expectation of the concept (4 percent and above change) while one observation does not.

Next, we need to further check our concept across more data points and more stocks. Run the test across multiple stocks with daily prices over at least 5 years. Observe which stocks give positive trend reversals within a defined duration. If the number of positive results is better than negative ones, then continue with the concept. If not, tweak the concept and retest or discard the concept completely and return to step 1.

3. Develop the Trading Model

In this stage, we fine tune the trading model and introduce necessary variations based on assessment results of the concept. We continue to verify across large datasets and observe for more variations. Does the strategy outcome improve if we consider specific weekdays? For example does the stock price dipping by 3 percent on a Friday result in a cumulative 5 percent or more increase within the next week? Does the outcome improve if we take high-volatility stocks with beta values above 4?

We can verify these customizations whether or not the original concept shows positive results. You can keep exploring multiple patterns. At this stage you can also use computer programming to identify profitable trends by letting algorithms and computer programs analyze the data. Overall, the aim is to improve the positive outcomes from our strategy leading to more profitability.

Some traders get stuck in this stage, analyzing large datasets endlessly with slight variations in parameters. There is no perfect trading model. Remember to draw a line on testing and make a decision.

4. Perform a Practicality Study

Our model is now looking great. It shows a positive profit for a majority of trades (for example, 70 percent wins of $2 and 30 percent losses of $1). We conclude that for every 10 trades, we can make a handsome profit of 7*$2 – 3*$1 = $11.

This stage requires a practicality study which can be based on following points:

  • Is the brokerage cost-per-trade leaving sufficient room for profit?
  • I may have to make up to 20 trades of $500 each to realize a profit, but my available capital is just $8000.Does my trading model account for capital limits?
  • How frequently can I trade? Is the model showing too frequent trades above my capital available, or too few trades keeping profits very low?
  • Does the theoretical outcome match with necessary regulations. Does it require short selling or long dated options trade which may be banned, or holding of simultaneous buy and sell positions which may also not be allowed?

5. Go Live or Abandon and Move to a New Model

Considering the results of the above testing, analysis, and adjustment, make a decision. Go live by investing real money using the trading model or abandon the model and start again from step 1.

Remember, once you go live with real money it is important to continue to track, analyze, and assess the result, especially in the beginning.

6. Be Prepared for Failures and Restarts

Trading requires constant attention and improvements to strategy. Even if your trading model has consistently made money for years, market developments can change at any time. Be prepared for failures and losses. Be open to further customizations and improvements. Be ready to trash the model and move on to a new one if you lose money and can find no more customizations.

7. Ensure Risk Management by Building in What-If Scenarios

It may not be possible to include risk management in selected trading model depending on chosen strategies, but it is wise to have a backup plan if things don’t appear to be as expected. What if you buy the stock that went down 3 percent, but it did not show trend reversal for the next month? Should you dump that stock at a limited loss or keep holding on to that position? What should you do in the case of a corporate action like a rights issue?

The Bottom Line

Hundreds of established trading concepts exist and are growing daily with the customizations of new traders. To successfully build a trading model, the trader must have discipline, knowledge, perseverance, and fair risk assessment. One of the major challenges comes from the trader’s emotional attachment to a self-developed trading strategy. Such blind faith in the model can lead to mounting losses. Model-based trading is about emotional detachment. Dump the model if it is failing and devise a new one, even if it comes at a limited loss and time delay. Trading is about profitability, and loss aversion is in-built in the rule‑based trading models.

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