How to become a trading “Master” & the Anatomy of a Trading System

Many people believe that trading is a profession with a high barrier to entry. After more than 15 years in the markets, analyzing, trading, and mentoring traders of all levels, it has become clear that if one can balance both ambition and patience, this barrier can be broken. While it is important to maintain this balance, what is often overlooked and undervalued is the necessity of a systematic approach.

So, for trading to become a full-time career path, a part-time opportunity, or just a way to generate supplemental income, a solid trading system is necessary.

In this article we will examine the components of a successful trading system, laying the foundation for anyone interested in profiting from the markets consistently. It is not going to be a technical or economic approach to the theme but a roadmap to the collection of checkpoints required to become balanced and successful as a profiteer, in search of becoming a trading “Master”.

A system is a set of parameters used to turn inputs into outputs, and data into decisions. This is usually achieved through a series of “if…”, “then…” statements. Without a clear guide, a repeatable process, and a flow of these statements, trading results cannot be evaluated. Only after having a significant sample size, evaluation, and finetuning will this be possible.

A trading system consists of 3 elements. These are:
A) Method
B) Money management
C) Psychology
A solid trading system needs all the above in perfect harmony and in sync, to produce consistent results. Each one of these has its own importance and effect in the system. Let us now go through them.

More than often, traders confuse the system with the method. A method is an important component of a system and should contain the following:

1. Set-up conditions
2. Entry signal
3. Protective stop loss
4. Re-entry strategy
5. Exit parameters

1) The set-up conditions include screening and comparison criteria between past data (technical analysis) and between markets (intermarket and fundamental analysis). There are many different markets available to trade. Which one should you trade at any given time? Employing a series of predefined screening and comparison criteria to reduce that number down to less fewer markets allows for the recognition of the numerous market conditions. These allow for the appropriate strategy implementation.

2) The entry signal, or trigger, is a unique signal used to determine when to enter a position. There are many different types of signals that can be applied. They typically involve some sort of move in line with the set up recognized during the screening process as described above. New traders usually spend a lot of time in search for the perfect entry signal, the “Holy grail”, but that does not seem to be a good idea, as it is only one of the five components of a method. And a method is only one of the three elements of a trading system.

3) The protective stop loss, as the name dictates, is there for capital protection, as markets do not move either way for ever. It is the worst-case scenario of loss a trader would want to experience. For example, it could be signalled by a drop in value (i.e., a 10% drop in the price), a price pattern that would get one out quickly if the market turned against, or a technical level.

4) A re-entry strategy is a strategy used when one gets stopped out of a position but chances for profit still exist, with the main setup idea still in place and active.

5) The exit strategy is one of the two factors in trading over which one has total control (the other one is money management / risk exposure). This is the most difficult part of trading. A great deal of time and thought should be dedicated on exit strategies, for one very good reason: money is made when exiting the market, and not when entering it. After all, a good exit strategy may favour trading results right away.

Position sizing is the part of a system that controls how much you are risking. It determines trading volume, and it is the outcome of the following limits of:

• Risk per year
• Risk per month
• Risk per week
• Risk per trade

Objectives can be met through position sizing. As stated above it is one of the two factors in trading that a trader has total control over.

Psychology includes all those parameters related to one’s ability to follow rules. Not just any rules, but the rules you create for yourself. The process behind trading decisions is different to how the brain is used to operating in everyday disciplines and matters. Doubt and hesitance that derive from price fluctuations create greed and fear, emotions that can jeopardize results. It has been observed that reliable trading methods that produced promising results while paper traded (traded through a demo account), resulted in a negative outcome when traded from the same person, under real market conditions, with real money at risk. Traders’ mindset is responsible and the only way to fill this reality gap is through a different mental approach, understanding that trading is a numbers and probabilities game, and while exposed to risk anything might happen.

To conclude, a trading system should reflect your beliefs (i.e., who you are as a trader and as a person). Many people are just looking for “any system that works,” but if your trading system doesn’t match your beliefs about the markets, the mind will eventually find a way to sabotage it, allowing irrational thoughts to prevail at the heat of the moment.

No system is a money-making machine that can be turned on and print cash forever. You are the one that will give value to it by having realistic objectives, and understanding the risks involved.