NOVICE TRADER
Know Your System, Use It Wisely
Trading Systems Defined
by Martha Stokes
What is your trading style? Here's an overview of different
types of trading systems that can be applied to different markets.
To succeed as a trader, you must understand
how the market works. This begins with a foundation of core market knowledge,
as can be seen in Figure 1. The next level is trading styles, followed
by trading systems, and then, at the top, the implementation of trading
strategies.
Figure 1: trading pyramid. Here you see the various levels of a
trading pyramid. Trading systems sit at the third level. Only after overcoming
this level can you implement your strategies.
One of the least-understood aspects of this formation is the trading
systems level, second from the top. Without a thorough understanding of
trading systems and the strategies designed for each kind of system, your
trading efforts may yield disappointing results. (See Figure 2.)
No matter how you trade the market, you are using a trading system.
A trading system is not a strategy, a software program, or an entry signal.
It is a set of rules and parameters developed around a formula of indicators
and price action for a specific type of market condition.
Often a trader will complain that a strategy doesn't work. They struggle
with meager results that entice them to continue trying but seldom pay
the bills. These traders go from seminar to seminar hoping to find the
“perfect” strategy. But it's not the strategy that's the problem. It's
the market condition under which the strategy is being applied that is
not right. You must find the right strategy for the right market.
Strategies work best when applied to the market conditions for which
they were designed. But before you can choose a strategy for the current
conditions, you must understand what a trading system is and which system
works under what condition.
Trading systems have been around for more than a century in many versions
and variations, but all trading systems used today fall under six categories.
Since the sixth is fundamental systems, we will not discuss it here.
TRADING SYSTEM TYPES
For technical analysis traders, there are five primary types of trading
systems (Figure 3). These systems are:
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Trending market trading systems
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Countertrend trading systems
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Breakout trading systems
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Trading range systems
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Hedge trading systems
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Trending market trading systems
Trending market?based systems are the most popular and most prevalent
of all trading system types. The first trending systems were developed
in the early 20th century. The first trending systems used moving averages
as the basis for buying, holding, and selling stocks. Obviously, today's
trending systems are more sophisticated while many are computer-generated
entry and exit signals. No matter how modern, trending systems fail during
certain market conditions because of the parameters of those systems.
A trending system assumes the stock market or certain sectors are moving
in a strong uptrend or downtrend. A strong uptrend or downtrend is defined
as one that has at least a 35-degree angle of ascent or descent with brief
retracements or bounces and/or weak consolidation patterns that form as
the stock or market moves. Short in duration, these periods are shallow
adjustments to price due to profit-taking or resting phases of the uptrend.
...Continued in the March issue of Technical Analysis of STOCKS
& COMMODITIES
Excerpted from an article originally published in the January 2007
issue of Technical Analysis of STOCKS & COMMODITIES magazine.
All rights reserved. © Copyright 2006, Technical Analysis,
Inc.
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