How To Pick a Trading Strategy
Picking a profitable trading strategy can be hard to do. Here's how to narrow it down.
The last couple of years have not been easy for traders. Just a few months into 2020 and we had an unprecedented reaction to Covid-19, followed by an explosive and seemingly limitless bulls market rally. That was followed by the bear market of 2022 and has left a lot of traders wondering how to pick a trading strategy.
Picking a trading strategy isn’t easy and in my opinion, it’s because of a couple of reasons:
Impatience (strategy hopping)
There are other reasons too, but traders mostly fail to pick a successful trading strategy because they give up too early before seeing if it fits them. In the case of 2020 to 2022, the environments have changed so quickly that for new traders, it’s been hard to find a trading strategy and have faith in it.
Think about it. We went from a “normal” market, to a panicked market, to a skittish bull market, to a roaring bull market, to a bear market.
Strategy hopping, changing subscription clubs and FOMO-chasing the latest fad leads to futile results as well.
There’s No Holy Grail in Trading
If you’re a completely new trader and have no idea what kind of trader you are, that’s a tough spot to be in.
While having an open mind about potential strategies, your No. 1 focus should be capital preservation. This is the exploratory stage where you need to figure out what works for you and in that stage, you have to be careful not to blow out your account.
If a holy grail exists for traders, it’s not in the reach of us retail traders. Maybe the Citadels and Renaissance Capitals of the world have them, but we don’t — and that’s okay!
If you’re a beginner and you’re willing to do the work, you’ll need to decide what kind of trader to be. Systematic vs. discretionary. Day trader vs. swing trader. Stocks vs. options vs. futures.
There’s a lot to unpack there and a lot of it depends on your personality and experimenting with which styles work best for you.
My focus here is for the intermediate trader — the one that has been around for a little bit, but has failed to nail down a strategy that works for them.
How to Pick a Trading Strategy in 4 Steps
Before we can even worry about how to properly size our trades, we have to land on a sound trading system. For those of you that have been bumbling through the years breaking even and struggling for consistency, here’s how to pick a trading strategy.
Analyze the Data
Keep a spreadsheet and/or log all of the details of the trade. Entry, size, time, duration, parameters — aka “why” — you entered, along with when and why you exited.
You can do this on your existing trades or your trades going forward. If it’s the latter, trade small! Regardless, you should be keeping a log of your trades going forward.
Using the “Cream of the Crop” Process
So if you have 100 trades, take your top 10 or 20 (I like 20). What do they have in common? Why did they work? We are looking for common themes that can be repeated over and over again as we refine our process.
Now Flip It — What Are Our Worst Results?
What are the bottom 10 or 20 trades? What do our worst losers have in common? This is your “Top Nots” list.
Maybe they were low-float stocks. Perhaps it was failing to honor a stop-loss. FYI: These “Top Nots” will become your rules in the future.
We’re trying to maximize what we’ve done best and minimize what we are worst at. Even if the thing our losses have most in common is trading the open on Friday, then we want to stop trading the open on Fridays!
Note: As you get better at eliminating your big mistakes, you will start to become more intimate with your strategy. For instance, maybe you a large portion of your losses come when your stop is just a little too tight. Perhaps your stop is getting hit in the first 10 minutes of the session, before reversing in your favor. Little nuances will show up and that will be the new challenge.
Narrow Your Focus
Say going into this, you’re trading stocks and futures, trading reversals, breakouts and pullbacks. Narrow your focus! It’s okay to trade more than one strategy, but only after you’ve mastered one to begin with.
In the example above, say your best 20 trades are dominated by trading reversals in the futures. Great. Then nix all other strategies and do it for a full quarter — at least. Focus only on refining your futures reversal trades. Also, focus on your “Top Nots” list.
Then you can start to add more pieces to the puzzle.
How I Picked My Trading Strategy
Over time, I dabbled with every strategy under the sun. Market-making, selling options, buying options, weekly swings, scalping, futures, stocks — you name it and I’ve probably tried it.
Ultimately, I realized that I preferred shorter-term swing trades. Something in the 1 to 5 day range. I also realized I liked buying pullbacks more than breakouts. I like big, liquid stocks that have good volume and tend not to have those “morning shakeouts.”
But I only came to those conclusions over time, as I continued to cull my top trades after a fresh batch of new trade data.
For instance, I did well buying pullbacks into active support via a key moving average, but did even better if it aligned with a prior breakout level or prior price support. Taking it a step further, I did even better if it was after a breakout to multi-month or all-time highs.
The Bottom Line
If you’re struggling to choose a trading strategy, hit the pause button. The markets are here 5 days a week, 52 weeks a year — it will always be here. Take a sample of your trading and see what’s doing the best and what’s killing your capital.
Focus on just one strategy that’s working and cutting out your tendencies that lead to your biggest losses (mine was ignoring my initial stop-loss hoping for a recovery and then letting a small loss turn into a big loss).
Ultimately, we’re trying to get one of three outcomes from any given trade: Big win, small win, small loss. We’re trying to avoid one outcome, which is the Big Loss.