Designing a trading strategy is an endeavor that is vital to your trading success. A strategy is a business plan and it allows you to formally design a way to make money in the capital markets. There are numerous pieces to this puzzle, which include analyzing your trading style, creating a framework for initiating a trade, implementing a risk management technique, and execution.
The key to any trading success is to create a framework that you can follow despite market fluctuation, and the emotional rollercoaster created by profits and losses. Investing can be a dominated by fear and greed, but veteran traders understand how to remove emotion from investing, and create a strategy that is immune to changes in sentiment.
Creating a trading style is finding a way to design a system that is in line with your investing philosophy. Investment personality describes a risk reward profile that can be converted into a trading style or strategy. For example, some traders like to purchase markets as they are moving higher. They enjoy catching the wave and riding it for a while. If this is you feel comfortable with this style, then you are likely to feel comfortable buying breakouts and selling breakdown.
Other traders enjoy buying markets on dips. When they see a market that is heavily oversold, they will purchase a financial asset in the hopes that the market rebounds quickly. The style involves catching a falling knife, and you need to feel comfortable with the market moving against you initially before it rebounds.
Investors should look to analyze the current market environment to determine which type of strategy will perform robustly under a given set of circumstances. For example, range bound markets usually mean revert, while trending markets tend to breakout or down. Additionally, spread markets, one assets vs. another asset, tend to mean revert, while single assets experience higher levels of volatility.
When analyzing a specific type of financial product, an investor needs to follow the market and determine if the financial instrument moves in a format that can be encapsulated by some type of formula. For example, implied volatility generally is a mean reverting type of process. Implied volatility is the expectation that a market will move by a specific amount over a designated period of time. This is the major input into options pricing and can be generally encapsulated by using a Bollinger band formula.
In the example above, the arrows reflect level in which the VIX volatility index moved to the upper end of the Bollinger band (2 standard deviations away from the 20-day moving average), and the lower end of the Bollinger band. By analyzing the path of movement a financial instrument, and analyst can adapt a strategy that fits the product.
By creating a framework for trading, an investor can then determine the type of trade they are looking to initiate. Binary options are leveraged products that allow an investor to generate returns base on quick movements in which the financial instrument is above or below a specific level at a specific time. An investor can either back-test a formula using historical data or observe historical trades to determine if binary options will be successful for a given instrument.
Binary options generally incorporate the risk that an investor will take on a given position. Generally when trading a market, a trader will need to place a mental stop at a given point to terminate a trade if it does not work out as expected. This type of risk management is engrained in binary options trading given that the risk is spelled out prior to transacting the trade. Binary options trading gives a specific payout, regardless how much the market moves in an investors favor.
Trading the capital markets is a significant endeavor. There are a number of steps a trader should take prior to even placing his first trade. In summary, a trader should first determine his trading personality. The second is to find financial instruments in which the price action conforms to the style or personality of the investor. The third step should be to create a framework that conforms to the price action of a financial instrument in an attempt to create a trading strategy. The last step is to determine if products such as binary options make the strategy cohesive and profitable.