How to Design a Stock Trading System?

How to Design a Stock Trading System

Before designing and developing a successful trading system, traders must understand the base theory of Efficient Market Hypothesis (EMH). The current market price of traded assets (e.g., stocks, bonds, or property) already reflect all fundamental and economic influences and known information.

Therefore, the price action is taken into consideration. Most of trading systems are based on this understanding of the market. The rule of trading system here is built corresponding to price action as well.

Developing a trading system involves the following components.

* Entry Rules (when traders should open a position)
* Exit Rules (when traders should close a open position)
* Money Management Rules (how much money should traders put in a trade?)
* Back-Testing (test the trading system by using historical data)

Before going further, there is an important thing to be remember:

There is no Holy Grail of trading systems.
There is no Stock Formula that makes traders win markets 100%.

Only one component, Entry Rules, from four components is taken into consideration to build an example trading system. The following factors are picked to be used in identifying possible entry points.

1. Liquidity: how much money the stock trades at. Avoid stocks that don’t trade enough whether traders can risk being trapped in stocks where the market is moving against them if the stocks have low liquidity. For example here, the 21-day average of volume multiplied by the closing price of liquid stock must greater than $200,000.
2. Trigger: the signal that will indicate it is time to enter a trade. The trigger condition doesn’t hold “true” over extended periods of time but occurs only at one point in time, such as moving average cross over. For example, the first day when a faster moving average (a shorter period Moving Average) crosses above a slower Moving Average (a longer period moving average) which is considered a bullish crossover .
That is the basic of designing a Stock Trading System

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