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Importance Of Trading System In Stock And Commodity Trading Business
Many people take up trading stocks and futures to earn some extra money. Some take up trading as their full time job. Majority of them start trading without knowing the basic rules of stock trading business. Stock trading is not the practice of going to your broker’s office and give buy or sell orders. It is not the act of following your broker’s advice or any other analyst’s advice. Stock trading is a mind game in which your emotion plays a very important role. It is the homework, you do before buying or selling any particular security or future that counts in this business of stock trading. Trading is not following some fundamental economic indicators. You often hear advices that, such company has made so much profits, so you should buy it or worldwide tea production has declined this year, so you should buy tea stocks. It is generally seen that, such fundamental news has always been discounted in the price of the stock or future and the corresponding move in its price has already taken place before the trader takes position according to such fundamental news. So, you can not predict the price movement of stocks or futures on the basis of such fundamental news or indicators.
You, therefore, need an objective method, which can give you specific buy and sell points. You also need to find out the specific levels at which you should book profit or loss. Technical analysis is the method, you should use to achieve this. In technical analysis the only input is ‘price’. The basic postulates of technical analysis says that, all factors affecting prices of stocks or commodity futures are always factored in the their price data. You have to use these price data to find out the values of different technical indicators, which will help you to predict price movement of stocks or commodity futures, in advance, with reasonable degree of certainty. Such prediction always has some amount of uncertainty. So, what you find out is the probability of a move to occur. Thus, technical analysis only finds out the probability of a move from a particular level. You may find out 20 day moving average (20 DMA) of any security. If the price of any security crosses 20 DMA in the downward direction, it implies that the price may go down. It act
1000
ually means that, the probability of getting a downward movement is high i.e. the probability of getting a return when traded in that direction is high. In other words, you can expect that the probability of getting an upward movement from this point is low i.e. the probability of getting an adverse movement in the upward direction or the risk is low. So, you may have a risk and return ratio in your favor. This is the only type of opportunity in the stock or futures market, you should look for to deploy your funds for taking up any position in that security. However, finding out such high probability levels does not guarantee you a profit. Probability always means uncertainty (or certainty). You should, therefore, always try to protect yourself from any movement opposite to your desired direction resulting in loss. Probability of such a movement is always there, though less, as compared to that in your favorable direction, which you predicted with the technical analysis methods or indicators.
You, therefore, should book your losses short in case of any adverse movement of price. On the other hand you have to trail your profits, if you really get the favorable price movement in your expected direction.
In each of your trade, you have to follow a preplanned trading action. You must write down what you will do, if certain things happen after your taking position in any security or future contract. You must write down such plans. You must also back test such plans over the historical price data of the concerned security. Such written trading plan is called a ‘trading system’. A trading system is utmost important tool which you use to arrest the irrational and uncertain behavior of the market of trading instruments. The accuracy level of the trading system should be at least 50%. 50% accuracy level means, if you take 100 trades, then in 50 trades your predefined profit target levels will be achieved and in the other 50 trades your predefined stop loss is hit. Since, you always have stop loss and profit target in the ratio of 1:2 or 1:3, you will make net profit. You may have different trading systems for different securities. There are certain trading systems which work for several securities or futures. Some trading systems may be useful to trade Dow , but they may not be useful in trading Intel. Some may be useful to trade soybean, where they may not be so good in trading gold or silver. There are some systems which have been used by the traders widely and which are effective for many kinds of markets. Some trading systems are chart based whereas some are technical indicator based. Whatever may be the trading system, you need one for your stock trading business. A solid, back tested trading system with at least 50% accuracy is all you want to have to successfully run a stock trading business.
These trading systems will also make your trading mechanical and emotion free. The use of a trading system will also save you from the evil of over trading. You just have to be mentally prepared to follow rigidly your trading system and earn consistent profit from share market.
By: systemtrader
Article Directory: http://www.articledashboard.com
The author of this article advocates the use of mechanical trading system. He runs a web site www.tradingcats.in.
Visit the above web site to read a free stock trading course spread over 20 chapters. He may be contacted at mailtradingcats@gmail.com
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Posted under Stock Market Trading Systems
This post was written by admin on February 9, 2010
