I’m not going to s**t you… building a trading system from scratch is a pretty big job.
You are going to be spending a few months hunched over charts and excel spreadsheets tinkering and measuring like a mad scientist. I love it, but I’m a weird animal.
No wonder most people want to short cut the process by taking one of my systems (or someone else’s) and modifying it to suit.
But lets say you don’t want to take that easy path.
Where do you even start?
Here’s a huge pro tip. Probably the BIGGEST tip I can give any aspiring system trader.
Probably 95% of professional trading systems use THE SAME BASIC EDGES, just framed in a different way.
My buddy Ernest Chan is an ex Morgan Stanley Quant, and he literally wrote the textbook on algo trading (this is the book). Wanna know what his two production systems are?
A mean reversion system for FX and a breakout system for futures.
Nothing fancy, nothing flashy. Solid. Dependable.
You know what the vast majority of my trades are? Trend following and mean reversion.
You know what virtually every trend following fund uses as an entry technique for their systems?
Almost every one of the top 10 trend following firms uses 50 day breakouts for entry. Sure some of them scale in, some of them do things a little bit different… but for the most part these guys are in almost the same positions at the same time.
For good reason. When you are betting real money you want to extremely sure you are going to make it back.
And every real trader knows how badly we can fool ourselves. I’m particularly susceptible to believing all kinds of BS about markets which just isn’t true.
We all are, if we are being honest.
So the pros stick to the classics.
Like an 80’s cover band. Like 90’s rap music. The classics never go out of style.
So your first port of call when thinking about an edge to build a system should be the SAFE, SOLID CHOICES. I’m talking breakouts, pullbacks in uptrends, opening gaps, mean reversion, intermarket correlations, momentum.
Stuff that isn’t controversial in any way, shape or form. Forget your Gann angles and Kondratieff cycles… stick to the classics.
So, let’s get to work. You need to build a system that is congruent with your market beliefs.
Can we all agree that this statement is a pretty decent statement?
You want to buy pullbacks in uptrends in strong stocks in a bull market. (you really do)
Let’s unpack that statement a bit.
1) Pullbacks in uptrends
2) In strong stocks
3) In a bull market
We can (and will) come up with black and white definitions of all of those things… then put them into a system and start optimising and testing.
But think about how much time we have saved here, and how much risk (of building a crappy system) we have avoided.
We are 99% sure that the system has a basis which is real, observable every day, and explainable in terms of market psychology.
Everyone knows pullbacks in uptrends are an edge. Test it any way you like. Rock solid.
Why on earth would we even bother with fancy-pants custom indicators and esoteric theories, unless they are just to confirm the fundamental thing we already know.
“That pullbacks in uptrends in strong stocks in a bull market have an edge”
Which brings us to the next logical question I’m sure you are thinking of right now.
How do we know which is a good pullback to buy, and which ones are going to keep falling?
We don’t… but we can tweak the odds in our favour by BEING SPECIFIC. This is a key concept in designing high probability entries that we cover in the System Building Masterclass (currently closed for new members)
Some ideas we could test. We could set a MINIMUM PULLBACK. That could be a minimum Fibonacci retracement. It could be a close below a significant moving average. It could be a number of consecutive lower closes.
It could be oversold on whatever indicators you personally favour.
Choose whichever fits with the technical analysis you already use. What I mean is that if you don’t like moving averages, don’t use them. The CONCEPT is what is important, and the concept here is that we should start looking to buy the dip when we have a decent pullback.
Here I’ve put a 50 period exponential moving average over Facebook’s chart for illustration purposes.
So those 4 little boxes in the chart above are nice places for us to get long.
But what sort of entry pattern lets us get long on a pullback with confidence?
Answer is the RETEST PATTERNS (from the Price Action Masterclass here.)
What you are looking for is a big low, then a move up, and a move down which doesn’t break the low.
Here are the exact rules
1) Touch or below 50 EMA forming a low
2) One or more higher closes (higher than the previous bar)
3) One or more lower closes without breaking the low in (1)
4) Buy if price breaks above the high of the bar in (3)
Why does this work better than just buying the dip?
Because you have evidence the dip is over. From experience I can tell you that a perfect trade isn’t the one that makes you the most money.
A perfect trade is the one that doesn’t cause you any grief. You buy it, it starts going up, and keeps going up. You never worry about it, never stress.
The retest entry (after a suitable dip) gives you a wonderful place to put your stop loss, and an entry when the market is moving in your favour. It’s the perfect entry for bull markets, and a solid candidate to build your system around.
You could also just keep it simple and buy on a close above a moving average of your choice after a pullback.
What kind of system are YOU planning on building?
Truth telling time now. If you aren’t trading with a system, eventually you are going to mess it up. Honestly, trading whatever we want whenever we want is just too difficult in the long run to manage. I certainly can’t do it, and only a handful of people I’ve ever met are that good.
So if you’ve tried to trade the hard way and failed… take heart my brothers and sisters it was NOT YOUR FAULT it didn’t work out. You just tried to drive the formula one car before you learned to drive the Camry.
Time to get back to basics and BUILD A SYSTEM THAT SUITS YOU!
If you didn’t watch video 1 from the free system building training in yesterday’s post) I STRONGLY SUGGEST you do. In it I show you how to narrow down exactly what sort of trading system you should build and how to get started.
It is part of a 3 video series where I teach you what you need to know to build a system of your own.
For those who asked, the System Building masterclass is temporarily closed now but the dramatically beefed up and revamped version comes out October 3rd. Actually on October 3rd 7pm EST to celebrate I’m giving a free webinar where I’ll teach you my core trend following system.
If you’ve been to one of my webinars before you know that I’m just going to cram knowledge down your throat solidly for about 90 minutes while you try and drink from the fire hose.
I’m excited as hell, don’t miss it (I’ll have a link to sign up tomorrow)
The next System Building Training Video will come out in a few days.