Getting Started Trading Systems The 10 Power Principles of Successful Trading Systems

At Rockwell Trading we develop and test up to 25 trading systems a month. The 10 Power Principles for Successful Trading Systems is a set of rules we established and refined to help us effectively evaluate a trading system. Using these Power Principles you too can find solid trading systems - whether they be those you develop yourself or those you obtain from other sources. You can be assured of a high probability of success by applying these simple principles.

Principle #1: Few rules - easy to understand

It may surprise you that the best trading systems have less than 10 rules. The more rules you have, the more likely you "curve-fitted" your trading system to the past, and such an over-optimized system is very unlikely to produce profits in real markets.

It's important that your rules are easy to understand and execute. The markets can behave very wildly and move fast, and you won't necessarily have the time to calculate complicated formulas in order to make a trading decision. Think about successful floor traders: The only tool they use is a calculator, and they make thousands of dollars every day.

Principle #2: Trade electronic and liquid markets

We strongly recommend that you trade electronic markets because the commissions are lower and you receive instant fills. You need to know as fast as possible if your order is filled and at what price, because based on this information you plan your exit. You should never place an exit order before you know that your entry order is filled. When you trade open outcry markets (non-electronic) you might have to wait a few minutes before you receive your fill. By then the market might have already turned, and your profitable trade become a loss!

When trading electronic markets you receive your fills in less than one second and can immediately place your exit orders. Trading liquid markets you can avoid slippage,
which will save you hundreds or even thousands of dollars.

Principle #3: Make consistent profits

You should always look for a trading system that produces a nice and smooth equity curve, even if in the long run the net profit is slightly smaller. Most professional traders prefer to take small profits every day instead of big gains every now and then. If you trade for a living, you need to pay your bills from your trading profits, and therefore you should regularly deposit profits in to your trading account.

Making consistent profits is the secret of successful traders!

Principle #4: Maintain a healthy balance between risk and reward

Let me give you an example: If you go to a casino and bet everything you have on
"red", then you have a 49% chance of doubling your money and a 51% chance of losing everything. The same applies to trading: You can make a lot of money if you are risking a lot, but then risk of ruin is very high. You need to find a healthy balance between risk and reward.

Let's say you define "ruin" as losing 20% of your account, and you define "success" as making 20% profits. Having a trading system with past performance results let you calculate the "risk of ruin" and "chance of success".

Your risk of ruin should be always less than 5%, and your chance of success should be 5-10 times higher, e.g. if your risk of ruin is 4%, then your chance of success should be 40% or higher.

Principle #5: Find a system that produces at least five trades per week

The higher the trading frequency the smaller the chance of having a losing month. If you have a trading system that has a winning percentage of 70%, but only produces 1 trade per month, then 1 loser is enough to have a losing month. In this example you could have several losing months in a row before you finally start making profits. In the meantime, how do you pay your bills?

If your trading system produces five trades per week, then you have in average 20 trades per month. Having a winning percentage of 70% - your chances of a winning month are extremely high.

That's the goal of all traders: Having as many winning months as possible.

Principle #6: Start small - grow big

Your trading system should allow you to start small and grow big. A good trading system allows you to start with one or two contracts, and then increases your position as your trading account grows. This is in contrast to many "martingale" trading systems that require increasing position sizes when you are in a losing streak.

You probably heard about this strategy: Double your contracts every time you lose, and one winner will win back all the money you previously lost. It's not unusual to have 4-5 losing trades in a row, and this would already require you to trade 16 contracts after just 4 loss! Trading the e-mini S&P you would then need an account size of at least $63,200 just to meet the margin requirement. That's why martingale systems don't work.

Principle #7: Automate your trading

Emotions and human errors are the most common mistakes traders make. Clearly, they are to be avoided by any means possible. Especially during fast markets, it is crucial that you determine the entry and exit points fast and accurately; otherwise, you might miss a trade or find yourself in a losing position. For that reason you should automate your trading and look for a trading system that either already is or can be automated. Automating your trading makes it free of human emotion. The buy and sell operations are all automatic, hands-free, with no manual interventions and you can be sure that you make profits when you should, according to your plan.

Principle #8: Have a high percentage of winning trades

Your trading strategy should produce more than 50% winners. There's no doubt that trading systems with smaller winning percentages can be profitable, too, but the psychological pressure is enormous. Taking 7 losers out of 10 trades and not doubting the system takes great discipline, and many traders can't stand the pressure. After the sixth loser they start "improving" the system or stop trading it completely.

Especially for beginners it is a big help to gain confidence in your trading and your system if you have a high winning percentage of more than 65%.

Principle #9: Look for a system that is tested on at least 200 trades

The more trades you use in your backtesting (without curve-fitting), the higher the probability that your trading system will succeed in the future. Look at the following table:

The more trades you have in your
backtesting, the smaller the margin of error, and the higher the probability of producing profits in the future.

Principle #10: Chose a valid backtesting period

I recently saw the following ad: "Since 1994 I've taught thousands of traders worldwide a Simple and Reliable E-Mini trading methodology".

That's very interesting, because the e-mini S&P was introduced in September 1997, and the e-mini
Nasdaq in June 1999, therefore none of these contracts existed before 1997. What kind of e-mini trading did this vendor teach from 1994-1997???

The same applies to your backtesting: If you developed an e-mini S&P trading strategy, then you should backtest it only for the past 2-4 years, because even though the contract has existed since 1997, there was practically no one trading it (see chart below):

Now you should have working method for separating the good trading system from the poor one. By applying this checklist you will easily identify trading systems that work and those that will never make it.

 

[donaldduke]

Why?

I'm confused. The basic premise of this article is that is possible to design a hands off automated system that consistently makes money. That they have done it at least once. If this were so, wouldn't these folks be sitting on a beach in the Riviera, compounding their gains until the size of their system ran into liquidity issues? Wouldn't a series of successful automatic trading systems eventually mean the end of all the electronic markets ? Theoretically, it would consolidate all the market capital the hands of the system owners......

It is not my intention to be rude or ungrateful, and I hope that someone will be able to point out the error in my logic..

Thanks,
JO

For the same reasons that all the traders with profitable (non mechanical) systems
havent sucked all the money out of the markets and put an end to all trading.

 

[jmreeve]

I thought the purpose of the article was to sell their $600 pdf file? Where did you see them promoting a brokerage?

In the part on the website that says:

FREE Bonus:
You can either trade the system manually or
let the computer trade it for you

We already programmed the CoinCollector into an automated order execution platform called Strategy Runner.

There are some other choice bits too like....

Stop Loss

The CoinCollector does not use a stop/loss. We tested all different kinds of stops (percentage, fixed dollar amount, etc) but it performs best without adding a stop loss. Actually, its performance increases by 30% when we "add" no stop loss.

Here is why:

If you have ever traded the e-mini S&P you probably recognized, that in the past year, the highest difference from yesterday's close to today's close was (just) 21.25 points. The big players in the market take care that the market always bounces back after a big move. These are the so called overbought / oversold situations.

The justification for not using a stop is total b*s* and calls into question either the level of competence or the integrity of this company. If the market started to trend heavily or really tanked due to some event then anyone trading this system would get wiped out.

 

[roberk]

I think on the stop loss issue they probably reverse direction (stop and reverse) , or cover at days close, otherwise, like you say it would eventually blow up. So still a valid strategy ( I assume).

Strategy runner works with different brokers thus they are not promoting their 'special' one.

I know from hours spent trying to program intraday systems that they are are very hard to do.
How can a back-tested system understand order flow, what the different sectors and blue-chips are doing, when breaking news causes a move, and a few other things I don't want to mention? As far as I can tell it can't ,which is why I stay discretionary.
Nevertheless, I'd like to know what the strategy is, even if just for keeping tabs on the competition..

 

[donaldduke]

The expectancy of the system is really pi$$ poor.

70% win rate, but the average loser is 50% bigger than the average winner.

The article gave 10 principles of trading, one of these should have been:

ENSURE YOUR WINNERS ARE BIGGER THAN YOUR LOSERS.

But obviously you aint going to get a 70% win rate if you follow that principle and then you aint going to
get many people buying your system.

Ill probably get told off for this but:
In the final analysis these guys are just pedaling the usual garbage, ah well like
jesse livermore said: Nothing new ever occurs in the game of speculation.

In fact the whole Knowledge lab article is a copy of the sales propaganda on the site:

http://www.rockwelltrading.com/trading_system_step_2.htm

Contrast this to sidinuks excellent article and his free system which has much better
expectancy.

Its a shame that T2W have let this one into the lab.

 

[Tuffty]

donaldduke, I was quite disappointed to see that T2W lets articles like this be put in the knowledge lab.

 

[donaldduke]

Tuffty,

I have voted and given it a very low rating, if others do the same then we can hope it will get removed
from the lab.

 

[Tuffty]

Posted by Markus H on another thread in response to a question about increasing the selling price of the system:

"Rockwell Trading has been operating for more than two months now. Though nobody in the company has received any kind of compensation (e.g. bonus, salary, etc.) we had $18,000 cost to set up the website, purchase hardware, software, other infrastructure and so on.

To date the income of Rockwell Trading is less than $5,000, so there's a huge gap.

So far we are covering this gap from our trading profits, but we don't want to do this indefinitely. Our idea is that Rockwell Trading is at least covering costs."

I can only deduce from these comments that the business plan of Rockwell Trading assumes that SELLING the system is much more profitable than TRADING the system. Of course within that business plan is a great need to market the system better. At least that is on track with the publication of this article.

 

[ZDO]

Every system makes money - if you sell enough copies

 

[Trader333]

shazbots,

Systems work people dont

Can you inform me about any system that does as you have suggested on an ongoing basis in all market conditions because I have done extensive research on this and have never found one ?


Paul

 

[donaldduke]

Well i dont know about all market conditions, but i know of systems that have averaged over 40% a
year (using 1% risk per trade) over the last 10 years without ever having more than a 12% drawdown
(and even those were quite rare).

Some years have been only 20% and some years have been 100% and everything else
in between. But no years were loss making,(doesnt mean it cant happen in the future though).

Now if you want to make a 80-100% a year you would use 2% risk per trade instead and
have to suffer twice the drawdowns.

Surely youve been able to find such systems too?

With good money mangement and discipline such systems are enough to make any account compound massively over a five year period.

Ofcourse most people cant wait 5 years.

 

[jmreeve]

I think on the stop loss issue they probably reverse direction (stop and reverse) , or cover at days close, otherwise, like you say it would eventually blow up. So still a valid strategy ( I assume).

Counter trend systems don't usually work like this. If the market goes down, you buy.
If it keeps going down then you stick with the position hoping it will turn about.
This is why stops have such a devastating effect on the profit performance of these sorts of
systems as they tend to take you out of a trade at a high level of loss often just before it does actually
turn around. A market crash would probably wipe out an account traded solely with this system.

Counter trend systems are best traded along side trend following systems as they tend to have
an equity curve that is inversely correlated.

The expectancy of the system is really pi$$ poor.

70% win rate, but the average loser is 50% bigger than the average winner.

The article gave 10 principles of trading, one of these should have been:

ENSURE YOUR WINNERS ARE BIGGER THAN YOUR LOSERS.

But obviously you aint going to get a 70% win rate if you follow that principle and then you aint going to
get many people buying your system.

Ill probably get told off for this but:
In the final analysis these guys are just pedaling the usual garbage, ah well like
jesse livermore said: Nothing new ever occurs in the game of speculation.

Seconded, couldn't agree more.

 

[equtrader]

The title of the article was kind of misleading. These are not general rules but the authors' personal opinion about succesful trading systems. For example, it is almost impossible to develop a trend following system with a success rate > 50%. Most trend followers would be satisfied to have nine small losers in a row and then one huge winner riding the trend. That is where the big money is, anyway.

The article had a falacy in it: on one hand it argued for automated trading systems and on the other hand asserted that a good system is one that the trader feels confortable with. If a good system is one that is adjusted to the psychological limits of the trader in advance, then there is no reason to worry about execution. One reason to go with automated systems is the relief they provide in executing strategies a human would feel a lot of stress doing. - Joe

 

[peterpr]

To be honest that's not my understanding of what went wrong at LTCM <Snip> GJ

Not sure any of that is at variance with what I posted actually.

My knowledge of the LTCM story comes primarily from Nicholas Dunbar's 'inventing Money'. The vast bulk of their day-to-day trading operations were automated. Multiple interlocking systems designed by 'quants' and overseen by a management system that struggled to keep up with the phenomenal growth of the operation.

I agree that the final debacle was precipitated by large financial institutions being given privilaged access to inside information and (arguably) mis-using it, but that is what happens in 'markets' all the time and it is just one of the reasons why inadequately moderated computerised systems inevitably fail. It's a bit like when the CBOT exchange goes down on a trending day. The DJ floor traders are very quick to exploit a difficult situation for the the exposed YM traders - and they just love it too!!. Not so bad when we're talking about a tiny percentage of total liquidity and the YM boys can hedge with another contract on another exchange, but a bloody disaster when your open interest represents a substantial percentage of the entire market(s) and there is simple nowhere else to go.

 

[jmreeve]

The article had a falacy in it: on one hand it argued for automated trading systems and on the other hand asserted that a good system is one that the trader feels confortable with. If a good system is one that is adjusted to the psychological limits of the trader in advance, then there is no reason to worry about execution. One reason to go with automated systems is the relief they provide in executing strategies a human would feel a lot of stress doing. - Joe

Using automation to relieve the stress of execution is a fallacy in my experience.
If you feel stressed about a trading strategy then you are quite likely to end up watching the automated system and being stressed about what it is doing without your control. If this stress or frustration gets too much most people will just shut the automated system down completely.

Automation is useful to relieve the boredom of waiting for signals and to achieve fast accurate order executions. It is not a panacea for all human trading weaknesses.

 

[Markus_H]

What a feedback!

We submitted several articles to the editors of T2W, and together we decided to publish this one because it makes some potentially debate inspiring statements, which we think provides real value to the community. And it did...

Thanks to everybody for sharing your views, opinions and experience.

In the following I will respond to the most controversial posts:

The expectancy of the system is really pi$$ poor.

70% win rate, but the average loser is 50% bigger than the average winner.

The article gave 10 principles of trading, one of these should have been:

ENSURE YOUR WINNERS ARE BIGGER THAN YOUR LOSERS.

Not necessarily. Here's why:

Average Win: $143
Average loss: $214
Winning percentage: 70%​

Calculating Expectancy:
Average win * winning percentage - Average Loss * (1-winning percentage), i.e
$143 * 0.7 - $214 * (1 - 0.7) = $100.1 - $64.2 = $35.9

As long as the winning percentage is bigger 50% your average loser can be higher than your average winner. Only if you drop below 50% you should make sure to have bigger winners than losers otherwise the expectancy will become negative.

Disagree with point 5 and would add a point 11 that you should trade lots of different systems at the same time.

I absolutely agree and in fact we do recommend trading multiple systems (see: http://www.rockwelltrading.com/blog/2005/04/can-i-trade-1000000-with-your-trading.html).

In the introduction of the knowledge lab article we mention: "Using these Power Principles you too can find solid trading systems - whether they be those you develop yourself or those you obtain from other sources". That's the reason why we didn't add it as a principle.

The justification for not using a stop is total b*s* and calls into question either the level of competence or the integrity of this company.

It is incorrect that we are "not using a stop". The system uses a stop-and-reverse technique. In our backtesting and real trading this stop-and-reverse approach works better than a hard "stop loss" (e.g. dollar amount of percentage or volatility based stop). The snippet you copied from our website explains why. It's not a "justification" for not using a stop. Reading your post and our explanation I agree that it could be misleading. We will improve it.

Markus

 

[vonmoose]

I enjoyed the article. Now, can guest or member recommend a system(s) that match or fall within the 10 criteria?
cheers, Vonmoose

 

[rdstagg]

I have only just come across this thread and felt compelled to add my penny's worth.
I thought the response by the author was well measured and incisive to some fairly heavy criticism.
Automation serves 2 purposes ;
1. It is quicker and less prone to slippage.
2. it means the system takes EVERY trade - it doesn't exclude the ones that you "know" are just plain wrong.

Mr Charts is right in that every system is prone to degradation, as is every pattern??
Patterns take longer to degrade but they do - only to be replaced by new patterns.

To say a market in 2007 is the same as a market in 1984 is like saying that cars or computers are the same. Similarly the markets in 2017 will NOT be like those of today.
Where Mr Charts and others who are successful score is their understanding of the principles behind the patterns, not just the patterns. It's the same for automated systems. I have run my system for 4.5 years now and its automated. I CONSTANTLY tweak with it - that I view is my job. However the DRIVER behind the system ( its a breakout strategy) has never changed. Only my trade management, position sizing, profit protection, exits ,etc have altered. Obviously I backtest but I also paper trade any change for 3 months real time before I adopt it into the system.
90% of my changes are never adopted as they dont' pass all the tests.

I rated the principles article 9/10 - its the PRINCIPLES and the understanding of why you trade that are key.

 

[milktrader]

How come no mention of walk-forward testing, or out-0f-sample testing? Optimizing a data set without doing it is a road to curve fitting

 

[btherichb]

thank you very much