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Saturday, December 14, 2019

Six Key Factors to a Great Trading System

Featured Tip
By Van K. Tharp, PhD

Most people, as they learn about trading, are exposed to a lot of misinformation. It’s almost as if there is an intelligence agency putting out information to make sure that the average person can't get ahead in trading.

In short, there are six major factors that are the keys to your success trading well. These six factors include:

Factor 1: Reliability, meaning “what percentage of the time do you make money?” is the first key factor. Most people emphasize this. They want to be right on every trade because they were taught in the schools that 70% or less is failure. However, the real facts are that you can be right about 30% of the time and make good money.

Factor 2: The relative size of your profits compared to your losses is the second key factor. I write a lot about thinking about your trades in terms of R-multiples. This key success factor basically states that you want your losses to be 1R or less and you want your profits to be large multiples of R. This is essentially the golden rule of trading – “cut your losses short and let your profits run.” It’s one of the real keys to success, but it is very hard for most people to do.

Factor 3: The third factor is the cost of your trading. When I first started trading, it costs about $65 each time you got in and out of the market. Trading costs were atrocious. Now you can get in and out of trades for a fraction of that. However, trading costs can still mount up in an active account. Several years ago I was trading very actively. I was up about 30% on the year and I noticed that my trading costs totaled more than my profits. Thus, even with today’s massive discounts, it still costs a lot to trade.

Factor 4: The fourth key factor is how often you get a good trade or trading opportunity. For example, if you can make an average profit of 1R per trade and you make 50 trades per year, you’ll be up 50R. But if you make 500 trades, you’ll be up 500R.

Factor 5: The fifth key factor is the size of your trading capital. When your account is too small, it's very difficult to make good returns. But when your account gets to a decent size, then making good returns becomes much easier. This occurs simply because some accounts are just too small to trade. The reverse also occurs. When you get to big, so big that you can move markets just by entering or exiting, then it also becomes much more difficult to make good returns.

Factor 6: The final key factor is your position sizing. Position sizing is that part of your trading that tells you “how much” throughout the course of a trade. It is probably responsible for 90% of your performance variability – that’s how important it is.

Most people would just want to be right most of the time. However, you can be right 99% of the time and still be wiped out on any of the following scenarios:

a) You don’t have enough money to trade and the one time you are wrong you are wiped out.
b) Your position sizing is too big so that the one time you are wrong you are wiped out.
c) Your one loss is so big (regardless of position sizing) that it wipes out all of your profits (perhaps you have small stops and your loss is a 100R loss).

All of those factors could wipe you out, so you must understand all of these factors together and how they work.

This tip is very abbreviated to give you food for thought. However, there is a full chapter dedicated to this topic in my book Trade Your Way to Financial Freedom, Chapter Seven.

I've recently been researching new material as it relates to system development. I will cover that in upcoming webinar (no date yet), which will cover topics in both Trading Genius II, which is formerly titled System Thinking, (a workshop I am streaming in January), and the new discoveries on systems will be added to the How to Develop Winning Trading Systems workshops (coming in February).

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