How to Create Successful Stock Trading Strategies

It's no secret that more than 80% of people who venture into stock trading ultimately end with less money than they began with. I started trading back in the late 90's, and over the years I have undergone an arduous process of trial and error whereby hundreds of different trading strategies were evaluated and tested. I eventually arrived at a highly effective four step process for designing, developing and implementing trading strategies from start to finish. The process that I am about to share with you is a simple and almost risk-free method for developing and implementing stock trading strategies. The four steps are:

1.) Conceive a testable trading idea.
2.) Determine whether the idea was profitable in the past.
3.) Test and refine the idea using a trading simulator.
4.) Begin small with real money and increase your position size over time.

The entire process starts with conceiving a technical or fundamental based trading idea that can be put to an objective test. During this stage, you want to identify related events that tend to result in profitable opportunities. There must be a causal relationship between two events in which the second event is a consequence of the first event. For example, you may notice that whenever a certain price pattern occurs (i.e., the first event), a stock usually closes above its previous day's close more than 60% of the time (i.e., the second event). Profitable trading ideas can be ascertained in a number of ways. Observing market behavior, reading market literature, talking to other traders, and examining past trades, are just a few ways to uncover profitable trading opportunities.

Next, you must thoroughly evaluate what happened in the past whenever the first event occurred. How many times did it lead to profitable trading opportunities? A word of caution that should be mentioned here is the past is not a prologue to the future with respect to trading because of inherent mental biases which tend to produce curve-fitting. The majority of the time, you will find that your trading idea is only fools gold and does not produce profitable results in the future. As a result, you must only view historical results with a grain of salt. Only use historical results as a way to determine whether the trading idea deserves further evaluation. If the idea worked well in the past, this gives credence for further investigation; however it, in no way, implies that the idea will work well in the future.

The purpose of the third step is to determine whether the trading idea stands a chance of working under real market conditions. During this step, you test the feasibility of the idea using a real-time trading simulator. Advances in trading simulation technology now allow you to experience trading conditions that are very close to real life without risking your actual money. But more importantly, this step will allow you to determine whether your idea is feasible under real market conditions. Continually refine and improve the strategy during this step until it is producing the desired returns you seek.

Finally, after you have determined that the idea is working to your satisfaction using the trading simulator, start trading the strategy with a small amount of real money, and gradually increase your position size as you achieve success. The goal here is to start out risking very small amounts of money until your idea proves its worthiness under real trading conditions. Since you will be using very small position sizes, you are able to design, develop, and implement successful stock trading strategies almost risk-free.