Trading is a risky business.
Before even starting your adventure in the world of stock trading, you must have a trading strategy, which is essential for your long-term survival in this space.
There are many components that make up a good business strategy; however, there are two key steps any successful business plan must follow. When it comes to creating your own trading strategy, it is absolutely critical to make sure your winners are bigger than your losers, and secondly, implement strong risk management strategies.
Moving forward, we will explore what ingredients are needed to build your business strategy step by step.
Why have a business strategy?
First of all, it helps you control your operations. If you do not have a system behind your operation, it will be very difficult to find new business opportunities and respond to new market conditions once you have started the operation.
Developing a successful business strategy will also introduce consistency because if you already consistently know what you are looking for, you will improve your ability to spot business opportunities.
Essentials of a Trading Strategy
The essential components of a good trading strategy are made up of four basic elements:
- Developing directional bias, rate the entry
- Determination of stop-loss and take-profit targets
- Define your preferred time frame
- Use risk management
Establishing a directional bias is simply a matter of deciding whether you think the stock is going up or whether you think the stock is going down.
Basically, developing a directional bias will help you determine the direction of the trend and whether to buy or sell.
The process of establishing a directional bias can be divided into two components:
- Predict where the stock price is most likely to rise: up or down
- Trading rules that validate your directional bias
To rate your entry you have two alternatives:
- Fundamental analysis
- Technical analysis.
When trading stocks, it is also recommended to understand the real fundamentals of the trade you are doing, even if you are trading solely on technical grounds. You just need to know what fundamentals are currently affecting your stocks.
For example, you need to know dividend dates because it can really affect stocks in a big way, and you can take advantage of them using your technical skills.
When it comes to technical analysis, you need to set your key technical levels and then look for the price to break through or bounce back. There are many stock reversal patterns and technical tools that we have already reviewed, such as MACD, RSI, Bollinger Bands, Fibonacci, Moving Averages and more; all of them can be relevant and determine whether you are going long or short.
- Determination of Stop Loss and Take Profit targets
Determining your stop loss and potential profit target is one of those things you need to set, right before you place a trade. This will be absolutely critical in establishing whether the trade makes sense from a risk-reward perspective.
By setting a protection loss limit, you will minimize your losses. You will know in advance how much you will lose if you make a mistake in the trade.
You should also set realistic profit targets and your price actin reading skills can go a long way in helping you choose pragmatic profit levels.
- Define your preferred time frame
There is no right or wrong time frame to trade as it really depends on your personality. If you need to be in control of your trades and cannot bear any deductions when in a trade or if you want to collect quick profits, lower intraday charts may work better for your situation.
If you have a day job, it will be quite difficult to focus on intraday time frames like the 5 minute, 15 minute, or 1 hour time chart. However, the good news is that stock trading is best suited for long-term investments with a 1-3 year time horizon.
There are no magic techniques or secrets to choosing the perfect time frame; this is something you will have to decide for yourself.
- Risk management strategy
Risk management is by far the most important aspect of your stock trading strategy. You will have to stick to very strict money management parameters if you want to be a successful trader and develop a winning stock trading strategy.
Make sure your risk is at least half the reward or, in other words, your potential profit is twice your potential loss. The higher the risk / reward ratio you have, the better. It will remain profitable even if your strategy only generates winners less than 50% of the time.
The 2% money management rule is a well known strategy. It states that you should never risk more than 2% of your account balance in a single operation. Not only will the 2% rule make your losses more manageable, it can also eliminate the chances of losing your entire account balance.
Let’s say you have $ 25,000 in your trading account. If you only bet 2% of your equity on a particular trade that has a 1: 3 risk/reward ratio, then your potential loss on this trade is only $ 500, while your potential profit is $ 1,500.
The goal of trading is to make money and a solid risk management strategy can help you achieve that goal.
When determining your business strategy, it is absolutely critical to understand your own personality. Why? because your personality will be closely linked to your strategy. No two merchants are the same. One person may be more successful as an active stock trader and others are much more successful as a long-term trader.