Once in awhile, I get emails asking me to review a trading strategy (and tell the trader what's “wrong” with it).
Most of the time, the trader is trading an Idea, not a Strategy. If you aren't familiar with the difference, then this post will show you how to tell.
There are actually two stages that come before you have a proven trading Strategy. You need to go through all three stages, in order to have a trading method that works and that you are confident in.
If you choose to ignore these steps, you can end up spinning your wheels for years. I would like to help you avoid that fate.
Stage 1: Idea
An Idea is a very general concept. It could be something like:
- “I notice that the Asian Drift usually goes in the opposite direction of the actual trend for the day.”
- “Looking for a strong trend on the daily chart, then waiting for a pullback on the one hour chart looks like it would be profitable.”
- “Price tends to reverse at daily pivot points.”
However, some traders mistake these generalizations for a trading Strategy and start trading it in their live account.
That obviously never ends well.
Don't get me wrong, the overall concept behind a lot of trading Ideas are sound. But if you don't test and apply them in a uniformed manner, you have zero chance of becoming consistently profitable.
These simple Ideas could be traded in so many ways.
That's why you need a Sketch…
Stage 2: Sketch
Here's where things get interesting.
An Idea is a general hypothesis on how to profitably enter the market. But a sketch takes it one step further and defines specific trade entry, management, exit parameters and more.
- Will you scale in to the trade or only have one entry?
- Will you scale out of the trade?
- Will you add to a winning trade (pyramid)?
- Are there certain days that you should not be trading?
- How do you know if you should bail early?
- And more!
To create a complete sketch from any trading idea, download this free worksheet. It will give you all the parameters you need to create your own Sketch.
But you still are not ready to trade live yet…
Stage 3: Strategy
Once the Sketch has been proven in backtesting and forward testing, then it is time to take it into live trading, with real money. If the Sketch holds up under live conditions, only then is it considered a proven Strategy.
Anything else is just an Idea, opinion, rumor or untested Sketch.
Final Thoughts on Developing a Profitable Trading Strategy
So if you are losing consistently, ask yourself if you really have a Strategy, or if you are actually trading an Idea or a Sketch.
There is a huge difference between the three of them.
Once you understand where you are in the process, it's easy to move forward to the next step.
But what if your Sketch doesn't test well? Keep testing different things or find a course that can give you proven strategies.
Just be sure that they match your trading personality.