Quantified Trading Strategies: The Four Most Important Factors in Trading

Whether you are a professional trader or a trading rookie, there are four factors that matter more than anything else when it comes to choosing your strategies to manage and grow your money over time.

1. You must make money.

Relative performance is for mutual fund managers. The whole point of managing your own money is to grow your account, to have more money at the end of the month, year, presidential term, decade and so on, than you had at the beginning.

This is why you set aside the time to carefully design and test your own trading strategies – or to seek out those who have. If you are managing your own money, “keeping pace” is not enough. You want what is called “alpha” – performance beyond what the market gives you – and you should not settle for less than that.

2. You want balance, not crazy risks.

What if someone offered you a trading strategy that had you earning 6% one month, losing 10% the next month, and then earning 8% the third month? Say that pattern, more or less, repeated itself over and over quarter after quarter.

How long do you think the average trader would be able to stick with a trading strategy that whipped around like that? What if one of those 10% down months was closer to 15% or even 20%? Does anyone really believe that the average trader would hang around to wait for a snapback after a monthly hit like that?

A large part of managing and growing your money successfully is using strategies that are balanced and not overly volatile. Even if the strategy produces gains, trading strategies that are too volatile are very hard to maintain psychologically. What’s worse, the average trader usually abandons these overly-volatile strategies at the worst time (i.e., after a big losing period).

There’s nothing to be gained by making trading any harder than it is. When choosing and designing your trading strategy, keep in mind how volatile the strategy is. If big winners are followed by big losers, over and over again, then that strategy may be more trouble than it is worth.

3. You have to know what you are doing.

In addition to keeping volatility low, it is important that you as the trader understand what you are doing. It is far easier to adopt and stick with a trading strategy when you feel as if you understand how the strategy “thinks”.

If you can look at a market and tell yourself with a strong degree of accuracy what your trading strategy would suggest you do in those conditions – buy, sell, sell short or stand pat – then you are on the right track.

On the other hand, if your trading strategy frequently produces signals that you never understand, you may be in a difficult position to assess when your strategy is operating within normal parameters and when it is not.

Being able to make this call, by the way, was how many hedge fund traders were able to avoid the worst of the financial crisis in 2008. When conditions, based on the data, became abnormal, many of these hedge fund traders pulled the plug and stopped trading.

These bold moves saved millions of dollars for those who understood their trading strategies, knew when truly atypical circumstances had developed, and acted accordingly.

4. Your investing and trading strategy should be “easy”.

Do you know of any trader who would rather make money “the hard way”?

Your trading strategy should be simple and straightforward. One of the big reasons why many traders underachieve is because they attempt to emulate the strategies of traders and investors WHO TRADE AND INVEST FOR A LIVING. If you work a full-time job, raise a full-time family or both, then it is wasted effort to attempt to trade and invest the way that full-time traders and investors do.

To be blunt, this means that there are some alternatives – like quantified trading strategies – that are especially geared toward traders and investors who are not able to spend hours pouring over balance sheets or page after page of technical price charts.

But whatever trading strategy you choose, unless you are a full-time professional, following your strategy should be no more challenging than your daily commute to work or running errands around town on the weekend.

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To learn more about implementing these concepts and building truly balanced portfolios to manage and grow your money over time, click here to read more about trading and investing with The Machine.

David Penn is Editor in Chief of TradingMarkets.com