Developing a strategy is a lot of work. Developing a successful strategy will crush your brain noodles. A trading strategy is a continuous work just like a relationship. You have to test it, nurture it, improve it and make sure that it continues to make money for you in these ever changing market conditions.
Today, we have come up with 5 things (like a checklist) that you should do to make your strategy really work.
1. Solid FundamentalsNope, we’re not talking about trading based on fundamental factors like company management, macro economic factors and such (not sure if anyone does that today, anyway). What we are talking about is the basis, the core of your strategy. The quantitative edge that your strategy has over the market, regardless of whether your strategy is based on momentum, arbitrage, marketing making or scalping or anything else.
How to know if your strategy has solid fundamentals? It’s easy, here is a checklist
- Have clearly defined entry and exit rules
- Goals! Know thy target. Your strategy should know when the trade should be cashed out even before getting into a position
- Stop losses! Your strategy should know when to get out when things don’t work out as expected
- Well defined risk levels for both, individual trades and overall account
How to get a new strategy?
there are tons of trading forums that discuss quantitative strategies and people share their experience. However, the strategies shared on forums might not be necessarily profitable and ‘ready to go’ but it is a good place to get ideas for your strategy.
Some of the websites that we think can be useful are:
- EP Chan’s blog
- Nuclear Phynance
- The Whole Street
Tons of financial research papers get released every year based on quantitative methods for trading. You could read a few to get some ideas for your next million dollar trading strategy (just make sure to fill us in when you find a good one :P)
Here are some sites that publish useful financial research papers
- Cornell University
- Journal of Financial and Quantitative Analysis
- Risk Library
- SSRN (Social Science Research Network)
2. Back-Testing Your StrategyNow, this sounds like a very common thing to do. But wait, there is a merit in doing this right. And we’re going to tell you how to do this correctly.
There are multiple things that you need to make sure are correct while performing the backtesting. The ultimate aim is to make sure that your backtesting is as close to the real market scenario as possible.
Here is a list of things that you need to keep in mind while performing the backtesting
- Decide beforehand, which are going to be your most important metrics. Standard metrics to start with can be profit/loss, max drawdown and Sharpe or Sortino ratios, etc
- Make sure your data is cleaned, i.e. free of all garbage data points and it is as per the required format by the backtesting software, before you start the backtesting
- Do not try to overfit the data. Overfitting is only going to satisfy you momentarily, you’ll lose money in real conditions
- Perform in-sample and out of sample testing. In-sample testing is running your strategy over a given set of data and optimizing it whereas out of sample testing is running your strategy over a data which is not part of the data for which you optimized your strategy, this practice is widely used in all sorts of testing and offers a good understanding of how the strategy might perform during the real market conditions. If the results of your out of sample testing are as good as the results you saw in your in-sample testing, most likely your strategy shall do a good job for you!
3. Know Your StrengthsWhat is it that you are better at than most of the traders out there? Identify that and bet all of your eggs on it. If you think of it, everyone has some unique quality that can be leveraged in your trading strategy.
Some people are good at spotting counterintuitive trends, some people have great analytical skills, some people are great at coding, some people are good at handling their emotions. All of these factors can be applied to a trading strategy and used as an advantage.
Know your strategy:
Understand what your strategy demands, for example, if yours is an HFT (High-Frequency Trading) strategy, then factors like colocation, infrastructure and direct market access (DMA) are very important for the success of your strategy. Similarly, if your strategy is a low frequency strategy that is of trend following type, then the ability of your strategy to correctly spot trends becomes one of the most important factors and in this case, the factors mentioned above do not matter much.
4. OptimizeIf you ask us, when is a good time to stop optimizing one’s strategy? we’d outrightly say ‘NEVER’. That’s correct! Markets always evolve and that’s why you and your strategy should keep evolving too.
While optimizing a strategy means making marginal changes to strategy parameters to improve the outcome by a small fraction, it is also important to note that making changes in the strategy requires you to do the entire process of testing all over again in order to minimize the risks of unexpected behaviors.
So how do you optimize your strategy?
Well, it’s mostly ‘try and check’ method, you change the values of the parameters by small margins and check, you will have to try out different combinations. You can also do simulations and see what parameters fit the best for your chosen assets and markets. There are several trading simulation software available, we’ve made a separate blog post on this, you can read the same here.
5. This is a businessIndeed, trading is a serious business and you should treat it like one. Any business requires you to put in hours and efforts! Same is the case with trading. If you thought trading would be your ticket to easy money and relaxed vacations (well that can happen but you have to work really hard to reach there) then you’re probably seeing this wrong way.
As in any business, you'd need enough competitive edges to surpass the competition. Edges can include the infrastructure you have, your skills, your trading system, technology, the cost of credit that you have access to, risk management, etc. More edges you have, better your chances of success. And lately using technology for all of your trading related tasks is the new trend, they’re calling it the algorithmic trading or system trading.
Algorithmic trading is not easy but it certainly has a lot of benefits over the traditional way of trading, we have made a detailed blog post and ‘Why should you be doing algorithmic trading?’ you can check out here or know on best algorithmic trading platform.
Next stepsAnd there is an easy way, If you want to learn various aspects of Algorithmic trading then check out the Executive Programme in Algorithmic Trading (EPAT®). The course covers training modules like Statistics & Econometrics, Financial Computing & Technology, and Algorithmic & Quantitative Trading Strategies. EPAT® equips you with the required skill sets to build a promising career in algorithmic & quantitative trading. Enroll now!
Or you can start now with trading strategy paradigms, different programming languages that can be used for trading and the advantages of algorithmic trading over traditional trading techniques by checking out the self-paced certification courses on Quantra!