The Key Idea
The strategy you intend to trade will usually be determined by your beliefs about the market and the objectives you’re trying to achieve. Therefore, your beliefs and objectives will determine your Key Idea.
Your Key Idea is your working hypothesis; the foundations of your strategy and how it will work.
One of the most famous Key Ideas was declared by the Turtle Traders, specifically Richard Dennis. Being trend traders they acknowledged that every trend, without fail, was preceded by a breakout. From that start point they used a standard channel breakout to enter plus they had a ‘fail safe’ breakout entry which guaranteed they’d capture every new trend.
The Key Idea of Warren Buffett is to buy a great company at a cheap price. From this Key Idea he built specific rules and guidelines to achieve the goal.
The beliefs of many of the world’s great traders can be found in various texts such as the Market Wizards series by Jack Schwager.
Here are some examples:
> The market only trends 30% of the time so a mean reversion system will do better most of the time.
> The big money is made in the big trends.Buying low beta stocks is a safe strategy.
> Understanding a companies fundamentals is the key to above average returns.
> The institutionalization of the market has increased noise so I need to trade short term.
Objectives:
Your objectives are also very important in the design process.
In many instances I hear, “I want to make as much money as possible”.
Well, we all do, but that’s a very one dimensional view of the world.
Indeed, there is much research to suggest extremely successful traders view profits as a by-product and not the main goal. Many successful traders are passionate about the markets and it’s that passion, not the want of profits, that enables them to succeed.
Taking a more holistic view, objectives encompass many other dimensions, such as your personal risk tolerance and your lifestyle factors.
You may have found the Holy Grail system that generates a 70% annual return but you also note that it comes with a 50% drawdown. If you can only stomach a 10% decline in your capital then the end result is meaningless because chances are you’ll never travel the journey to achieve it.
The same is true if you’re a busy parent and have developed a scalping system that requires you to sit in front of a screen for 15-hours a day. It’s probably not a realistic end game.
So your objectives must be broader than profitability. They must be aligned with your beliefs. They must be aligned with realistic expectations and they must be aligned with your lifestyle.
Examples:
> If a system doesn’t make a profit in any 3-month period its a poor strategy.
> I work a full time job and have a busy family life so I need a simple strategy that takes minimal time to implement.
> I invest in property but I’d like to earn a second income for additional spending money.
> I’m happy to make 10% per year but really must protect my capital.
> I want to be in control and manage my retirement savings.
In the Trading System Mentor Course students are advised to think carefully about their beliefs and their objectives. Only then can they design, build and implement a strategy that is truly aligned with their personalities. For an introduction to systematic trading and building systems have a look at our Beginners Guide to Building Trading Systems.
