We are often asked, “What is the best way to trade”?
That is not an easy question to answer. In fact, we would go as far as to say there is no right answer to that question.
First of all, we don’t view any specific way of trading to be the “best”. We all have different personalities, risk tolerances, beliefs, and biases. These attributes will go a long way in dictating what is the optimal approach one should take in the markets.
It is often said that you should find a method that fits your personality. There is some truth to this. After all, the best strategy is ultimately the one you can stick with and execute with a steadfast disciple. This is assuming, of course, that your strategy has a real edge.
That being said, below are eight things we have come to believe are best practices when deciding what is the best way for you to risk money in the markets.
- Systematically combine fundamental analysis, technical analysis, and quantitative analysis.
Our research has shown that the combination of these three disciplines has synergistic effects and leads to large edges and Alpha in the marketplace. Furthermore, the combination of these three disciplines leads to larger edges than each discipline in isolation. For more information on this concept, check out the webinar for our upcoming Quantamentals course here.
2. Trade strategies that are based on inherent human behavioral biases.
Humans are humans; we aren’t going to change. Rooting your strategies in the behavioral mistakes of others can lead to strategies with sustainable Alpha. Structural edges can go away over time but behavioral edges are here to stay!
This was a focus in our recent book, The Alpha Formula If you read the book, you saw strategies with a large amount of Alpha in them for the past 1 ½ decades. Most of that Alpha was created from behavioral edges inherent in the markets.
3. Combining several strategies into a portfolio can greatly increase the risk-adjusted returns of that portfolio.
Specifically focus on finding minimally correlated strategies, which when combined together greatly reduces risk. Ray Dalio has become one of the greatest investors in history because of this approach. He mathematically showed the positive effect of combining minimally correlated strategies. Three to four minimally correlated strategies goes a long way to increasing risk-adjusted returns.
4. Approach portfolio management through the lens of “First Principles”.
This means having at least one strategy in your portfolio that is designed to benefit from times when markets go up, times when markets go down, and times when markets go through stress.
This naturally leads to uncorrelated strategies, as each strategy is designed to profit from a different market truth. When combined together, these strategies produce strong risk-adjusted return portfolios.
5. Utilize time horizon diversification.
Time horizon diversification means trading strategies with different average holds per trade. This increases the positive effects of diversification, specifically decreasing your risk and increasing your risk-adjusted returns. Ideally, you would have strategies in your portfolio with holding periods ranging from short-term (a couple of days), intermediate-term (weeks to months) and long term (month to years).
6. Quantify as much as possible.
This will give you confidence in your systems and increase the likelihood that you will stick with the strategy should it begin a run of bad performance. On a related note, gaining the skills to be able to test signals, build strategies and do your own research is very valuable, and we would argue necessary, for any systematic trader.
We view Python as the ideal coding language to learn for quantitative trading research. We are not alone in this view, all of the top hedge funds, investment banks, and proprietary trading firms use Python as their main coding language. To learn more about Python and to sign up to receive immediate access to our online Python Programming for Traders course, click here.
7. Don’t just focus on returns.
Always view returns in the context of the risk you are taking. Focus on other metrics of performance used by professionals, which typically incorporate both return and risk, such as the Sharpe ratio. Risk metrics such as standard deviation and max drawdown should also be emphasized. Furthermore, high Alpha and low Beta numbers should also be the goal and an area of focus.
8. Consistency in execution. “See The Trade, Take The Trade”.
This sounds simple; for many professionals, it’s the hardest thing to do, especially when volatility rises. If you are going to trade with systems/models, then follow the models. Picking and choosing which trades to take, especially if you make this decision based on how the trade makes you feel, is almost always the wrong approach
We hope you find the above trading best practices helpful in determining what your exact approach to the market should be.
New Podcast and Strategy Signals
Listen – Chris Cain did a great one-hour interview about The Alpha Formula and building high performing portfolios on the popular podcast, All Star Charts. To listen to the podcast, please click here.
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Upcoming Events Schedule
February 13 – Special Announcement! Introducing The Connors Research Trading Strategy Series.
Gain access to high performing trading strategies and portfolios along with free daily signal generation. To learn more about the strategies being offered, sign-up for our free webinar here.