Too often you hear traders boasting of how great their trading system is. How it generates huge profits with guaranteed signals. Just as often you hear these same people tell stories of how they lost their asses and blew their accounts. If these traders had such a foolproof system then how come they so often lose as big as they win? It comes down to the system. Many traders don’t fully understand what a successful trading system is or what it looks like. It is much more than a tool, strategy, or success rate. A successful system allows you to make steady, incremental gains while protecting your account from wicked losses.
To understand what I’m talking about let’s start with some simple definitions.
First, what is a tool? A tool is a device or implements used to do a job. For the prediction market trader, this could mean an economic calendar, oscillator, or another form of technical analysis. Tools can be used to measure the market and they can be used to pinpoint entries and exits. Tools are not a strategy by themselves but they are a big part of what a trading strategy is built on. Take MACD for example. MACD is a very useful and widely respected trading tool. It measures the convergence and divergence of two moving averages; traders use it as a measure of the market’s momentum. However, on its own and without a plan or direction this tool can provide just as many false signals as it does good ones.
To avoid false signals and whiplashes you must apply strategy to your tools.
What is a trading strategy? The Webster’s Online Dictionary defines strategy as a careful plan of action or policy designed to achieve an overall goal or aim, usually over time. Investopedia goes on to say that it is an investor’s plan of attack to guide their investment decisions. This plan is based on risk tolerance, individual goals, and capital requirements. Strategies can be based all or in part on a tool or group of tools but are still not a system in and of themselves. The strategy tells you what and when to trade but the overall system will also tell you how to trade, all the while keeping the long-term safety of your account at the forefront. Let’s refer back to the MACD. By itself, it is a tool but when you apply a set of rules to the indicator you can transform it into a strategy. Some common rules used with the MACD are to only take trend following signals and/or only take signals when asset prices are at or near an important support/resistance line. Over time it is likely you will hone your strategy as you gain experience.
So, What Is a Trading System?
Now we get to the crust of the biscuit. What is a trading system? First, let’s refer back to Webster’s. A system is a regularly interacting or independent group of items forming a unified whole. Needless to say, there is a lot to know about trading systems. At heart, though they are just like Webster says, a group of interacting parts that form a whole. The first two parts are the tools and the strategy. The tools do the work, the strategy directs their overall purpose but there is still one thing missing.
No matter how you define it money management is what lets you sleep at night. Wild trading, risky habits, and gambling are sure ways to lose and can keep you up late worrying about losses. Especially if you are trading your rent money, grocery money, or even worse your date money. Money management is in effect a system within your system. It dictates how much each trade will be and how many trades you can make at one time. Most importantly it does both of those things in a way that ensures your account is never in danger of catastrophic loss. To be on the safe side use the 2% rule. The Percent Rule helps you to define your risk tolerance and apply it to your trading.
Implementing the 2% rule means that you never risk more than 2% on any one trade. As an example let’s assume an account is worth $2,000. This is not an unreasonable amount to assume a newbie may open an account with. Two percent of the $2,000 is $40. This means that each trade cannot risk more than $40. If there is no trade insurance or rebate with your broker this means no trade is going to be more than $40. Until your account grows. As the account grows so too does that 2%. Eventually, the $40 will be $100 and then $400 or more.
Remember, a complete system includes all three aspects; the tools, the strategy, and the money management. Using them together is the surest way to a successful career trading binary options.