The 10 tests of a good trading strategy

There seem to be a plethora of trading strategies hitting my desk at the moment – the “to test” pile is getting every higher.

Knowing whether a system is right for you or not, is always tough. And when there are so many to chose from – it just gets harder.

Which is why I thought it might be a good moment to recap on my checklist of what I look for in a trading system.

Here are 10 filters that you can run through to judge whether any system is up to scratch, and the right one for you …

1 • Can I make the time commitment?

If a trading system requires that you spend 8am–midday glued to your computer screen, and you have a day job, chances are that it’s not for you.

Likewise, if it involves placing a trade at 6am each morning, and you’re more of a night owl – it’s unlikely that you’ll manage to stick with it.

2 • Do I have the necessary funds?

Some systems require a large initial investment, especially if they use wide stop losses and require you to hold multiple positions at one time. Check what funds are required.

3 • Does it come with any guarantee?

If the person or company selling this system doesn’t have enough faith in it to offer you a guarantee, then I can’t see any reason why you should have any faith in it.

4 • Do I trust the source of this strategy?

Do the sellers include full contact details? Are they a registered UK company? If you can’t track down the company, then you may have problems fulfilling the guarantee.

So, if you’re happy with your answers to these questions … let’s move on to the interesting bit – the profits!

5• Are its claims genuine?

£25,000 in your first month …? £300,000 by the end of the year …? £1,500 by tomorrow morning …?

Anybody who wants to sell something, will want to show it in its best light – that’s fair enough. BUT many trading products are downright misleading in their claims.

Here I’d like to show you the tricks they use – and how you can get to the real bottom line …

6 • Are they using crazy staking plans?

Sure, you might have £1,500 by tomorrow morning if you were prepared to risk £1,000 – and you won! Yes, you may have made £300,000 in the next six months if you’ve a spare £100,000 to spare today and are willing to take some hefty risks with it.

These big numbers sound very tempting, but taken alone, they tell you very little about the profitability of a trading technique.

You’re better off paying attention to the percentage gains that you can make, or the number of pips gained. And always bear in mind that they may be risking a greater percentage of their pot that you’d be willing to do.

7 • Have they included financing charges?

Do they include the cost of the spread, slippage and the financing charges in their track record? Often, these costs aren’t factored in and will make a significant difference to the returns you get.

8 • Are the results back tested only?

No doubt you’ve heard the saying that “hindsight is always 20:20” – and nowhere is it more true than in trading histories!

Back testing has a genuine place in the creation of trading strategies, but it is something that is easily misused in the hands of marketers trying to sell systems.

Back testing is the process of applying a trading technique to historical data in order to verify how it would have performed in that period.

Sounds fair enough – but the simple fact is that because of the knowledge we have about the past, it’s far easier to create a profitable system that will work on historical data than one that’ll work in the future.

Backtesting software comes with “optimization” features that allow for strategies to be tweaked to perfection – and these features are too often misused by system creators.

Optimization on past data means that stop losses and profit targets can be tweaked to perfection, any uncomfortable losses can be taken out of the equation by introducing new “rules” – it can make what looks on first glance like a glowing track record. But, none of this means that it will work in live market conditions.

9 • Is it being traded live, and by who?

Nothing beats strict forward testing of trading results – i.e. someone live trading it in the market.

When I look at a trading system, I want to see live trading results. I want to know that the systems creator is genuinely trading that strategy. (You’d be amazed how often this isn’t the case!)

Why on earth should I risk my money if the system’s creator isn’t prepared to prove that he or she is doing the same!

Plus, I like to see some testimonials from ordinary traders – are they able to replicate the creator’s results, or is the system just too tricky to follow?

10 • Am I being realistic?

What I’ve laid out above are some pretty stringent requirements.

In Trader’s Bulletin I like to draw your attention to the strategies that best meet these demands, but I’ll be honest with you – it’s unusual to find a trading technique that ticks every box.

And, what suits one trader, might not suit the next person.

Different traders will have different demands when it comes to returns, to risk profiles, and to risk/reward ratios.

And, of course, even comprehensive forward testing can’t guarantee that a system will continue to be profitable in the future – but at least you know where you stand and that it hasn’t had the “spin doctor” treatment.

Over the coming weeks, I’ll be passing on recommendations of trading products that I’ve tested and am happy to give the thumbs up to.

I’ll also be sending you more free trading resources, trading advice, and technical-analysis tit-bits!

Related posts:

How to choose the right trading strategy Exposed: 3 trading tricks the “gurus” use