Creating, and refining a strategy part 1

There are thousands of trading strategies that people come up with. Many will share them with videos of their successes and failures, while others you may never hear about. Like a good magic trick, when someone develops one it may be a while before the secret is revealed. With all the effort and testing that is involved creating a strategy is no overnight success but how do you know where you should start? What are you even looking for to create a strategy?

The first thing you would want to know is what is your time frame? As you looking to develop a buy or sell program for trading second by second, a long term investment strategy or something in between? In any case you will likely start with a product. Stocks, options, futures, currencies, what is the product you will deploy your strategy on? Today we will focus in on stocks as they are the most common.

You should know that not all stocks are created equal. Really think about what you hope to accomplish and know that you will not be able to run your strategy on every stock. Volume is critical here because you will be testing your strategy going forward and you may want to look back in history to see how it would have performed then. If you pick stocks that have low volume your test results will be skewed due to slippage. Also you would not necessarily know for sure what price you would have been filled at. No matter what strategy you build stick with stocks that have millions of shares traded each day.

Now the hard part... You have to think of something that you think may be profitable. It could be that you think a 5% pullback on a stock that is above the 200 day moving average is a good buy point. Maybe you think that when a stock was down 3% one day and the very next day is up 3% that this is a good buying opportunity. It could be a stock that has earnings news and gaps higher than 10%, maybe that is something interesting. The point is you want to sit back and watch for a while and ask yourself "hey what happens after a stock...?"

Once you have a few questions written down then you can move on to the fun part. Testing! Go back in history first and see what happened to stocks that matched your question. Did they go higher by 1%, 10% or not at all? I used to draw a line right down the middle of a piece of paper and on the left side I would write a % return if it was a successful move and on the other side a -% return if it immediately moved lower. If your -% return column has more than the positive then you may want to refine before going live. Also I could quickly see about how much a stock moved when it was a winner and about how much as a loser so I could better approach targets and losses.

Of course these days you can use almost any trading package to do all the heavy lifting for you and get way more data than you can fit on a piece of paper!