The 4 main components of a Trading System

And why you must have one

Successful traders all have one job, and one thing in common: They have designed a profitable trading system and followed it efficiently.

A trading system is your user manual. Your guide. Your rulebook.

A mistake means not following your rules. If you don’t have rules, everything you do is a mistake. - Van Tharp

Consistent profitability means minimizing mistakes. Therefore a trading system and rules are critical for success.

Trading systems have four main components. Each of these should contain rules for the following tasks:

1. Market evaluation

2. Identifying Low-risk trade ideas

3. Risk management

4. Evaluation

Before a trade idea can be formed and considered it is important to know the overall condition of the markets.

• Is it bullish or bearish?

• How is that defined?

Once the opinion of market type is established then trade ideas can be generated.

• What looks more attractive; long or short trades?

• Which sectors or industries are showing the best opportunities?

• How is that defined?

Then a risk management plan must be generated.

• What is the appropriate position size?

• Where will the protective stop-loss be placed?

• Is there a profit target?

And finally, how did it all work out?

• Did the trade meet the objectives?

• Were mistakes made?

Unless everything went perfectly according to plan there will be feedback that can be used to evaluate and modify the system.

Lather. Rinse. Repeat.

There is an almost infinite number of tasks and actions that a trader can take. Some of them are beneficial. The vast majority are destructive. They can all probably be categorized in one of these four areas. Consider this framework as you design or evaluate your own trading system.