STRATEGY BUILDING PROCESS
The process of building trading strategies is very sophisticated. This entire Ebook aims to provide extremely valuable information on how to approach the proper development and building of trading strategies.
To fully embark on this topic, we need to know the meaning of basic concepts, primarily trading strategy and backtesting.
There are two main goals in developing a trading strategy:
The first goal is that a strategy will make consistent profits in live trading, and the second is that it will beat your traded market in the long run. In other words, it will beat a buy and hold strategy from a returns and stability point of view. Otherwise, there is no reason to dedicate your life to this time demanding activity.
The trading strategy is defined by:
- a set of trading and clearly quantified conditions and associated parameters that define the entry and exit price levels of individual trades in a given market or set of markets,
- a traded market or set of markets,
- trading sessions,
- and timeframes
- money management rules, i.e., rules for managing trading positions and their sizes, so-called Position Sizing. In other words, it means a set of rules defining how and when we should gradually increase or decrease the number of traded units (for example, futures contracts) in order to achieve optimal profits while eliminating the overall risk in relation to our trading capital.
The basic tool for building business strategies is backtesting.
Backtesting is the process of testing a trading strategy on the historical data of a particular market or set of markets (backtest). The aim is to obtain a list of trades in chronological order that meets the rules of the defined trading strategy and to evaluate whether the strategy was sufficiently profitable and stable on these historical price data.
Traders should take backtests in all seriousness and subject their trading strategies, which they are going to trade live, to quality testing. No one wants to trade a strategy that has failed in history.
In our book, we are focusing mainly on backtesting and all sorts of its pitfalls. Above all, we will analyze in detail:
- Selection of market or set of markets, time frame (Timeframe), and trading session
- Selection of a platform for algorithmic trading – backtesting and live trading to eliminate random trading
- Defining entry and exit conditions, gradual development and improvement of strategy on in-sample data
- Out-of-sample testing, Cluster Walk forward analysis, and stress tests
- Money Management, Position Sizing, and Portfolio Trading